United Natural Foods, Inc. — Fiscal 2020 Q3 Form 10-Q Summary
Business context and reporting period
UNFI distributes natural, organic, specialty, produce and conventional grocery and non-food products and provides support services in the United States and Canada. The filing covers the unaudited 13-week quarter and 39-week year-to-date periods ended May 2, 2020, compared with April 27, 2019. Results reflect the October 2018 Supervalu acquisition and the COVID-19 pandemic.
Key financial metrics
| Metric | Q3 FY2020 | Q3 FY2019 | FY2020 YTD | FY2019 YTD |
|---|---|---|---|---|
| Net sales | $6.668 billion | $5.963 billion | $18.825 billion | $14.980 billion |
| Gross profit | $856.5 million | $788.6 million | $2.403 billion | $1.963 billion |
| Gross margin | 12.85% | 13.22% | 12.77% | 13.10% |
| Operating income (loss) | $71.7 million | $69.7 million | $(377.4) million | $(357.3) million |
| Net income (loss) attributable to UNFI | $88.1 million | $57.1 million | $(326.5) million | $(303.9) million |
| Diluted EPS | $1.60 | $1.12 | $(6.10) | $(5.99) |
| Adjusted EBITDA | $222.2 million | $168.2 million | $475.0 million | $396.9 million |
Quarterly sales increased 11.8%, gross profit increased 8.6%, operating income increased modestly, and net income increased 54.4%. Year-to-date sales rose 25.7%, partly because FY2020 included an additional period of Supervalu results. Year-to-date results remained depressed by impairment charges and integration-related costs.
Operating expenses were $774.4 million in the quarter, or 11.61% of sales, compared with 12.37% in the prior-year quarter. Interest expense declined to $47.1 million from $54.9 million in the quarter, but increased year to date to $145.2 million from $121.1 million because of acquisition financing. The quarterly tax benefit included an approximately $28.4 million CARES Act benefit related to net operating loss carrybacks.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $452.3 million, including $311.1 million from continuing operations, versus $77.2 million total in the prior-year period.
- Year-to-date capital expenditures were $118.2 million versus $137.0 million; fiscal 2020 capital spending was estimated at approximately $190 million.
- Cash and cash equivalents were $56.4 million at May 2, 2020, compared with $42.4 million at August 3, 2019.
- Total debt, including current maturities, was $2.561 billion, down from $2.906 billion at fiscal year-end. The balance included $1.778 billion under the Term Loan Facility and $816.0 million under the ABL facility.
- ABL availability was $1.154 billion after $95.1 million of letters of credit. Total liquidity, including cash, was approximately $1.21 billion.
- Management stated that no material scheduled debt maturities were expected until fiscal 2024, although asset-sale and excess-cash-flow prepayments may be required.
- Operating lease liabilities totaled $1.016 billion on a present-value basis, and finance lease liabilities totaled $159.9 million.
Material changes versus the prior comparable period
- COVID-19 drove pantry loading, higher food-at-home spending and increased wholesale demand, particularly through supermarket and Whole Foods channels. Supermarkets sales rose 15.3% and Whole Foods sales rose 16.1% in the quarter.
- Gross margin declined because of a mix shift toward lower-margin conventional products and lower vendor promotional funding, partly offset by lower inventory shrink.
- UNFI incurred approximately $20 million of incremental continuing-operation operating expenses related to pandemic response, including emergency wages, overtime, safety measures and expanded logistics capacity.
- Fiscal 2020 year-to-date included $425.4 million of goodwill and asset impairment charges, including a $421.5 million impairment of U.S. Wholesale goodwill. This reduced reported operating results and contributed to the year-to-date net loss.
- Restructuring, acquisition and integration expenses declined to $10.4 million in the quarter and $54.4 million year to date, compared with $19.4 million and $134.6 million, respectively.
- UNFI adopted the new lease accounting standard at the beginning of fiscal 2020, recognizing approximately $1.1 billion of operating lease liabilities and corresponding right-of-use assets. The adoption did not materially affect operating results or cash flows.
- The company temporarily borrowed an additional $278.5 million on the ABL facility as a COVID-19 precaution, repaid it during the quarter, and made additional net ABL repayments of $371.2 million.
Outlook, commentary, risks and unusual items
Management expected near-term sales, margin and cost leverage benefits to continue while food-at-home spending remained elevated. It also expected fourth-quarter gross margin to be diluted year over year by customer and product mix changes and anticipated improved fill rates as logistics capacity expanded. Management cautioned that pandemic-related benefits could lessen or reverse as purchasing patterns normalize.
After quarter-end, UNFI determined that the Cub Foods business and most remaining Shoppers locations were no longer likely to be sold within one year. Beginning in the fourth quarter, these operations were expected to return to continuing operations, requiring presentation restatements and an estimated approximately $48 million of incremental depreciation and amortization expense.
Other significant matters include ongoing Supervalu integration and distribution-center consolidation, possible additional retail divestiture and restructuring costs, a $10.6 million multiemployer pension withdrawal liability recorded in the second quarter, and approximately $252 million of non-cancelable purchase obligations. The company disclosed approximately 38 opioid-related lawsuits and a False Claims Act case in which relators alleged damages exceeding $100 million before trebling and penalties; management considered the risk of loss reasonably possible but could not estimate a range.
Principal risks include the duration and severity of COVID-19, demand normalization or reversal of pantry-loading, supply-chain and facility disruptions, labor and safety costs, customer concentration, low industry margins, customer credit risk, additional impairment charges, execution of Supervalu synergies, retail divestiture costs, interest-rate and LIBOR transition risk, fuel costs, and multiemployer pension liabilities.
Important facts for investors to verify
- Whether COVID-19 sales gains and margin performance persist after consumer purchasing patterns normalize.
- The fourth-quarter accounting and financial impact of returning Remaining Retail to continuing operations, including the estimated $48 million depreciation and amortization adjustment.
- Cash conversion, inventory and accounts receivable levels, and whether working-capital cash benefits reverse as inventories and payables normalize.
- Progress on debt reduction, ABL availability, mandatory prepayments and compliance with credit agreement covenants.
- Potential additional goodwill, long-lived asset, lease and retail-disposal impairments or restructuring charges.
- The outcome and potential exposure from the False Claims Act litigation, opioid-related lawsuits and other contingencies.
- Execution of distribution-center consolidation, technology integration and anticipated Supervalu synergies.
- Continuing dependence on Whole Foods Market, whose distribution agreement was scheduled to expire September 28, 2025.