United Natural Foods, Inc. Fiscal 2015 Form 10-K Summary
Business context and reporting period
United Natural Foods, Inc. (UNFI) is a distributor and retailer of natural, organic and specialty foods and non-food products in the United States and Canada. The filing covers the 52-week fiscal year ended August 1, 2015; fourth-quarter data are also provided. UNFI operated 31 distribution centers totaling approximately 7.7 million square feet, served more than 40,000 customer locations and offered more than 85,000 products. The company’s principal reportable segment was wholesale distribution, with retail, manufacturing and branded-products activities reported as “Other.”
UNFI completed its acquisition of Tony’s Fine Foods in July 2014 for approximately $202.7 million. Tony’s contributed approximately $882.8 million of fiscal 2015 net sales. Whole Foods Market remained UNFI’s largest customer, representing approximately 35% of fiscal 2015 net sales; its distribution agreement expires September 25, 2020.
Financial performance and key metrics
| Metric | Fiscal 2015 | Fiscal 2014 | Change |
|---|---|---|---|
| Net sales | $8.185 billion | $6.794 billion | Up 20.5% |
| Gross profit | $1.261 billion | $1.128 billion | Up 11.8% |
| Gross margin | 15.4% | 16.6% | Down 120 basis points |
| Operating income | $242.0 million | $210.8 million | Up 14.8% |
| Operating margin | 3.0% | 3.1% | Down 10 basis points |
| Net income | $138.7 million | $125.5 million | Up 10.6% |
| Diluted EPS | $2.76 | $2.52 | Up 9.5% |
| Cash flow from operations | $48.9 million | $62.4 million | Down $13.6 million |
| Capital expenditures | $129.1 million | $147.3 million | Down $18.2 million |
Fiscal 2015 sales growth included 7.9% organic growth, Tony’s contributions and approximately 2% food-price inflation. Sales increased across all customer categories: independently owned natural-products retailers rose 19.2%, Whole Foods Market rose approximately 16.5%, conventional supermarkets rose 21.5%, and other sales rose 47.5%.
The lower gross margin primarily reflected dilution from Tony’s, a shift toward lower-margin supernatural-chain and conventional-supermarket sales, the $9.3 million customer-contract adjustment, unfavorable Canadian foreign exchange and lower fuel surcharges. Operating expenses rose 11.1% but declined to 12.4% of sales from 13.5%, providing partial offset.
Fiscal 2015 operating expenses included approximately $3.0 million of facility start-up costs, $0.6 million of Canadian intangible-asset impairment, $0.2 million of restructuring costs and $0.3 million of Tony’s acquisition costs, partially offset by a $0.8 million energy grant. A $4.2 million gain from a Prescott, Wisconsin land transfer was included in other income.
Liquidity, debt and cash flow
- Cash and cash equivalents were $17.4 million at August 1, 2015, compared with $16.1 million a year earlier.
- Working capital was $1.023 billion, up from $854.5 million, driven primarily by higher inventory and receivables.
- Inventories increased to $982.6 million from $834.7 million; days in inventory improved slightly to 50 from 51. Days sales outstanding improved to 22 from 23.
- Revolving-credit borrowings were $363.0 million. The borrowing base was $581.4 million, with $35.2 million of letters of credit and $2.6 million of reserves; remaining availability was $180.6 million.
- Long-term debt, including the current portion, was $186.4 million, versus $33.5 million in fiscal 2014. This included a $140.0 million real-estate-backed term loan and a $13.9 million capital lease obligation.
- Total long-term debt and capital leases, excluding the current portion, were $174.8 million. Total contractual obligations were $837.8 million, including debt, leases, inventory commitments and diesel-fuel commitments.
- Net cash used in investing activities was $142.1 million, reflecting $129.1 million of capital expenditures and no major acquisition during fiscal 2015. Net cash provided by financing activities was $94.4 million.
Management stated that cash on hand and available revolving-credit capacity were sufficient for operations and planned capital expenditures over the next 12 months. Management expected annual operating cash flow of approximately $75 million to $125 million in fiscal 2016 and fiscal 2017, fiscal 2016 capital expenditures of approximately $49 million to $59 million, and capital expenditures of approximately 0.6% to 0.7% of fiscal 2016 net sales, excluding potential sale-leaseback transactions.
