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UNFI > SEC Filings for UNFI > Form 10-Q on 11-Dec-2013All Recent SEC Filings

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Form 10-Q for UNITED NATURAL FOODS INC


11-Dec-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;
          union-organizing activities that could cause labor relations
difficulties;
          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 August 3, 2013 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 operations and financial condition.


Overview

We believe we are a 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-eight distribution centers, representing approximately 6.6 million square feet of warehouse space, provide us with the largest capacity of any North American-based distributor in the natural, organic and specialty products 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 31,000 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 thirteen 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 platform at our Lancaster, Texas facility in September 2010 and we converted our Ridgefield, Washington facility in July 2012. We expect to complete the roll-out of all existing, broadline facilities by the end of fiscal 2017. 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 continues to impact our financial results. For the three months ended November 2, 2013, inflation in food prices was approximately 2.0% when compared to price levels in the three months ended October 27, 2012. Based on the recent trend, we believe that levels are stabilizing near 2 to 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 15 years. We currently serve as the primary distributor to Whole Foods Market in all of its regions in the United States pursuant to our distribution agreement that expires on September 25, 2020. Whole Foods Market accounted for approximately 36% of our net sales for each of the three months ended November 2, 2013 and October 27, 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. We have 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 and 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. In the first quarter of fiscal 2012 we completed the divestiture of our conventional non-foods and general merchandise lines of business, including certain inventory related to these product lines in order 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 November 2, 2013 our distribution capacity totaled approximately 6.6 million square feet. In May 2013 we began operations at our new Albert's distribution facility in Logan, New Jersey, and in June 2013 we commenced operations at a new 540,000 square foot distribution center in Aurora, Colorado and consolidated all existing Aurora operations, including an Albert's location and off-site storage, into one building. We have also commenced a multi-year expansion plan, which includes construction of a distribution center in Sturtevant, Wisconsin, from which we expect to begin operations in the spring of 2014, breaking ground on a new distribution center in Montgomery, New York, and another facility planned for 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 as 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 three months ended October 27, 2012, other expense includes a pre-tax charge of $4.9 million related to an agreement to settle a multi-state unclaimed property audit.

Critical Accounting Policies

The preparation of our condensed 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 August 3, 2013, 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
                             November 2,      October 27,
                                 2013            2012
Net sales                       100.0  %        100.0  %
Cost of sales                    83.1  %         83.3  %
Gross profit                     16.9  %         16.7  %
Total operating expenses         13.9  %         14.1  %
Operating income                  3.0  %          2.6  %
Other expense (income):
Interest expense                  0.1  %          0.1  %
Interest income                     -  %            -  %
Other, net                          -  %          0.3  %
Total other expense, net          0.1  %          0.4  %
Income before income taxes        2.9  %          2.2  %
Provision for income taxes        1.2  %          0.7  %
Net income                        1.7  %          1.5  %


___________________________________________________

Three Months Ended November 2, 2013 Compared To Three Months Ended October 27, 2012

Net Sales

Our net sales for the three months ended November 2, 2013 increased approximately 13.6%, or $192.0 million, to $1.6 billion from $1.4 billion for the three months ended October 27, 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 $7.6 million in incremental sales during the three months ended November 2, 2013 related to our acquisition of Trudeau Foods,
LLC. Net sales for the quarter ended November 2, 2013 also benefited from food price inflation of approximately 2.0% compared to price levels in the first quarter of the prior fiscal year.


Our net sales by customer type for the three months ended November 2, 2013 and October 27, 2012 were as follows (in millions):

                                                         Net Sales for the Three Months Ended
                                             November 2,              % of          October 27,         % of
Customer Type                                   2013                Net Sales          2012           Net Sales
Independently owned natural
products retailers                    $       526                        33 %     $         484            34 %
Supernatural chains                           571                        36 %               507            36 %
Conventional supermarkets                     404                        25 %               345            25 %
Other                                         101                         6 %                74             5 %
Total                                 $     1,602                       100 %     $       1,410           100 %

Net sales to our independent retailer channel increased by approximately $42 million, or 9%, during the three months ended November 2, 2013 compared to the three months ended October 27, 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 first quarter of fiscal 2014 compared to the first quarter of fiscal 2013.

