United Natural Foods, Inc. 2011 Q3 Form 10-Q Summary
Business context and reporting period
United Natural Foods, Inc. is a distributor and retailer of natural, organic and specialty products serving the United States and Canada. This unaudited Form 10-Q covers the three and nine months ended April 30, 2011, compared with the periods ended May 1, 2010. Wholesale is the only reportable segment; “Other” includes retail, manufacturing and unallocated corporate activities.
Fiscal 2011 included the acquisition of SunOpta Distribution Group assets in Canada and the Rocky Mountain and Southwest distribution business of Whole Foods Market Distribution. The Whole Foods transactions made UNFI the primary distributor to Whole Foods Market in all U.S. regions.
Financial performance and liquidity
| Metric | Q3 FY2011 | Q3 FY2010 | 9M FY2011 | 9M FY2010 |
|---|---|---|---|---|
| Net sales | $1,204.0 million | $985.7 million | $3,371.4 million | $2,768.7 million |
| Gross profit | $218.5 million | $182.4 million | $609.5 million | $513.6 million |
| Gross margin | 18.2% | 18.5% | 18.1% | 18.6% |
| Operating income | $38.9 million | $33.8 million | $100.3 million | $88.6 million |
| Operating margin | 3.2% | 3.4% | 3.0% | 3.2% |
| Net income | $23.4 million | $19.5 million | $59.5 million | $50.7 million |
| Diluted EPS | $0.48 | $0.45 | $1.25 | $1.17 |
Q3 sales increased 22.1%, operating income increased 15.0%, and net income increased 19.9%. For the first nine months, sales increased 21.8%, operating income increased 13.2%, and net income increased 17.4%.
Operating expenses increased 20.9% in Q3 and 19.8% year to date, but declined as a percentage of sales to 14.9% from 15.1% in Q3 and to 15.1% from 15.3% year to date. The effective tax rate was 40.0% in Q3 and 39.4% year to date, compared with 40.0% in the prior-year periods.
Cash and cash equivalents were $24.3 million at April 30, 2011, compared with $13.8 million at July 31, 2010. Nine-month operating cash flow was a use of $32.8 million, versus cash provided of $33.1 million in the prior year, primarily because of increases in inventory of $101.8 million and accounts receivable of $62.2 million. Investing cash use was $46.4 million, including $24.5 million of capital expenditures and $22.0 million for acquired businesses.
Financing activities provided $89.8 million, including $138.3 million of net proceeds from a secondary common stock offering and $65.6 million of net repayments under notes payable. The company reported $177.0 million outstanding under its revolving credit facility, $21.8 million of letters of credit and approximately $199.9 million of remaining availability. Long-term debt, including the current portion, was $49.7 million. The company was in compliance with its fixed-charge coverage covenants.
Working capital increased to $391.3 million from $194.2 million at July 31, 2010. Days in inventory remained 50, while days sales outstanding increased to 21 from 20.
Material changes versus the prior comparable period
- Sales growth reflected organic growth, new conventional supermarket customers, the Canadian acquisition and expanded Whole Foods distribution. Whole Foods represented approximately 36% of sales in both Q3 periods.
- Q3 sales from UNFI Canada were approximately $56.7 million; incremental sales from the expanded Whole Foods relationship were approximately $39.2 million. Nine-month amounts were $148.6 million and $94.3 million, respectively.
- Sales mix shifted toward lower-margin supernatural and conventional supermarket channels. Those channels represented approximately 58% of Q3 and nine-month sales, compared with 56% and 55%, respectively, in the prior-year periods.
- Gross margin declined because of channel mix and higher inbound freight costs. Year-to-date results also reflected start-up costs and inefficiencies at the Lancaster, Texas facility.
- Year-to-date operating expenses included $4.4 million of Lancaster start-up labor and other costs, $0.6 million of executive severance and $0.2 million of intangible impairment charges, partially offset by a $2.6 million litigation and arbitration settlement.
- The October 2010 secondary offering increased shares outstanding and reduced revolving-credit borrowings. Common shares issued during the offering totaled approximately 4.4 million.
Guidance, outlook, risks and unusual items
Management expected fiscal 2011 sales to improve over fiscal 2010, with growth led by the Whole Foods and conventional supermarket channels. These channels are expected to produce lower gross margins than independent retailers, although they generally have lower costs to serve.
Management expected supply-chain, warehouse-management and information-technology initiatives to reduce operating expenses as a percentage of sales. The company expected approximately three to five quarters to fully realize the targeted operating efficiencies and planned implementation of its warehouse-management and procurement system across distribution centers by the end of fiscal 2013.
Management projected $30 million to $50 million of annual operating cash flow for fiscal 2011 and 2012, capital expenditures of no more than approximately 1% of sales for those years, and fiscal 2011 capital expenditures of $42 million to $45 million. The filing states that cash on hand and available credit were sufficient for operations and planned capital expenditures over the following twelve months.
Key risks include dependence on major customers, particularly Whole Foods Market; low-margin and economically sensitive operations; inflation and fuel-price increases; execution of the Lancaster and national warehouse-management systems; Canadian operational initiatives; acquisition integration; capital allocation; consumer spending; supply shortages; and covenant or refinancing considerations as the $400 million revolving facility approached its November 2012 maturity.
The company used fixed-price diesel supply agreements covering approximately 2.8 million gallons through July 2011 and maintained an interest-rate swap with a fair-value liability of $1.6 million at April 30, 2011. Routine litigation was not expected to have a material adverse effect. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Investor verification items
- Verify the sustainability of sales growth and the concentration of approximately 36% of sales with Whole Foods Market.
- Assess whether the lower-margin channel mix can be offset by operating efficiencies and supply-chain improvements.
- Monitor inventory and receivables growth, working-capital requirements and the conversion of earnings into operating cash flow.
- Confirm integration results and incremental profitability from the Canadian and expanded Whole Foods businesses.
- Review progress at the Lancaster facility and the planned company-wide warehouse-management system rollout.
- Evaluate liquidity, covenant compliance, revolving-credit availability and refinancing needs before the November 2012 maturity.
- Consider exposure to diesel fuel prices, inflation, interest rates, customer concentration and acquisition-related contingencies.