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UNFI > SEC Filings for UNFI > Form 10-Q on 6-Jun-2013All Recent SEC Filings

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Form 10-Q for UNITED NATURAL FOODS INC


6-Jun-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. In some cases you can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plans," "planned," "seek," "should," "will," and "would," or similar words. You should read statements that contain these words carefully because they discuss future expectations, contain projections of future results of operations or of financial positions or state other "forward-looking" information.

Forward-looking statements involve inherent uncertainty and may ultimately prove to be incorrect or false. You are cautioned not to place undue reliance on forward-looking statements. Except as otherwise may be required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or actual operating results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including, but not limited to:

our dependence on principal customers;
our sensitivity to general economic conditions, including the current economic environment, changes in disposable income levels and consumer spending trends;
our ability to reduce our expenses in amounts sufficient to offset our increased focus on sales to conventional supermarkets and the resulting lower gross margins on these sales;
our reliance on the continued growth in sales of natural and organic foods and non-food products in comparison to conventional products;
our ability to timely and successfully deploy our new warehouse management system throughout our distribution centers and our transportation management system Company-wide;

          increased fuel costs;
          our sensitivity to inflationary and deflationary pressures;
          the relatively low margins and economic sensitivity of our business;
          the potential for disruptions in our supply chain by circumstances
beyond our control;
          the ability to identify and successfully complete acquisitions of

other natural, organic and specialty food and non-food products distributors; and
management's allocation of capital and the timing of capital expenditures.

This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. You should carefully review the risks described under "Part I. Item 1A. Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended July 28, 2012 and any cautionary language in this Quarterly Report on Form 10-Q or our other reports filed with the SEC from time to time, as the occurrence of any of these events could have an adverse effect on our business, results of operation and financial condition.


Overview

We believe we are the leading distributor based on sales of natural, organic and specialty foods and non-food products in the United States and Canada, and that our twenty-six distribution centers, representing approximately 6.2 million square feet of warehouse space, provide us with the largest capacity of any North American-based distributor in the industry. We offer more than 65,000 high-quality natural, organic and specialty foods and non-food products, consisting of national brands, regional brands, private label and master distribution products, in six product categories: grocery and general merchandise, produce, perishables and frozen foods, nutritional supplements and sports nutrition, bulk and food service products and personal care items. We serve more than 27,000 customer locations primarily located across the United States and Canada, the majority of which can be classified into one of the following categories: independently owned natural products retailers, which include buying clubs; supernatural chains, which consist solely of Whole Foods Market Inc. ("Whole Foods Market"); conventional supermarkets, which include mass market chains; and other which includes foodservice and international customers.

Our operations are comprised of three principal operating divisions. These operating divisions are:

our wholesale division, which includes our broadline natural, organic and specialty distribution business in the United States, UNFI Canada, which is our natural, organic and specialty distribution business in Canada, Albert's, which is a leading distributor within the United States of organically grown produce and non-produce perishable items, and Select Nutrition, which distributes vitamins, minerals and supplements;

our retail division, consisting of Earth Origins Market, which operates our 14 natural products retail stores within the United States; and

our manufacturing division, consisting of Woodstock Farms Manufacturing, which specializes in the international importation, roasting, packaging and distribution of nuts, dried fruit, seeds, trail mixes, granola, natural and organic snack items, and confections, and our Blue Marble Brands product lines.

