United Natural Foods, Inc. — Fiscal 2018 First-Quarter Form 10-Q
Business Context and Reporting Period
United Natural Foods, Inc. distributes and retails natural, organic and specialty food and non-food products in the United States and Canada. The report covers the 13-week quarter ended October 28, 2017, compared with the 13-week quarter ended October 29, 2016. The company operated 33 distribution centers with approximately 8.7 million square feet of warehouse capacity and served more than 43,000 customer locations.
Wholesale is the only reportable segment. Other activities include retail stores, manufacturing, branded products and brokerage. Whole Foods Market represented approximately 35% of first-quarter sales, compared with 33% in the prior-year quarter.
Financial Performance and Key Metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $2.458 billion | $2.278 billion | Up 7.9% |
| Gross profit | $367.2 million | $349.0 million | Up 5.2% |
| Gross margin | 14.94% | 15.32% | Down 38 basis points |
| Operating income | $55.1 million | $53.3 million | Up 3.3% |
| Operating margin | 2.24% | 2.34% | Down 10 basis points |
| Net income | $30.5 million | $29.2 million | Up 4.4% |
| Diluted earnings per share | $0.60 | $0.58 | Up $0.02 |
| Effective tax rate | 41.8% | 39.8% | Up 2.0 percentage points |
| Net cash used in operating activities | $72.0 million | $7.3 million | Use increased $64.8 million |
Operating expenses increased 5.6% to $312.1 million but declined to 12.70% of sales from 12.98%, reflecting fixed-cost leverage. Share-based compensation increased to $7.3 million from $6.7 million. Interest expense declined to $3.7 million from $4.5 million, primarily because of lower outstanding debt. Other income was $0.9 million versus other expense of $0.4 million in the prior-year quarter.
Operating cash flow was adversely affected by a $136.6 million inventory increase, largely from advance holiday purchasing, and a $75.4 million increase in accounts receivable due to collection timing. These uses were partly offset by a $72.4 million increase in accounts payable. Capital expenditures were $5.3 million, compared with $9.2 million.
Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $21.2 million at October 28, 2017, compared with $15.4 million at July 29, 2017.
- Inventories were $1.168 billion and accounts receivable were $598.7 million at quarter-end.
- Notes payable, primarily revolving-credit borrowings, were $287.8 million. Current debt was $12.2 million and long-term debt was $147.0 million, for reported debt of approximately $447.0 million excluding other financing obligations.
- The revolving credit facility had a borrowing base of $882.6 million, $287.8 million of borrowings and $31.0 million of letters of credit, leaving $563.8 million of availability.
- The company had $116.1 million outstanding under its term loan. It was in compliance with the term-loan financial covenants and was not subject to the revolving facility’s springing fixed-charge coverage covenant during the quarter.
- Working capital increased 6.7% to approximately $1.02 billion. Days inventory and days sales outstanding were each 48 and 21 days, respectively, unchanged from July 29, 2017.
- Management stated that cash on hand and available revolver capacity were sufficient for operations and planned capital expenditures over the next twelve months.
Material Changes Versus the Prior Comparable Period
- Sales growth was led by Whole Foods Market, where sales increased approximately 14% or $106 million, following its acquisition by Amazon.com in August 2017.
- Independent-retailer sales increased approximately 7%, while conventional-supermarket sales increased approximately 5%. The conventional-supermarket mix declined to approximately 28% of sales from 30%.
- Gross margin compressed because growth with lower-margin supernatural-chain and conventional-supermarket customers outpaced growth in other channels.
- Operating-margin pressure from lower gross margin was partly offset by operating-expense leverage and lower interest expense.
- Operating cash flow deteriorated substantially because of seasonal inventory buildup and accounts-receivable timing.
- The board authorized a $200 million share-repurchase program. The company repurchased 162,073 shares for $6.4 million during the quarter, leaving approximately $193.6 million authorized for future repurchases.
- The company adopted ASU 2016-09 for share-based compensation, recognizing a $0.9 million unfavorable tax item in the quarter and recording an approximately $0.8 million reduction to retained earnings and $1.3 million increase to additional paid-in capital for forfeiture accounting.
- The company adopted deferred-tax balance-sheet classification guidance prospectively, reclassifying $40.6 million from current deferred-tax assets to noncurrent deferred-tax liabilities.
Guidance, Outlook, Commentary and Risks
Management expected fiscal 2018 sales to grow over fiscal 2017 levels, driven by new and existing customers, acquisitions and broader product offerings. Management expected much of the growth to come from lower-margin supermarket channels. Planned fiscal 2018 capital expenditures were approximately 0.6% to 0.7% of sales, focused largely on information technology and the shared-services center. The company did not provide a specific earnings or revenue numerical forecast in the filing.
The company expected to complete rollout of its warehouse-management system to all existing U.S. broadline facilities by the end of fiscal 2019. It did not expect to open or begin construction of a new distribution center during the remainder of fiscal 2018.
Key risks include customer concentration, particularly Whole Foods Market; lower margins from conventional and large-chain customers; competition from conventional distributors, retailers and online distributors; customer-retention and integration risks related to acquisitions; execution risk in warehouse, transportation and shared-services systems; fuel and foreign-exchange volatility; supply-chain disruptions and product shortages; labor costs and union activity; dependence on growth in natural and organic products; and the ability to realize restructuring and cost-savings benefits.
The company had $2.9 million of remaining restructuring liabilities, primarily severance and transition costs, at quarter-end. Interest-rate exposure was partly hedged through swaps with aggregate notional value of $270 million. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Whether inventory and receivables normalize after the holiday buildup and collection-timing effects, and whether operating cash flow improves.
- Whether Whole Foods Market sales growth remains durable and whether customer concentration creates increased financial risk.
- Whether sales growth in lower-margin channels causes continued gross-margin compression.
- Progress and costs associated with the warehouse-management system, transportation-management system and shared-services-center initiatives.
- Future utilization of the $200 million repurchase authorization and its effect on debt, interest expense and liquidity.
- Compliance with term-loan covenants and continued availability under the revolving credit facility.
- The eventual effect of the pending revenue-recognition, lease and hedging accounting standards, which the filing stated could not yet be reasonably estimated.