United Natural Foods, Inc. — Fiscal 2011 Second-Quarter Form 10-Q
Reporting period: Three and six months ended January 29, 2011, compared with January 30, 2010. The filing is unaudited. UNFI distributes natural, organic and specialty products primarily in the United States and Canada, with wholesale as its only reportable segment and retail, manufacturing and corporate activities included in “Other.”
Financial performance and metrics
| Metric | Three months ended Jan. 29, 2011 | Year-over-year change | Six months ended Jan. 29, 2011 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $1.114 billion | +24.1% | $2.167 billion | +21.6% |
| Gross profit | $198.6 million | +19.2% | $391.0 million | +18.0% |
| Gross margin | 17.8% | Down from 18.5% | 18.0% | Down from 18.6% |
| Operating income | $31.7 million | +15.0% | $61.4 million | +12.1% |
| Operating margin | 2.9% | Down from 3.1% | 2.8% | Down from 3.1% |
| Net income | $18.7 million | +19.6% | $36.1 million | +15.8% |
| Diluted EPS | $0.39 | Up from $0.36 | $0.77 | Up from $0.72 |
Operating expenses were $166.9 million in the quarter and $329.6 million for six months, representing 15.0% and 15.2% of sales, respectively, versus 15.5% in both comparable prior-year periods. The effective tax rate was 39.0%, compared with 40.0%.
Cash flow, balance sheet, debt and liquidity
- Six-month operating cash flow was an outflow of $51.7 million, versus $26.1 million of cash provided in the prior-year period. Working-capital investment included $76.4 million of inventory growth and $42.9 million of accounts receivable growth.
- Investing cash outflow was $36.1 million, including $14.3 million of capital expenditures and $21.9 million for acquired businesses.
- Financing cash inflow was $91.3 million, primarily reflecting $138.3 million of net proceeds from a secondary offering, partially offset by $57.6 million of repayments under notes payable.
- Cash and cash equivalents were $17.3 million at January 29, 2011, compared with $13.8 million at July 31, 2010. Working capital was $361.2 million, up from $194.2 million.
- Total debt was approximately $236.0 million, consisting primarily of $185.0 million outstanding under the revolving credit facility and $50.0 million of long-term debt including the current portion. The filing reports approximately $194.2 million of remaining revolving-credit availability after $19.5 million of letters of credit and $1.3 million of reserves.
- The $400 million secured revolving facility matures November 27, 2012; the term loan matures July 28, 2012. UNFI was in compliance with its fixed-charge coverage covenants as of January 29, 2011.
Material changes versus the prior comparable period
- Sales growth was driven by organic growth, new conventional-supermarket customers, UNFI Canada and expanded Whole Foods Market distribution. Whole Foods accounted for approximately 37% of quarterly sales and 36% of six-month sales, compared with 36% and 35%, respectively, in the prior-year periods.
- The company completed the acquisition of Whole Foods Distribution’s Rocky Mountain and Southwest distribution business and became Whole Foods Market’s primary distributor in those regions. The transaction contributed approximately $40.4 million of quarterly sales and $55.1 million of six-month sales; management expects approximately $160 million of incremental annual revenue.
- UNFI Canada contributed approximately $47.2 million of quarterly sales and $91.9 million of six-month sales. The filing states that its net income was not significant relative to consolidated net income.
- Sales mix shifted toward lower-margin supernatural-chain and conventional-supermarket channels. These channels represented approximately 59% of quarterly sales and 58% of six-month sales, versus 56% and 55% in the prior-year periods.
- Gross margin declined because of channel mix, expedited and incremental freight, reduced manufacturer charge-backs and startup issues at the Lancaster, Texas facility. Operating margin also declined despite operating-expense leverage.
- Lancaster startup inefficiencies were approximately $2.5 million in the quarter and approximately $4.4 million of labor and other expenses were incurred during the six-month period. A $2.6 million litigation and arbitration settlement reduced operating expenses.
- The October 2010 secondary offering increased shares outstanding by 4.43 million and generated approximately $138.3 million of net proceeds, primarily used to repay revolving-credit borrowings and support the Whole Foods transaction.
Guidance, outlook, risks and unusual items
- Management expected fiscal 2011 sales to improve over fiscal 2010, led by Whole Foods expansion, conventional-supermarket opportunities, new customers and increased product penetration.
- Management expected lower gross margins from the growing Whole Foods and conventional-supermarket channels, with a goal of offsetting the pressure through supply-chain, warehouse-management and information-technology efficiencies.
- The national warehouse-management and procurement system began operating at Lancaster and was planned for rollout to all distribution centers by the end of fiscal 2013. As of March 1, 2011, applicable routes had been transitioned to Lancaster.
- Management expected $30 million to $50 million of annual operating cash flow for fiscal 2011 and fiscal 2012, capital expenditures of no more than approximately 1% of sales for those years, and fiscal 2011 capital expenditures of $42 million to $45 million.
- Key risks include customer concentration, particularly Whole Foods; low industry margins; economic and consumer-spending sensitivity; inflation and diesel-fuel costs; execution of the Canadian and warehouse-management initiatives; acquisition integration; and capital-allocation decisions.
- UNFI had fixed-price fuel agreements covering approximately 2.8 million gallons through July 2011 at prices ranging from $2.27 to $2.93 per gallon. It also maintained an interest-rate swap with a reported fair-value liability of $1.9 million.
- The filing reports no material changes to contractual obligations or risk factors, no material adverse expected outcome from routine litigation, and effective disclosure controls with no material internal-control changes.
Investor verification priorities
- Verify whether Whole Foods concentration and the expanded regional distribution agreement support the expected incremental annual revenue without creating unacceptable customer or margin concentration.
- Assess whether Lancaster and the broader warehouse-management rollout achieve the promised cost, freight and service efficiencies.
- Monitor gross-margin and operating-margin trends as lower-margin supermarket channels grow faster than independent retailers.
- Reconcile the expected recovery in operating cash flow with inventory and receivables growth and the stated $30 million to $50 million annual operating-cash-flow outlook.
- Review debt maturities, covenant compliance and refinancing requirements before the 2012 revolving-facility and term-loan maturities.
- Evaluate integration and execution risks associated with UNFI Canada, the Whole Foods assets and other acquired businesses, including contingent consideration and restructuring liabilities.