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United Natural Foods Inc  (NYSE:UNFI)
Q2 2019 Earnings Conference Call
March 05, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Chantal and I will be your conference operator today. At this time, I would like to welcome everyone to the United Natural Foods, Inc. Second Quarter Fiscal 2019 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Steve Bloomquist, VP of Investor Relations, you may begin your conference.

Steven Bloomquist -- Vice President of Investor Relations

Thanks Chantal and good afternoon everyone, and thank you for joining us on today's call. By now you should have received a copy of the earnings release issued this afternoon. The press release, the webcast and the supplemental slide deck are available under the Investors section of our website at www.unfi.com under the Events tab.

Joining me on today's call are Steve Spinner, our Chairman and Chief Executive Officer; Sean Griffin, the CEO of SUPERVALU; Mike Zechmeister, our Chief Financial Officer; and Chris Testa President of UNFI. Steve, Sean and Mike will provide a business update, speak about our performance in the quarter and address our fiscal '19 outlook. We'll take your questions after management's prepared remarks concludes.

Before we begin, I'd like to remind everyone that comments made by management today during the call may contain forward-looking statements. These forward-looking statements include, plans, expectations, estimates and projections that might involve significant risks and uncertainties. These risks are discussed in the Company's earnings release and SEC filings. Actual results may differ materially from the results discussed in these forward-looking statements.

And lastly, I'd like to point out that during today's call, management will refer to certain non-GAAP financial measures. Reconciliations to the most comparable GAAP financial measures are included in the scheduled included in our press release.

With that I will turn the call over to Steve.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Thank you, Steve and good evening, everyone, and thank you for joining our Second Quarter Earnings Call. I will start with some comments on the quarter and our fiscal 2019 outlook. Sean will then provide more detail into SUPERVALU's results, including our integration work. Mike will further review our financials and updated outlook.

First and foremost, we are progressing rapidly and positively toward integrating legacy SUPERVALU into UNFI. Our strategy to create the most sophisticated and scale supply chain network for retail is without equal, it is compelling. This is a long-term strategy which will take some time to deliver. In the near term, we will face temporary challenges associated with the integration and the optimization of our distribution network. While I'm disappointed by the performance at several of our SUPERVALU distribution centers, which was the primary driver of our EBITDA shortfall, we are seeing material improvement in these DCs every day. We have a long history of change management, network improvement and growth. And it's important to keep in mind that at legacy UNFI during the last six years, we've built four new distribution centers. We know how to build an efficient and productive supply chain.

Let's start with total Company net sales, which increased by more than $3.6 billion in the quarter to $6.1 billion. Legacy UNFI, net sales were up 5.8%, which was primarily attributable to the supernatural channel. The macroeconomic environment continues to be challenging in several of our distribution channels, driven in part by accelerating store closures, slowing new store growth, and a hyper-competitive chase for consumers. Despite these near term trends, the demand for better-for-you products remains strong and we should cycle through these short-term headwinds.

SUPERVALU added nearly 3.5 billion in net sales In line with our expectation. As I mentioned earlier, SUPERVALU's contribution to adjusted EBITDA was not where we want it or frankly expected it to be. We believe we have a good understanding of the underlying issues and have begun taking the appropriate measures to quickly address and correct them. Sean will go into more details from an operational perspective. But one of the most impactful issues with the higher-than-anticipated expenses where several distribution center realignment and optimization projects. These challenges are short term in nature and we're confident we'll fix them.

Our financials also reflect a $370 million goodwill impairment charge we took this quarter, which Mike will get into shortly. This charge was driven primarily by the change in value of UNFI stock price since the acquisition was announced. This is a non-cash charge that does not impact our cash flows or business operations. Mike will also address UNFIs conversion to LIFO legacy UNFI, which negatively impacted Q2 and our anticipated adoption of a 338(g) tax elections, which will positively impact the Company fight over 300 million in cash taxes over the next 15 years.

From an earnings per share perspective, we delivered $0.44 in adjusted earnings per share for the quarter, well above our estimates. However, we benefited from lower depreciation and amortization expense relative to our prior guidance. This change is reflected in our increased full-year outlook for EPS and adjusted EPS.

While the overall results are not what we would like, I am pleased with the progress we're making on bringing UNFI and SUPERVALU together. Let me call out a few noteworthy accomplishments over the last three months. First, our integration work is proceeding largely as planned, and we remain comfortable with our cost synergy estimate of more than a $185 million in year 4. Next month, we'll be expanding the distribution of several of our exclusive label brands into more distribution centers, while Harvest Field Day, Woodstock Farms in everyday essentials are in demand by retailers and we will derive income -- incremental sales for us. At the same time, we're also in the process of preparing to convert to a single payroll system with this summer go live date. And our supply chain teams are completing the initial project plans for several distribution center consolidations, including transitioning from five distribution centers in the Pacific Northwest into two locations that we announced last month. All really good for UNFI and really good for our customers.

Second, we finalized our new supply chain structure, which set in motion the framework for how the new UNFI will work together. As part of this, we've gone from six regions, three each had both UNFI and SUPERVALU, two of four region structure, these four regions will encompass all distribution centers as well as our Albert's and Tony's business units. This new structure will facilitate greater collaboration across our network, support the standardization of systems and processes, deliver greater cross-selling opportunities and fully leverage our great scale and diversification.

Third, our suppliers are embracing what we're doing and recognize that UNFI will be a growth vehicle for them over the short and long term. We've completed over 30 top-to-top supplier meetings and the feedback, as we suggested on our Investor Day, continues to be overwhelmingly favorable. And we're winning new business a long tenured conventional customer service out of our Hopkins Minnesota distribution center recently signed a new supply agreement for natural and organic product where will have our Racine, Wisconsin distribution center partner with the Hopkins, Minnesota DC and servicing their stores.

