UNITED NATURAL FOODS, INC. CAUTIONARY STATEMENTS FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
This Quarterly Report and the documents incorporated by reference in this Quarterly Report contain forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Exchange Act, 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," "plan," "seek," "should," "will," and "would," or similar words. Statements that contain these words and other statements that are forward-looking in nature should be read 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. These statements are based on our management's beliefs and assumptions, which are based on currently available information. These assumptions could prove inaccurate. 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:
• the impact and duration of the COVID-19 outbreak;
• our dependence on principal customers;
• the potential for additional asset impairment charges;
• our sensitivity to general economic conditions including changes in
disposable income levels and consumer spending trends;
• our ability to realize anticipated benefits of our acquisitions and
dispositions, in particular, our acquisition of SUPERVALU INC.
("Supervalu");
• the possibility that restructuring, asset impairment, and other charges
and costs we may incur in connection with the sale or closure of our
retail operations will exceed our current expectations;
• our reliance on the continued growth in sales of our higher margin natural
and organic foods and non-food products in comparison to lower margin
conventional grocery products;
• increased competition in our industry as a result of increased
distribution of natural, organic and specialty products, and directdistribution of those products by large retailers and online distributors;
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• increased competition as a result of continuing consolidation of retailers
in the natural product industry and the growth of supernatural chains;
• our ability to timely and successfully deploy our warehouse management
system throughout our distribution centers and our transportation
management system across the Company and to achieve efficiencies and cost
savings from these efforts;
• the addition or loss of significant customers or material changes to our
relationships with these customers;
• volatility in fuel costs;
• volatility in foreign exchange rates;
• 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 or our distribution
capabilities by circumstances beyond our control, including a health
epidemic (such as the recent outbreak of COVID-19, or the novel
coronavirus);
• the risk of interruption of supplies due to lack of long-term contracts,
severe weather, work stoppages or otherwise;
• moderated supplier promotional activity, including decreased forward
buying opportunities;
• union-organizing activities that could cause labor relations difficulties
and increased costs; and
• our ability to identify and successfully complete asset or business
acquisitions.
You should carefully review the risks described under "Part II. Item 1A Risk
Factors" of this Quarterly Report on Form 10-Q and under "Part I. Item 1A Risk
Factors" of our Annual Report on Form 10-K for the year ended August 3, 2019 as
well as any other cautionary language in this Quarterly Report, as the
occurrence of any of these events could have an adverse effect, which may be
material, on our business, results of operations, financial condition or cash
flows.
EXECUTIVE OVERVIEW
Business Overview
As a leading distributor of natural, organic, specialty, produce and
conventional grocery and non-food products, and provider of support services in
the United States and Canada , we believe we are uniquely positioned to provide
the broadest array of products and services to customers throughout North
America . We offer more than 250,000 products consisting of national, regional
and private label brands grouped into 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. Through our October 2018 acquisition of Supervalu, we are
transforming into North America's premier wholesaler with 59 distribution
centers and warehouses representing approximately 30 million square feet of
warehouse space. We believe our total product assortment and service offerings
are unmatched by our wholesale competitors. We plan to aggressively pursue new
business opportunities to independent retailers who operate diverse formats,
regional and national chains, as well as international customers with
wide-ranging needs.
Our Strategy
A key component of our business and growth strategy has been to acquire wholesalers differentiated by product offerings, service offerings and market area. In fiscal 2019, the acquisition of Supervalu accelerated our "build out the store" strategy, diversified our customer base, enabled cross-selling opportunities, expanded our market reach and scale, enhanced our technology, capacity and systems, and is expected to deliver significant synergies and accelerate potential growth. We believe our significant scale and footprint will generate long-term shareholder value by positioning us to continue to grow sales of natural, organic, specialty, produce and conventional grocery and non-food products, including our Private Brands Business and professional services across our network. We believe we will realize significant cost and revenue synergies from the acquisition of Supervalu by leveraging the scale and resources of the combined company, cross-selling to our customers, integrating our merchandising offerings into existing warehouses, optimizing our network footprint to lower our cost structure, and eliminating redundant administrative costs.
We maintain long-standing customer relationships with customers in our supernatural, supermarket, independent and other channels. Some of these long-standing customer relationships are established through contracts with our customers in the form of distribution agreements.
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We currently operate approximately 76 retail grocery stores acquired in the Supervalu acquisition. We intend to thoughtfully and economically divest these stores over the long-term; however, as discussed below within Divestiture of Retail Operations, we have determined that we no longer expect to divest theCub Foods business and the majority of the remaining Shoppers locations (collectively "Remaining Retail") within one year. Accordingly, we will present the Remaining Retail business within continuing operations beginning in the fourth quarter of fiscal 2020. In our third quarter fiscal 2020 Condensed Consolidated Financial Statements included in this Quarterly Report, Remaining Retail is presented within Discontinued Operations, as the determination to change the plan of sale occurred subsequent to the end of the third quarter of fiscal 2020. As described below we entered into agreements to sell 13 retail stores and closed six additional stores. In the third quarter of fiscal 2020, we closed on the sale of 12 of these Shoppers stores. We have been the primary distributor toWhole Foods Market for more than 20 years. We continue to serve as the primary distributor toWhole Foods Market in all of its regions inthe United States pursuant to a distribution agreement that expires onSeptember 28, 2025 .