In recent years, our sales to existing and new customers have increased through the continued growth of the natural and organic products industry in general; increased market share as a result of our high quality service and a broader product selection, including specialty products, and the acquisition of, or merger with, natural and specialty products distributors; the expansion of our existing distribution centers; the construction of new distribution centers; the introduction of new products and the development of our own line of natural and organic branded products. Through these efforts, we believe that we have been able to broaden our geographic penetration, expand our customer base, enhance and diversify our product selections and increase our market share. Beginning in fiscal 2009, our strategic plan has focused on increasing market share, particularly in our conventional supermarket channel. This channel typically generates lower gross margins than our independent retailer channel, but also typically has lower operating expenses. As part of our "one company" approach, we are in the process of rolling out a national warehouse management and procurement system to convert our existing facilities into a single warehouse management and supply chain platform. We launched this system upgrade at our Lancaster, Texas facility in September 2010 and we converted our Ridgefield, Washington facility in July 2012. We plan to go live on our third facility in fiscal 2013 and expect to complete the roll out of this system upgrade in all of our existing, broadline distribution centers by the end of fiscal 2016. These steps and others are intended to promote operational efficiencies and further reduce our operating expenses as we attempt to offset the lower gross margins we expect to generate by increased sales to the supernatural and conventional supermarket channels.

During fiscal 2012, we made pivotal changes including completing the divestiture of our conventional non-foods and general merchandise lines of business that began in the fourth quarter of fiscal 2011. In connection with the divestiture, we moved the remaining organic and natural specialty product inventory from our Harrison, Arkansas facility to other distribution centers across the United States, and closed the Harrison, Arkansas facility. We were also successful in bringing onboard the single largest national customer at one time in our history.

Inflation continued to impact our financial results for the first nine months of fiscal 2013, albeit at lower levels than in fiscal 2012. For the quarter ended April 27, 2013, inflation in food prices was approximately 1.8% when compared to price levels in the three months ended April 28, 2012. We believe that based on the recent trend that levels are stabilizing near 2-3%. Moderate levels of annual inflation, which we generally consider to be between 2% and 4%, are beneficial to our results as the majority of our pricing is on a cost plus structure, and price changes in this range are more easily passed through the supply chain. We believe the current trend of moderate inflation will continue over the next 12 months.

We have been the primary distributor to Whole Foods Market for more than 14 years. Effective June 2010, we amended our distribution agreement with Whole Foods Market to extend the term of the agreement for an additional seven years. Under the terms of the amended agreement, we will continue to serve as the primary wholesale natural grocery distributor to Whole Foods Market in its United States regions where we were serving as the primary distributor at the time of the amendment. The amendment extended the expiration date of the agreement from September 25, 2013 to September 25, 2020. On July 28, 2010,


we announced that we had entered into an asset purchase agreement under which we agreed to acquire certain assets of Whole Foods Distribution Inc. ("Whole Foods Distribution") previously used for their self-distribution of non-perishables in their Rocky Mountain and Southwest regions, and to become their primary distributor in these regions. We closed this transaction in late September 2010 in the case of the Southwest region and early October 2010 in the case of the Rocky Mountain region. We now serve as the primary distributor to Whole Foods Market in all of its regions in the United States, and have amended our distribution agreement with Whole Foods Market effective October 11, 2010 to include these regions. Whole Foods Market accounted for approximately 37% of our net sales for the three and nine months ended April 27, 2013 and 36% of our net sales for the three and nine months ended April 28, 2012.

We expanded our operations into Canada with the acquisition of certain Canadian food distribution assets of the SunOpta Distribution Group business of SunOpta Inc. through our wholly-owned subsidiary, UNFI Canada, for cash consideration of $65.8 million in June 2010. With the acquisition, we became the largest distributor of natural, organic and specialty foods, including kosher foods, in Canada. During fiscal 2012, we utilized our UNFI Canada platform to further expand in the Canadian market, including through our purchase of substantially all of the assets of a specialty food distribution business in the Ontario market in November 2011. During the first quarter of fiscal 2013, we also utilized this platform for our August 2012 acquisition of substantially all of the assets of a dairy distribution business in the central Canada market.

