Jun 9, 2015
Executives
Katie Turner - Managing Director, ICR Inc. Steven L.
Spinner - President, Chief Executive Officer & Director Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP Sean F.
Griffin - Chief Operating Officer
Analysts
Rupesh D. Parikh - Oppenheimer & Co., Inc.
(Broker) Robert F. Ohmes - Bofa Merrill Lynch Meredith Adler - Barclays Capital, Inc.
Steven Forbes - Guggenheim Securities LLC Sean P. Naughton - Piper Jaffray & Co (Broker) Scott Van Winkle - Canaccord Genuity, Inc.
Karen F. Short - Deutsche Bank Securities, Inc.
Scott A. Mushkin - Wolfe Research LLC Vincent J.
Sinisi - Morgan Stanley & Co. LLC Kelly A.
Bania - BMO Capital Markets (United States) Andrew P. Wolf - BB&T Capital Markets
Operator
Greetings, and welcome to the United Natural Foods Third 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. As a reminder, this conference is being recorded.
I would now turn the conference over to Ms. Katie Turner of ICR.
Thank you, Ms. Turner.
You may now begin.
Katie Turner - Managing Director, ICR Inc.
Thank you. Good afternoon.
By now you should have all received a copy of the third quarter fiscal 2015 earnings press release issued 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 risks 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 and a reconciliation of all the non-GAAP financial measures can be found under the Investors section of the company's website. And with that, I'd like to turn the call over to Steve Spinner.
Steven L. Spinner - President, Chief Executive Officer & Director
Thank you, Katie. And welcome to UNFI's summary discussion of our third quarter 2015 results and updated expectations for our fiscal year ending August 1, 2015.
It is an exciting, challenging, and very opportunistic time for our industry. UNFI strategically made decisions over the last several years to build out our capacity and begin a migration towards the perimeter of the store, which we believe is one of the new frontiers for growth in our space.
We began moving our Albert's business towards fresh foods in addition to organic produce and acquired Tony's Fine Foods last year. Fresh perimeter products now represent approximately 15% of our total revenue and are the fastest growing categories.
As you know, we also began a significant campaign to increase capacity across North America. And this has resulted in over 2 million square feet of added capacity with a significant concentration in refrigerated storage over the past 24 months, which we anticipate will serve as UNFI's primary enabler toward increasing market share and the national rollout of our fresh platform.
Additionally, we further built our refrigerated logistics equipment and technology ensuring a sophisticated cold chain and food safety environment. In several important markets, we now have the capacity to add new customers.
Our industry is changing rapidly. Major media outlets are talking about the consumers' migration toward healthy organic food.
June's issue of Fortune magazine, highlighted the war on big food, and the changing demand for cleanier ingredients from America's largest food manufacturers. Major retailers are talking about migration to a more varied and robust product offering of natural and organic food.
Many estimate that there are over 100,000 new retail points offering natural products from convenience stores, colleges, hospitals, restaurants, e-tailers as well as mass conventional and hard goods retailers. All different kinds of retailers are getting involved in carrying some of these products driven by consumers' demand.
Major retailers are very quickly introducing private label organic brands, further propelling growth of organic throughout the country, and the speed in which this change is taking place is challenging our growth in the near term. However, we've faced these challenges before, we adapt and we would discover what's new.
With that, it is important to keep in mind that natural organic foods represent less than 5% of the total foods sold at retail. UNFI's market share in the natural and organic food space is estimated to be 12%.
I believe that the fastest growth for organic consumption and distribution is in front of us despite the headwinds we face today. And these numbers don't include the total retail for fresh and gourmet/ethnic.
Additionally, we believe that ethnic/gourmet products and fresh foods represent significant incremental growth opportunities for UNFI. With a market share of less than 6% in each of these fast growing product channels, we believe there is considerable growth ahead for UNFI through these channels.
We believe these channels are well-built for our infrastructure and UNFI is in the early stage of our implementation here. There is capacity, intellectual capital, and a customer base in-place today for further escalating our growth in these areas.
We estimate this opportunity for UNFI over the next decade to be over $10 billion in today's dollars. And we now have a sales and category management team specifically focused on developing business opportunities in this exciting area.
In July, we will begin shipping two significant new customers, which combine the joint strength of UNFI broadline and Tony's Fine Foods, which continues to support our strategic assumption that there is significant value in UNFI's leadership position as the preeminent provider of logistics, distribution and category management for our retailers, center store, and perimeter. However, despite the projected growth ahead, we have seen softness in UNFI's revenue over the last several quarters, and with approximately 7% organic growth in our third quarter fiscal 2015, there are several important factors, I believe that are pressuring our short-term sales.
One, the speed at which our products have been adopted across retail channels, not currently served by UNFI, has impacted overall demand as some consumers chose to make their purchases elsewhere. Two, the speed at which UNFI's customers have been impacted by product availability across a wider array of retail options.
Three, the speed at which retailer organic private label has escalated. Four, produce deflation and continued higher levels of supplier shortages influence UNFI's revenue negatively by approximately 60 basis points.
And five, we do have some short-term drag at Albert's and the Canadian FX, which equals about 100 basis points of revenue. We also believe these trends are short-term in nature driven primarily by, one, the increase in demand while painful in short-term, I believe, will find its way into UNFI's sphere of customers as consumers seek out a wider product offering.
Crossover consumers will find their way to retailers, offering a wider array of organic and natural products. These retailers are all within UNFI's existing customer base.
Two, UNFI's customer base is expanding across Internet e-tailers, conventional foodservice and ethnic/gourmet as well as fresh. And three, customer wins in the fresh categories.
As investors and analysts, it is very important to understand the importance of the model UNFI has built over the last several years. In partnership with our growing roster of customers, UNFI now has distribution centers no more than 200 miles from 85% of the North American population.
This translates into logistics programs that provide a high service level, low cost solution unlikely to be matched. We have scale which drives down distribution costs and including a product offering that now exceeds 65,000 line items across fresh, grocery, frozen, produce, deli, bakery, prepared foods, ethnic/gourmet and food service.
Our scale is one of our most significant competitive advantages. UNFI now operates more than 1,000 trucks utilizing over 30 distribution locations across North America.
We deliver over 2 million cases per day. Additionally, we now operate a national demand planning and replenishment platform that manages distribution logistics from point of manufacturer to delivery locations.
