Business Context and Reporting Period
United Natural Foods, Inc. is a distributor and retailer of natural, organic and specialty foods and non-food products in the United States and Canada. The company operates wholesale, retail and manufacturing businesses; wholesale is its only reportable segment. This unaudited Form 10-Q covers the quarter and six months ended January 26, 2013, compared with January 28, 2012.
Financial Highlights
| Metric | Three Months Ended Jan. 26, 2013 | Year-over-Year Change | Six Months Ended Jan. 26, 2013 | Year-over-Year Change |
|---|---|---|---|---|
| Net sales | $1,445.7 million | Up 12.3% | $2,855.7 million | Up 14.0% |
| Gross profit | $241.7 million | Up 8.3% | $477.6 million | Up 8.5% |
| Gross margin | 16.7% | Down from 17.3% | 16.7% | Down from 17.6% |
| Operating income | $39.0 million | Up 3.9% | $75.5 million | Up 18.8% |
| Operating margin | 2.7% | Down from 2.9% | 2.6% | Up from 2.5% |
| Net income | $22.6 million | Up from $22.0 million | $44.2 million | Up from $37.2 million |
| Diluted earnings per share | $0.46 | Up from $0.45 | $0.89 | Up from $0.76 |
Six-month operating results benefited from lower operating expenses as a percentage of sales, higher fixed-cost leverage and expense controls. The six-month effective tax rate was 35.6%, compared with 39.4%, primarily because of a $2.9 million net discrete tax benefit. Excluding those items, management estimated an annual effective tax rate of approximately 39.8%.
Cash Flow, Debt and Liquidity
- Cash used in operating activities was $48.6 million for the first six months, improving from $57.8 million used in the prior-year period. Working-capital investment included $94.6 million of inventory growth and $51.1 million of accounts-receivable growth.
- Cash used in investing activities was $27.0 million, including $20.0 million of capital expenditures and $9.3 million for acquired businesses.
- Cash provided by financing activities was $67.3 million, principally reflecting $361.9 million of revolving-credit borrowings, partially offset by $302.8 million of repayments.
- Cash and cash equivalents declined to $8.1 million at January 26, 2013, from $16.1 million at July 28, 2012.
- Total notes payable and long-term debt were approximately $175.2 million, including $173.9 million outstanding under the revolving credit facility. Total liabilities were $651.5 million and stockholders’ equity was $1,028.7 million.
- The amended revolving credit facility has a $500 million commitment and matures May 24, 2017. At January 26, 2013, the borrowing base was $475.3 million, outstanding borrowings were $173.9 million, letters of credit and reserves were $34.1 million, and remaining availability was $267.3 million.
- Management stated that cash on hand and available credit were sufficient for operations and planned capital expenditures over the next twelve months.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by organic wholesale growth, increased conventional-supermarket activity, Whole Foods Market growth, approximately 2.0% food-price inflation in the quarter, and $14.3 million of quarterly sales from three acquisitions completed during the first quarter of fiscal 2013. The acquisitions contributed $25.5 million of sales for the six-month period.
- Whole Foods Market represented approximately 37% of quarterly and six-month sales. Conventional supermarkets represented 25% of quarterly sales and 25% of six-month sales, up from 24% in the prior-year six-month period.
- Gross margin declined because of customer and product mix shifts toward lower-margin supermarket channels, fewer promotional opportunities, increased private-label sales, higher shrink and freight costs, and supplier out-of-stocks.
- Operating expenses increased in absolute dollars but declined as a percentage of sales to 14.0% from 14.4% for the quarter and to 14.1% from 15.0% for six months.
- Quarterly operating expenses included $3.6 million of labor-action costs at the Auburn, Washington facility. The labor action was resolved in February 2013, with normalized labor costs expected beginning in the third quarter.
- Six-month other expense included a $4.9 million charge to settle a multi-state unclaimed-property audit. The period also included a $1.6 million impairment charge related to termination of a licensing agreement.
- Three acquisitions required approximately $9.2 million of cash consideration and may require up to $3.7 million of contingent consideration through February 2017. Valuations of acquired intangible assets remained provisional.
Guidance, Outlook and Risks
- Management expected fiscal 2013 sales to exceed fiscal 2012 sales, supported by new and existing customers, specialty-food distribution, supermarket growth and moderate food-price inflation.
- Management expected operating cash flow of approximately $70 million to $100 million in each of fiscal 2013 and fiscal 2014 and intended to limit fiscal 2013 capital expenditures to approximately 1.3% of net sales.
- The company expected supermarket-channel growth to outpace independent-retailer growth, resulting in continued pressure on gross-margin percentages. It plans to offset this pressure through supply-chain efficiencies, information-technology improvements and rollout of its warehouse-management and procurement system.
- The system was expected to be deployed at a third facility in the second half of fiscal 2013 and completed across all distribution centers by the end of fiscal 2016.
- Key risks include customer concentration, particularly Whole Foods Market; economic and consumer-spending conditions; lower margins in conventional and supernatural channels; fuel-price volatility; inflation or deflation; supply-chain disruptions; execution of warehouse and transportation systems; acquisition integration; and capital-allocation decisions.
- The company had fixed-price agreements covering approximately 5.2 million gallons of diesel fuel through July 2013 at prices ranging from $3.33 to $3.99 per gallon.
- Management reported no material changes to previously disclosed risk factors or contractual obligations, no material adverse effect expected from routine litigation, and effective disclosure controls as of the period end.
Facts Investors Should Verify
- Whether sales concentration with Whole Foods Market remains approximately 37% and whether the distribution agreement remains effective through September 2020.
- Whether lower gross margins from supermarket-channel growth are offset by operating efficiencies as management expects.
- Whether working-capital growth, particularly inventory and receivables, converts into positive operating cash flow.
- The final valuation and contingent consideration for the three fiscal 2013 acquisitions.
- The financial impact of the unclaimed-property settlement, licensing-asset impairment and Auburn labor-action costs.
- Progress and costs associated with the new Aurora, Colorado distribution center and the warehouse-management system rollout.
- Compliance with revolving-credit availability requirements and the springing fixed-charge coverage covenant if availability declines.