Another conventional customer supplied out of our Champaign, Illinois DC, operates stores in the Chicagoland market, including an extensive catering offerings. In their new natural organic and specialty supply agreement, they've opted for a full service, meaning a dedicated UNFI team will be working exclusively in the stores with this retailers team, managing the process from order to delivery and beyond.

At Legacy UNFI, we've talked about adding conventional produced to further enable a truly built out fresh offering to our Albert's business unit. With over 1.5 billion in annual protein sales, we are positioned as a national retail focus, fresh distributor, able to compete in most markets with the widest range of products available. Our customers want and need to consolidate suppliers in order to reduce cost in their supply chain. Additionally, we are winning services business at legacy UNFI retailers. These include coupon redemption, credit card processing and payroll services. These are great examples of our build-out in store cross selling strategy coming to life and a testament to our field personnel working with these customers to drive their business forward.

The last example of our earning new business is the win we had recently of a 10 store retailer who had been with a competing wholesaler for 79 years. And we are now proud to welcome them to the UNFI family. The owner cited our offerings, services and other people as the key factors in their decision to sign with us. Our sales teams are executing against a healthy pipeline of cross-selling opportunities. These include expanded professional services and product portfolios into our newly combined account base, in addition to attracting new customers.

Let me now turn the call over to Sean for some further insights. Sean?

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Thank you, Steve and good evening everyone. Tonight I'll cover two topics. The first, SUPERVALU's performance in the second quarter, and impact to our updated outlook for the fiscal year, as well as some insight into the integration and transition work and the progress that was well under way. So let's begin with the results at SUPERVALU, which quite frankly were disappointing. Compared to the guidance we gave in December, the adjusted EBITDA from SUPERVALU's wholesale business were significantly short of our expectations in the quarter. The single biggest driver of this shortfall has been meaningfully higher costs related to the disruption of distribution center realignments and integration, execution at a small number of distribution centers, including the two network realignment projects that I discussed at January's Investor Day. And as a reminder, specifically the move from Lancaster, Pennsylvania to a new distribution center configuration in Harrisburg and Carlyle PA, as well as the consolidation and optimization of distribution centers in the Pacific Northwest. To date, these projects have proved more challenging than we originally had anticipated, which has resulted in significantly higher labor, trends, transportation and train costs.

Now on a positive note, what we've learned from these opportunities, these challenges, if you will, as informed the change and how we go forward, and significantly and positively impacted our AG stabilization and standardization event which occurred as planned in January, this past January. We are seeing improving trends sequentially in these challenge DCs as our national supply chain team is now moving us forward. Relative to our December guidance, we've lowered our rest of the year outlook for SUPERVALU's wholesale business based on what we experienced in Q2 as well as our plan to accelerate the opening of our new Centralia facility in the Pacific Northwest. Although lower than three months ago, we are factoring in continuous sequential improvement the balance of the year. It is important to note that these operational issues are within our control. Detailed planning followed by a high level of execution by experienced teams is our path forward. We are on a path toward fixing these issues by the end of our fiscal '19. And as Steve mentioned, we have the right people and the right systems to further enable SUPERVALU's Legacy DC performance.

Let me also comment on another initiative that I've undertaken this quarter, which is to take a deeper dive into customer level profitability. Through detailed analysis of our customer base, we are seeing some areas where we believe we can improve our profitability. And we are looking into such areas as by example, do we have incremental categories or item level sales opportunities with the existing customer relationships that will improve our economics as well as show benefits to our customers. An exercise not unlike how we're assessing our cross-selling opportunities. In essence, can we sell more to existing customers. Where we are under-penetrated in our service offerings to our customers, how we are reviewing customer order frequency and delivery size and can we deploy incentives but lower customer labor cost while improving our operational economics. On their customers in the portfolio that we will need to rationalize if we cannot move up the profitability hurdle through additional purchases of goods, services or by increasing our price.

Now let me provide some additional insight into the UNFI SUPERVALU integration work. Overall, we're very pleased with the way the two companies are coming together. There is a great deal of hard work being done and much that is being accomplished in a relatively short period of time. I'd like to take a moment to highlight a few.

First, we've actioned nearly a 10% reduction in our administrative workforce since we closed on the SUPERVALU acquisition. This is the result of a thorough and detailed bottoms up organizational design and assessment work which has been done and focused on evolving to the structure that we believe to be the most appropriate and effective in supporting our long-term operating model and go-to-market strategy. I'm also happy to say we've successfully standardized the AG Florida business into SUPERVALU's systems last month. This transition was very well planned and very well executed. It creates operating efficiencies for UNFI as well as streamlines many customer facing processes such as ordering, invoicing and reporting. Our indirect procurement team, which focuses on goods and services, not for resale is actively working on 44 projects, which will utilize our new scale on a combination of our two companies that lower our companywide cost structure. As an early example, we've negotiated a new service agreement with a single provider of companywide travel and third-party staffing. Additionally, we renegotiated several inventory supplier agreements and implemented preferred trade terms across several categories. And finally, I am most encouraged by the success we're having in capturing new profitable business with both existing customers as well as new customers to our enterprise.