The ability to distribute specialty food items (including ethnic, kosher and gourmet) has accelerated our expansion into a number of high-growth business markets and allowed us to establish immediate market share in the fast-growing specialty foods market. We have now integrated specialty food products and natural and organic specialty non-food products into most of our broadline distribution centers across the country. Due to our expansion into specialty foods, we were awarded new business with a number of conventional supermarkets since fiscal 2010 that we previously had not done business with because we did not distribute specialty products. We believe that distribution of these products enhances our conventional supermarket business channel and that our complementary product lines continue to present opportunities for cross-selling. On June 9, 2011, we entered into an asset purchase agreement with L&R Distributors pursuant to which we agreed to sell our conventional non-foods and general merchandise lines of business, including certain inventory related to these product lines. This divestiture was completed in the first quarter of fiscal 2012, and has allowed us to concentrate on our core business of the distribution of natural, organic, and specialty foods and non-food products.

To maintain our market leadership and improve our operating efficiencies, we seek to continually:

          expand our marketing and customer service programs across regions;

          expand our national purchasing opportunities;

          offer a broader product selection;

          offer operational excellence with high service levels and a higher
percentage of on-time deliveries than our competitors;

          centralize general and administrative functions to reduce expenses;

          consolidate systems applications among physical locations and
regions;

          increase our investment in people, facilities, equipment and
technology;

          integrate administrative and accounting functions; and

          reduce the geographic overlap between regions.

Our continued growth has allowed us to expand our existing facilities and open new facilities in an effort to achieve increasing operating efficiencies. We have made significant capital expenditures and incurred considerable expenses in connection with the opening and expansion of our facilities. At April 27, 2013 our distribution capacity totaled approximately 6.2 million square feet. In September 2010, we began shipping products from our distribution center in Lancaster, Texas, which serves customers throughout the Southwestern United States, including Texas, Oklahoma, New Mexico, Arkansas and Louisiana. In October 2010, in connection with the acquisition of the Rocky Mountain distribution business of Whole Foods Distribution, we took over the operations, including the assumption of an operating lease, at a distribution center in Aurora, Colorado, augmenting our existing Aurora, Colorado facility which was at capacity, in serving customers in Colorado, Utah, Arizona, and New Mexico. In April 2012, we entered into a lease for a new 540,000 square foot distribution center in Aurora, Colorado which became operational in May 2013 and will replace our existing two broadline distribution centers, an Albert's distribution center and an off-site storage location. In May 2013, we began operations at our new Albert's distribution center in Logan, New Jersey. We have also announced a multi-year expansion project with an additional distribution center planned for the United States in Sturtevant, Wisconsin, Montgomery, New York, and Northern California.


Our net sales consist primarily of sales of natural, organic and specialty products to retailers, adjusted for customer volume discounts, returns and allowances. Net sales also consist of amounts charged by us to customers for shipping and handling and fuel surcharges. The principal components of our cost of sales include the amounts paid to manufacturers and growers for product sold, plus the cost of transportation necessary to bring the product to our distribution facilities, offset by any consideration received from suppliers in connection with the purchase or promotion of the suppliers' products. Cost of sales also includes amounts incurred by us at our manufacturing subsidiary, Woodstock Farms Manufacturing, for inbound transportation costs and depreciation for manufacturing equipment. Our gross margin may not be comparable to other similar companies within our industry that may include all costs related to their distribution network in their costs of sales rather than as operating expenses. We include purchasing and outbound transportation expenses within our operating expenses rather than in our cost of sales. Total operating expenses include salaries and wages, employee benefits (including payments under our Employee Stock Ownership Plan), warehousing and delivery, selling, occupancy, insurance, administrative, share-based compensation, depreciation and amortization expense. Other expenses (income) include interest on our outstanding indebtedness, interest income, unrealized foreign exchange gains or losses and other miscellaneous income and expenses. During the nine months ended April 27, 2013 other expense also includes a pre-tax charge of $4.9 million in the first quarter related to an agreement to settle a multi-state unclaimed property audit.

Critical Accounting Policies

The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The SEC has defined critical accounting policies as those that are both most important to the portrayal of our financial condition and results of operations and require our most difficult, complex or subjective judgments or estimates. Based on this definition and as further described in our Annual Report on Form 10-K for the year ended July 28, 2012, we believe our critical accounting policies include the following: (i) determining our allowance for doubtful accounts, (ii) determining our reserves for the self-insured portions of our workers' compensation and automobile liabilities and (iii) valuing goodwill and intangible assets. For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies or estimates since our most recently filed Annual Report on Form 10-K.

