Tree Gets the Ax; OATS, UNFI Reunite

OATS and Tree post quarterly losses; analyst says new business means $.10/share earnings increase in FY05 for UNFI.

Wild Oats Markets Inc. (Nasdaq: OATS) has decided to terminate its relationship with distributor Tree of Life and return to United Natural Foods Inc. (Nasdaq: UNFI), its distributor until 4Q02. In an Oct. 29 announcement OATS says that mutual expectations under its agreement with Tree of Life, a subsidiary of Dutch-based Koninklijke Wessanen, were “unlikely to be met” and that Tree of Life would relinquish the primary distribution role. The transition will be complete during 1Q04; Tree of Life will continue to support Wild Oats' stores during that period.

"On reviewing the relationship it was apparent that over the near term our collaboration was not likely to meet the expectations of either party," states Tree of Life Chairman and CEO Rick Thorne, in an Oct. 29 Tree of Life announcement. "So after much discussion we mutually concluded that it was in both our interests to terminate the relationship."

OATS also says the agreement is mutual and notes that Tree of Life will move to the position of secondary distributor.

As a result of the new business for UNFI, Salomon Smith Barney's Greg Badishkanian, VP of equity research, has raised FY05 EPS estimates by $.10. However, Badishkanian is maintaining UNFI FY04 estimates due to expected initial start-up costs. Smith Barney has increased its 12-month, UNFI target price from $39 to $45.

When OATS left UNFI last year, the grocer comprised 13.5 percent of the distributor's business. The investment firm says that UNFI could reap intangible benefits of regaining OATS as a customer including affirmation that its service levels are superior, improved industry pricing and reduced investments by Tree of Life. Nonetheless, Smith Barney rates UNFI a High Risk due to its relatively high total debt to total capitalization, a low market capitalization of $545 million and a higher-than-market beta, according to an Oct. 29 report.

OATS preliminary 3Q03 net loss figures are $861,000 or $.03/share vs. net income of $2.2 million or $.08/share for 3Q02. OATS attributes the loss, in part, to an inability to achieve anticipated supply-chain improvements through its distribution arrangement with Tree of Life. OATS began its transition to Tree of Life in September 2002. For the first few quarters of the agreement distribution performance improved steadily. However, during 3Q03, performance did not meet mutual expectations, and OATS was forced to increase purchases from other suppliers and distributors, incurring higher costs.

Anticipated 3Q03 net sales are $237 million vs. $228.1 million for 3Q02. The grocer expects comparable-store sales to be 0.8 percent for the recent quarter vs. 5.6 percent for 3Q02. OATS says the results include pre-tax charges of $1.5 million or $.03/share for asset write-offs, restructuring charges and “accelerated depreciation for the planned closure or relocation of distribution centers and warehouses,” according to the OATS announcement.

Tree of Life posted losses in 1Q and 2Q03 for the first time in its 30-year history. The loss, says Tree of Life, can be attributed in part to the costs associated with serving Wild Oats. Tree of Life says the loss of the OATS account will result in a $150-million reduction in sales volume. Smith Barney calls OATS “an unprofitable customer” for Tree of Life.