Business Context and Reporting Period
United Natural Foods, Inc. (UNFI) distributes natural, organic, specialty, conventional grocery and non-food products and provides support services in the United States and Canada. This Form 10-Q covers the 13 weeks ended November 2, 2019, the first quarter of fiscal 2020, compared with the 13 weeks ended October 27, 2018. Fiscal 2020 results include a full quarter of Supervalu operations, acquired on October 22, 2018; therefore, year-over-year comparisons are not fully comparable.
Financial Performance and Position
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $6.020 billion | $2.868 billion | Up 109.9% |
| Gross profit | $771.0 million | $412.3 million | Up 87.0% |
| Gross margin | 12.81% | 14.38% | Down 157 bps |
| Operating expenses | $775.4 million | $363.2 million | Up 113.5% |
| Operating loss | $(444.0) million | $(18.8) million | Worsened by $425.2 million |
| Net loss attributable to UNFI | $(383.9) million | $(19.3) million | Worsened by $364.6 million |
| Diluted loss per share | $(7.21) | $(0.38) | Worsened by $6.83 |
| Adjusted EBITDA | $121.7 million | $86.2 million | Up $35.5 million |
Reported sales growth primarily reflected approximately $3.30 billion of Supervalu sales included in the current period versus approximately $224 million in the prior period. Excluding Supervalu, sales increased approximately $74 million, or 2.8%. Gross margin declined primarily because of lower margins on conventional products and channel mix; a $6.5 million LIFO charge reduced gross profit by approximately 11 basis points.
Q1 FY2020 included $425.4 million of goodwill and asset impairment charges, including a $421.5 million impairment of U.S. Wholesale goodwill, a $2.5 million purchase-accounting goodwill adjustment and $1.4 million of property and equipment impairment. Restructuring, acquisition and integration expense was $14.3 million versus $68.0 million in the prior period.
- Cash and cash equivalents were $39.8 million at November 2, 2019, compared with $42.4 million at August 3, 2019.
- Net cash used in operating activities was $134.9 million, including $135.5 million used by continuing operations, versus $107.0 million used in the prior-year quarter.
- Capital expenditures were $41.1 million versus $16.4 million.
- Total debt, including the current portion and net of issuance costs and discounts, was $3.070 billion versus $2.906 billion at fiscal year-end.
- Working capital was $1.570 billion, up from $1.459 billion, primarily because of seasonal inventory growth.
- Operating lease assets and liabilities of approximately $1.1 billion were recognized upon adoption of ASC 842; the adoption did not materially affect earnings or cash flows.
Debt, Liquidity and Cash Flow
The ABL Credit Facility had $695.7 million of remaining availability at November 2, 2019, after $1.318 billion of U.S. ABL borrowings and $77.4 million of letters of credit. The Company was not subject to the ABL fixed-charge coverage covenant during the quarter. The Term B loan had $1.787 billion outstanding and matures in 2025, subject to an earlier maturity under specified Whole Foods agreement conditions. The $150 million 364-day tranche was repaid on October 21, 2019, primarily through additional ABL borrowings and asset-sale proceeds.
Management stated that near-term debt maturities through fiscal 2023 are expected to be funded with internally generated funds, asset-sale proceeds or ABL borrowings. However, operating losses or weaker cash flow could limit debt repayment capacity. Approximately $2.20 billion of notional debt was hedged through pay-fixed, receive-floating interest-rate swaps.
Material Changes and Management Commentary
- Management combined the Supervalu and legacy UNFI wholesale reporting units and recorded the substantial U.S. Wholesale goodwill impairment after a sustained decline in market capitalization and enterprise value.
- UNFI continued integrating Supervalu, consolidating distribution facilities and implementing a single national warehouse management and procurement platform. Pacific Northwest network consolidation is expected to continue through fiscal 2020.
- The Company is divesting acquired retail operations and reported Cub Foods and Shoppers as discontinued operations. Discontinued operations generated $610.8 million of sales and $25.0 million of net income in the quarter.
- Subsequent to quarter-end, UNFI agreed to sell 13 Shoppers stores and close four locations. Estimated aggregate pre-tax costs and charges are $32 million to $42 million.
- UNFI expects additional integration and restructuring costs during fiscal 2020. It expects fiscal 2020 capital expenditures not to exceed 1.0% of net sales, with spending focused on distribution network and technology projects.
- A $664.0 million lump-sum pension settlement was paid on November 4 and November 12, 2019. Management expected an approximately $10.0 million non-cash pension settlement charge in the second quarter.
Risks, Contingencies and Unusual Items
- The Company identified risks from low operating margins, customer concentration, conventional-grocery competition, fuel and foreign-exchange volatility, supply-chain disruptions, integration execution and potential additional impairments.
- A False Claims Act qui tam matter involving prescription-drug pricing had alleged damages exceeding $100 million before trebling and statutory penalties. Following an adverse summary-judgment ruling, management considered a loss reasonably possible but could not estimate a range.
- UNFI was named in approximately 38 opioid-related lawsuits, although a majority involving former New Albertson’s pharmacies are subject to defense and indemnification arrangements. Management stated that it had not recorded material accruals for these proceedings.
- Guarantees and contingent liabilities included maximum undiscounted guarantee payments of $35.1 million and approximately $247.0 million of non-cancelable purchase obligations.
- The Company participates in underfunded multiemployer pension plans. A significant reduction in contributions or market exits could trigger withdrawal liabilities; fiscal 2020 continuing-operations contributions were estimated at approximately $37 million.
Important Facts for Investors to Verify
- Whether Supervalu integration and distribution-center consolidation produce the expected cost synergies without further operational disruption or restructuring charges.
- Whether sales growth excluding Supervalu continues and whether gross margins stabilize, particularly across conventional grocery products.
- The adequacy of liquidity and ABL availability in light of seasonal working-capital needs, operating cash outflows and approximately $3.1 billion of debt.
- The final costs and proceeds from Shoppers and other retail divestitures, including potential impairment, severance and multiemployer pension liabilities.
- The outcome and potential exposure from the False Claims Act litigation and other legal proceedings.
- Whether further goodwill or long-lived-asset impairment charges are required if market capitalization, enterprise value or projected cash flows decline.
- The second-quarter accounting impact of the $664.0 million pension settlement and the expected approximately $10.0 million non-cash charge.