UNITED NATURAL FOODS INC annual report, FY2019

United Natural Foods, Inc. — Fiscal 2019 Form 10-K Summary

Business context and reporting period

UNFI is a distributor of natural, organic, specialty, produce and conventional grocery and non-food products, with related support services in the United States and Canada. The filing covers the 53-week fiscal year ended August 3, 2019; fiscal 2018 had 52 weeks. Results are significantly affected by the October 22, 2018 acquisition of SUPERVALU Inc. for approximately $2.3 billion, including assumed debt and liabilities.

The combined company operated 63 distribution centers and warehouses representing approximately 32.2 million square feet and served approximately 30,000 customer locations.
Whole Foods Market remained the largest customer, representing approximately 21% of fiscal 2019 net sales. Its distribution agreement expires September 28, 2025.
UNFI classified the acquired Cub Foods and Shoppers retail operations as discontinued operations and intended to divest them.

Financial performance and key metrics

Metric	Fiscal 2019	Fiscal 2018
Net sales	$21.387 billion	$10.227 billion
Gross profit	$2.785 billion	$1.523 billion
Gross margin	13.02%	14.89%
Operating income (loss)	$(291.0) million	$227.2 million
Operating margin	(1.36)%	2.22%
Net income (loss) from continuing operations	$(350.7) million	$165.7 million
Net income (loss) attributable to UNFI	$(285.0) million	$165.7 million
Diluted earnings (loss) per share	$(5.56)	$3.26
Adjusted EBITDA	$562.5 million	$361.6 million

Supervalu contributed approximately $10.47 billion of continuing-operations net sales for the 41 weeks after acquisition.
Fiscal 2019 included a $292.8 million goodwill impairment charge related to the Supervalu Wholesale reporting unit, $153.5 million of restructuring, acquisition and integration expenses, and a $24.1 million LIFO charge.
Income from discontinued operations was $65.8 million after tax on $2.094 billion of net sales.
Net cash provided by operating activities was $284.5 million, including $175.1 million from continuing operations and $109.4 million from discontinued operations.
Capital expenditures were $207.8 million, compared with $44.6 million in fiscal 2018.
Cash and cash equivalents were $45.3 million, including $42.4 million attributable to continuing operations, at year-end. Working capital was $1.459 billion.

Debt, liquidity and capital structure

Total debt, including the current portion, was $2.906 billion at August 3, 2019, compared with $318.8 million a year earlier. The increase primarily financed the Supervalu acquisition.
Debt consisted principally of $1.865 billion outstanding under the Term Loan Facility and $1.080 billion under the ABL Credit Facility, net of applicable issuance costs and discounts.
Remaining ABL availability was $919.2 million at year-end, with $76.2 million of outstanding letters of credit.
Fiscal 2020 scheduled debt maturities were $102.7 million, excluding potential mandatory prepayments. Capital lease payments were expected to be approximately $24.7 million.
The company had $2.2 billion of interest-rate swaps that effectively fixed portions of LIBOR-based debt; the swaps had a net liability fair value of $76.6 million.
The company paid no dividend and stated that it had no current intention to pay cash dividends.

Material changes versus the prior comparable period

Reported sales more than doubled, increasing 109% primarily because of the Supervalu acquisition and the additional fiscal week. Supermarket-channel sales increased to $12.505 billion from $2.820 billion.
Whole Foods sales increased 17% to approximately $4.393 billion, while its share of total sales declined from 37% to 21% because of the broader Supervalu customer base.
Gross margin declined 187 basis points, reflecting customer mix, the LIFO charge, and the absence of a $20.9 million favorable inventory-accrual estimate change recorded in fiscal 2018.
Operating results shifted from profit to loss due to goodwill impairment, integration and restructuring costs, increased depreciation and amortization, higher distribution costs and substantially higher interest expense.
Interest expense increased to $180.0 million from $16.0 million because of acquisition-related borrowing, lease obligations and financing costs.
Fiscal 2019 operating cash flow increased from continuing operations, primarily because of inventory reductions and cash acquired with Supervalu, but cash used in investing activities increased to $2.259 billion, including $2.292 billion for the acquisition.
UNFI adopted LIFO for certain legacy UNFI inventories, reducing fiscal 2019 continuing-operations net income by approximately $11.0 million after tax.

Guidance, outlook, commentary and unusual items

Management expected the competitive environment to remain challenging and anticipated continued margin compression, but believed cost savings and cross-selling opportunities could offset the pressure.
Management planned continued integration of Supervalu, distribution-network optimization, cost-synergy realization, national warehouse-management and procurement systems, and expansion or automation of distribution facilities.
Additional integration and restructuring costs were expected in fiscal 2020, including potential costs associated with retail divestitures, headcount reductions, store closures, severance and multiemployer pension obligations.
The Pacific Northwest network was being consolidated from five distribution centers into two. Management expected future savings but had not completed all closures as of year-end.
The company expected to fund fiscal 2020 debt maturities through internally generated funds, asset-sale proceeds, ABL borrowings or new debt issuance.
As of August 3, 2019, the Supervalu purchase-price allocation remained preliminary. Changes to acquired asset and liability valuations could change goodwill and the recorded impairment charge.
On August 1–2, 2019, UNFI initiated a lump-sum settlement window for certain SUPERVALU Retirement Plan participants. Payments were expected around November 1, 2019 and were expected to require a pension-plan remeasurement.
UNFI adopted the new lease standard on August 4, 2019 and estimated recognition of approximately $1.1 billion of operating lease liabilities and corresponding right-of-use assets, with no material expected impact on earnings or cash flows.

Principal risks and contingencies

Dependence on Whole Foods Market and other large supermarket customers; customers may self-distribute, change suppliers, reduce purchases or terminate arrangements.
Low-margin, highly competitive grocery distribution industry, including pricing pressure, retailer consolidation, e-commerce and direct manufacturer distribution.
Execution risk in integrating Supervalu, realizing synergies, optimizing distribution capacity and implementing technology systems.
High leverage, variable-rate debt, restrictive covenants, refinancing requirements and exposure to interest-rate changes.
Potential additional goodwill or long-lived-asset impairment charges.
Underfunded single-employer and multiemployer pension plans, potential withdrawal liabilities and labor negotiations involving approximately 4,800 employees covered by collective bargaining agreements.
Supply-chain disruptions, vendor out-of-stocks, product recalls, food-safety matters, fuel costs, tariffs, weather and inflation or deflation.
Pending litigation included opioid-related claims, a False Claims Act matter involving pharmacy pricing, and a putative class action concerning fuel surcharges. Management recorded no material accrual for these proceedings and could not estimate a reasonably possible loss range for the latter two matters.
Contractual obligations totaled approximately $6.264 billion, including $3.003 billion of debt principal, $1.732 billion of operating leases, $913 million of debt interest and $74 million of multiemployer plan withdrawal liabilities.

Most important facts for investors to verify

Progress toward Supervalu integration, distribution-center consolidation and the timing and magnitude of promised cost synergies.
Post-acquisition organic sales, customer retention, gross-margin trends and the effect of Whole Foods purchasing levels.
Debt repayment, refinancing of the 364-day tranche, mandatory excess-cash-flow prepayments and covenant headroom.
Final Supervalu purchase-price allocation and whether additional goodwill or asset impairment charges are required.
Cash generation after capital expenditures, working-capital needs, interest expense and discontinued-operation cash flows.
Proceeds and liabilities associated with divesting the remaining Cub Foods and Shoppers retail operations.
Potential exposure from pension obligations, multiemployer withdrawals, pending litigation and assigned lease guarantees.