Our new business wins, which Steve touched upon, amount to nearly 200 million on an annualized basis and really we're just getting started. And I'll finish by repeating my comment there. While Q2 was a disappointment that will have a carryover effect on how we're thinking about the balance of the year, the challenges that we're facing are short-term in nature. We can fix them. I'm encouraged by the many positive improvements we're seeing in this business and the opportunity that's ahead of us to create the largest and most sophisticated supply chain and services network for retail grocery throughout the US and Canada. Our teams are highly focused and we are coming together quickly, capture our synergies and execute our strategic vision.

With that, I'll turn the call over to Mike.

Michael Paul Zechmeister -- Chief Financial Officer

Thank you, Sean, and good evening. I will cover our second quarter performance and updated outlook for fiscal 2019. Let's start with our second quarter results, which now include a full-quarter contribution from SUPERVALU. Q2 net sales were $6.15 billion, an increase of approximately $3.62 billion compared to Q2 last year. SUPERVALU accounted for $3.47 billion of the increase while Legacy UNFI accounted for the remaining $2.68 billion, which represents a comparable year-over-year growth in Q2 of approximately 5.8%. We experienced inflation of 1.26% for the second quarter, which is the highest we've seen in 12 quarters, dating back to second quarter of fiscal 2016.

From a channel perspective, legacy SUPERVALU is now included in our reporting. Supermarket channel now represents 63.5% of total net sales including SUPERVALU's wholesale net sales of $3.2 billion, excluding the impact of SUPERVALU legacy UNIF's supermarket channel net sales decreased by approximately 1.4% in Q2. Second quarter Supernatural net sales grew 18.2% over Q2 of last year, and represented 17.9% of total net sales compared to 36.8% of total net sales in Q2 last year.

Net sales in the independent channel grew 25.3% and represented approximately 13.2% of total net sales. Excluding the impact of SUPERVALU, independent channel net sales grew by approximately 4.6%. Lastly, our other channel grew by 44% and represented 5.5% of total net sales. Legacy UNFI sales in this channel decreased by 17.4%, driven primarily by e-commerce declines where we have yet to cycle sales declines from the less profitable business that we exited last fiscal year.

Let's turn to gross margin. Gross margin for the second quarter was 12.39% of net sales and included $8.6 million non-cash expense to complete the unwind of the stepped-up basis of SUPERVALU's inventory, resulting from the purchase accounting that we discussed last quarter. Excluding this expense, gross margin in the second quarter was 12.53% of net sales, a decrease of 217 basis points compared to the same period last year. This decrease was driven by the mix impact of adding SUPERVALU, which operates at a lower gross margin rate higher levels of shrink at Legacy SUPERVALU distribution centers, and a shift in customer mix within Legacy UNFI including softer sales to non-supernatural channel customers with higher margins. Within Legacy UNFI, we also experienced lower year-over-year freight expense, which was offset in Q2 by LIFO charge, driven by increased inflation.

Q2 operating expenses totaled 12.23% of net sales, 43 basis points favorable to the 12.66% in last year's second quarter. Legacy UNFI's operating expenses as a percent of net sales were lower by approximately 54 basis points, primarily driven by the benefit -- excuse me -- of acquisition synergies. For the quarter, legacy SUPERVALU operating expenses as a percent of net sales were approximately 20 basis points higher than legacy UNFIs. Even though last year's Q2 results did not include SUPERVALU, legacy SUPERVALU -- legacy SUPERVALU's year-over-year operating costs were higher in Q2 due to the impact of the network realignment projects that Sean discussed, as well as additional rent expense from the sale leasebacks completed by legacy SUPERVALU over the past 10 months.

In the second quarter, Legacy UNFI fuel costs decreased by one basis point as a percent of net sales in comparison to Q2 of fiscal '18, and represented 44 basis points of distribution and sales. Our diesel fuel costs per gallon increased 3.6% in Q2 versus Q2 last year and the Department of Energy's national average for diesel fuel was up approximately 6.4% or $0.19 per gallon compared to the same period last year. Share-based compensation expense, which is excluded from adjusted EBITDA, represented 17 basis points of total net sales in Q2 compared to 26 basis points in the second quarter of last year.

Operating loss for the second quarter excluding discontinued operations was $408 million and included several non-recurring items. First, we recorded a goodwill impairment charge of $370.9 million. I'll elaborate on that a bit. Second, we recorded restructuring, acquisition and integration-related costs totaling $47.1 million, which includes $19.5 million for least reserves related to the exit of retail banners. Third was the $8.6 million non-cash charge related to unwinding the stepped-up inventory basis SUPERVALU which I referenced earlier. Excluding these amounts, operating income was $19 million or 30 basis points as a percent of net sales compared to $51 million or 2.04% of net sales last year when excluding the $11.2 million in charges related to exiting the Company's first origins market retail banner. In Q2, the decline was primarily driven by lower gross margins and higher operating expenses related to the DC network realignment that Sean referenced earlier.

Adjusted EBITDA for the second quarter was $143 million, an increase of 79% compared to $80 million last year, driven primarily by the addition of SUPERVALU. Net interest expense in Q2 was $58.7 million and included expense of $2.5 million related to the now-retired SUPERVALU bonds and the write-off of $1.0 million of unamortized issuance costs related to certain term loan prepayments made in Q2 with proceeds from asset sales. Excluding these amounts, net interest expense in Q2 was $55.2 million.

At the end of the second quarter we had approximately $2.0 billion of interest rate swaps, resulting in approximately 66% of our debt portfolio, effectively having fixed interest rates. Q2 GAAP EPS was a loss of $6.72, driven by the nonrecurring items outlined earlier. Excluding these items, adjusted EPS was $0.44 compared to $0.71 in last year's second quarter, with the change driven primarily by lowering adjusted operated -- operating income, higher interest expense, partially offset by the continuation -- of the contribution from discontinued operations.

