UNITED NATURAL FOODS INC annual report, FY2020

United Natural Foods, Inc. — Fiscal 2020 Form 10-K Summary

Reporting period: Fiscal year ended August 1, 2020 (52 weeks), compared with fiscal 2019 ended August 3, 2019 (53 weeks). Results include the impact of the October 2018 SUPERVALU acquisition and the COVID-19 pandemic.

Business context

UNFI is a distributor of natural, organic, specialty, produce, conventional grocery and non-food products, with related retailer services in the United States and Canada. It operates primarily through Wholesale and Retail reportable segments, with additional manufacturing and branded-product activities. The company served approximately 30,000 customer locations through 55 distribution centers and warehouses totaling approximately 29 million square feet.

During the fourth quarter, UNFI determined that Cub Foods and most remaining Shoppers locations no longer met the criteria for probable sale within 12 months. These businesses were reclassified from discontinued operations to continuing operations, and prior periods were recast.

Key financial metrics

Metric	Fiscal 2020	Fiscal 2019	Change
Net sales	$26.514 billion	$22.307 billion	+18.9%
Gross profit	$3.875 billion	$3.209 billion	+20.8%
Gross margin	14.61%	14.38%	+23 basis points
Operating income (loss)	$(195.6) million	$(199.8) million	Improved $4.2 million
Operating margin	(0.74)%	(0.90)%	Improved
Net loss attributable to UNFI	$(274.1) million	$(284.7) million	Improved $10.6 million
Diluted loss per share	$(5.10)	$(5.56)	Improved
Adjusted EBITDA	$672.9 million	$562.9 million	+19.6%
Adjusted EBITDA margin	2.54%	2.52%	+2 basis points

Fiscal 2020 included $425.4 million of goodwill and asset impairment charges, including a $421.5 million impairment of all goodwill assigned to the U.S. Wholesale reporting unit. Restructuring, acquisition and integration expenses were $86.4 million, while the company recorded a $50.0 million non-cash charge associated with returning Retail assets to continuing operations.

Cash flow, debt and liquidity

Cash provided by operating activities of continuing operations was $452.4 million, compared with $289.0 million in fiscal 2019.
Capital expenditures were $172.6 million, down from $228.5 million.
Total debt was $2.498 billion at year-end, down $408.9 million from $2.907 billion.
Cash and cash equivalents were $47.0 million; working capital was $1.335 billion.
Total liquidity was approximately $1.28 billion, including $1.235 billion of unused ABL Credit Facility availability.
UNFI repaid a net $323.3 million under the ABL Credit Facility and $91.9 million of Term Loan Facility principal during fiscal 2020.
The company made a $72.0 million excess-cash-flow debt prepayment in the first quarter of fiscal 2021. Other fiscal 2021 debt maturities were expected to be $12.8 million.
Interest expense, net increased to $191.6 million from $180.8 million. Approximately $1.99 billion of debt notional was hedged through interest-rate swaps.

Material changes versus the prior comparable period

Net sales growth reflected a full additional 12 weeks of SUPERVALU results in fiscal 2020, partially offset by the extra 53rd week in fiscal 2019. Underlying sales excluding these effects increased approximately 6.2%.
COVID-19 materially increased food-at-home demand, especially in the second half of fiscal 2020. Wholesale and Retail volumes benefited, although foodservice, bulk and certain international categories declined.
UNFI estimated approximately $56 million of incremental COVID-19 operating expenses, including temporary wage increases, overtime, safety measures and higher logistics costs.
Gross margin improved overall, primarily because of Retail mix and lower promotional activity, but Wholesale gross margin declined 12 basis points, including pressure from conventional-product mix and reduced vendor promotions.
Operating expenses increased 19.3% and rose modestly as a percentage of sales, reflecting higher incentive compensation, pandemic costs and bad debt expense associated with customer bankruptcies.
Adjusted EBITDA increased to $672.9 million, led by Wholesale Adjusted EBITDA of $591.0 million, up 28%, and Retail Adjusted EBITDA of $86.4 million, up 153%.
UNFI completed the consolidation of five Pacific Northwest distribution centers into two facilities and recorded a $10.6 million multiemployer pension withdrawal liability related to the consolidation.
Goodwill declined from $442.3 million to $19.6 million following the U.S. Wholesale impairment.
UNFI adopted ASC 842 lease accounting, recognizing approximately $983 million of operating lease assets and $1.005 billion of operating lease liabilities at year-end.

