United Natural Foods, Inc. — Fiscal 2015 Third-Quarter Form 10-Q
Business context and reporting period
United Natural Foods, Inc. distributes and retails natural, organic and specialty products in the United States and Canada. The filing covers the quarter and nine months ended May 2, 2015, compared with the periods ended May 3, 2014. The wholesale business is the company’s only reportable segment; “Other” includes retail, manufacturing, branded products and corporate costs. The July 2014 acquisition of Tony’s Fine Foods materially affected the current-period results.
Financial performance and key metrics
| Metric | Three months ended May 2, 2015 | Prior comparable period | Nine months ended May 2, 2015 | Prior comparable period |
|---|---|---|---|---|
| Net sales | $2.115 billion | $1.782 billion | $6.124 billion | $5.030 billion |
| Gross profit | $325.9 million | $298.1 million | $944.1 million | $837.5 million |
| Gross margin | 15.4% | 16.7% | 15.4% | 16.7% |
| Operating income | $69.0 million | $62.6 million | $176.9 million | $159.5 million |
| Operating margin | 3.3% | 3.5% | 2.9% | 3.2% |
| Net income | $41.8 million | $36.4 million | $102.6 million | $92.1 million |
| Diluted EPS | $0.83 | $0.73 | $2.04 | $1.85 |
- Quarterly sales increased 18.7%; nine-month sales increased 21.7%. Tony’s contributed approximately $213.7 million of quarterly sales and $661.1 million of nine-month sales.
- Quarterly operating income increased 10.2%, while nine-month operating income increased 10.9%. Net income increased 14.7% for the quarter and 11.4% for the nine months.
- Total operating expenses were $256.9 million for the quarter and $767.2 million for the nine months. Operating expenses declined to 12.2% and 12.5% of sales, respectively, from 13.2% and 13.5%.
- Interest expense increased to $3.9 million for the quarter and $10.7 million for the nine months, primarily due to higher borrowings and average interest rates.
- The effective tax rate was 40.0% for the quarter and 39.7% for the nine months.
Cash flow, balance sheet, debt and liquidity
- Net cash used in operating activities was $6.2 million for the nine months, compared with $20.6 million used in the prior-year period. Working-capital investment included $116.7 million of inventory growth and $67.2 million of accounts-receivable growth.
- Net cash used in investing activities was $108.6 million, including $98.5 million of capital expenditures and $8.0 million for acquired businesses.
- Net cash provided by financing activities was $122.6 million. Cash and cash equivalents increased to $23.9 million from $16.1 million at August 2, 2014.
- At May 2, 2015, total debt obligations were approximately $549.4 million, comprising $360.6 million of notes payable, $188.8 million of long-term debt including the current portion, and related financing obligations included in debt.
- The revolving credit facility had a $588.1 million borrowing base, $360.6 million of borrowings, $36.3 million of letter-of-credit commitments and reserves, and $191.2 million of remaining availability.
- The company had $142.5 million outstanding under its real-estate-backed term loan and was required to make quarterly principal payments of $2.5 million. A forward interest-rate swap is intended to fix the effective rate on $140.0 million of term-loan borrowings at approximately 4.295% beginning August 3, 2015.
- Management stated that cash on hand and available credit were sufficient for operations and planned capital expenditures over the next 12 months.
Material changes versus the prior comparable period
- Sales growth reflected Tony’s, organic growth across wholesale channels and food-price inflation of approximately 2.5% in the quarter and 2.2% for the nine months.
- Gross margins declined by 130 basis points in both comparison periods, primarily from Tony’s lower-margin sales, customer-channel mix, unfavorable Canadian foreign exchange and lower fuel surcharges.
- Operating-margin compression was partly offset by operating leverage and lower operating expenses as a percentage of sales.
- Whole Foods Market represented approximately 35% of quarterly sales and 34% of nine-month sales, compared with 36% in both prior comparable periods.
- The company recorded a $4.2 million pre-tax gain from the transfer of land associated with its Prescott, Wisconsin facility.
- The company recorded a cumulative $7.7 million prior-period sales adjustment in the second quarter and a total $9.3 million fiscal-2015 sales reduction related to incorrectly calculated contractual obligations to a customer for fiscal 2009 through 2014. Management concluded the corrections were not material to prior or current periods.
Guidance, outlook, commentary and risks
- Management expected sales for the remainder of fiscal 2015 to exceed the prior-year comparable period, driven substantially by Tony’s, new customers, broader product offerings and growth in conventional supermarkets and supernatural chains.
- Management expected operating cash flow of $75 million to $125 million annually for fiscal 2015 and fiscal 2016, and planned fiscal-2015 capital expenditures of approximately 2.0% to 2.2% of net sales, excluding potential sale-leaseback transactions.
- The warehouse-management-system rollout is expected to reach all existing facilities by the end of fiscal 2017. The company expects efficiency gains to help offset structurally lower gross margins in supermarket channels.
- Key risks include customer concentration, particularly Whole Foods Market; low industry margins; economic and consumer-spending sensitivity; fuel-price volatility; inflation or deflation; supply-chain and labor disruptions; product shortages; acquisition integration; and execution of the WMS and other operational initiatives.
- Management reported a material weakness in internal control over financial reporting related to the completeness and accuracy of calculations of amounts owed to a customer. Remediation steps had been implemented, but the weakness remained as of May 2, 2015 because the controls had not operated long enough to demonstrate effectiveness. Disclosure controls and procedures were therefore deemed ineffective.
- The company was not subject to the revolving-credit fixed-charge coverage covenant during the quarter. The term loan includes leverage, fixed-charge coverage and loan-to-value covenants.
Investor verification items
- Verify the sustainability of sales growth after separating Tony’s acquisition contribution, food inflation and the $9.3 million contractual-obligation correction.
- Assess whether operating efficiencies can offset ongoing gross-margin dilution from Tony’s and supermarket-channel growth.
- Monitor Whole Foods Market concentration and the September 2020 distribution-agreement expiration.
- Review debt paydown, revolving-credit availability, covenant compliance and the effect of higher interest rates after the swap becomes effective.
- Confirm remediation and independent testing of the material weakness in customer-obligation controls.
- Track capital spending, new-facility ramp-up, WMS implementation and the company’s ability to convert earnings into positive operating cash flow.