As an example, UNFI can pick up a manufacturer's new item on a Friday, and have it set in over 6,000 retail locations within five business days. We believe the demand for this type of complex infrastructure that we offer is increasing and increasing rapidly.
UNFI has an infrastructure of over 1,000 sales associates in the field, assisting retailers in their quest to ensure that they have the right product on the shelf, by geography using UNFI's proprietary data tools. One of the fastest growing categories is private label.
UNFI currently handles logistics on private label for many of our retailers and now have the capacity in many markets to further ramp up this expertise by using our scale with co-packers to drive down costs. We are managing freight via intermodal, rail, air, ship, truck, e-commerce, contract carrier and fulfillment through a network built to handle a growing and changing industry.
We believe that there is no other network capable of adjusting to the changing requirements of our growing customer base. While retailers with captive distribution can and should in some cases buy product direct, we believe there will continue to be a growing demand for UNFI services which include consolidation of slower moving products, breadth of product line in many cases, a distribution solution which carries a lower cost than that of the captive.
In customers with captive distribution, UNFI's business continues to grow at a rate considerably faster than the industry despite the continued threat of direct. When retailers calculate the delivered margin difference between captive and UNFI and factor inventory carrying costs and UNFI's higher service level, there is a compelling argument for UNFI distribution versus captive.
Given the capital intensive nature of building and running distribution centers, I believe that there are more and more retailers that will outsource distribution of our products to UNFI. Slower moving products which are the vast majority of our products when comparing them to conventional food items demand the heightened level of attention due to the more expensive and complicated logistics required.
For example, seasonal products, new products, shippers, and ingredient-specific products require a greater degree of category management, resets and product expertise. As we discussed during our calls this fiscal year, UNFI has been building infrastructure and capacity.
This quarter was no different, as we completed our Twin Cities facility and approach completion of our Gilroy, California facility. With Gilroy near completion, we will focus on using this capacity to further increase our market share and we'll moderate our capital expenditures, which we'll discuss in detail during our discussion next quarter regarding fiscal 2016 guidance.
While we face some headwind in the near term in our top line revenue and gross margin, as our business further migrates to lower margin fast growth retailers, we remain optimistic that demand will move us forward, and we believe our scale and infrastructure will continue to differentiate us in the marketplace. From an expense perspective, our history also demonstrates a proven track record of managing costs in tight sales and margin environments.
As we look at gross margin, there is a cyclical supplier reaction to increase demand by pulling back from promotional trade spend, and we are seeing reduced discounting during these high demand cycles. UNFI is adapting to a changing industry and deploying its assets to take advantage of the migration to a broader customer base and one with a heavy focus on fresh.
I believe we are well suited to succeed here. The opportunities are significant, our strategy is strong and we have the infrastructure and scale to deliver.
Now, I'll turn the call over to Mark Shamber, our CFO to discuss results of the third quarter. Mark?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Thanks, Steve, and good afternoon. Net sales for the third quarter of fiscal 2015 were $2.11 billion, which represents growth of 18.7% or approximately $333 million over the prior year third quarter net sales of $1.78 billion.
Excluding the impact of the acquisition of Tony's Fine Foods, sales increased by 6.7%. Inflation increased modestly both sequentially and on a year-over-year basis for the third quarter, coming in at 2.52% a 37-basis point rise from Q2 and an 88-basis-point increase from last year's third quarter, which had inflation at 1.64%.
On a year-to-date basis, net sales of $6.12 billion, yielding sales growth of approximately $1.09 billion or 21.7% over the first nine months of fiscal 2015 (sic) [2014] Excluding the approximately $674 million in net sales coming from the Tony's and Trudeau acquisitions, our year-to-date comparable sales growth is 8.3%. For the third quarter of fiscal 2015, the company reported net income of $41.7 million or $0.83 per diluted share, an increase of approximately $5.4 million or 14.7% from the prior year, while diluted earnings per share increased by 13.8%.
Net income for the third quarter of fiscal 2014 was $36.4 million or $0.73 per diluted share. On a channel basis, supermarket sales increased by 22.1% in the third quarter, with supermarkets representing 26% of sales.
Sales growth in the independents channel was 16.6% and for the quarter independents represented approximately 32% of sales. The supernatural channel sales increased by 14.9% and the supernatural channel represented 35% of sales in the third quarter of fiscal 2015.
Food service comprised approximately 5% of sales after growing by 53.5% in the third quarter. Excluding the impact of the Tony's Fine Foods acquisition, supermarket sales increased by 5.9%, independents sales growth was 3.2%, supernatural's sales grew by 9.8%, and food service had sales growth of 23%.
At 15.4%, gross margin for the quarter showed a 132 basis point decline over the prior year's third quarter gross margin of 16.7%, and was up sequentially 57 basis points. The primary drivers to our lower gross margin in the third quarter of fiscal 2015 continued to be items covered in previous quarter's earnings calls.
The dilutive impact of Tony's Fine Foods represented approximately 47 basis points of the gross margin decline compared against the prior year's third quarter. Our gross margin was also negatively impacted on a year-over-year basis due to lower fuel surcharge revenues, the decline in the value of the Canadian dollar on our Canadian business, and the shifting mix in customer growth.
Gross margin for the fiscal 2015 year-to-date was 15.4%, compared to 16.7% in the prior year; a decline of 123 basis points, again driven by the same factors in Q3 that I just covered, with dilution from Tony's representing approximately 52 basis points of the dilution on a year-to-date basis. Our operating expenses in the quarter were 12.2% of net sales, compared to 13.2% for the same period last year.
This represents a 107 basis point improvement over the prior year, as operating expenses as a percentage of net sales continue to benefit from the acquisition of Tony's, and the related cost structure, the mix shift in our business, positive trends in our self-insurance areas, lower fuel costs and lower performance-based incentive expense. Fuel had a positive impact of 13 basis points on operating expenses in comparison to the third quarter of fiscal 2014 as fuel represented 57 basis points of distribution net sales in the third quarter of fiscal 2015.
Fuel expenses were 7 basis points better than the second quarter of fiscal 2015, when fuel came in at 64 basis points of net sales. Nationally, our diesel fuel costs in the third quarter of fiscal 2015 decreased by approximately 12% from the prior year's third quarter, while the national average price decreased to $2.85 a gallon, a decline of 28.5% compared to $3.99 a gallon in the third quarter of fiscal 2014, per the Department of Energy.
