United Natural Foods, Inc. Fiscal 2017 Form 10-K Summary
Business context and reporting period
UNFI is a distributor and retailer of natural, organic and specialty food and non-food products in the United States and Canada. Fiscal 2017 comprised 52 weeks and ended July 29, 2017. The company operated 33 distribution centers totaling approximately 8.7 million square feet, served more than 43,000 customer locations and offered more than 110,000 products.
Wholesale distribution was the only reportable segment. Other operations included Earth Origins retail stores, Woodstock Farms Manufacturing, Blue Marble Brands and brokerage activities. Whole Foods Market remained UNFI’s largest customer, representing approximately 33% of fiscal 2017 net sales. Its distribution agreement expires September 28, 2025.
Key financial metrics
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Net sales | $9.274 billion | $8.470 billion | Up 9.5% |
| Gross profit | $1.429 billion | $1.279 billion | Up 11.7% |
| Gross margin | 15.4% | 15.1% | Up 30 basis points |
| Total operating expenses | $1.203 billion | $1.055 billion | Up 14.0% |
| Operating income | $226.0 million | $224.1 million | Up 0.9% |
| Operating margin | 2.4% | 2.6% | Down 20 basis points |
| Net income | $130.2 million | $125.8 million | Up 3.5% |
| Diluted EPS | $2.56 | $2.50 | Up 2.4% |
| Cash flow from operations | $280.8 million | $296.6 million | Down $15.8 million |
| Capital expenditures | $56.1 million | $41.4 million | Up $14.7 million |
Net income margin was approximately 1.4%, compared with 1.5% in fiscal 2016. The effective tax rate was 39.3%, compared with 39.6% in the prior year. Fiscal 2017 included a $6.1 million pretax gain from the sale of the company’s stake in Kicking Horse Coffee.
Cash and cash equivalents were $15.4 million at year-end. Working capital was $958.7 million, down from $991.5 million. Accounts receivable were $525.6 million and inventory was $1.032 billion. Total assets were $2.887 billion and stockholders’ equity was $1.682 billion.
Debt and liquidity
At July 29, 2017, borrowings under the revolving credit facility were $223.6 million, with $33.5 million of outstanding letters of credit and approximately $626.7 million of remaining availability. The facility matures April 29, 2021 and provides commitments of up to $850 million for U.S. subsidiaries and $50 million for UNFI Canada, subject to borrowing-base limitations.
Long-term debt, including the current portion, was $162.0 million, compared with $173.6 million at the prior year-end. The real-estate-backed term loan had a balance of $118.5 million and matures no later than August 2022. The company was in compliance with its term-loan covenants and was not subject to the revolving facility’s springing fixed-charge coverage covenant during fiscal 2017.
Management stated that cash on hand and available revolving-credit capacity were sufficient for operations and planned capital expenditures over the following twelve months. Fiscal 2018 capital expenditures were expected to be approximately $53 million to $73 million, focused primarily on information technology and the shared services center.
Material changes versus the prior comparable period
- Sales growth was driven primarily by fiscal 2016 acquisitions and the first-quarter fiscal 2017 acquisition of Gourmet Guru, while broad food-retail softness, limited inflation and business rationalization offset some growth.
- Conventional supermarket sales increased approximately 20.1% to $2.747 billion and rose to 30% of total sales from 27%. Whole Foods sales increased approximately 4.9% to $3.096 billion, but its share of total sales declined from 35% to 33%.
- Gross margin improved due to margin-enhancement initiatives and acquisition mix, partially offset by competitive pricing pressure and a lack of inflation.
- Operating expenses grew faster than sales, increasing to approximately 13.0% of sales from 12.5%. Acquired businesses had higher service costs, and fiscal 2017 included $6.9 million of restructuring expenses.
- Share-based compensation increased to $25.7 million from $15.3 million, including $9.0 million related to performance-based awards.
- Net cash used in investing activities decreased to $60.0 million from $350.9 million because fiscal 2017 included approximately $9.2 million of acquisition spending versus $306.7 million in fiscal 2016.
- Net cash used in financing activities was $224.6 million, primarily reflecting repayment of revolving-credit and long-term debt borrowings.
Guidance, outlook, commentary and unusual items
- Management expected fiscal 2018 net sales to grow over fiscal 2017, with most growth expected from lower-margin Whole Foods and conventional supermarket channels.
- The company expected operating efficiencies from supply-chain improvements, the warehouse management system, transportation-management initiatives and the planned shared services center to help offset lower gross margins and higher service costs.
- The national warehouse management and procurement system had been implemented at 14 facilities, with completion across existing U.S. broadline facilities expected by the end of fiscal 2019.
- UNFI recorded $6.9 million of fiscal 2017 restructuring costs, primarily severance and employee transition costs, with $4.3 million remaining as a restructuring liability at year-end.
- Two Earth Origins stores were closed during the first quarter of fiscal 2017. A collective bargaining agreement at the Edison, New Jersey facility had expired, and the company was negotiating with employees. In August 2017, Moreno Valley, California transportation employees voted for Teamsters representation.
- The company early adopted the revised goodwill impairment standard without a financial statement impact. No goodwill or indefinite-lived intangible asset impairment was identified.
Principal risks and contingencies
- Customer concentration is significant: Whole Foods accounted for approximately one-third of sales, and conventional supermarkets accounted for approximately 30%.
- The business operates on low margins and faces pricing pressure from grocery consolidation, direct manufacturer distribution, customer self-distribution, online competitors and conventional distributors.
- Acquisition integration, retention of acquired customers and suppliers, and achievement of expected synergies remain important execution risks.
- Failure or delay in implementing warehouse, procurement, transportation and other technology systems could disrupt operations or prevent anticipated cost savings.
- Results are exposed to food-cost inflation or deflation, supplier shortages, weather and agricultural conditions, fuel costs, foreign exchange rates and supply-chain disruptions.
- Food safety, product recalls, regulatory compliance, cybersecurity incidents, labor disputes, self-insurance claims and adverse litigation could materially affect results.
- Contractual commitments included $16.3 million of inventory purchase commitments, $255.3 million of future operating-lease payments and $33.5 million of letters of credit.
- No pending material legal proceedings were disclosed. Management stated that disclosure controls and internal control over financial reporting were effective as of July 29, 2017.
Most important facts for investors to verify
- Whether Whole Foods and conventional-supermarket volumes, pricing and contract economics support growth without further margin compression.
- Progress and costs associated with the warehouse-management system, transportation initiatives and shared services center.
- Actual fiscal 2018 capital expenditures, operating cash flow and debt repayment relative to management’s plans.
- Retention and profitability of the Haddon, Nor-Cal, Global Organic and Gourmet Guru acquisitions.
- Compliance with revolving-credit and term-loan covenants as availability changes.
- Labor negotiations, union-related costs and any effects on distribution-center operations.
- Exposure to food inflation or deflation, supplier availability, fuel prices and customer credit losses.