Let me provide some color on the goodwill impairment charge. Given where our equities has been trading, we performed a comprehensive review of our goodwill, which resulted in a $370.9 million non-cash impairment charge in Q2 on the SUPERVALU wholesale reporting unit goodwill. This charge has no impact on the Company's cash flows or debt covenants. We anticipate that additional purchase accounting adjustments in Q3 or Q4 could have an impact as well.

Total Q2 capital expenditures were $71.3 million or 1.16% of net sales, including discontinued operations as we continue to step up efforts to build capacity in the Southeast and Western regions of the country. In Q2, we reduced our total net debt by approximately $165 million, approximately $120 million of the net debt reduction was funded with cash generated from operations, net of capital expenditures and working capital performance, and including approximately $70 million in net cash received from the sale of foreign backers and several other parcels of surplus real estate. Another driver of the net debt reduction in Q2 was a $47 million reduction in capital lease obligations due to the reclassification of approximately $31 million of build-to-suit retail property agreements to other long-term liabilities, and a reduction of approximately $16 million due to purchase accounting adjustments.

As a reminder, early in Q2, $566 million was used to retire the outstanding SUPERVALU bonds using the restricted cash that was set aside on the Q1 balance sheet. Q2 net debt to EBITDA leverage was approximately 5.0 times excluding operating leases, and net adjusted debt-to-EBITDAR was approximately 4.5 times. These leverage calculations are based on the Q2 ending face value of debt less cash on hand and the midpoint of updated adjusted EBITDA guidance for fiscal 2019 adjusted to include a full-year contribution from SUPERVALU. At the end of Q2, we had $819 million of available liquidity through a combination of outstanding lender commitments under our ABL credit facility and balance sheet cash. This is the highest level of available liquidity in UNFI company history.

Let's turn to our fiscal 2019 guidance. Based on our performance to date in the revised outlook for the remainder of the year we continue to expect full year net sales to be in the range of $21.5 billion to $22.0 billion including the benefit of the 53rd week. Fiscal 2019 adjusted EBITDA including Cub and Shoppers through the end of fiscal '19 is expected to be in the range of $580 million to $610 million, which is down $62.5 million at the midpoint versus our prior guidance of $650 million to $665 million. There are three primary drivers of the lower adjusted EBITDA guidance. The largest driver is the weaker-than-anticipated Q2 results on our legacy SUPERVALU wholesale business combined with the updated distribution center realignment expectations that Sean referenced earlier. Together, these factors reduced our adjusted EBITDA outlook for fiscal 2019 by $35 million to $40 million.

Second is our revised expectations associated with gross margin challenges on our legacy UNFI business, including softer sales to non-supernatural channel customers and decreased vendor promotion activity. This contributed to a $10 million to $15 million reduction in our adjusted EBITDA guidance. Third, UNFI elected to move on to LIFO inventory accounting for specified dry packaged products, which combined with the higher inflation assumption on the overall company inventory is expected to contribute another $10 million to $15 million of non-cash expense in fiscal 2019 compared to our previous adjusted EBITDA guidance. As a reminder, under LIFO, fiscal year-over-year inflation is expected on that year-end inventory, LIFO reserves are increased. This results in higher cost of goods relative to the FIFO inventory method, but lower cash taxes by electing to move legacy UNFI onto LIFO we expect to avoid approximately $50 million in cash taxes that would have been payable that we moved to legacy SUPERVALU off the LIFO method.

Our fiscal 2019 GAAP EPS is expected to be a loss in the range of $6.50 to $6.10 per basic share. Fiscal 2019 adjusted EPS is expected to be in the range of $2 to $2.40 per diluted share. The increase in adjusted EPS guidance is driven by lower than previously forecasted depreciation and amortization, resulting from our updated work on purchase accounting and lower than previously forecasted stock-based compensation expense.

Fiscal 2019 guidance for adjusted interest expense and capital expenditures remain unchanged. Adjusted interest expense is expected to be in the range of $181 million to $191 million, and capital expenditures are expected to be 1.3% to 1.5% of net sales. Our forecast for one-time restructuring, acquisition and integration-related expenses for fiscal 2019 increased by $9.5 million to $172 million due to higher than previously forecasted severance expense. As a reminder, if Shoppers or Cub were divested prior to the end of the fiscal year, we would expect to incur additional one-time expenses.

Our press release contains a reconciliation between GAAP net income and adjusted EBITDA, and the supplemental slides provide a walk from the midpoint of our previous guidance for adjusted EBITDA and adjusted EPS to the midpoint of our revised guidance.

Moving to taxes, we continue to expect to pay less than $20 million in cash taxes related to fiscal '19 business operations. We did however make a $59 million tax payment in Q2 that was not related to fiscal ' 19 business operations, which I'll review momentarily. Normally we would provide an adjusted tax rate, but given the negative expected GAAP earnings and the positive adjusted earnings, we believe the adjusted tax rate is not as helpful as providing the estimated cash tax that we expect to pay. We are working on a significant and valuable tax collection related to the SUPERVALU acquisition that we expect to make in the back half of fiscal '19. These 338(g) tax elections to treat the acquisition for tax purposes only as an asset purchase rather than a stock purchase. They will allow UNFI to utilize a significant portion of the $2.9 billion capital loss carry forward at SUPERVALU generated from the divestiture of Albertson's in calendar 2013. Under these elections, we will be able to step up the tax basis of the acquired assets the fair market value, which provides UNFI with increased future depreciation and amortization deductions, lowers our taxable income and reduces future tax obligations to achieve the 338(g) benefits, we made a $59 million cash tax payment in February or an ordinary income associated with these elections. Net of that payment, we expect these elections to generate cash tax savings of an estimated $300 million over the next 15 years. The 338(g) related tax savings are expected to begin in the back half of fiscal 2019 -- in fiscal 2020, we are expecting net cash benefits of more than $20 million associated with these elections.