Results of Operations

The following table presents, for the periods indicated, certain income and
expense items expressed as a percentage of net sales:

                                Three months ended         Nine months ended
                             April 27,     April 28,    April 27,    April 28,
                                2013          2012         2013         2012
Net sales                     100.0  %       100.0  %    100.0  %      100.0  %
Cost of sales                  83.2  %        82.4  %     83.3  %       82.4  %
Gross profit                   16.8  %        17.6  %     16.7  %       17.6  %
Total operating expenses       13.4  %        14.1  %     13.8  %       14.7  %
Operating income                3.4  %         3.5  %      2.9  %        2.9  %
Other expense (income):
Interest expense                0.1  %         0.1  %      0.1  %        0.1  %
Interest income                   -  %           -  %        -  %          -  %
Other, net                        -  %           -  %      0.1  %          -  %
Total other expense             0.1  %         0.1  %      0.2  %        0.1  %
Income before income taxes      3.3  %         3.5  % *    2.7  %        2.8  %
Provision for income taxes      1.3  %         1.4  %      1.0  %        1.1  %
Net income                      2.0  %         2.1  %      1.7  %        1.7  %


___________________________________________________


* Total reflects rounding


Three Months Ended April 27, 2013 Compared To Three Months Ended April 28, 2012

Net Sales

Our net sales for the three months ended April 27, 2013 increased approximately 12.8%, or $178.2 million, to $1.6 billion from $1.4 billion for the three months ended April 28, 2012. This increase was primarily due to organic growth (sales growth excluding the impact of acquisitions) in our wholesale division from our supernatural chain customer as well as increased sales within our conventional supermarket channel. Our organic growth is due to the continued growth of the natural and organic products industry in general, increased market share as a result of our focus on service and value added services and broader selection of products, including specialty foods. In addition to net sales growth attributable to our organic growth, we also benefited from the inclusion of $12.5 million in incremental sales during the three months ended April 27, 2013 related to our acquisitions of certain assets of three distributors completed during the first quarter of fiscal 2013. Net sales for the quarter ended April 27, 2013 also benefited from food price inflation of approximately 1.8% compared to price levels in the third quarter of the prior fiscal year.

Our net sales by customer type for the three months ended April 27, 2013 and April 28, 2012 were as follows (in millions):

                                                        Net Sales for the Three Months Ended
                                              April 27,               % of          April 28,         % of
Customer Type                                   2013                Net Sales         2012          Net Sales
Independently owned natural
products retailers                    $       528                        34 %     $       487            35 %
Supernatural chains                           573                        37 %             496            36 %
Conventional supermarkets                     381                        24 %             336            24 %
Other                                          84                         5 %              69             5 %
Total                                 $     1,566                       100 %     $     1,388           100 %

Net sales to our independent retailer channel increased by approximately $41 million, or 8%, during the three months ended April 27, 2013 compared to the three months ended April 28, 2012. While net sales in this channel have increased, they have grown at a slower rate than net sales in our supernatural and conventional supermarket channels, and therefore, represent a lower percentage of our total net sales in the third quarter of fiscal 2013 compared to the third quarter of fiscal 2012.

Whole Foods Market is our only supernatural chain customer, and net sales to Whole Foods Market for the three months ended April 27, 2013 increased by approximately $77 million, or 16%, as compared to the three months ended April 28, 2012, and accounted for approximately 37% and 36% of our total net sales for the three months ended April 27, 2013 and April 28, 2012, respectively. The increase in net sales to Whole Foods Market is primarily due to increases in same-store sales, as well as new store openings.