Guidance, outlook and management commentary

Management expected sales and margin benefits to remain above historical levels while food-at-home spending remained elevated, but cautioned that benefits could lessen or reverse as consumer behavior normalizes.
Management planned to use free cash flow primarily to reduce debt and improve leverage after investing in the business.
Fiscal 2021 capital expenditures were expected to be $200 million to $250 million, primarily for distribution-network optimization and technology.
UNFI expected additional distribution-center integration costs and continued cost-saving opportunities beyond the $185 million minimum long-term SUPERVALU synergy target, which management stated it had exceeded.
The company intended to pursue cross-selling, private-brand growth, e-commerce and expanded retailer services.
UNFI planned to divest Retail assets over the intermediate term, but could not reasonably estimate the eventual costs and charges, including severance, store closures, stranded costs and potential multiemployer pension liabilities.
The Save-A-Lot services agreement was expected to wind down near December 2021, putting approximately $24 million of fiscal 2020 services revenue at risk unless replaced or offset by cost reductions.

Principal risks and contingencies

Whole Foods Market represented approximately 18% of fiscal 2020 net sales; its distribution agreement expires September 28, 2025. Changes in purchasing, self-distribution or renewal terms could materially affect results.
The business operates at low margins and faces intense competition, retailer consolidation, direct manufacturer distribution, customer self-distribution and e-commerce pressure.
COVID-19 creates uncertainty regarding demand normalization, supply-chain disruptions, labor availability, facility closures, vendor out-of-stocks, safety costs and foodservice demand.
Leverage remains substantial, with approximately $2.50 billion of debt, variable-rate exposure and restrictive debt covenants. Debt maturities and mandatory prepayments require continued cash generation and asset-sale proceeds.
Retail divestitures may produce lower proceeds than expected and may leave stranded leases, liabilities and pension obligations.
Multiemployer pension plans are generally underfunded. Fiscal 2020 contributions were $52.3 million, and contractual withdrawal liabilities totaled approximately $51.6 million at year-end; further withdrawals could create material obligations.
Customer bankruptcies increased bad debt expense; the allowance for uncollectible receivables rose to $55.9 million from $20.7 million.
Future impairment charges remain possible because goodwill and asset valuations depend on forecasts, discount rates, market capitalization and operating performance.
The company disclosed pending opioid-related litigation and an appeal of a False Claims Act matter, although no material legal accrual had been recorded for the disclosed proceedings as of year-end.

Investor verification checklist

Verify the sustainability of COVID-related sales gains, gross-margin performance and elevated food-at-home demand.
Reconcile Adjusted EBITDA to GAAP results and assess the recurring nature of integration, impairment, restructuring and other adjustments.
Monitor debt reduction, the $72.0 million excess-cash-flow payment, future maturities and ABL availability.
Assess progress and final economics of Retail divestitures, including stranded lease and pension obligations.
Evaluate Whole Foods retention and contract-renewal risk before the September 2025 expiration.
Review customer credit quality, bad debt trends and exposure to financially stressed independent retailers.
Assess the impact of reduced vendor promotions, product shortages, labor costs and distribution-center integration.
Review multiemployer pension funding status, collective bargaining expirations and potential withdrawal liabilities.
Confirm the effect of ASC 842 lease liabilities and other contractual obligations, which totaled approximately $5.265 billion in the disclosed schedule.