Now let me turn the call back over to Steve.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Thanks, Mike. Let me wrap it up by saying there's a lot of great work going on, which isn't always apparent in our quarterly results. In addition to the progress we're making on integrating these two companies in the sales wins we've achieved, we're making great progress on divesting our retail assets. You will recall, our goal is to thoughtfully and economically divest the retail centers with a focus on maximizing value, which would allow us to strategically focus solely on our wholesale business and I think we're on the path toward doing just that.

I'd say that we're well down the path on selling Shoppers and I'm confident we'll get that done in the coming months. And we continue to evaluate alternatives for Cub, which quite frankly is a great retail banner and has attracted interest. We will be thoughtful and careful as we determine the next steps for Cub stores, our associates, our franchisees and our partners. In January, we also talked about other opportunities to monetize assets and we're making good progress here too. Our DC rationalization work may result in duplicative facilities that can be monetized. We're working on our surplus real estate portfolio and evaluating various alternatives that can also improve cash flow.

During the last several months, as Mike mentioned, we sold $70 million of property and assets and this continues to be a focus for us, and very well could be other assets that could be sold and add value. I've mentioned many times that this transaction is a long-term play, and that position has not changed or undeterred and as committed as ever to the strategic rationale of this deal. As we do this work, the feedback we continually receive strongly with reinforces that our long-term thesis for this business remains right on target. Must improve our results going forward, but we also know that we can make the corrections to get us back on track, and I'm extremely confident and proud in our people and the plans we have to do so.

With that, we're ready to take your questions.

Questions and Answers:

Operator

(Operator Instructions) Your first question comes from Rupesh Parikh with Oppenheimer. Your line is open.

Rupesh Parikh -- Oppenheimer & Co. -- Analyst

Good evening, and thanks for taking my question. So maybe I guess maybe to start off, given the weaker SUPERVALU performance and some of the UNFI challenges on gross margins, how are you guys thinking about the impact of these headwinds, I guess, on your longer-term EBITDA forecast?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. So Sean -- Hi Rupesh, it's Steve. So on the Legacy UNFI and certainly let me speak for Sean, but certainly on the SUPERVALU challenges, we think that they're relatively near term, there are some headwinds that we're facing as we integrate the SUPERVALU previously acquired UG, AG business into the UNFI network. I think that generally in the UNFI, our legacy business, we are facing some headwinds associated with just the general macro trends, store closures, some difficulty that some of our conventional retailers are having bringing consumers into the stores, but I think that those are generally cyclical and we'll work our way through them. Obviously, we haven't given any guidance for 2020 yet, but we're starting to give that some thought now. Sean?

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Yeah, I would just say Rupesh that, we've captured the issues related to the realignment activities that I discussed here this afternoon, as well as in January in our outlook for the remainder of our FY '19, and I'm sure that this is a topic that folks would want to understand more about. So these are complex projects. They require very thoughtful detailed plans to execute and they require frankly and they demand a very talented experienced team to execute. And having acquired the business here, really in the 1st of November, these projects were under way with the existing plan and change the resources in place and looking at what we know now, we did not anticipate kind of where we would land here in the quarter. However, what I can say is that, we have a team in place. We have to buy supply chain leaders and organization and talent in these DCs running points around a plan that frankly I think our leadership team certainly I have great confidence in for this team for many, many years. And we've done a lot of stand-ups of new DCs and expansions of existing DCs, so lives and so on and so forth. So as difficult as the quarter is and its impact on the fiscal year will come through at these distribution fundamentals project base, require lot of hard work, but they're not structural.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. And I would also add, because I know everybody probably has it on their mind and that is the question that we had all the time. As you know as it panned out as you thought it would. And I think generally the answer to that question is that it's more challenging than we thought it would be. The complications associated with SUPERVALU having just acquired two businesses on their own and then UNFI coming behind it and acquiring SUPERVALU in its entirety, so it didn't quite pan out as we thought it would. However, I think we would have still made the same decision. The strategic value is right on. We're committed to the process. Synergies are good. We're building out the store opportunities are phenomenal and we're starting to see those. We're bringing the companies together faster than we had originally anticipated. So I think it's really some short-term pain to get the UNFI culture embedded into the SUPERVALU network which we will do.

Rupesh Parikh -- Oppenheimer & Co. -- Analyst

Okay, great. Thank you. I'll pass it on.

Operator

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

John Heinbockel -- Guggenheim Securities -- Analyst

Let me start top line, so the $200 million of new business, was that all SUPERVALU? And secondly the realignment issues, from outside it doesn't look like that's impacting top line very much customer disruption. Is that correct -- right issues that you're throwing a lot of cost at the problem?

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Yeah. Hey, John, this is Sean. To answer the first part of the question, yes, this is SUPERVALU business that we're talking about in the $200 million of new. And secondarily, I would say that we did have some disruption in terms of certain customers that frankly we can't understand, I mean they have to run a retail shop, we respect that. If we can execute at a high level, they have every right to go seek alternative supply, but we haven't lost any customer per se. It's just some dilution in our penetration. And again we believe -- I certainly believe that this is short-term that our overall value proposition is very solid and it's improved certainly. So look at, we'll get any of weeks or losses back over a period of time.

