United Natural Foods, Inc. Fiscal 2018 Form 10-K Summary
Business context and reporting period
UNFI is a distributor of natural, organic and specialty foods and non-food products in the United States and Canada, serving more than 40,000 customer locations through 33 distribution centers totaling approximately 8.8 million square feet. The filing covers the 52-week fiscal year ended July 28, 2018; the fourth quarter ended July 28, 2018. Wholesale is the only reportable segment, supplemented by manufacturing, branded products and other activities.
Whole Foods Market was UNFI’s largest customer, representing approximately 37% of fiscal 2018 net sales. The distribution agreement expires September 28, 2025. During fiscal 2018, UNFI disposed of its Earth Origins retail business.
Financial performance and key metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $10.227 billion | $9.274 billion | +10.3% |
| Gross profit | $1.523 billion | $1.429 billion | +6.6% |
| Gross margin | 14.9% | 15.4% | Down 50 bps |
| Operating income | $227.2 million | $226.0 million | +0.5% |
| Operating margin | 2.2% | 2.4% | Down 20 bps |
| Net income | $165.7 million | $130.2 million | +27.3% |
| Diluted EPS | $3.26 | $2.56 | +27.3% |
| Cash flow from operations | $109.5 million | $280.8 million | Down $171.3 million |
| Capital expenditures | $44.6 million | $56.1 million | Down $11.5 million |
Net sales growth was led by Whole Foods Market, whose sales increased approximately 21.4% or $662 million. Supermarket sales increased 4.0%, independent-channel sales increased 6.0%, and other sales increased 3.5%.
Net income benefited from a lower effective tax rate of 22.1% versus 39.3% in the prior year. The reduction reflected the Tax Cuts and Jobs Act, including a $21.7 million tax benefit from remeasuring deferred tax liabilities and a $15.5 million benefit from the lower federal tax rate. Operating results were affected by customer mix, higher inbound freight costs, $16.1 million of Earth Origins restructuring and impairment charges, and approximately $5.0 million of acquisition-related costs for the pending SUPERVALU transaction.
Balance sheet, liquidity and debt
- Cash and cash equivalents were $23.3 million at July 28, 2018, compared with $15.4 million at the prior year-end.
- Working capital increased to $1.090 billion from $958.7 million, primarily because inventory increased $104.1 million to support demand.
- Total debt, including current and long-term debt, was approximately $360.2 million, consisting principally of $210.0 million under the ABL facility and $150.2 million of long-term debt.
- The existing ABL borrowing base was $884.5 million; borrowings were $210.0 million, letters of credit were $24.3 million, and remaining availability was $650.2 million.
- UNFI was not subject to the ABL fixed-charge coverage covenant during fiscal 2018 and was in compliance with the existing term-loan covenants.
- Total contractual obligations were $619.0 million, including $231.7 million of non-capitalized lease obligations, $210.0 million of ABL notes payable and $151.3 million of long-term debt maturities.
Operating cash flow declined substantially because accounts receivable increased $67.3 million and inventories increased $108.8 million. Financing activities used $54.0 million, including $24.2 million of share repurchases. The company had a $200 million repurchase authorization and repurchased 614,660 shares during fiscal 2018.
Material changes versus the prior comparable period
- Sales accelerated, particularly following Amazon’s acquisition of Whole Foods Market, but the increased concentration in lower-margin customer channels reduced gross margin.
- Operating income was essentially flat despite higher sales, as freight, fulfillment and restructuring costs offset operating leverage.
- Net income increased materially, primarily because of tax benefits associated with the TCJA and higher sales.
- Operating cash conversion weakened because of increased working-capital investment.
- UNFI recorded $16.1 million of Earth Origins restructuring and impairment expenses, including a $7.9 million goodwill impairment, $3.4 million of long-lived asset impairment and $2.7 million of disposition losses.
- A $20.9 million reduction in accounts payable from a change in estimate for supplier invoice accruals increased fiscal 2018 net income by $13.9 million, or $0.27 per diluted share.
- UNFI entered into an agreement to acquire SUPERVALU for approximately $2.9 billion, including assumed debt and liabilities. The transaction was pending at fiscal year-end.
Guidance, outlook, risks and unusual items
Management projected fiscal 2019 net sales growth of 8.6% to 10.5%, assuming continued natural and organic product demand. Management expected inbound freight headwinds to dissipate in the first half of fiscal 2019, subject to no further material increases in freight or fuel rates.
For the first full year after closing the SUPERVALU transaction, management projected combined net sales of approximately $24.2 billion to $24.8 billion and Adjusted EBITDA of $655 million to $675 million. Management expected more than $175 million of annual cost synergies by the third year after closing and $185 million by the fourth year, with approximately $95 million of Year One implementation costs and $110 million in years two through five. These projections are non-GAAP, exclude certain pension benefits and purchase-accounting effects, and depend on closing and integration.
- The SUPERVALU acquisition required antitrust and shareholder approvals and was expected to require up to $3.50 billion of additional debt, substantially increasing leverage, interest-rate exposure and covenant risk.
- On August 30, 2018, UNFI entered into a new $2.0 billion ABL facility and committed to a $2.05 billion term loan facility, subject to the merger closing and other conditions.
- UNFI intended to prepay approximately $110 million under its existing term loan on October 1, 2018 and fund the repayment with additional ABL borrowings.
- Customer concentration, especially Whole Foods Market, exposes results to changes in purchasing, self-distribution, store growth and contract terms.
- The business operates on low margins and faces pricing pressure from grocery consolidation, conventional distributors, direct distribution and online competitors.
- Other key risks include integration execution, warehouse-system implementation, freight and fuel costs, supply disruptions, food safety and recalls, labor relations, cybersecurity, customer credit losses, self-insurance reserves and goodwill impairment.
Important facts for investors to verify
- Whether the SUPERVALU acquisition closed on the expected timetable and the final purchase price, financing structure and resulting leverage.
- Actual post-close sales, margins, cash flow, synergy realization and integration costs compared with management’s projections.
- Whether Whole Foods Market concentration declined and whether the distribution agreement continues to generate expected volumes and economics.
- Inventory, receivables and operating cash flow trends, particularly after the fiscal 2018 working-capital build.
- Changes in gross margin and operating margin as supermarket and supernatural-channel sales expand.
- Compliance with financing covenants, borrowing-base availability and exposure to variable interest rates.
- Resolution of the supplier-accrual accounting estimate and any further Earth Origins or other impairment charges.