United Natural Foods, Inc. — Fiscal 2012 Form 10-K Summary
Business context and reporting period
United Natural Foods, Inc. is a distributor, retailer and manufacturer of natural, organic and specialty foods and non-food products in the United States and Canada. The filing covers the 52-week fiscal year ended July 28, 2012, including fourth-quarter results. The company operated 26 distribution centers, served more than 23,000 customer locations and offered more than 65,000 products.
Wholesale distribution was the only reportable segment. Retail operations included 13 Earth Origins stores in the United States, while manufacturing included Woodstock Farms Manufacturing and Blue Marble Brands. Whole Foods Market represented approximately 36% of fiscal 2012 net sales and remained the company’s largest customer.
Financial performance and key metrics
| Metric | Fiscal 2012 | Fiscal 2011 | Change |
|---|---|---|---|
| Net sales | $5.236 billion | $4.530 billion | 15.6% increase |
| Gross profit | $916.0 million | $824.8 million | 11.1% increase |
| Gross margin | 17.5% | 18.2% | Down 70 basis points |
| Operating income | $155.2 million | $129.7 million | 19.7% increase |
| Operating margin | 3.0% | 2.9% | Up 10 basis points |
| Net income | $91.3 million | $76.7 million | 19.1% increase |
| Diluted earnings per share | $1.86 | $1.60 | 16.3% increase |
| Net cash from operations | $66.2 million | $49.8 million | Increase of $16.4 million |
| Capital expenditures | $31.5 million | $40.8 million | Decrease of $9.3 million |
Fiscal 2012 sales growth was led by wholesale distribution, including a large national conventional supermarket customer that began shipping in October 2011, continued Whole Foods Market growth and stronger performance in Canada. Sales to conventional supermarkets increased 25.7% to approximately $1.246 billion and rose to 24% of total sales from 22%. Supernatural-chain sales increased 15.8% to approximately $1.883 billion, while independent-retailer sales increased 9.1% to approximately $1.847 billion.
Operating expenses increased 9.5% to $760.8 million, but declined to 14.5% of sales from 15.3%. The improvement reflected expense controls, higher fixed-cost coverage and operating efficiencies. Fiscal 2012 included approximately $5.1 million of severance and other restructuring costs related to the divestiture of conventional non-foods and general merchandise, approximately $1.6 million of customer onboarding costs and $11.4 million of share-based compensation expense.
The fourth quarter generated net sales of $1.344 billion, gross profit of $231.2 million, income before taxes of $41.5 million and net income of $25.1 million, or $0.51 diluted earnings per share. Comparable fourth-quarter 2011 figures were net sales of $1.159 billion, gross profit of $215.3 million, income before taxes of $28.3 million and net income of $17.2 million, or $0.35 diluted earnings per share.
Liquidity, debt and financial position
- Cash and cash equivalents were $16.1 million at July 28, 2012, compared with $16.9 million a year earlier.
- Working capital increased to $612.7 million from $381.1 million, primarily because the refinanced revolving facility was classified as long-term debt.
- Total assets were $1.494 billion and stockholders’ equity was $978.7 million.
- The company amended and restated its secured revolving credit facility in May 2012. The facility provides commitments of up to $500 million and matures May 24, 2017.
- Borrowings under the facility were $115.0 million at year-end. Remaining availability was $341.8 million after letters of credit and reserves.
- The company used the new facility to repay its $47.1 million term loan and settled its related interest-rate swap, resulting in a $0.3 million interest expense charge.
- The company had approximately $24.0 million of inventory purchase commitments, $15.6 million of fixed-price diesel fuel commitments and $24.0 million of outstanding letters of credit.
- Management stated that cash on hand and available credit were sufficient for operations and planned capital expenditures over the following 12 months.
Material changes versus the prior comparable period
- Sales growth accelerated through increased conventional-supermarket and Whole Foods Market business, including national distribution to a new conventional supermarket customer.
- Sales mix continued shifting toward conventional supermarkets and supernatural chains, which generally produce lower gross margins but lower average costs to serve.
- Gross margin declined from 18.2% to 17.5%, partly because of sales mix, higher perishable inventory shrink, improper storage in certain categories and increased use of third-party inbound freight.
- Operating margin improved despite the lower gross margin because operating expenses grew more slowly than sales.
- The company completed the divestiture of its conventional non-foods and general merchandise lines, incurred $5.1 million of related fiscal 2012 severance and other costs and sold the Harrison, Arkansas facility in the fourth quarter for a nominal gain.
- UNFI Canada acquired substantially all assets of an Ontario specialty food distributor for approximately $3.0 million, with potential earn-outs of up to $1.95 million through November 2014.
- The national warehouse management and procurement system was implemented at the Ridgefield, Washington facility in July 2012. Rollout across the distribution network was expected by the end of fiscal 2015.
- The company entered into a lease for a new 535,000-square-foot Aurora, Colorado facility, expected to become operational in summer 2013 and consolidate several existing facilities.
- No goodwill or indefinite-lived intangible impairment was recognized in fiscal 2012. The prior year included $5.8 million of property impairment and $0.2 million of intangible impairment.
Guidance, outlook, commentary and risks
Management expected fiscal 2013 net sales to exceed fiscal 2012, supported by new customers, increased product penetration of existing customers, continued growth in conventional supermarkets and supernatural chains, and food-price inflation similar to the second half of fiscal 2012. The filing did not provide a specific revenue or earnings-per-share forecast.
Management expected operating cash flow of approximately $70 million to $100 million annually in fiscal 2013 and fiscal 2014, planned to limit fiscal 2013 capital expenditures to approximately 1.3% of net sales, and separately estimated fiscal 2013 capital requirements of $70 million to $80 million. Management intended to use operating cash flow to reduce debt and fund working capital and capital expenditures.
Key risks include customer concentration with Whole Foods Market, low industry margins and pricing pressure, continued migration toward lower-margin channels, economic weakness and reduced discretionary spending, food-cost inflation or deflation, fuel-price volatility, supply-chain disruptions, technology implementation risk, customer credit losses, acquisition integration risk, regulatory and product-liability exposure, self-insured workers’ compensation and automobile claims, and labor risk. Employees at the Auburn, Washington facility had authorized a work stoppage while negotiations for a new collective bargaining agreement remained unresolved.
The company had no pending material legal proceedings. Management and KPMG LLP concluded that disclosure controls and internal control over financial reporting were effective as of July 28, 2012.
Important facts for investors to verify
- Whether the company can sustain sales growth while protecting gross margin as conventional-supermarket and Whole Foods Market sales increase.
- Actual customer concentration and the terms, renewal provisions and operational requirements of the Whole Foods Market distribution agreement, which expires September 25, 2020.
- Progress, cost and realized savings from the national warehouse management and procurement system rollout.
- Execution, capital spending and capacity benefits associated with the new Aurora, Colorado distribution center.
- Operating cash conversion, particularly the impact of inventory and accounts receivable growth on future liquidity.
- Availability, borrowing-base calculations, covenant requirements and interest-rate exposure under the amended revolving credit facility.
- Potential costs or disruption from the Auburn labor negotiations and other collective bargaining agreements.
- Exposure to diesel fuel commitments, food inflation, agricultural supply constraints and inventory shrink.
- Potential tax benefits of up to approximately $4.5 million from the resolution or expiration of certain unrecognized tax benefits, which were not assured.