Business Context and Reporting Period
United Natural Foods, Inc. (UNFI) filed this Form 10-K for the 52-week fiscal year ended July 30, 2016. UNFI distributes natural, organic and specialty food and non-food products primarily in the United States and Canada, serving more than 43,000 customer locations through 33 distribution centers totaling approximately 8.7 million square feet. Wholesale distribution is the principal reportable segment; other activities include Earth Origins retail stores, Woodstock Farms manufacturing and branded products.
Whole Foods Market represented approximately 35% of fiscal 2016 net sales. UNFI’s distribution agreement with Whole Foods expires September 28, 2025.
Financial Performance and Key Metrics
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Net sales | $8.470 billion | $8.185 billion | +3.5% |
| Gross profit | $1.279 billion | $1.261 billion | +1.5% |
| Gross margin | 15.1% | 15.4% | -30 bps |
| Operating income | $224.1 million | $242.0 million | -7.4% |
| Operating margin | 2.6% | 3.0% | -40 bps |
| Net income | $125.8 million | $138.7 million | -9.4% |
| Diluted EPS | $2.50 | $2.76 | -9.4% |
| Cash flow from operations | $296.6 million | $48.9 million | +$247.7 million |
| Capital expenditures | $41.4 million | $129.1 million | -$87.7 million |
Fourth-quarter fiscal 2016 net sales were $2.214 billion, gross profit was $345.5 million, income before taxes was $57.7 million, net income was $34.7 million and diluted EPS was $0.69.
Fiscal 2016 operating expenses were $1.055 billion, or 12.5% of sales, compared with 12.4% in fiscal 2015. The effective tax rate was 39.6% in both years. Cash and cash equivalents were $18.6 million at year-end, and working capital was $991.5 million.
Liquidity, Debt and Balance Sheet
- Total assets were $2.852 billion and stockholders’ equity was $1.520 billion at July 30, 2016.
- Revolving-credit borrowings were $426.5 million, with $37.4 million of outstanding letters of credit and approximately $368.7 million of remaining availability. The revolving facility matures April 29, 2021 and provides up to $900 million of stated U.S. and Canadian commitments, subject to borrowing-base limitations.
- Long-term debt, including current maturities, was $173.6 million; total long-term debt and capital leases excluding current maturities was $161.7 million.
- The real-estate-backed term loan had a balance of approximately $128.4 million and requires quarterly principal payments of $2.5 million.
- Management stated that cash on hand and available credit were sufficient for operations and planned capital expenditures over the next 12 months.
Material Changes Versus the Prior Comparable Period
- Sales growth was supported by acquisitions and approximately 1.5% organic growth, but was constrained by termination of a large conventional supermarket relationship in September 2015.
- Nor-Cal contributed approximately $51.4 million of fiscal 2016 sales, and Haddon contributed approximately $100.4 million after their acquisitions. Global Organic was also acquired in March 2016.
- Conventional supermarket sales declined approximately 5.8% to $2.259 billion and decreased to 27% of total sales from 29%. Whole Foods sales increased approximately 4.9% to $2.951 billion and rose to 35% of total sales from 34%.
- Gross margin declined because of competitive pricing pressure, moderated supplier promotional activity, reduced fuel surcharges and unfavorable Canadian foreign exchange, partly offset by acquisition benefits.
- Operating income and net income declined despite higher sales, reflecting margin pressure, higher operating expenses, acquisition-related costs, restructuring, bad debt expense and facility startup costs.
- Operating cash flow improved substantially as fiscal 2015 inventory investment and receivables growth did not recur. Investing cash outflows increased to $350.9 million, primarily because of the three fiscal 2016 acquisitions.
- UNFI recorded $5.6 million of restructuring and asset impairment expense, including $4.4 million of cost-saving measures related to lost Albertsons/Safeway/Eastern Supermarket business and $0.8 million related to closing two underperforming Earth Origins stores.
- Goodwill increased to $366.2 million from $266.6 million, primarily due to acquisitions. Management reported no goodwill or indefinite-lived intangible-asset impairment.
Guidance, Outlook, Commentary and Risks
- Management expected fiscal 2017 net sales to grow, with much of the anticipated growth in the lower-margin Whole Foods and conventional supermarket channels.
- Management expected annual operating cash flow of approximately $175 million to $230 million for fiscal 2017 and fiscal 2018.
- Fiscal 2017 capital expenditures were expected to be approximately $55 million to $80 million, or roughly 0.6% to 0.8% of sales, focused largely on information technology and efficiency initiatives.
- UNFI expected to complete its U.S. broadline warehouse management system rollout by the end of fiscal 2018. Delays, implementation costs or failure to realize expected efficiencies could adversely affect results.
- Key risks include substantial customer concentration, especially Whole Foods; competition from self-distribution and conventional grocery distributors; low industry margins; food and product safety events; supply-chain disruptions; fuel, commodity and foreign-exchange volatility; acquisition integration; cybersecurity and technology disruption; labor organizing and union costs; self-insurance claims; and debt covenant compliance.
- As of July 30, 2016, UNFI had approximately $18.9 million of inventory purchase commitments, $2.6 million of diesel fuel commitments and $264.6 million of future non-capitalized lease obligations.
- Subsequent events included the August 2016 acquisition of Gourmet Guru and a September 1, 2016 amendment that changed the applicable margin on the term loan.
- KPMG and management concluded that the consolidated financial statements and internal control over financial reporting were effective as of July 30, 2016. Management excluded Nor-Cal and Haddon from its internal-control assessment because of their recent acquisitions.
Facts Investors Should Verify
- Whether Whole Foods’ 35% sales concentration remains stable and whether the distribution agreement continues to provide the expected economics.
- Progress in integrating Haddon, Nor-Cal, Global Organic and Gourmet Guru, including customer retention, synergies, margins and incremental debt.
- Whether lower-margin channel growth can be offset by operating efficiencies and the warehouse and transportation technology rollout.
- Revolving-credit availability, borrowing-base calculations, interest rates, term-loan covenants and compliance under changing operating conditions.
- Cash conversion, inventory and receivables trends, capital expenditures and the sustainability of management’s $175 million to $230 million operating-cash-flow expectation.
- Potential exposure from food recalls, supply disruptions, fuel commitments, self-insured liabilities, labor negotiations and future restructuring or impairment charges.
- The effect of the reported immaterial prior-period corrections and the adoption of forthcoming lease, revenue and stock-compensation accounting standards.