Our year-over-year decline in diesel fuel cost is below the Department of Energy's percentage due to our locking in a portion of our pricing using fixed price contracts and the growth of our business. Share-based compensation expense during the third quarter of fiscal 2015 totaled $2.4 million or 11 basis points as a percentage of net sales, compared to $3.6 million or 20 basis points in the prior year.
Operating income for the quarter was 3.3%, a 25 basis point decline over the prior year's third quarter operating income of 3.5%. Other income during the quarter consisted of a gain of $4.2 million associated with the transfer of land in our new Twin Cities location in Prescott, Wisconsin, which is consistent with our previous guidance.
We recorded an incremental $348,000 in income taxes to record our tax rate at 40% for the third quarter, bringing our year-to-date tax rate to 39.7%, which is our revised forecast for our fiscal 2015 tax rate due to changes in apportionment and other tax related items. Inventory was $948 million at quarter-end, as days inventory on hand average 47 days for the third quarter, an improvement of 2.5 days over the prior year's third quarter when we were at 49 days.
Consistent with my statements in previous quarters, the primary driver of our year-over-year improvement in inventory is inclusion of Tony's, as Tony's inventory turns at a faster rate than UNFI's broadline distribution business due to the heavier perishable concentration. DSO for the third quarter deteriorated modestly on a year-over-year basis, increasing by about a third of a day, but remaining consistent with the second quarter at 22 days.
Capital expenditures were $42.4 million in the quarter bringing us to $98.5 million for the year-to-date, representing 1.6% of net sales on a year-to-date basis. Based on our current run rate, we would expect full year gross CapEx to be approximately $135 million to $150 million.
During the quarter, we generated approximately $4 million of free cash, although we continue to expect to be free cash flow negative for fiscal 2015. Outstanding commitments under our credit facility were approximately $397 million at quarter-end with available liquidity of approximately $216 million including cash and cash equivalents.
Our leverage improved from the prior quarter to 1.9 times on a trailing 12-month basis. As discussed in today's press release, we are revising our guidance for fiscal 2015 to reflect sales trends in our business.
We now expect net sales to be in the range of $8.15 billion to $8.19 billion, which represents a 20% to 20.5% increase on our total net sales over fiscal 2014. Our previous sales guidance was a range of $8.19 billion to $8.29 billion.
In addition, we are narrowing our diluted earnings per share guidance of fiscal 2015 to a range of approximately $2.75 to $2.79. This reflects the change in sales trends and current projections for our tax rate to be approximately 39.7%.
Our previous GAAP earnings guidance was $2.81 to $2.90 per diluted share. Adjusted for the impact of the $7.7 million reduction in net sales described in our earnings release, our adjusted earnings per diluted share for fiscal 2015 is expected to be in the range of $2.84 to $2.88 per diluted share, an increase of approximately 12.7% to 14.3% over fiscal 2014 GAAP to earnings per diluted share of $2.52.
At this point, we'll turn the call back to the operator to moderate the question-and-answer session. Operator?
Operator
Thank you. We will now be conducting a question-and-answer session.
We do ask that you limit yourself to one question and one follow-up, so everyone may have a chance to ask their questions. The first question is from Rupesh Parikh of Oppenheimer.
Please go ahead.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Thanks for taking my question. I have a longer term question, maybe for you Steve.
So with all the headwinds that you're seeing right now in your business, do you still think that UNFI can get back to that double-digit type organic sales growth you guys laid out at your Analyst Day. I'm just trying to think you guys have talked a lot about your opportunities in fresh and ethnic or gourmet and I just want to get a sense of whether you feel there is enough growth there to maybe offset some of the slowdown we're seeing (23:19) in other categories.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah, absolutely. We invested a lot in infrastructure as you know Rupesh.
We are more than well prepared to begin – we've already begun, but to see a really nice rollout of our fresh platform. I talked in my comments that a couple of customers that we had won that are rolling out in July.
The total value of those customers is approximately $100 million. And it's really compelling to be able to be a provider of center store and a provider of fresh.
The economics work really well for the retailer. We see a lot of room in the customer pipeline, that we're excited about.
We see a lot of opportunity, as you said in your question in ethnic/gourmet, we now have a complete sales force dedicated to it. And we – I think we are very fortunate in that.
A couple of years ago, we saw the shift moving more towards fresh, and we've built these big refrigerated facilities, with refrigerated loading docks and refrigerated delivery equipment in Hudson Valley, in Racine, in Twin Cities, in Gilroy and Denver. And so we're ready, ready.
So if you look at the culture of the company, we've gotten used to growing at double-digits. And so I would say that wholeheartedly, yeah, we are excited about getting back there.
And we think there is plenty of room to do it.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Okay. Thanks for the color.
And maybe just switching topics. So as we look at the revenue trends by the various channel, it seems like the independent channel slowed pretty meaningfully this quarter.
Do you think that channel is more susceptible to what's happening out there right now with more different retailers carrying more natural organic products?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean, I think that they are the most susceptible, for sure, right.
So independents have to shift their business model. They have to be better at perimeter, they have to be better at being differentiated because if they're going to try to compete on a price-per-price basis on organic cereal, it's not going to end well.
But they've been there before in different ways. It's going to take them a little while to figure it out, but I do have a fairly high level of confidence that they will figure it out.
And I do really believe that we added so many new points of retail that carry a very narrow set of SKUs. And so while it's difficult in the short-term – we've been talking about crossover consumers for the last three years.
And so now I think it's certainly the optimist in me says boy, there are so many more places for somebody to jump into the space, but once they jump into the space, they're going to realize very quickly that that retailer is not going to be able to satisfy the demand, and it's going to push the consumers back into the more traditional UNFI customer base, independent...
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Thank you for all the color.
Steven L. Spinner - President, Chief Executive Officer & Director
Yes.
Operator
Thank you. The next question is from Robby Ohmes of Bank of America.
Please go ahead.
Robert F. Ohmes - Bofa Merrill Lynch
Steve, maybe just a follow-up on that question. Can you help us think about how soon you could return to double digit growth and what the barriers are to all the investments you're making in refrigeration coming online in a way that maybe supports a stronger revenue outlook?