Material changes versus the prior comparable period
- Tony’s was included for a full fiscal year in 2015 versus only the fourth quarter in 2014, materially increasing sales and adding perishable, protein, cheese, deli and foodservice distribution capabilities.
- Sales grew substantially, but gross margin declined from 16.6% to 15.4% because of product and customer mix, Tony’s dilution and other stated items.
- Operating expense leverage improved, with operating expenses falling from 13.5% to 12.4% of sales.
- Interest expense increased from $7.8 million to $14.5 million because of higher borrowings, higher average rates and the Providence headquarters capital lease.
- Cash flow from operations declined despite higher net income, primarily because inventory increased $153.7 million and accounts receivable increased $42.3 million.
- UNFI opened its Hudson Valley, New York and Prescott, Wisconsin distribution centers and continued construction of a Gilroy, California facility, expected to begin operations in the third quarter of fiscal 2016.
- The company recorded a cumulative $7.7 million out-of-period adjustment and a total fiscal 2015 net-sales reduction of $9.3 million related to an incorrect calculation of customer contractual obligations. Management deemed the errors immaterial to prior and current periods.
Guidance, outlook, commentary and risks
Management expected fiscal 2016 net sales to increase but at a lower rate than fiscal 2015 because a significant conventional-supermarket customer was terminating its relationship in September 2015. UNFI expected approximately $4 million to $5 million of restructuring expense in the first quarter of fiscal 2016, principally for severance related to that termination. Management expected continued growth from new customers, additional products sold to existing customers, specialty products, Tony’s offerings and food-price inflation, while acknowledging that much of the growth would be in lower-margin channels.
- Customer concentration is significant: Whole Foods Market represented approximately 35% of fiscal 2015 sales, and conventional supermarkets represented approximately 26%.
- The company operates in a low-margin, highly competitive distribution industry and faces pricing pressure, customer consolidation, direct manufacturer sales and customer self-distribution.
- Growth in lower-margin channels and fresh perishables may pressure gross margins if operating efficiencies do not offset the mix shift.
- Integration of Tony’s, new facilities and the national warehouse-management and procurement system could involve execution costs, disruptions and delays. The system rollout was expected to be completed by the end of fiscal 2018.
- UNFI had no outstanding commodity swap agreements at year-end and remained exposed to diesel-fuel volatility, although it had fixed-price fuel commitments totaling approximately $21.7 million.
- The company is exposed to variable interest rates. A swap effective August 3, 2015 was intended to fix the effective rate on $140.0 million of term-loan debt at approximately 4.295%.
- Debt agreements include financial and operating restrictions. The revolving facility had a springing fixed-charge coverage covenant, but UNFI was not subject to that covenant at year-end because availability exceeded the applicable threshold. The term loan includes leverage, fixed-charge and loan-to-value covenants.
- UNFI is primarily self-insured for workers’ compensation and automobile liability and had $18.7 million of related accrued liabilities at year-end.
- Risks also include supply interruptions, severe weather and drought, food safety and product recalls, regulatory compliance, cybersecurity incidents, labor disputes, customer credit losses and adverse legal proceedings.
- Management identified a material weakness in internal control during fiscal 2015 related to customer contractual-obligation calculations, implemented remediation and concluded that internal control over financial reporting was effective as of August 1, 2015. KPMG provided an unqualified opinion on the financial statements and internal controls.
Most important facts for investors to verify
- Whether the lost conventional-supermarket customer produces the expected sales decline and the projected $4 million to $5 million restructuring charge in fiscal 2016.
- Whether Tony’s integration and the company’s perishable-food strategy generate sufficient growth and synergies without further gross-margin dilution.
- Progress, cost and operating benefits from the warehouse-management, procurement and transportation-technology rollout.
- Inventory growth, working-capital conversion and operating cash flow relative to reported net income.
- Revolving-credit availability, term-loan and fixed-charge covenant compliance, and sensitivity to interest-rate changes.
- Dependence on Whole Foods Market and the effect of customer concentration, pricing pressure and supplier or customer consolidation.
- Effectiveness of the remediation of the prior control weakness and whether additional contractual-obligation errors arise.
- Exposure to fuel costs, food inflation or deflation, foreign exchange, supply disruptions, recalls, labor actions and self-insured claims.