Whole Foods Market is our only supernatural chain customer, and net sales to Whole Foods Market for the three months ended November 2, 2013 increased by approximately $64 million, or 13%, as compared to the three months ended October 27, 2012, and accounted for approximately 36% of our total net sales in each of the three months ended November 2, 2013 and October 27, 2012. 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 November 2, 2013 increased by approximately $59 million, or 17%, from the three months ended October 27, 2012, and represented approximately 25% of our total net sales in each of the three months ended November 2, 2013 and October 27, 2012. The increase in net sales to conventional supermarkets is due to continued success in our strategy of seeking 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 $27 million, or 36%, during the three months ended November 2, 2013 compared to the three months ended October 27, 2012, and accounted for approximately 6% and 5% of total net sales for the three months ended November 2, 2013 and October 27, 2012, respectively.

As we continue to aggressively pursue new customers and expand relationships with existing customers, we expect net sales for the remainder of fiscal 2014 to grow over net sales for fiscal 2013. 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.

Cost of Sales and Gross Profit

Our gross profit increased approximately 14.9%, or $35.2 million, to $271.2 million for the three months ended November 2, 2013, from $236.0 million for the three months ended October 27, 2012. Our gross profit as a percentage of net sales was 16.9% for the three months ended November 2, 2013 and 16.7% for the three months ended October 27, 2012. The increase in gross profit as a percentage of net sales between the first quarter of fiscal 2014 and the comparable period in fiscal 2013 is primarily due to inventory demand planning initiatives coupled with a reduction in freight expenses as a percentage of sales year over year.

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 November 2, 2013, approximately 64%, or $123 million, of our $192 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 November 2, 2013 and October 27, 2012 were to the supernatural and conventional supermarket channels.


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 11.9%, or $23.8 million, to $223.2 million for the three months ended November 2, 2013, from $199.4 million for the three months ended October 27, 2012. The increase in total operating expenses for the three months ended November 2, 2013 was primarily due to higher sales volume. During the three months ended October 27, 2012, we recorded an intangible asset impairment of $1.6 million related to the termination of a long-term licensing agreement. We also recorded $1.0 million in labor action related costs at our Auburn, Washington facility in the first quarter of fiscal 2013. The labor action was resolved in February 2013.

Total operating expenses for the three months ended November 2, 2013 included share-based compensation expense of $5.5 million, compared to $4.7 million in the three months ended October 27, 2012. Share-based compensation expense was higher during the three months ended November 2, 2013 primarily due to increases in the grant date fair value of awards in recent years as our stock price has appreciated, as well as the expense from our granting two-year performance-based vesting equity awards to our senior executives as part of a new component to their compensation arrangements that began in fiscal 2012.

As a percentage of net sales, total operating expenses decreased to approximately 13.9% for the three months ended November 2, 2013, from approximately 14.1% for the three months ended October 27, 2012. The decrease in total operating expenses as a percentage of net sales was primarily attributable to the growth in the supernatural and conventional supermarket channels which in general have lower operating expenses and higher fixed cost coverage due to higher sales as well as the other expenses in the first quarter of fiscal 2013 noted above. We expect that we will be able to continue to reduce our operating expenses as a percentage of net sales as we continue the roll-out of our national warehouse management and procurement system upgrade. We first launched this system upgrade at our Lancaster, Texas facility in September 2010, and we converted our Ridgefield, Washington facility in July 2012. We expect to complete the roll-out to all existing facilities by the end of fiscal 2017.

Operating Income

Operating income increased approximately 31.3%, or $11.5 million, to $48.0 million for the three months ended November 2, 2013, from $36.6 million for the three months ended October 27, 2012. As a percentage of net sales, operating income was 3.0% for the three months ended November 2, 2013 compared to 2.6% for the three months ended October 27, 2012. The increase in operating income and operating income as a percentage of sales is primarily attributable to the net sales growth and operating expense controls discussed above.

Other Expense (Income)

Other expense (income) decreased $3.8 million to $1.8 million for the three months ended November 2, 2013, from $5.6 million for the three months ended October 27, 2012. Interest expense for the three months ended November 2, 2013 was $1.9 million compared to $1.0 million for the three months ended October 27, 2012. The increase in interest expense is primarily due to $0.6 million of non-cash interest expense related to the Aurora, Colorado facility which is accounted for under the financing method due to our meeting the criteria for continuing involvement in this sale-leaseback transaction. Interest income was $0.1 million for the three months ended November 2, 2013 compared to $0.2 million for the three months ended October 27, 2012. Other expense for the three months ended October 27, 2012 included $4.9 million recorded in connection with . . .

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