Business Context and Reporting Period
United Natural Foods, Inc. is a distributor and retailer of natural, organic and specialty products serving primarily the United States and Canada. This unaudited Form 10-Q covers the 13-week second quarter and 26-week year-to-date periods ended January 27, 2018, compared with the periods ended January 28, 2017.
The company operated 33 distribution centers, served more than 43,000 customer locations and offered more than 110,000 products. Wholesale is the only reportable segment; “Other” includes retail, manufacturing, branded products, brokerage and certain corporate costs.
Financial Highlights
| Metric | Q2 FY2018 | Q2 FY2017 | 26 Weeks FY2018 | 26 Weeks FY2017 |
|---|---|---|---|---|
| Net sales | $2.528 billion | $2.286 billion | $4.986 billion | $4.564 billion |
| Gross profit | $371.5 million | $344.9 million | $738.7 million | $694.0 million |
| Gross margin | 14.70% | 15.09% | 14.82% | 15.21% |
| Operating income | $40.2 million | $46.3 million | $95.3 million | $99.6 million |
| Operating margin | 1.59% | 2.02% | 1.91% | 2.18% |
| Net income | $50.5 million | $25.5 million | $81.0 million | $54.7 million |
| Diluted EPS | $0.99 | $0.50 | $1.59 | $1.08 |
| Net cash from operations | Not separately provided | Not separately provided | $(35.1) million | $96.9 million |
Q2 sales increased 10.6%; year-to-date sales increased 9.2%. Operating expenses were $331.3 million in Q2 and $643.4 million year to date. Interest expense was $4.2 million in Q2 and $7.9 million year to date.
Net income benefited materially from tax items associated with the Tax Cuts and Jobs Act. The Q2 tax provision was a benefit of $14.0 million, compared with a $16.5 million provision in the prior-year quarter. The year-to-date effective tax rate was 8.9%, versus 39.6% in the prior-year period.
Liquidity, Cash Flow and Capital Structure
- Cash and cash equivalents were $25.4 million at January 27, 2018, compared with $15.4 million at July 29, 2017.
- Cash flow from operations was negative $35.1 million year to date, primarily because accounts receivable increased $109.1 million and inventories increased $109.0 million, partially offset by a $60.6 million increase in accounts payable.
- Capital expenditures were $15.5 million year to date, compared with $22.7 million in the prior-year period.
- Total debt consisted of $287.0 million of revolving-credit borrowings, $156.1 million of long-term debt including the current portion, and related financing obligations included in long-term debt. The balance sheet separately reported $12.3 million of current debt and $143.8 million of long-term debt.
- The revolving credit facility had a borrowing base of $882.4 million, $30.3 million of outstanding letters of credit and remaining availability of $565.0 million at January 27, 2018. The facility matures April 29, 2021.
- The company reported compliance with its term-loan financial covenants and was not subject to the revolving-credit fixed-charge coverage covenant during Q2.
- Working capital increased 10.4% to approximately $1.06 billion from $958.7 million at July 29, 2017. Days inventory increased to 49 from 48, and days sales outstanding increased to 22 from 21.
Material Changes Versus Prior Comparable Period
- Sales growth was led by the supernatural-chain channel, consisting solely of Whole Foods Market. Whole Foods sales increased approximately 19% in Q2 and 17% year to date, and represented 37% and 36% of company sales, respectively, versus 34% and 33% in the comparable periods.
- Independent-retailer sales increased approximately 6% in both Q2 and the first 26 weeks. Conventional-supermarket sales also increased approximately 6% in both periods.
- Gross margin declined because lower-margin customer channels grew faster and inbound freight costs increased.
- Q2 operating income declined 13.1% to $40.2 million, while year-to-date operating income declined 4.3% to $95.3 million. Q2 included $11.2 million of restructuring and asset-impairment expenses.
- Despite lower operating income, net income increased because of the TCJA-related tax benefits and lower interest and other expenses.
- Debt-related interest expense declined year over year, primarily because of lower outstanding debt.
- The company repurchased 564,660 shares for $22.2 million during the first 26 weeks under a $200.0 million authorization; $177.8 million remained available at January 27, 2018.
Outlook, Commentary, Risks and Unusual Items
- Management expected fiscal 2018 sales to grow above fiscal 2017 levels, with growth primarily in lower-gross-margin supernatural and conventional supermarket channels.
- Management planned fiscal 2018 capital expenditures of approximately 0.6% to 0.7% of net sales and expected to fund operations and planned expenditures through operating cash flow and the revolving credit facility.
- The warehouse management system had been implemented at 15 facilities, with rollout to all existing U.S. broadline facilities expected by the end of fiscal 2019.
- The company expected to commence construction and open additional distribution-center capacity after fiscal 2018, which could increase capital requirements.
- Earth Origins, the 12-store retail business, recorded approximately $11.4 million of restructuring and impairment charges. The company decided to close three underperforming stores, including $0.2 million of severance and closure costs, $3.3 million of long-lived-asset impairments and $7.9 million of goodwill impairment. Approximately $2.6 million of additional exit-related restructuring charges were expected in the second half of fiscal 2018.
- The TCJA produced a provisional $21.9 million net benefit from remeasurement of deferred tax balances and a $6.5 million benefit from the lower federal tax rate. These estimates remained subject to adjustment during the SAB 118 measurement period.
- Key risks include dependence on Whole Foods Market, competitive pressure from conventional grocers and online distributors, low operating margins, customer and supplier concentration, supply-chain disruption, fuel and foreign-exchange volatility, execution of warehouse and transportation systems, and potentially higher Earth Origins exit costs.
- Management stated that there were no pending material legal proceedings, no material changes to previously disclosed risk factors and no material changes to contractual obligations.
Important Facts for Investors to Verify
- Whether Whole Foods Market sales concentration remains elevated and how the Amazon ownership relationship affects future volumes, margins and contract economics.
- Whether gross-margin pressure from channel mix and inbound freight persists, and whether operating efficiencies offset that pressure.
- The sustainability of reported net income and EPS excluding the nonrecurring or provisional TCJA tax benefits.
- Working-capital requirements, particularly the sharp year-to-date increases in receivables and inventory and the resulting negative operating cash flow.
- The final cost and timing of Earth Origins store closures, additional restructuring charges and any further impairment risk.
- Future borrowing levels, share repurchases, interest-rate exposure and compliance with term-loan and revolving-credit covenants.
- The timing, cost and operational benefits of the warehouse-management rollout and any new distribution-center construction.