United Natural Foods, Inc. — Fiscal 2017 First-Quarter 10-Q Summary
Business Context and Reporting Period
United Natural Foods, Inc. distributes and retails natural, organic and specialty products primarily in the United States and Canada. The company serves more than 43,000 customer locations through wholesale distribution, retail, manufacturing and branded-product operations. The filing covers the unaudited 13-week period ended October 29, 2016, compared with the 13-week period ended October 31, 2015.
Wholesale is the only reportable segment; “Other” includes retail, manufacturing, branded products and certain corporate expenses. Results include the acquisitions of Nor-Cal Produce, Haddon House and Gourmet Guru, as well as other fiscal 2016 acquisitions.
Financial Highlights
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $2.278 billion | $2.077 billion | Up 9.7% |
| Gross profit | $349.0 million | $313.9 million | Up 11.2% |
| Gross margin | 15.3% | 15.1% | Up 20 basis points |
| Operating income | $53.3 million | $53.9 million | Down 1.0% |
| Operating margin | 2.3% | 2.6% | Down 30 basis points |
| Net income | $29.2 million | $30.1 million | Down 3.0% |
| Diluted earnings per share | $0.58 | $0.60 | Down $0.02 |
| Effective tax rate | 39.8% | 39.9% | Essentially unchanged |
Operating expenses increased 13.7% to $295.7 million and rose to 13.0% of sales from 12.5%. The increase reflected acquired business volumes, higher depreciation and amortization, and higher share-based compensation. Fiscal 2016 operating expenses included approximately $2.8 million of restructuring and transition costs and $1.8 million of bad-debt expense, neither of which recurred in the current quarter.
Cash Flow, Balance Sheet, Debt and Liquidity
- Operating cash flow was negative $7.3 million, compared with $5.5 million provided in the prior-year quarter. Working-capital use included a $55.1 million inventory increase and a $43.3 million accounts-receivable increase, partly offset by a $33.9 million increase in accounts payable.
- Investing cash flow was negative $19.3 million, including $9.2 million of capital expenditures and $10.1 million for acquired businesses.
- Financing cash flow was positive $21.6 million, primarily reflecting revolving-credit borrowings and bank-overdraft increases, partially offset by revolving-credit repayments.
- Cash and cash equivalents declined to $13.6 million from $18.6 million at July 30, 2016.
- Total assets were $2.943 billion and total liabilities were $1.391 billion at October 29, 2016. Inventories were $1.078 billion and accounts receivable were $534.3 million.
- Revolving-credit borrowings were $421.2 million, with $37.4 million of outstanding letters of credit and remaining availability of $421.9 million. The revolving facility matures April 29, 2021 and permits up to $900 million of stated U.S. and Canadian commitments, subject to its terms.
- Long-term debt, including the current portion, was $173.1 million. Term-loan borrowings were $128.3 million. The company also reported $421.2 million of notes payable under its revolving facility.
- The company was in compliance with its term-loan financial covenants and was not subject to the revolving facility’s springing fixed-charge coverage covenant during the quarter.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by acquisitions and organic growth across wholesale channels. Conventional supermarket sales increased 13%, independent-retailer sales increased 10%, and Whole Foods Market sales increased 5%.
- Whole Foods Market represented approximately 33% of sales, compared with 34% in the prior-year quarter, maintaining significant customer concentration.
- Gross margin improved modestly because of the acquired businesses, but was pressured by reduced supplier promotional activity, competitive pricing and lower fuel surcharges.
- Operating and net margins declined despite higher sales and gross profit because operating expenses grew faster than revenue and interest expense increased to $4.5 million from $3.7 million.
- No restructuring or asset-impairment expense was recorded in Q1 FY2017, compared with $2.8 million in the prior-year quarter.
- Interest-rate swaps with aggregate notional value of $290 million were outstanding and designated as cash-flow hedges.
Guidance, Outlook, Commentary and Risks
- Management expects fiscal 2017 sales to grow over comparable fiscal 2016 periods, driven by new customers, expanded product offerings, acquisitions and cross-selling.
- Management expects growth in the lower-margin supernatural and conventional-supermarket channels to outpace other channels, which may reduce gross-margin percentages.
- The company intends to offset margin pressure through supply-chain efficiencies, information-technology improvements and continued rollout of its warehouse-management system, which management expects to complete across U.S. broadline facilities by the end of fiscal 2018.
- Management expects average operating cash flow of $175 million to $230 million for fiscal years 2017 and 2018 and plans fiscal 2017 capital expenditures of approximately 0.6% to 0.8% of net sales.
- Key risks include customer concentration, retention of acquired customers, competitive pricing and self-distribution by retailers, lower-margin channel mix, food-price deflation, fuel-cost volatility, supply-chain disruptions, labor costs, execution of technology initiatives, acquisition integration and the company’s ability to reduce expenses sufficiently.
- Management stated that cash on hand and available revolver capacity should be sufficient for operations and planned capital expenditures over the next twelve months. The filing states that there were no material changes to previously disclosed contractual obligations or risk factors and no pending material legal proceedings.
Most Important Facts to Verify
- Whether acquisition-related sales growth converts into sustainable organic growth and operating leverage.
- Progress in reducing operating expenses as a percentage of sales while implementing the warehouse-management platform.
- Customer concentration and the status of the Whole Foods Market distribution agreement, which expires September 28, 2025.
- Inventory and receivables growth, working-capital requirements and the timing of conversion to positive operating cash flow.
- Revolver utilization, covenant headroom and interest-rate exposure as acquisitions and seasonal working capital increase borrowings.
- Retention and integration of Haddon, Nor-Cal, Global Organic and Gourmet Guru customers and operations.
- The impact of lower-margin conventional-supermarket growth, competitive pricing, supplier promotions and food-price deflation on future gross margins.