Net sales to conventional supermarkets for the three months ended April 27, 2013 increased by approximately $45 million, or 13%, from the three months ended April 28, 2012, and represented approximately 24% of our total net sales in each of the three months ended April 27, 2013 and April 28, 2012. The increase in net sales to conventional supermarkets is due to continued success in our strategy to be the sole supplier of natural, organic and specialty products to our conventional supermarket customers.

Other net sales, which include sales to foodservice customers and sales from the United States to other countries, as well as sales through our retail division, manufacturing division, and our branded product lines, increased by approximately $15 million, or 22%, during the three months ended April 27, 2013 compared to the three months ended April 28, 2012, and accounted for approximately 5% of total net sales for both the three months ended April 27, 2013 and April 28, 2012.

As we continue to aggressively pursue new customers and expand relationships with existing customers, we expect net sales for the remainder of fiscal 2013 to grow over net sales for fiscal 2012. We believe that the integration of our specialty business into our national platform has allowed us to attract customers that we would not have been able to attract without that business and will continue to allow us to pursue a broader array of customers as many customers seek a single source for their natural, organic and specialty products. We believe that our projected net sales growth will come from both sales to new customers and an increase in the number of products that we sell to existing customers. We expect that most of this net sales growth will occur in our lower gross margin supernatural and conventional supermarket channels. Although sales to these customers typically generate lower gross margins than sales to customers within our independent retailer channel, they also typically carry a lower average cost to serve than sales to our independent customers. We also believe that food price inflation similar to the levels experienced during the first three quarters of fiscal 2013 will contribute to our projected net sales growth for the remainder of fiscal 2013.


Cost of Sales and Gross Profit

Our gross profit increased approximately 7.6%, or $18.5 million, to $263.0 million for the three months ended April 27, 2013, from $244.5 million for the three months ended April 28, 2012. Our gross profit as a percentage of net sales was 16.8% for the three months ended April 27, 2013 and 17.6% for the three months ended April 28, 2012. The decline in gross profit as a percentage of net sales between the third quarter of fiscal 2013 and the comparable period in fiscal 2012 is primarily due to the continued shift in our customer mix towards the supernatural and conventional supermarket channels, lower inflation, increased sales of customers' private label brands, which carry a lower gross margin, and increased in-bound freight expenses. Changes in the product mix, including the acquisition of a produce brokerage business, which has lower gross margins, also negatively impacted gross margin in the quarter ended April 27, 2013.

Our gross profits are generally higher on net sales to independently owned retailers and lower on net sales in the supernatural and conventional supermarket channels. For the three months ended April 27, 2013, approximately 69%, or $122 million of our $178 million total net sales growth was from increased net sales in the supernatural and conventional supermarket channels. As a result, approximately 61% of our total net sales in the three months ended April 27, 2013 were to the supernatural and conventional supermarket channels compared to approximately 60% in the three months ended April 28, 2012.

We anticipate net sales growth in the supernatural and conventional supermarket channels will continue to outpace growth in the independent retailer and other channels. We expect that our distribution relationship with Whole Foods Market and our opportunities in the conventional supermarket channel will continue to generate lower gross profit percentages than our historical rates. We will seek to fully offset these reductions in gross profit percentages by reducing our operating expenses as a percent of net sales primarily through improved efficiencies in our supply chain and improvements to our information technology infrastructure, including our ongoing national warehouse management and procurement system upgrade.

Operating Expenses

Our total operating expenses increased approximately 6.8%, or $13.2 million, to $209.1 million for the three months ended April 27, 2013, from $195.9 million for the three months ended April 28, 2012. The increase in total operating expenses for the three months ended April 27, 2013 was primarily due to higher sales volume, $0.9 million in non-cash straight-line rent expense associated with our new Denver, Colorado area facility and $1.5 million in labor action related costs at our Auburn, Washington facility. The labor action was resolved in February 2013 and our labor-related operating expenses at our Auburn facility have returned to normalized levels.

Total operating expenses for the three months ended April 27, 2013 included share-based compensation expense of $3.1 million, compared to $2.5 million in the three months ended April 28, 2012. Share-based compensation expense was . . .

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