John Heinbockel -- Guggenheim Securities -- Analyst

And then I guess as a follow-up to right to the prior question, right. So obviously 2020 is going to come here at some point, but when you think about the 2022 targets top and bottom line, Steve, you generally still comfortable that you're close to that, because I guess you'll get some of these expense overages back at some point.

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Yeah. I mean I think at this point, we're pretty comfortable with those numbers.

John Heinbockel -- Guggenheim Securities -- Analyst

Okay. Thank you.

Operator

Your next question comes from Vincent Sinisi with Morgan Stanley. Your line is open.

Vincent J. Sinisi -- Morgan Stanley -- Analyst

Hey, good afternoon guys. Thanks very much for taking my question. So just kind of the follow up a bit further. Just on the kind of the DC obstacles, as you are thinking about, you know to John's point, the 2022 targets. Are there any other kind of large-scale projects between now and then of this thing magnitude where if you do have maybe a bit more difficulty than originally expected that could of course be impactful or would you say that in the grand scheme of things what you are going through with this is just about kind of the most in that's kind of risk that you have or that you can foresee at least?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. Vincent, just remember that the vast majority of the issues that we're facing today are specifically associated with companies that SUPERVALU acquired before we bought them. So these issues they will probably going to happen no matter what, so -- and we don't obviously see that repeating again as we look forward. Sean?

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Yeah. I would say that we certainly have -- look at our network, part of our strategy and we've contained this, and spent some time going through some detail around optimization of our distribution center network. So we have work ahead of us to do, no question. But these are going to be plans that we offer. With our team, we have a playbook in place, we know how to do this, and actually -- I think in your script you identified number of DCs that we've opened up in the last six years or in the last 9 to 10 years, we've opened up 6 or 7 distribution centers from a greenfield, and any number of expansions, and it is hard work but it requires playbook and we are good at that. It's just, this is a transitionary moment if you will where there are a lot of things going on in the acquisitions of UG/AG, the fold out of two distribution centers versus the Lancaster DC and TA. So sort of all at the same time and frankly we just acquired the business. So gaining a lay of the land, the talent, the buttons to push, it takes time, and frankly we're disappointed in where we are today, but we remain optimistic that we know how to get this work done.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. Sean, it's a little shortcuts. Under Sean's leadership and a lot of the folks here is going to find, we have a very tenured and extremely capable by chain groups that have been together for long time. So as Sean mentioned, we've got a playbook, we know how to do this and playing out well this time.

Vincent J. Sinisi -- Morgan Stanley -- Analyst

Yeah, I know. Until you guys point obviously there is a lot going on at once, build new, that's fair and helpful to hear the commentary. And then maybe just as a super fast follow whatever you can say at this point, it was interesting to hear kind of this quarter you're kind of taken a new approach or deeper look at kind of individual customer profitability. I guess, kind of how you see that like kind of give us maybe if you can or whatever you can kind of how are you attacking that, is this going to be something that a lot ones are spread out over time and that there are a lot of opportunity that you think it maybe any initial kind of conversations or negotiations that we've had how they gone, that'd be great.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. I really don't want to go too far with that, Vincent. However, I would say that one of the things that was really important for me over the last 120 days is to really get a chance to learn and understand this business. And so I've been at it for a lot of years and we're getting into the details here. These last four months has inspired me that we have opportunities, and the best place to go with an opportunity that we're discussing around customer profitability is to sell more to that customer, drive the economics, they're important around delivery size, scale, et cetera. That's why we did this deal. And so when you pair that with some of the opportunities frankly that we're seeing here in the near term, it actually plays very well what I think we can get done.

Vincent J. Sinisi -- Morgan Stanley -- Analyst

Okay, all right. Best of luck guys. Thank you.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Thank you.

Operator

Your next question comes from Karen Short with Barclays. Your line is open.

Karen Short -- Barclays -- Analyst

Hi, thanks. I guess a couple of questions. One is, I mean obviously I fully appreciate that this is a very difficult integration, but I'm just wondering -- and with respect to your due diligence process, what did you think -- what did you miss I guess with respect to how difficult the unified and associated integration was? I mean any color there, because obviously there's a lot of risk to the entire integration, so any help that you could give us to comfort us that you're not going to have other blips going forward would be helpful.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. Let me take it. Karen, it's Steve, and I'll turn it over to you. Karen, I would say that, you know, again what we're talking about here has a lot of unique complexities that we don't anticipate become sort of the road map of what's ahead. SUPERVALU just acquired Unified Grocers, just acquired AG. There' a lot going on they -- at the same time they're folding out a distribution center in Lancaster, PA into two DCs, not one for one. So that came with a lot of complexity, and frankly at the end of the day that just requires a tremendous amount of talent to execute that. And so could we have understood the dynamics and diligence? Yeah, I mean you can always look back over your shoulder and say we could have done this, so we could have done that, and we should have done a better job, et cetera, et cetera, but you know that's not for today. Today we are looking at what we've learned and how that informs going forward and making the appropriate changes to both the plans, playbook and the talent and we've done all those things.

Karen Short -- Barclays -- Analyst

Okay, that's helpful. And I guess looking at the distribution space in general, obviously you're looking to -- I'm talking more about conventional than natural and organic, but it applies to both. I mean you're obviously looking to gain share in both segments, but your competitors are as well. So I guess the question I have is, it feels like the competitive landscape is taking -- potentially taking a meaningful step up as you -- as you and your number one competitor and potentially number three get more aggressive. So I guess, how do we get comfortable that this is kind of a race to the bottom in terms of the margins?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. Karen, what I would tell you is that there is nobody in the US or Canada that had anywhere near the infrastructure, scale, the DCs that are closest to the consumer, the services, when I say services to payroll, coupon redemption, financial services and a whole slew of other things, the breadth of line, the supply chain and a whole host of other things that quite frankly we take decades or any one of our competitor, whether it'd be number one, number three or number 10 to replicate. And so our challenge in the near term is to use sales force that is rapidly coming together to make sure that we're selling the conventional non-foods to the natural and now we're selling the natural to the conventional and using the platform for me and produce and all the things that truly built out our store to every single customer we have. And so that way we become less reliant on the overall growth rate of the industry and all about taking share and I'm really confident that we will do that well.