Thanks.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean, look I don't think it's going to happen tomorrow.
It's going to be slow, but sure, which I think is the better way to do it. We've got a couple of great opportunities in our customer pipeline as I said earlier.
We've got two really nice wins that are rolling out in the next couple of weeks that we're excited about. And like I said to Rupesh's question, it's a really compelling model to be able to say to a retailer, we can combine economically the fresh and the center store, and the gourmet/ethnic into a pretty good story and having the capacity to do it, goes a long way.
So I really wouldn't want to back myself into a corner to say specifically when we're going to get back to 11%, 12%, 13%, 14% other than culturally we're very driven towards being there.
Robert F. Ohmes - Bofa Merrill Lynch
And can you just comment on just the supermarket channel, and has there been an acceleration in their sort of shifting of items into their internal distribution? What is the trend there and what gets it to stop?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. So, interestingly, we haven't seen anything change in the way conventional retailers who have captive, migrate the products to direct.
And interestingly, if you do the math and you look at the distribution difference, the cost difference between captive to UNFI and then you apply a cost of capital because in the direct model they have to carry five weeks' worth of inventory, in our model we're carrying a week's worth of inventory, if you apply a service level component to it, in other words, our service level is going to be in the 93%, 94% range. Their service levels because they're only buying for themselves is going to be in the 83%, 84% range, because they only buy in truckload.
If you do all that math, in many cases, it's a wash as to whether the retailer is better off buying it direct or buying it through UNFI. So we've actually seen products migrate back to UNFI after having been direct, even though the conventional retailers first inclination is to say, well once it reaches to a certain volume, it's going to be more efficient for us to take it direct.
So it really is nothing new there.
Robert F. Ohmes - Bofa Merrill Lynch
Got it. Thank you very much.
Operator
Thank you. The next question is from Meredith Adler of Barclays.
Please go ahead.
Meredith Adler - Barclays Capital, Inc.
Thanks for taking my question. I have a question about private label.
And you said a couple of things that were interesting, I mean, not only do you have the capacity to handle from a logistics perspective retailers private label, but something about working with co-packers, and I wasn't sure exactly, could you maybe talk about that a little bit more?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah, sure. So Meredith, if you think about it this way, there is a limited number of co-packers who actually make this product, and so in many cases, you got one co-packer making many different retailers' private label.
Well, because these products are relatively slow moving, yeah, we are buying many brands from the same co-packer. We have the ability to consolidate the weight or the volume into intermodal or rail or full truck to get to a really efficient low cost distribution model.
And so our slots are agnostic to what's in them. As long as the product moves, we are okay with it, which is why we are carrying a lot of retail private label.
And again just for the simple fact that there are a limited number of co-packers and we are already buying direct from so many of them, I mean, the economics just work in our favor.
Meredith Adler - Barclays Capital, Inc.
And just a follow-up to that is what is the obstacle to making that happen? Is there any pushback from the retailers or the co-packers?
Steven L. Spinner - President, Chief Executive Officer & Director
Generally, I would say no. I mean, I think, there are some retailers who just want to buy direct and for them that's what works and that's okay.
I think for in many cases, there are items that are private label that work best in direct and there are many items in private label that work best in UNFI distribution. Those are the programs that I think that work most efficiently.
Meredith Adler - Barclays Capital, Inc.
Okay.
Steven L. Spinner - President, Chief Executive Officer & Director
It doesn't have to be black and white.
Meredith Adler - Barclays Capital, Inc.
And if I may just ask another question, this is maybe a little bit bigger picture, but did you anticipate the slowdown on the dry grocery side and the timing of that slowdown when you started pushing for more fresh and investing in refrigerator capacity?
Steven L. Spinner - President, Chief Executive Officer & Director
Yes. So I think, a couple of years ago, we knew that the industry was going to migrate to fresh, right.
And fortunately, we got a lot of people with lot of background in fresh given where we came. And in many respects kind of the retail is just a little bit behind what happened in food service in a lot of cases.
And so when food service migrated to fresh, and so we said, what I think as we look at our business out over the next couple of years, our business is going to migrate to fresh, we need to be really good at it and have the capacity. So we were fortunate.
Did the change in center store happen faster than we thought? For sure, for sure, because it happened really quickly.
All of a sudden, the product became much more available in so many places. So I think we were a very little surprised by the speed at which it took place, but not by the overall shift in the migration from center store to perimeter.
Meredith Adler - Barclays Capital, Inc.
And I'll be selfish ask one more related question, does the slowdown have an impact on return on invested capital because you have invested a lot of capital?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I think that if you go back to 2008 or 2009 when we had a slowdown because of the recession, we responded in a way that said we're going to be much more careful in how we allocate our capital.
We're going to be much more careful on how we create free cash, and we were very successful in 2009 and 2010 as a result of that. So when the top line slows, we have to have a much more disciplined approach around our CapEx, which is exactly what we're doing.
Meredith Adler - Barclays Capital, Inc.
Okay. Thank you.
Operator
Thank you. The next question is from Steven Forbes of Guggenheim Securities.
Please go ahead.
Steven Forbes - Guggenheim Securities LLC
Hi, guys.
Steven L. Spinner - President, Chief Executive Officer & Director
Hi.
Steven Forbes - Guggenheim Securities LLC
Going back to the two customers that you're bringing on in July, can you talk about what DCs these customers are going to be served out of? And I guess just broadly what drove the new wins?
What brought them on board?
Steven L. Spinner - President, Chief Executive Officer & Director
Yes, it's primarily West Coast and the wins were really a matter of having the capacity on the fresh side, having the capacity on the center store and being the expert in making sure the stores have the right products at the shelf I think were the two or the couple of key factors that moved us in that direction.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. No, I think it's all of that and we have demonstrated high rate of execution, fill rate, logistics, and that translates very positive for prospective customers.
And to that end, the pipeline continues to be very robust, certainly not from a July perspective, but certainly looking forward to the next couple of quarters.
Steven Forbes - Guggenheim Securities LLC
And then when thinking about some of your larger conventional customers, say those that may eventually have to scale to switch over to a direct distribution model, how much visibility do you have into the tipping point of such an event? And is there a specific discount that would prevent this from happening?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah, the question is it's different by retailer because everybody does it a little bit differently, some do it by line, some do it by SKU, some do it by product category. I would tell you that one of the components to our gross margin contraction is the fact that we are giving up a little margin to ensure that where it makes sense we keep the direct.
