United Natural Foods, Inc. (UNFI) — Fiscal 2019 Third-Quarter Form 10-Q
Reporting period: 13 weeks ended April 27, 2019; year-to-date period of 39 weeks ended April 27, 2019. Comparative periods ended April 28, 2018. The filing is unaudited. UNFI distributes natural, organic, specialty, conventional grocery and non-food products in the United States and Canada. Results include Supervalu from its October 22, 2018 acquisition.
Business Context
UNFI acquired Supervalu for approximately $2.3 billion, including assumed debt, to expand scale, customer reach, product assortment, distribution capacity and expected synergies. The company is integrating the businesses, consolidating distribution centers and pursuing the divestiture of Supervalu’s retail operations, which are reported as discontinued operations.
Financial Performance and Key Metrics
| Metric | Q3 FY2019 | Q3 FY2018 | 39 Weeks FY2019 | 39 Weeks FY2018 |
|---|---|---|---|---|
| Net sales | $5.963 billion | $2.649 billion | $14.980 billion | $7.634 billion |
| Gross profit | $788.6 million | $408.1 million | $1.963 billion | $1.147 billion |
| Gross margin | 13.22% | 15.41% | 13.10% | 15.02% |
| Operating income (loss) | $69.7 million | $82.2 million | $(357.3) million | $177.5 million |
| Operating margin | 1.17% | 3.10% | (2.39)% | 2.32% |
| Net income (loss) attributable to UNFI | $57.1 million | $51.9 million | $(303.9) million | $132.9 million |
| Diluted EPS | $1.12 | $1.02 | $(5.99) | $2.61 |
Q3 sales increased 125.1%, primarily from $3.24 billion of Supervalu sales. Excluding Supervalu, sales increased approximately 2.8%. Whole Foods Market sales increased approximately 11% in the quarter and 16% year-to-date.
Q3 operating income declined despite higher gross profit because of higher depreciation and amortization, restructuring and integration costs, and the absence of the $20.9 million prior-year benefit from an accounting estimate change. The year-to-date operating loss includes a $332.6 million goodwill impairment charge.
Interest expense increased to $54.9 million in Q3 and $121.1 million year-to-date, compared with $4.3 million and $12.1 million, respectively, in the prior-year periods, primarily due to acquisition-related borrowings. Net periodic benefit income, excluding service cost, was $10.9 million in Q3 and $22.7 million year-to-date.
Cash Flow, Liquidity and Debt
- Cash provided by operating activities was $77.2 million year-to-date, including $6.4 million from continuing operations and $70.8 million from discontinued operations. Continuing-operations operating cash flow was $(31.3) million in the prior-year period.
- Investing cash outflow was $2.200 billion, including $2.282 billion paid for the Supervalu acquisition and $137.0 million of capital expenditures.
- Financing cash inflow was $2.140 billion, including $1.912 billion of long-term borrowings and net revolving-credit borrowings. Cash and cash equivalents totaled $40.9 million, including $37.9 million attributable to continuing operations, at April 27, 2019.
- Total long-term debt, including the current portion and before certain debt issuance adjustments, was approximately $3.051 billion; reported long-term debt was $2.944 billion and current debt was $133.7 million.
- The ABL Credit Facility had $791.4 million of remaining availability after $80.6 million of outstanding letters of credit. The company was not subject to the ABL fixed-charge coverage covenant in the quarter.
- Capital expenditures are expected to remain below 1.5% of fiscal 2019 net sales; longer-term capital spending is expected to be approximately 1.0% of net sales. The company expects to use internally generated cash and asset-sale proceeds to reduce debt.
Material Changes Versus the Prior Comparable Period
- The Supervalu acquisition more than doubled reported sales and materially increased assets, liabilities, debt, depreciation and amortization.
- Total assets increased to $7.327 billion from $2.964 billion at July 28, 2018, while total liabilities increased to $5.797 billion from $1.119 billion.
- Gross margin fell 219 basis points in Q3 and 192 basis points year-to-date. The company cited business mix, the prior-year accounting estimate benefit and LIFO charges, including a $7.4 million Q3 and $13.7 million year-to-date LIFO charge.
- Goodwill and asset impairment charges totaled $332.6 million year-to-date, including a $38.3 million favorable adjustment in Q3, following an impairment of the Supervalu Wholesale reporting unit.
- Restructuring, acquisition and integration expenses totaled $19.4 million in Q3 and $134.6 million year-to-date.
- Retail assets and liabilities held for sale totaled $540.7 million and $117.0 million, respectively, at April 27, 2019. Discontinued operations generated $24.4 million of after-tax income in Q3 and $47.8 million year-to-date.
Guidance, Outlook, Commentary and Risks
- Management expects approximately $13 million of additional acquisition and integration costs and $2 million of additional restructuring expense for the remainder of fiscal 2019. Additional retail-divestiture costs, including severance, store closures and multiemployer pension charges, could be material but could not be reasonably estimated.
- The company expects interest expense to remain substantially higher than before the Supervalu acquisition and expects approximately $35 million of net periodic benefit income, excluding service costs, for fiscal 2019.
- Management is accelerating distribution-network integration, including Pacific Northwest consolidation, warehouse automation and implementation of common warehouse-management and procurement systems.
- The company hedged approximately $2.2 billion of notional floating-rate debt through interest-rate swaps. Interest-rate exposure, integration execution, customer concentration, low operating margins, competition, fuel costs, supply-chain disruption, labor negotiations and further impairment charges remain significant risks.
- Multiemployer pension plans include several red or deeply underfunded plans. The company expects annual contributions of approximately $40 million to $50 million for multiemployer plans, excluding withdrawal obligations, and has a $35.7 million withdrawal liability payable over 20 years.
- Total contractual obligations were approximately $6.401 billion, including $3.152 billion of long-term debt, $1.025 billion of debt interest, $1.567 billion of operating leases and $208 million of capital leases.
- The filing states that disclosure controls were effective. Internal-control integration for Supervalu remains in process.
Important Facts for Investors to Verify
- Whether final Supervalu purchase-accounting adjustments change the $332.6 million goodwill impairment charge or acquired asset and liability values.
- Actual progress and costs of Supervalu integration, distribution-center consolidation and expected synergies.
- Debt repayment capacity, covenant compliance, the October 2019 maturity of the $94.3 million 364-day term-loan tranche and future mandatory prepayments.
- Gross-margin trends, LIFO effects, vendor-fund assumptions and the sustainability of operating cash flow.
- Timing and proceeds from remaining retail divestitures and any related severance, lease, pension or closure liabilities.
- Potential additional goodwill or long-lived-asset impairment if operating performance, market capitalization or valuation assumptions deteriorate.
- Exposure to underfunded multiemployer pension plans, collective-bargaining expirations, customer concentration and supply-chain or labor disruptions.