Karen Short -- Barclays -- Analyst

Okay, that's helpful. And sorry, just two housekeeping. Is the DNA that you just reported in this quarter, is that the right run rate to use? And then on your EBITDA guidance, is this LIFO or FIFO EBITDA guidance?

Michael Paul Zechmeister -- Chief Financial Officer

Yeah. Karen, this is Mike. So first of all on the depreciation and amortization, barring any additional changes in Q3 and Q4 to purchase accounting, this would be a good run rate to use. And then the adjusted EBITDA guidance that we provided is a LIFO-based number.

Karen Short -- Barclays -- Analyst

Okay. Thank you.

Operator

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

Anthony Bonadio -- Wells Fargo Securities -- Analyst

Hey guys, this is actually Anthony Bonadio on for Ed. Thanks for taking my question. So just quickly on your exclusive brands. I know you guys touched on the build-out in your opening remarks at the Analyst Day. Can you just give us a quick update on your efforts here and any potential upside you could see from a margin perspective? And then any color you might be able to give in terms of what you're seeing around growth would be helpful as well. Thanks.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

On the exclusive brands, I wouldn't provide any color around the margin. Obviously our margin as is deeper on our exclusive brands than it is typically on our other products. And right now as I mentioned in my script, exclusive brands like Wild Harvest, which was on legacy SUPERVALU field there, which was on Legacy UNFI, everyday essentials and a whole host of other brands are making a real difference for us. We do over 1.5 billion a year in private brands. So it's a place that we have a lot of scale and a great deal of capacity on both Legacy UNFI and SUPERVALU to make a real difference for retailers.

I think the second question you said was about growth, what was the question?

Anthony Bonadio -- Wells Fargo Securities -- Analyst

Yeah, just how it's trending within that segment?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

You're talking about private brands growth?

Anthony Bonadio -- Wells Fargo Securities -- Analyst

Yeah, exactly.

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

I might just interject that what we've seen in the short period of time here now a few months is that, private brands in some respects is a bit of the tip of the spear as it relates to cross selling. We're already moving SUPERVALU legacy private brands into our UNFI customer base, and as Steve mentioned field day at other Blue Marble Brands, UNFI legacy brands into conventional SUPERVALU legacy retails including Cup, Foods, for one, so we're well on our way and private brands is actually leading us.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

And one other thing I would add is, you know, Legacy UNFI retail services, which is essentially using all of the expertise around UNFI natural specialty better for you products and applying that discipline to the legacy SUPERVALU conventional retailer so that they have the right products at shelf in the right geography will drive a lot of our cross-selling, and that's just pure data based selling on behalf of our retail sales force.

Anthony Bonadio -- Wells Fargo Securities -- Analyst

That's helpful. Thanks guys.

Operator

Your next question comes from Kelly Bania with BMO Capital. Your line is open.

Kelly Bania -- BMO Capital Markets -- Analyst

Hi, thanks for taking the questions. Also wanted to ask a couple on gross margin. I guess excluding the mix shift just from adding SUPERVALU into the mix and the vendor promotion and the issues that SUPERVALU that you called out. Wondering if you can just isolate kind of what you guys see as the core gross margin mix shift degradation if there is any for the quarter?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

It's just primarily driven by our fastest growing customer is our lowest margin customer.

Kelly Bania -- BMO Capital Markets -- Analyst

Yes. So can you quantify that?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

I don't think we are (inaudible).

Kelly Bania -- BMO Capital Markets -- Analyst

Okay. And in terms of your guidance for this year and longer term, was there a change to your D&A guidance in -- as part of your adjusted EBITDA guidance for this year and as we think about the 470 million you provided in January for fiscal 2022, is that still the right number?

Michael Paul Zechmeister -- Chief Financial Officer

Yeah. So adjusted EBITDA obviously does not include depreciation or amortization expense. So the updated guidance that we provided, you see the impact of the reduction to depreciation, amortization as you look at the EPS line for GAAP or adjusted EPS, but it wouldn't have impacted adjusted EBITDA dollars.

Kelly Bania -- BMO Capital Markets -- Analyst

Okay. And just maybe another on the vendor promotional activity. Can you help us understand what's driving that? Is that something you also see as a near-term issue which areas of the business is that impacting and what you're expecting on that front going forward?

Christopher P. Testa -- President, UNFI

Yeah. Hey Kelly, this is Chris. Yeah, that's primarily on the UNFI legacy business and it just -- primarily we believe as part of the macro environment as more and more suppliers are holding their price, watching promotional funds, reducing promotional funds, being more margin conscious. I do think it is temporary, and there are methods that we have in place to mitigate it and improve that trend. So we do believe it is short-term based.

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. And the other thing Kelly is, if you look at our historical supplier out of stocks on the UNFI legacy side, they're still at all time highs. And so if we -- if the benefit, the suppliers can give us the product, then obviously they're going to have a great difficulty promoting it.

