United Natural Foods, Inc. — Fiscal 2015 Second-Quarter Form 10-Q
Business context and reporting period
United Natural Foods, Inc. distributes and retails natural, organic and specialty products in the United States and Canada. The filing covers the three and six months ended January 31, 2015, compared with the periods ended February 1, 2014. The July 2014 acquisition of Tony’s Fine Foods contributed materially to reported growth.
Key financial metrics
| Metric | Three months ended January 31, 2015 | Six months ended January 31, 2015 |
|---|---|---|
| Net sales | $2.017 billion; up 22.5% | $4.009 billion; up 23.4% |
| Gross profit | $299.2 million | $618.2 million |
| Gross margin | 14.8%, versus 16.3% | 15.4%, versus 16.6% |
| Operating income | $49.5 million; 2.5% margin | $107.9 million; 2.7% margin |
| Net income | $27.8 million, or $0.55 diluted EPS | $60.9 million, or $1.21 diluted EPS |
| Net cash used in operating activities | Not separately provided | $(52.9) million |
- Six-month net sales growth was driven by Tony’s, organic growth across wholesale channels and approximately 2.1% food-price inflation. Tony’s contributed approximately $232.6 million of second-quarter sales and $447.4 million for the six months.
- Operating expenses were $249.7 million in the quarter and $510.3 million for the six months. Expense ratios improved to 12.4% and 12.7% of sales, respectively, from 13.3% and 13.6%.
- Interest expense increased to $3.6 million for the quarter and $6.8 million for the six months, reflecting higher borrowings and average interest rates.
- Cash and cash equivalents were $27.5 million at January 31, 2015. Working capital was $975.8 million.
- Total reported debt, including current debt, notes payable and long-term debt, was approximately $555.0 million. The company had $364.6 million outstanding under its revolving facility, $36.2 million of letters of credit and reserves, and $182.0 million of remaining revolver availability.
- Capital expenditures were $56.2 million for the six months; investing cash outflows were $66.3 million. Financing activities provided $131.1 million, including $150.0 million of term-loan borrowings.
Material changes versus the prior comparable period
- Revenue increased substantially, primarily from the Tony’s acquisition and continued growth in conventional supermarkets, Whole Foods Market and independent retailers.
- Profitability was pressured by lower-margin Tony’s and supermarket-related sales, lower fuel surcharges, unfavorable foreign exchange in Canada and a $7.7 million second-quarter reduction in sales related to a customer contractual obligation. Gross margin declined 150 basis points, while operating margin declined approximately 50 basis points.
- Quarterly net income was essentially flat versus the prior year, increasing from $28.0 million to $27.8 million as higher sales and lower operating-expense ratios were offset by margin dilution and higher interest expense. Six-month net income increased from $55.7 million to $60.9 million.
- The company entered into a $150.0 million real-estate-backed term loan and a forward-starting interest-rate swap effective August 3, 2015. The swap covers an initial $140.0 million notional amount at a fixed swap rate of 1.795% and is intended to produce an effective rate of approximately 4.295% on the hedged debt.
- The company identified a material weakness in internal control over financial reporting involving the completeness and accuracy of calculations of amounts owed to a customer. It recorded cumulative out-of-period sales reductions of $9.3 million, including $7.7 million in the second quarter, and stated that disclosure controls were not effective as of January 31, 2015.
Guidance, outlook, risks and unusual items
- Management expects fiscal 2015 sales to exceed the prior year, driven largely by Tony’s and continued growth in lower-gross-margin supermarket channels. No specific revenue or earnings-per-share guidance was provided.
- Management expects annual operating cash flow of approximately $75 million to $125 million for fiscal 2015 and fiscal 2016, and intends to keep fiscal 2015 capital expenditures at approximately 2.0% to 2.2% of net sales.
- The warehouse management and supply-chain system rollout is expected to reach all existing facilities by the end of fiscal 2017. New or expanded facilities in Wisconsin and California are expected to increase capacity but require additional capital.
- Key risks include customer concentration, particularly Whole Foods Market, which represented approximately 35% of quarterly sales and 34% of six-month sales; low industry margins; integration and synergy execution for Tony’s; supply-chain disruptions; fuel-price volatility; economic and consumer-spending conditions; inflation or deflation; and successful deployment of operating systems.
- Other unusual items include $0.2 million of second-quarter restructuring expense, approximately $0.6 million of facility startup costs, foreign-currency translation losses of $11.9 million for the six months, and a $0.4 million foreign-exchange loss included in other expense.
Important facts for investors to verify
- Whether the material weakness has been fully remediated and whether additional customer-obligation errors or restatements could arise.
- Whether Tony’s integration delivers expected revenue, cost synergies and acceptable margins without further dilution.
- Progress toward improving gross margins while expanding lower-margin supermarket channels.
- Operating-cash-flow conversion, inventory and receivables growth, and the company’s ability to fund planned capital expenditures while reducing debt.
- Compliance with the term-loan covenants, including the required fixed-charge coverage, leverage and loan-to-mortgaged-property-value ratios.
- Whole Foods Market concentration and the status and renewal terms of its distribution agreement, which expires September 25, 2020.