It makes sense for the retailer and it makes sense for us. But again going back to the math, for retailers who really want to go through the exercise and you factor in cost of capital, service level, and the differential in the actual captive mark-up versus the UNFI mark-up, in many cases it's a wash.
So direct is not something I'm really concerned about.
Steven Forbes - Guggenheim Securities LLC
Thanks Steve.
Operator
Thank you. The next question is from Sean Naughton of Piper Jaffray.
Please go ahead.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Yes. You guys have talked in the past and I think you gave some of the numbers here, I just wanted to make sure that I understood what you were talking about before around produce deflation and FX, stock out, just any comments on those and how those impacted the organic growth rate in the quarter?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean, I talked about in my scripted portion that the produce deflation and the continued higher supplier shortages was about 60 basis points on revenue, but we also had Canadian FX and a little bit of additional drag at Albert's.
And if you – they are a little bit intermingled, but just the Canadian FX and Albert's was about 100 basis points, supplier shortage is 60 basis points, so it's 160 basis points between the two roughly.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Okay. That's helpful color.
And then just maybe on the gross margin as well, you gave Tony's was about 47 basis points and then you gave about three other numbers or three other categories. Were those all roughly equal as a component – or whether, or some of those more impactful than the other two categories?
Steven L. Spinner - President, Chief Executive Officer & Director
Tony's was 47 basis points, fuel was 12 basis points, FX on a basis points was...
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Well, but he's talking on the gross margin side (38:45) Yes, so I mean I would say, Sean, in that respect, I mean – I would tell you that the ones that we carved out were also at double-digits, but we typically don't break everything out from that standpoint, because it can shift from time to time. I mean, I would tell you that of the items that we discussed the fuel surcharge is dropping off due to the decline in diesel prices was probably the biggest after the Tony's, but I wouldn't want to give specific numbers, only because there is a little bit of estimation involved as to where you would have finished the year versus where we actually had it come in.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Okay. That's helpful.
And then just real quick on your outlook for fuel moving forward, I think you do lock in some of the contracts, should we expect to continue to get some basis point benefit for the remainder of the year?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. Well, what I would you tell you is that the way we've got our contracts right now, we'll get – some of the benefits that we captured in the third quarter, I mean, obviously dependent upon where fuel moves from here.
But we would continue to track it, somewhere along the same rate. And if fuel prices were to stay at these levels for an extended period of time, our current locks run out at the end of calendar 2015.
So, well, if prices are where they are, we'll get a portion of the benefit and/or have a little bit of a headwind through the end of the calendar year.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Okay. Thank you.
Operator
Thank you. The next question is from Scott Van Winkle of Canaccord Genuity.
Please go ahead.
Scott Van Winkle - Canaccord Genuity, Inc.
Hi. Thanks.
First a follow up on a couple of other questions about the two new customers shipping in July. Just to make sure I have it clear, these customers were doing no business with UNFI either on natural organic or with Tony's, so they're incremental to all segments of the business?
Steven L. Spinner - President, Chief Executive Officer & Director
The answer is a little complicated. But both customers were doing some business with either company.
But it's a significant amount of incremental business.
Scott Van Winkle - Canaccord Genuity, Inc.
Okay. So if they were doing a little bit of business, say, with Tony's, they're getting – Tony's is getting a lot more business as well as you're adding on the natural organic specialty side?
Steven L. Spinner - President, Chief Executive Officer & Director
Yes.
Scott Van Winkle - Canaccord Genuity, Inc.
Excellent. Okay.
And then, as we look at the Q3 growth rate by channel, kind of relative to what we saw in Q2 and obviously the channel shift we're seeing and expanding distribution in supermarket (41:16) explains independents and we saw the Whole Foods comps. But the deceleration in year-over-year growth that we see in the supermarket, obviously in Q2 you took a step down as the big currency hit from Canada as well as the Safeway Texas change, but this quarter, another deceleration.
Is there anything incremental? I know currency is a little bit worse.
Is it just a softer category environment or what was different in Q3 than Q2 and obviously we saw a lot of the stuff in Q2 as well.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah, Scott, I think, it just got softer.
Scott Van Winkle - Canaccord Genuity, Inc.
Yeah.
Steven L. Spinner - President, Chief Executive Officer & Director
I mean, I wish there was a silver bullet, everybody has been looking for it. We haven't found it.
I think it's just got softer.
Scott Van Winkle - Canaccord Genuity, Inc.
Okay. And then when you talk about the improvement kind of going into the fourth quarter, I think modest improvement in growth we saw in the press release.
Is that across all channels or is that more specific to one channel?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
No. That's across all the channels.
So we saw things start to pick up – I mean adjusting for the shift in Easter we saw things start to pick up towards the end of March, beginning of April. And as we got towards the end of April and continued into May, we've seen that.
Now, we're still dealing with some of that. I mean, we still obviously will have the FX headwinds in the fourth quarter and we're still seeing some of the deflation challenges with Albert's.
But as we look at the broadline business, we've seen a nice acceleration. And on a consolidated basis, we're probably in the 40 basis point, 50 basis point range without the new business being layered in yet.
Scott Van Winkle - Canaccord Genuity, Inc.
Great. Thank you.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Okay.
Operator
Thank you. The next question is from Karen Short of Deutsche Bank.
Please go ahead.
Karen F. Short - Deutsche Bank Securities, Inc.
Hi. Thanks for taking my question.
I guess, just following up on an answer that you gave to Meredith's question. You indicated that you saw the slowdown.
I think you said a while ago, I don't remember exactly what words you used or what timeframe you used, but yet you did continue to accelerate facility openings and square footage growth. So I guess the question I have is, in hindsight, was that the right decision because while you are as you said no more than 200 miles within 80% of the U.S.
population, it's not totally clear that that population is shopping at retailer that's supplied by you. So can you maybe give some color on that.
And then I guess the second question I would have as a follow up is do you have any flexibility on capacity if you needed to flex your capacity utilization?
Steven L. Spinner - President, Chief Executive Officer & Director
Well, on the first question, Karen, I would tell you we 100% made the right decision because without the capacity, we can't take on new customers, and we knew that. And we would have gone at the same speed, and we would have built the capacity for the refrigerated space that we need for our fresh platform.
