United Natural Foods, Inc. — Fiscal 2012 Second-Quarter Form 10-Q
Business context and reporting period
United Natural Foods, Inc. is a distributor and retailer of natural, organic and specialty foods and related products in the United States and Canada. The company serves more than 23,000 customer locations and operates wholesale, retail and manufacturing divisions; wholesale is its only reportable segment.
The filing covers the three and six months ended January 28, 2012, compared with the respective periods ended January 29, 2011. The financial statements are unaudited. Whole Foods Market represented approximately 37% of quarterly sales and 36% of year-to-date sales.
Financial performance and liquidity
| Metric | Three months ended Jan. 28, 2012 | Prior year | Six months ended Jan. 28, 2012 | Prior year |
|---|---|---|---|---|
| Net sales | $1.287 billion | $1.114 billion | $2.504 billion | $2.167 billion |
| Gross profit | $223.1 million | $198.6 million | $440.3 million | $391.0 million |
| Gross margin | 17.3% | 17.8% | 17.6% | 18.0% |
| Operating income | $37.5 million | $31.7 million | $63.6 million | $61.4 million |
| Operating margin | 2.9% | 2.9% | 2.5% | 2.8% |
| Net income | $22.0 million | $18.7 million | $37.2 million | $36.1 million |
| Diluted EPS | $0.45 | $0.39 | $0.76 | $0.77 |
- Quarterly sales increased 15.5%; year-to-date sales increased 15.5%. Growth reflected organic expansion, food-price inflation of approximately 4.4% in the quarter and 4.1% year to date, expanded Whole Foods distribution and new conventional-supermarket business.
- Quarterly net income rose approximately 17.5%, while year-to-date net income increased approximately 2.9%. Year-to-date diluted EPS declined because the prior-year period benefited from a lower share count following the 2010 equity offering.
- Six-month operating cash flow was negative $57.8 million, compared with negative $51.7 million in the prior year. Working-capital investment included increases of $79.5 million in inventories and $67.5 million in accounts receivable, partly offset by a $14.2 million increase in accounts payable.
- Six-month investing cash outflow was $15.0 million, including $12.9 million of capital expenditures and $2.5 million for acquisitions. Financing cash inflow was $82.9 million, primarily from $75.0 million of borrowings under notes payable.
- Cash and cash equivalents were $26.7 million at January 28, 2012, compared with $16.9 million at July 30, 2011. Working capital was $433.9 million, up from $381.1 million.
- Reported debt included $190.0 million of notes payable, $45.1 million of current long-term debt and $0.8 million of long-term debt, for approximately $235.9 million of balance-sheet debt excluding other obligations. The company also had a $400 million revolving facility, with $187.0 million of remaining availability after borrowings, letters of credit and reserves.
- The company was in compliance with its fixed-charge coverage covenants. The revolving facility matured November 27, 2012, and the $44.9 million term loan matured July 28, 2012; management expected to refinance or repay the term loan using a replacement revolving facility.
Material changes versus the prior comparable period
- Sales growth was led by Whole Foods Market and conventional supermarkets. Conventional-supermarket sales increased 32% in the quarter and 25% year to date; their share of sales increased to 25% and 24%, respectively, from 22% in both prior-year periods.
- Gross margin declined because of the greater mix of lower-margin Whole Foods and conventional-supermarket sales, as well as approximately $1.7 million of quarterly and $2.4 million of year-to-date inventory write-offs related primarily to perishables and storage issues.
- Operating expenses increased 11.2% in the quarter and 14.3% year to date, but decreased as a percentage of sales due to operating leverage and efficiency initiatives. Year-to-date expenses included approximately $5.3 million of severance and other costs from the divestiture of conventional non-food and general merchandise operations and approximately $1.6 million of start-up costs for a new national customer.
- The company completed the divestiture of its conventional non-food and general merchandise lines, closed the Harrison, Arkansas facility and classified approximately $2.6 million of property and equipment as held for sale. A second-quarter recovery of approximately $0.1 million reduced restructuring expenses.
- During the second quarter, UNFI Canada acquired substantially all assets of an Ontario specialty-food distributor for approximately $2.6 million, with potential earn-outs of up to $1.95 million. The purchase valuation remained provisional.
Guidance, outlook, commentary and risks
- Management expected fiscal 2012 net sales to continue growing versus fiscal 2011, driven by new and existing customers, broader product offerings and continued food-price inflation. The company expected most growth to come from lower-gross-margin Whole Foods and conventional-supermarket channels.
- Management projected annual operating cash flow of $75 million to $110 million for fiscal 2012 and fiscal 2013 and fiscal 2012 capital requirements of approximately $47 million to $52 million.
- The company planned to offset lower gross margins through supply-chain efficiencies, labor-management tools, fuel-management actions, centralization and rollout of its warehouse-management and procurement system to all distribution centers by the end of fiscal 2014.
- Key risks include dependence on major customers, particularly Whole Foods Market; low operating margins; economic and consumer-spending conditions; inflation and fuel costs; lower margins in conventional-supermarket growth; execution of the warehouse-management system rollout; acquisition integration; capital allocation; and refinancing of maturing debt facilities.
- Fixed-price fuel contracts covered approximately 3.6 million gallons through July 2012 at prices ranging from $3.56 to $3.90 per gallon. The company also maintained an interest-rate swap that fixed the effective rate on the hedged term-loan amount at approximately 5.70% and expired in July 2012.
- Management stated that routine litigation was not expected to have a material adverse effect, that there were no material changes to previously disclosed risk factors or contractual obligations, and that disclosure controls were effective.
Important facts for investors to verify
- Whether sales growth and new national-customer onboarding translate into sufficient cash generation after inventory and receivables normalize.
- Whether operating efficiencies can offset the continuing shift toward lower-margin customer channels.
- Renewal or replacement of the revolving credit facility and repayment or refinancing of the term loan before their 2012 maturities.
- Customer concentration, especially Whole Foods Market’s approximately 36% to 37% sales contribution.
- Final valuation and contingent consideration for the Ontario acquisition, and the ultimate proceeds from assets held for sale.
- Execution and costs associated with the warehouse-management and procurement-system rollout through fiscal 2014.