Kelly Bania -- BMO Capital Markets -- Analyst

Right. And then maybe Steve, just a last follow-up for you. You mentioned some issues at conventional retailers maybe just driving traffic to the stores. I just haven't heard that called out. Maybe you can just help us understand what you're hearing from your customers there and if there's anything you can do to help them with that?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Yeah. I mean it's just -- it's a general comment that would you look down on our customer list of conventional retailers, some of them are having difficulty bringing consumers into the store and having impact in their year-over-year index. And again it's not true across the entire customer mix, but certainly if you look at our performance in the quarter, it's the first time in a long time that that channel was actually negative versus prior year. Now I think that is cyclical, it's a short-term headwind, that will turn itself around, but the comment was specific to this particular quarter and some of the conventional retailers within that channel.

Steven Bloomquist -- Vice President of Investor Relations

Chantal, I think we'll take one more question before Steve add some concluding remarks.

Operator

Your next question comes from Andrew Wolf with Loop Capital Markets. Your line is open.

Andrew Wolf -- Loop Capital Markets -- Analyst

Great, thank you. So Sean, I think you said the costs in the distribution realignment and so forth were non-structural. So just help us understand that? Could you give a couple of examples like some of them are -- like when I think of non-structural cost with realignment, it's like, hey, we're moving inventory from the old DC to the new DC and once that labors done it goes away. Don't know that what you're talking about or is it something more kind of complex and harder to explain?

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Yeah. No Andy, actually the basic tenants that you just described is what we're talking about. So the extraordinary costs associated with hiring labor, training labor, the productivity sort of lead if you will around getting folks, getting the team up to speed on our productivity, that's a drain in terms of cost, inventory moves, et cetera, et cetera. So there are five or six key buckets that are over a period of time normalize out. So structural meaning that it doesn't become an ongoing issue. So I think we're on the same page.

Andrew Wolf -- Loop Capital Markets -- Analyst

Okay. And the other thing is, when you -- do these DCs have enough volume that as the metrics improve they'll normalize to the right profitability or are they -- I guess if you consolidating or they actually net greater volume greater productivity. Could you just speak to that a bit?

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Yeah, sure. I mean, keep in mind, when we're talking about the Pacific Northwest, which we spent some time illustrating in January, we're actually moving from five distribution centers into two. And so we are not deleveraging in that environment. We have an approximate demand relationships to the capacity, we're adding automation, it's a net win, it's a net positive, lowering both P&L expenses and there some positive balance sheet action as a result of it. And so in Lancaster PA and in other distribution centers that we take the appropriate actions to optimize, we'll be doing so based upon driving a return. So it will all be about as it always is about getting the right returns. There is aggravation in the short term around all these projects as one-time issues that we described, but we normalize, we get there, we right-size.

Andrew Wolf -- Loop Capital Markets -- Analyst

Okay. And just one other follow-up on the same topic. Steve you characterized that or you said there was a material improvement week-by-week at these affected distribution centers. So I don't know -- I don't know what it peaked in the second quarter. But if that's going to continue, that means by the fourth quarter -- the fourth quarter you're going to have somewhere between the second and third quarters the peak expense it and then the fourth quarter will be lower. Am I thinking right about that?

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Well, we sequentially improve the results from the DCs throughout the second quarter. We expect that to continue throughout the balance to the year, that's all involved in the revised guidance.

Andrew Wolf -- Loop Capital Markets -- Analyst

Okay. So the third quarter will have less impact in the floor. Okay, that's good to hear. And I guess would be last follow-up is on -- it was good to hear you're getting some new business. What are your expectations there? Do you think that -- is there -- I mean, do you have a pipeline of folks or do you have to concentrate on the issues you had this quarter before you can really aggressively pursue new business?

Christopher P. Testa -- President, UNFI

Hey Andy, it's Chris. The short answer to that second question is no. We are aggressively pursuing new business, in fact, receiving inbound inquiries on new business which is exciting. The pipeline is robust, ranging everything from an incremental sale, professional services to very, very large nine digit opportunities, which of course will take longer to print. There is no timeline on it in the sense of when they come, just the larger ones take a long time, the smaller ones are starting to see them now.

Andrew Wolf -- Loop Capital Markets -- Analyst

Okay. And Chris, your comments is for the whole enterprise not just for the UNFI side of the business, right?

Christopher P. Testa -- President, UNFI

Correct.

Andrew Wolf -- Loop Capital Markets -- Analyst

Okay, thank you.

Steven Bloomquist -- Vice President of Investor Relations

Thank you again for joining us tonight. We are on a long-term mission to transform the way food is procure and delivered. Our strategy is sound, despite some short-term integration and network optimization hurdles. UNFI will emerge as the most sophisticated and scale provider of solutions, services and products in US and Canada. Our heritage of excellence in better-for-you foods, paired with our fully built out store offerings and supply chain will move us forward over time. Thanks again for joining us and have a good evening.

Operator

This concludes today's conference call. You may now disconnect.

Duration: 68 minutes

Call participants:

Steven Bloomquist -- Vice President of Investor Relations

Steven L. Spinner -- Chief Executive Officer and Chairman of the Board

Sean F. Griffin -- Chief Executive Officer, SUPERVALU

Michael Paul Zechmeister -- Chief Financial Officer

Rupesh Parikh -- Oppenheimer & Co. -- Analyst

John Heinbockel -- Guggenheim Securities -- Analyst

Vincent J. Sinisi -- Morgan Stanley -- Analyst

Karen Short -- Barclays -- Analyst

Anthony Bonadio -- Wells Fargo Securities -- Analyst

Kelly Bania -- BMO Capital Markets -- Analyst

Christopher P. Testa -- President, UNFI

Andrew Wolf -- Loop Capital Markets -- Analyst

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