These decisions are decisions that you make years in advance. And so if we saw a slowdown six months from now that ship has already sailed because the shovel is in the ground, we own the land, these projects are two years incoming.
So it's not like you can shut it off on a dime. But the major point I want to try to make is it is 100% the right decision to invest in the buildings the way we have.
Now, on the other side, if we don't see some improvement in our top line sales number, in other words going back into the double-digits, would we slow our continued capacity expansion? For sure.
Because we would wait until we started filling the capacity a little bit longer to make sure that we have the customer pipeline or the product pipeline to utilize the capacity. On the second point in terms of flexibility, the way capacity usually works is if you build it they will come.
We will find a way to fill and use the capacity, rest assured.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
And, Karen, I would just add one other thing when you asked about the right decision on the DCs, I mean, we generally build the models from a sales growth standpoint quite conservatively, so that into the extent there is a deceleration in the sales growth rate that buildings still have a good return, and so usually, we're targeting the buildings to have a return in under five years. In most cases, we've exceeded that.
If we saw the sales growth moderate and stay at that pace we'd be roughly in the five years that we target.
Steven L. Spinner - President, Chief Executive Officer & Director
And the other – just one other interesting point, Karen, is when you look at cost to serve, the majority of the buildings that we build has a very fast payback, just based upon the elimination of miles. So when we fold out these new DCs, we're doing in a way that allows us to eliminate the thousands of miles to get from point A to point B.
So generally speaking, these buildings have less than three-year to four-year payback.
Karen F. Short - Deutsche Bank Securities, Inc.
Okay. Yeah.
You gave some very helpful metrics, I think, beginning of the call on that. I maybe follow up offline on that.
But I guess, the second question I have is, can you maybe give a little color on the organic growth rate and say non-perishables versus Tony's and then on Tony's, I think Mark, you had said that, well now the number, the dollar amount that you gave on Tony's includes any SKUs, a product that you're now supplying out of your legacy UNFI DCs, but do you have an organic growth rate on Tony's versus an organic growth rate on non-perishables or legacy SKUs?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Karen, I'm not sure. I can try to answer it offline.
I'm not sure that I can – I'm not sure that I understand the question, but I don't have a breakout between the non-perishable. I have to – we have to cut it in different ways than we usually present things to answer that question.
But I would tell you that to I think the second part of the question, there is not a significant amount of volume that is being served by Tony's at this point in time that was in legacy UNFI DCs or vice versa. To the extent that we're combining – we tend to be merging the loads versus having one DC or the other handle what was previously served by the other division.
Does that help on the second part of your question?
Karen F. Short - Deutsche Bank Securities, Inc.
Okay. Yeah.
That helps. I guess I'm just trying to get a sense of how much in terms of your organic growth rate, the slowdown is related.
I mean, I can obviously do as a percent of sales, but it seems like there is a pretty meaningful deceleration in the legacy non-Tony's UNFI component of the business?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
You mean, you're looking for us to break it up beyond the 6.7%. I guess, that's what I'm trying to understand – make sure I understand the question (48:48).
Karen F. Short - Deutsche Bank Securities, Inc.
Yeah. Yeah.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. Well, beyond...
Karen F. Short - Deutsche Bank Securities, Inc.
Well beyond the 6.7% or like 5.9% for supermarkets, 3.2% for independents, and 9.8% for supernatural.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Okay. Sorry, Steven and I are both looking each other.
I'm not sure, following the question. So I'll try to...
Karen F. Short - Deutsche Bank Securities, Inc.
We can follow up offline, that's okay..
Steven L. Spinner - President, Chief Executive Officer & Director
Okay.
Operator
Thank you. The next question is from Scott Mushkin of Wolfe Research.
Please go ahead.
Scott A. Mushkin - Wolfe Research LLC
Hey guys. Thanks for taking my questions.
So I wanted to look at the kind of the pricing issue. If we do – in our pricing surveys, we definitely show a lot of your customers price meaningfully above some of these people you mentioned Steve that are taking share.
So I guess my question for you is, what can you do to help your customers price more effectively in the market? It's number one.
And then my corollary to that question is, Wegmans which is a customer of yours, doesn't price meaningfully above the direct guys. And what's the difference between Wegmans and maybe the independents and Whole Foods?
What's Wegmans doing differently that's putting them in a better position in the marketplace?
Steven L. Spinner - President, Chief Executive Officer & Director
Well, on the first question, what can we do to help them on price, and there is really not a whole lot we can do to help them on price. What we can do is we can help to make sure they have the right items, right.
So if a new retailer in this space carries three of the most popular organic cereals and they try to compete price for price on those three items (50:35) they can't win. But what we can do is we can make sure that they have the right highly distinctive SKUs that have a greater ingredient offering that's more differentiating within the geography that provide consumers something different.
That's what we can provide and that's what will propel the independents forward over time other than a migration to perimeter. As it relates to Wegmans, I can't really comment on what any individual customer is doing.
In the case of the Wegmans stores, I mean they're trying to satisfy a wide variety – and this is my opinion, not fact. They're trying to satisfy a wide variety of consumers just by the size of the store and the magnitude of the product offering.
Sean F. Griffin - Chief Operating Officer
I think also that there is a narrow assortment in some of the retailers that presently we're not playing with. We have an opportunity as well to work with the independents around innovation and local brands and that's something that we spend a lot of time and have deployed resources to put our independents, particularly, in a position to win there.
Scott A. Mushkin - Wolfe Research LLC
And on the private label side, obviously Kroger is probably the 800 pound gorilla right now with their Simple Truth line and now targets moving them with Simply Balanced. I mean, is there something you can do for your operators or particularly the independents or maybe some of the regional supermarkets to help mimic what's going on in the private label area?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. We have actually a very robust private label program for independents.
It grows 20% plus a year. It's one of the fastest growing organic non-GMO brands within the – in this space.
And so we took great product for the independents to use to compete head-on with both of those brands.
Scott A. Mushkin - Wolfe Research LLC
And then, I guess my next question and I'm trying to understand the numbers a little bit, is that the supernatural channel accelerated I believe just a smidge yet the biggest component of that I believe is Whole Foods and they clearly decelerated quite a bit. So I'm trying to square that.
