United Natural Foods, Inc. — Fiscal 2019 Second-Quarter Form 10-Q
Reporting period: 13 weeks ended January 26, 2019, with year-to-date results for the 26 weeks ended January 26, 2019. Comparisons are to the periods ended January 27, 2018. The filing is unaudited. UNFI distributes natural, organic, specialty and conventional grocery and non-food products in the United States and Canada. The October 22, 2018 acquisition of SUPERVALU materially changed the scale, mix, capital structure and comparability of results.
Key financial metrics
| Metric | Q2 FY2019 | Q2 FY2018 | 26 weeks FY2019 | 26 weeks FY2018 |
|---|---|---|---|---|
| Net sales | $6.149 billion | $2.528 billion | $9.017 billion | $4.986 billion |
| Gross profit | $761.8 million | $371.5 million | $1.174 billion | $738.7 million |
| Gross margin | 12.39% | 14.70% | 13.02% | 14.82% |
| Operating income (loss) | $(408.1) million | $40.2 million | $(427.0) million | $95.3 million |
| Operating margin | (6.64)% | 1.59% | (4.74)% | 1.91% |
| Net income (loss) attributable to UNFI | $(341.7) million | $50.5 million | $(361.0) million | $81.0 million |
| Diluted earnings (loss) per share | $(6.72) | $0.99 | $(7.12) | $1.59 |
| Cash provided by operating activities | Not separately provided | Not separately provided | $25.9 million | $(3.4) million |
Operating expenses were $751.9 million in Q2 and $1.115 billion year-to-date. Interest expense was $58.7 million in Q2 and $66.2 million year-to-date, compared with $4.1 million and $7.7 million, respectively, in the prior-year periods. Discontinued operations contributed $21.4 million after tax in Q2 and $23.5 million year-to-date.
Liquidity, debt and cash flow
- Cash and cash equivalents from continuing operations were $49.5 million at January 26, 2019, compared with $23.3 million at July 28, 2018.
- Total debt, including current maturities and before certain debt issuance adjustments, was approximately $3.142 billion; carrying value of long-term debt, including the current portion, was $3.081 billion.
- The company had $1.242 billion of borrowings under its $2.1 billion ABL facility, $76.8 million of letters of credit and reported $766.4 million of remaining availability.
- The Term Loan Facility had $1.800 billion outstanding under the Term B tranche and $103.0 million under the 364-day tranche. The 364-day tranche matures October 21, 2019.
- Year-to-date investing cash outflow was $2.149 billion, including $2.282 billion for acquired businesses and $80.1 million of capital expenditures.
- Year-to-date financing cash inflow was $2.156 billion, primarily reflecting $1.905 billion of long-term borrowings and $2.699 billion of revolver borrowings, partly offset by repayments and debt issuance costs.
- Capital expenditures were $80.1 million year-to-date. Management expected fiscal 2019 capital spending not to exceed 1.5% of net sales and indicated a longer-term target of approximately 1.0% of net sales.
Material changes versus the prior comparable period
- Net sales increased 143.2% in Q2 and 80.9% year-to-date, primarily because Supervalu contributed approximately $3.47 billion and $3.70 billion of sales, respectively. Excluding Supervalu, sales increased approximately 5.8% in Q2 and 6.7% year-to-date.
- Gross margin declined because Supervalu operates at lower gross margins and the sales mix shifted toward supermarket and other conventional distribution channels. Q2 also included an $8.6 million inventory fair-value adjustment related to the acquisition.
- The company recorded a $370.9 million goodwill impairment charge for the Supervalu Wholesale reporting unit after a sustained decline in the company’s stock price and market capitalization. The charge reduced reported operating income and was non-cash, but remains subject to change as the acquisition accounting is finalized.
- Restructuring, acquisition and integration expenses were $47.1 million in Q2 and $115.1 million year-to-date, including severance, change-in-control payments, integration costs and closed-property reserves.
- Net debt and interest expense increased substantially following acquisition financing. The company also redeemed $530 million of Supervalu senior notes and made a $47 million mandatory prepayment on the 364-day tranche during Q2.
- Retail operations acquired with Supervalu were classified as discontinued operations and held for sale. Q2 discontinued-operations sales were $727.0 million and after-tax income was $21.4 million.
Guidance, outlook, risks and unusual items
- Management expected approximately $9 million of additional restructuring expense and approximately $20 million of additional acquisition and integration costs during the remainder of fiscal 2019. These estimates excluded potential costs associated with retail divestitures.
- Management expected approximately $35 million of net periodic benefit income, excluding service costs, for fiscal 2019 from acquired pension and postretirement plans.
- The company expects to use operating cash flow and asset-sale proceeds to reduce debt, but cautioned that operating losses or weaker earnings could limit debt repayment capacity.
- Management expects to use Supervalu capital loss carryforwards through anticipated Section 338(g) elections, with estimated net cash tax savings of approximately $300 million over 15 years. The company made approximately $59 million of related cash tax payments early in the third quarter.
- The company changed certain legacy UNFI inventory costing from FIFO to LIFO. The change reduced inventory by $3.3 million and increased Q2 and year-to-date net loss by $2.2 million, or $0.04 per diluted share. Management expected additional non-cash expense of approximately $10 million to $15 million in fiscal 2019 from the LIFO change and higher inflation assumptions.
- Key risks include integration and synergy execution, additional goodwill impairment, retail divestiture costs, customer concentration, competition, low operating margins, supply-chain disruption, fuel and foreign-exchange volatility, labor negotiations and multiemployer pension obligations.
- Whole Foods Market represented approximately 18% of Q2 sales and 24% of year-to-date sales. Its distribution agreement expires September 28, 2025, creating an important customer-concentration exposure.
- Approximately $6.588 billion of contractual obligations were disclosed, including debt, interest, operating and capital leases, purchase obligations, pension withdrawal liability and self-insurance liabilities.
- Outstanding guarantees had maximum undiscounted potential payments of $44.6 million, although management considered a material payout unlikely. The company also had a $35.7 million multiemployer pension withdrawal liability acquired in connection with Supervalu-related closures.
Important facts for investors to verify
- Whether Supervalu integration produces the anticipated cost synergies, cross-selling benefits and cash generation.
- The final purchase-price allocation for Supervalu and whether the $370.9 million goodwill impairment charge changes.
- Debt maturity, refinancing and covenant requirements, particularly the October 2019 364-day tranche and the company’s ability to reduce leverage.
- Progress and economics of the planned retail divestitures, including stranded leases, pension obligations, supply agreements and additional restructuring charges.
- Underlying operating performance excluding acquisition, impairment, restructuring, integration, inventory fair-value and LIFO-related items.
- Retention and future economics of Whole Foods Market and other major customers, as well as the impact of changing customer mix on gross margin.
- Execution of distribution-center consolidation, warehouse and transportation systems implementation, and the related capital spending and transition costs.