Business Context and Reporting Period
United Natural Foods, Inc. filed this unaudited Form 10-Q for the 13-week period ended October 27, 2018, the first quarter of fiscal 2019. The company distributes natural, organic, specialty and conventional grocery and non-food products in the United States and Canada.
On October 22, 2018, UNFI completed its approximately $2.3 billion acquisition of SUPERVALU INC. The quarter includes only five days of Supervalu operating results. Supervalu’s acquired retail operations were classified as discontinued operations and are intended to be divested.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $2.868 billion | $2.458 billion | Up 16.7% |
| Gross profit | $412.3 million | $367.2 million | Up 12.3% |
| Gross margin | 14.38% | 14.94% | Down 56 basis points |
| Operating expenses | $363.2 million | $312.1 million | Up 16.4% |
| Restructuring, acquisition and integration expenses | $68.0 million | None reported | New in period |
| Operating income (loss) | $(18.8) million | $55.1 million | Down $73.9 million |
| Net income (loss attributable to UNFI) | $(19.3) million | $30.5 million | Decline of $49.8 million |
| Diluted earnings (loss) per share | $(0.38) | $0.60 | Decline of $0.98 |
| Cash flow from operations | $(107.0) million | $(40.2) million | Higher use of cash |
| Capital expenditures | $16.4 million | $5.3 million | Up $11.1 million |
Continuing operations generated a net loss of $21.4 million, partly offset by $2.1 million of after-tax income from discontinued operations. The effective tax rate for continuing operations was 16.6%, compared with 41.8% in the prior-year quarter.
Liquidity, Debt and Balance Sheet
- Cash and cash equivalents were $53.9 million at October 27, 2018. Restricted cash of $566.4 million was deposited with the trustee for the redemption of Supervalu senior notes and was used to extinguish those notes on November 21, 2018.
- Total debt and capital lease obligations were $2.655 billion, compared with $150.2 million at July 28, 2018. Notes payable were $1.315 billion, and long-term debt excluding current maturities was $1.924 billion.
- The new Term Loan Facility totaled $1.950 billion, comprising a $1.800 billion seven-year tranche and a $150.0 million 364-day tranche due October 21, 2019.
- The ABL Credit Facility provided commitments of $2.100 billion. ABL borrowings were $1.327 billion, letters of credit were $78.9 million, and remaining availability was $682.4 million.
- Net cash used in investing activities was $2.141 billion, primarily reflecting the Supervalu acquisition, partially offset by $149.5 million of proceeds from distribution-center sale-leasebacks.
- Working capital increased by $567.6 million to approximately $1.66 billion, primarily due to the acquisition.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected the Supervalu acquisition and a 20% increase in sales to Whole Foods Market. Whole Foods represented approximately 36% of quarterly sales versus 35% in the prior-year quarter.
- Gross margin declined because of customer mix, growth in the lower-margin supernatural channel, higher inbound freight costs, and competitive pricing pressure, partly offset by vendor support and fuel-surcharge income.
- Operating results were reduced by $68.0 million of restructuring, acquisition and integration expenses, including $33.8 million of change-in-control payments and severance-related costs and approximately $31.9 million of acquisition and integration costs.
- Interest expense increased to $7.7 million from $3.7 million due to substantially higher debt incurred to fund the acquisition.
- The company adopted ASC 606 revenue recognition and new restricted-cash presentation requirements without a significant income statement or cash flow impact. It also changed the classification of book overdraft changes from financing to operating activities.
Outlook, Commentary, Risks and Unusual Items
- Management expects approximately $12 million of additional restructuring expense and approximately $45 million of additional acquisition and integration costs during the remainder of fiscal 2019, excluding retail-divestiture costs.
- The company expects to record approximately $17 million of closed-store reserve expense in the second quarter of fiscal 2019 related to Shop ’n Save closures.
- Fiscal 2019 capital spending is not expected to exceed 1.5% of net sales; longer-term capital spending is expected to be approximately 1.0% of net sales.
- Management expects substantially higher future interest expense because of acquisition-related borrowing and expects approximately $35 million of net periodic benefit income, excluding service cost, for fiscal 2019.
- UNFI expects fiscal 2019 contributions of approximately $5 million to $10 million to company-sponsored pension and postretirement plans and approximately $40 million to $50 million of contributions to multiemployer pension plans, subject to conditions and negotiations.
- Management cited integration and execution risks relating to Supervalu, including distribution-network optimization, systems integration, customer retention, realization of synergies and potential stranded costs from retail divestitures.
- Other significant risks include customer concentration, particularly Whole Foods Market; low operating margins and intense competition; variable interest rates and high leverage; labor and multiemployer pension obligations; supply-chain disruption; fuel costs; technology and cybersecurity risks; product liability; and potential impairment of goodwill or long-lived assets.
- The preliminary Supervalu purchase-price allocation remains subject to measurement-period adjustments. The company’s disclosure controls were deemed effective, but Supervalu’s internal controls were still being integrated.
Investor Verification Checklist
- Verify the final Supervalu purchase-price allocation, goodwill and intangible-asset valuations and any related impairment risk.
- Track debt reduction, refinancing of the $150.0 million 364-day tranche, ABL availability and compliance with applicable covenants.
- Assess whether projected Supervalu synergies offset integration costs, restructuring charges, margin pressure and higher interest expense.
- Confirm the timing, proceeds, supply agreements and stranded obligations associated with the planned retail divestitures.
- Monitor Whole Foods customer concentration and the September 2025 distribution agreement.
- Evaluate cash conversion, working-capital requirements and the effect of inventory, receivables and vendor-fund assumptions on operating cash flow.
- Review exposure to underfunded multiemployer pension plans, including the $35.7 million withdrawal liability and potential future contributions.