Also I know there were some kind of, you guys had a charge or something like that (53:12) out of the sales numbers last time. So I'm just trying to square that we don't have an inventory problem building up some place in the channel because the numbers seem to be go in different directions a little bit.
Steven L. Spinner - President, Chief Executive Officer & Director
Go ahead, Mark. Go ahead.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
I was going to say, I mean, I would say just in the supernatural channel it's only Whole Foods, I mean, just as a point of clarification there. But, I mean, I don't know what when we had the adjustment last quarter what it would've done to the number ex that.
But I would tell you that we saw some acceleration in our part of the business and again our quarter doesn't necessarily completely overlap with what they're seeing. So whether they were stronger in the center of the store or by virtue of the shift with what they reported versus where we're covering from that timeframe.
I can't fully explain it, but we did see it pick up a little bit in this quarter.
Steven L. Spinner - President, Chief Executive Officer & Director
You also get the benefit of new store openings as well as our continued rollout of prepared foods, fresh foods.
Scott A. Mushkin - Wolfe Research LLC
To that. And then finally, Steve, on acquisitions, I mean you talked about the capacity you built out on the Tony's acquisition.
I mean, is this an area of fresh, is this an area where we'd like to do more? It's not something you commented on, but I would think it must be.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. Four sure.
Scott A. Mushkin - Wolfe Research LLC
And what's your capacity to do it?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. So we're going to look at M&A across ethnic/gourmet, we're going to look at M&A across fresh and M&A in Canada, and we have a tremendous capacity to do it.
We've got a really strong pipeline. It's just a question of waiting for the right time, and make sure – making sure that we can buy it at the price because we typically would not overpay for a company, even if it was the most strategic company on earth.
We got to pay a fair price. So I think that I am really excited and optimistic about where we are from an M&A perspective and the easiest way for us to really fully build out the fresh platform is through M&A.
Scott A. Mushkin - Wolfe Research LLC
And balance sheet capacity, I think you have it...
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah.
Scott A. Mushkin - Wolfe Research LLC
... I mean, you are decently levered, not hugely levered, but you think you can go – where are you comfortable going to?
And then I'll yield. Thank you.
Steven L. Spinner - President, Chief Executive Officer & Director
I mean (55:36) we would historically go to around 3 times, where I think we ended the quarter at under 2 times. So I think we've got plenty of room on our balance sheet to do it.
Scott A. Mushkin - Wolfe Research LLC
Perfect. Thanks for taking my questions.
Really appreciate it.
Operator
Thank you. The next question is from Vincent Sinisi of Morgan Stanley.
Please go ahead.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Hi. Good afternoon.
Thanks very much for taking my question. I wanted to ask a little bit more kind of longer term here, regards to your sales force, I know you said you have over 1,000 sales associates and the first pressure this quarter that you guys had called out was the speed at which some of these products are being adopted, a channel (56:33) that you're not primarily serving, at this point.
So is there anything that you can or maybe are or will be doing more from the sales force perspective to see kind of what you can do to get some of those channels, not your primary right now, but to let them know what you are doing more from an infrastructure as well as from the assortment standpoint?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean we have separated out a sales channel specifically for ethnic/gourmet for the simple fact that there are a lot of ethnic/gourmet retailers that we don't have a relationship with today.
And so, we carved out that channel. We have a new sales force that specifically calls on them and that way we can really track our performance and we're very optimistic about our growth there.
The same thing applies to fresh. We'll be building out our sales channel for fresh as we have the appropriate SKUs across the country.
And if you look at our fastest growing customers, that's obviously where we're spending the most amount of time. And we were pretty fast to adapt, and we've done a lot of it already and we'll continue to do it.
Fortunately, we have a lot of resources out in the field.
Sean F. Griffin - Chief Operating Officer
I think also that we do have opportunity as it relates to collaboration with respect to the selling teams that are in the field around thinking about the portfolio of companies within UNFI versus solely recommissioned. (58:22) So, we believe that there are some other opportunities there.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Okay. That's helpful.
Thank you. And just as a quick follow-up, in regards to the Tony's infrastructure, I know that, as you said in the past, that you continue to roll these products further across the system.
Any updates this quarter just in terms of the distribution points that maybe since last quarter, can you give us a little bit of an update there?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean, we made a very conscious decision to be very proprietary about how we release that information because, as you might expect, there is a competitive part of that question, that we've just rather not talk about which DCs and when.
But, you guys know the DCs that we've built with refrigerated capacity, and those are going to be the markets that have the greatest speed to market with its group of products.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Okay. Fair enough.
Thanks very much.
Steven L. Spinner - President, Chief Executive Officer & Director
Thanks. You're welcome.
Operator
Thank you. The next question is from Kelly Bania of BMO Capital Markets.
Please go ahead.
Kelly A. Bania - BMO Capital Markets (United States)
Hi. Good evening.
I just wanted to follow up on the acceleration into the first couple of weeks of the fourth quarter. Just curious, if you could comment on how much of that is being driven by just a change in volume or if there's any change in price and I guess I ask because I was kind of surprised to see your inflation on a net basis accelerate sequentially, so particularly given some of the deflation in some of the produce that you mentioned, so just curious if it's any change in pricing there that we're seeing or if it was a volume pick-up and was – if there was a volume pick-up, was that in the core business or Tony's?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. Kelly, and I would tell you that while we did see some deflation challenges with Albert's, given their portion to the overall business, it did not have a meaningful impact on our overall inflation number.
And what we've seen in the fourth quarter, some of the increases that we saw from an inflationary standpoint in the third quarter were in place for a good part of the quarter. So, these aren't recent price increases, they sort of started in the March timeframe.
So, I would tell you that what we're – barring some major changes when it gets around the data when we close the month, I would tell you that most of what we're seeing now is volume and not price in the first four weeks to five weeks of this quarter.
Kelly A. Bania - BMO Capital Markets (United States)
Okay. That's helpful.
And then as we think about your comments about just trends in the center of the store clearly reflected in your core growth rate relative to some of the perimeter categories more reflected, I guess, by Tony's growth rate. Are you seeing that similar trend across all three channels?
I guess, the mix of your business with those channels is different. But do you feel like that slowdown was comparable in the center store categories at a similar rate with all of your channels?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. I mean I would say that we – it certainly appeared that way.
I mean we didn't see anything that was noticeable; I mean there may have an instances with an individual customer. But when you look across the broad swath of customers in each channel, it certainly appeared that it was across all the channels.
Kelly A. Bania - BMO Capital Markets (United States)
Okay. And then just lastly, if I can just squeeze in kind of one more big picture question, as you think about some of these retailers that have gained some share that primarily source direct, as you think about getting back to that kind of faster double-digit growth, do you think you need some other channels or parts of, say, the supermarket channels that have lagged in catering to this shift, whether it be either the drug channel or second tier supermarkets that haven't shifted towards natural organic, or perhaps dollar stores or mass market stores, do you need that – those other channels to maybe replace what has maybe eventually been lost to the direct sourcers of natural and organic?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I don't think so.
I mean, the reality is we sell most of them to one degree or another. I think when you look at our capabilities on Internet fulfillment, which is pretty stunning, we expect some pretty spectacular growth in that channel over the next couple of years.
And again, in my opinion, as I look out over the next year or year-and-a-half, there's been this massive migration on – and it's just not mass and drug, it's convenience store, it's so many points of retail. We were looking at a – an organic item here in the room that came from a hard goods retailer...
Sean F. Griffin - Chief Operating Officer
Home goods.
Steven L. Spinner - President, Chief Executive Officer & Director
Home goods, home goods. And so, I believe that we're going to get to a point where a lot of these retailers, non-conventional, in other words, non-conventional organic and natural retailers, who have run to add SKUs, are going to wake up one day and say, wait a second, these items, they don't move as fast as we'd like.
And so, I think that, a lot of those SKUs are ultimately going to find their way back to UNFI. I think, people are reacting to what they think is customer demand and they're placing the SKUs into stores and retail points that if you would have asked us five years ago, whether 7-Eleven would have a – an organic protein bar, we would have said it's probably not going to happen.
But, will there be enough demand to keep the products in those types of retail points, I think that the answer is probably not and we will get an influx of the items back to within our distribution network. When it happens?
I'm not sure. But I believe that is what will take place.
Kelly A. Bania - BMO Capital Markets (United States)
Thank you.
Operator
Thank you. And our final question comes from Andrew Wolf of BB&T Capital Markets.
Please go ahead.
Andrew P. Wolf - BB&T Capital Markets
Thanks. Just want to follow up on the sales cadence again.
So, Mark, you said it's 40 bps to 50 bps. Is that off the 6.7% internal sales growth for the...?
(01:05:36)
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yes.
Andrew P. Wolf - BB&T Capital Markets
Okay. And I just want to make – it hit the bottom early April, so it's been (01:05:43).
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
I mean, adjusting for where Easter shifted, yes.
Andrew P. Wolf - BB&T Capital Markets
Okay.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
So, we had to adjust our numbers to reflect having Easter earlier and having a strong week and a good week there, and a little bit of softness in the April. So, you take those weeks into the mix and adjust accordingly and it tended to be the end of March, beginning of April.
Andrew P. Wolf - BB&T Capital Markets
All right. So, if I were to plug that 7%, let's say, into my model, get to the higher end of sales and to get to the higher end of the implied Q4 EPS, looks like operating profit would turn up and still on the lower internal sales than you guys have been running.
So, what explains that? Have you adjusted operations more towards a current high-single-digit internal sales growth, where before it was geared to double-digit, or something else is going on in the gross profit line?
I'm just trying to understand – it's good thing, but I'm trying to understand why that would be.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Well, I mean, I think that, Andy, there is an element of it where certainly some of our DCs are still getting up to speed. We had some – we'll have some of the benefit in the fourth quarter associated with the new Twin Cities location versus where we were and we're moving business that was handled from other locations into that facility.
So we'll get some benefit there. But yes, I mean, we've certainly – we certainly, as we've had turnover within the DCs, if we're not growing at the same rate, we're not replacing all of those heads.
So Steve mentioned before that when we saw things – certainly it was a much greater degree, in 2008, 2009, but when we saw sales growth slow, we started managing the expenses based on that run rate. So we've taken that approach going into the fourth quarter and we started addressing it during the third quarter, but again it happened much more quickly than we anticipated.
So you weren't able to completely keep pace in the third quarter.
Andrew P. Wolf - BB&T Capital Markets
Okay. And, Steve, back to the – is it the $100 million, that's net incremental with too (01:07:49) small customers who are mainly Tony's customers based on – I'm trying to pieces the narrative together to understand the new business.
Steven L. Spinner - President, Chief Executive Officer & Director
But, I'm not going to...
Sean F. Griffin - Chief Operating Officer
We're not going to help you there, Andy.
Andrew P. Wolf - BB&T Capital Markets
Okay. All right.
Worth a shot. Could you tell us what it is – who gets – is it – what's getting displaced?
Is it is direct getting displaced or is it other distributors or another distributor?
Steven L. Spinner - President, Chief Executive Officer & Director
It's other distributors.
Andrew P. Wolf - BB&T Capital Markets
And lastly, Steve, just as you want to take the strategy national, obviously, this seems like a good incremental win and good news, but what – in your mind, what would be a tipping point kind of announcement in terms of size? And also, I just wanted to ask you about profitability.
Even on the $100 million, is that something where it's incrementally at the corporate rate and how this business will trend? Is it something, if you do get some big wins down the road, either in existing infrastructure or with (01:08:56) M&A assisted, what the profitability looks like?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean it'd be hard for me to comment on the profitability of any one customer.
I'm not sure that will be fair to talk about that. I think that tipping point is to continue to slowly but surely win new pieces of business in the geographies in which we've built the capacity.
And on the second side is to make the right acquisitions that we can fold in to the buildings that we built the capacity for. And so, I think, those are the two areas that I would kind of refer to as the tipping points.
Our Albert's business, we've converted to run up underneath our Tony's fresh platform, that's now completed. And so now, we have a produce protein, cheese and added value fresh product offering in a large swath of the United States.
And I would look forward to additional customer wins and I would look forward to some pretty interesting M&A within the space.
Andrew P. Wolf - BB&T Capital Markets
Great. Thank you.
Steven L. Spinner - President, Chief Executive Officer & Director
Okay. Thank you everybody for joining us today for our third quarter 2015.
We look forward to speaking with you again for a conclusion of our fiscal 2015 and our guidance of fiscal 2016. Thanks and have a great day.
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.