COVID-19 Impact
Impact and Response Consistent with our values, with the spread of COVID-19 and continuing impacts created by the virus, we remain focused on the safety and well-being of our associates, customers and end consumers and supporting our wholesale customers. As COVID-19 spread inMarch 2020 , shelter-in-place orders and national and state emergencies were issued in theU.S. , our business was designated as an essential business to enable us to continue to serve our customers during the COVID-19 pandemic. We experienced an initial surge in demand and sales in March and April of 2020 as consumers undertook efforts to stock their pantries and our related wholesale customer purchases surged. During the initial spreading of the virus and implementation of shelter-in-place and restaurant closures, we experienced a surge in demand, which impacted fill and service rates and depleted inventory levels. Based on historical purchasing levels, temporary customer supply allocation limits were put in place to ensure continued service to our wholesale customers' locations, which were removed as we added capacity. In response to the surge in demand, in the third quarter of fiscal 2020, we took immediate actions to respond to the pandemic, to support our associates' safety and wellbeing, and maximize our logistics network to serve the communities we supply, while delivering operational and financial results. These actions included: • hiring over 2,000 associates, and providing existing associates with temporary state of emergency wage increases and increased overtime to warehouse, driver and in-store associates;
• implementing heightened associate safety protocols to keep our workforce
healthy, including social distancing practices, implementing extensive
safety protocols at our retail locations to protect associates and
customers, and engaging additional professional cleaning companies in our
facilities;
• enhancing employee benefits, including wellbeing resources and covering
COVID-19 testing expenses and providing coverage for COVID-19 illness or
quarantine directed by the Company or a regulatory agency;
• expanding warehouse operational hours and entering into service provider
agreements to facilitate the transportation of our products to meet
heightened demand and increase service levels;
• donating over six million pounds of food and essential items to food banks
across the country;
• working with suppliers to prioritize the procurement and sale of
high-volume stock-keeping units;
• implementing enhanced high food safety standards for customers and
consumers; and
• reassuring the public that the supply chain remains intact, and that food
and essential products are available and safe.
We believe the Supervalu acquisition allowed us to better serve our wholesale customers' needs and compete in the current environment by providing additional warehouse and transportation capacity, as well as providing a broader array of products to our customers. As one of the largest wholesale grocery distributors inNorth America and in light of the continued expansion of our distribution network and build-out-the-store initiative, we believe we are well positioned to leverage our infrastructure in the current economic and social environment to continue to serve our customers and the communities in which they operate. 42
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We experienced the following impacts from COVID-19 in the third quarter of fiscal 2020:
• Sales. Our increase in sales in the third quarter was primarily driven by
higher sales volume due to the increase in food-at-home expenditures from
the economic impacts created by the COVID-19 pandemic, partially offset by
previously lost business.
• Gross Profit. Gross profit rates were impacted negatively by mix shifts
toward lower margin products and lower vendor promotions, which was
partially offset by lower levels of inventory shrink.
• Operating Expenses. Operating expense rates were positively impacted by
our ability to leverage fixed operating and administrative expenses, which
were partially offset by incremental costs related to COVID-19, including
the impact of temporary pandemic related incentives and additional costs
for safety protocols and procedures at the Company's distribution centers
and retail stores. When COVID-19 related health and safety requirements
are eased, we expect these costs to subside. These costs were necessary to
protect our employees, product quality standards, and wholesale and retail
customers. We estimate we incurred approximately
incremental operating expenses within continuing operations related to our
response to the pandemic and operating our business at a higher
through-put capacity.
• Operating Earnings. Our business model drives sales leverage, and provided
growth in operating earnings margin, as we leveraged the fixed and
variable costs of our supply chain network and administrative expenses.
Despite incremental labor and operating costs, incremental volume through
our distribution network and retail stores drove higher leverage on fixed
facility costs, semi-variable costs and general and administrative
expenses.
Working Capital and Liquidity
Reflecting the initial impact from the COVID-19 pandemic, working capital was reduced in the third quarter of fiscal 2020 by$214.5 million , as compared to the second quarter of fiscal 2020, which provided a strong source of cash flows from operating activities in the quarter. The surge in demand during the quarter discussed above initially depleted inventory levels of continuing operations, which ended$109.2 million lower in the quarter compared to the second quarter of fiscal 2020. Our Accounts payable fluctuated greatly during the quarter related to swings in Inventories, net, ending the quarter$253.4 million higher as compared to the second quarter of fiscal 2020, as we worked to respond to our customers' modified purchase patterns and prioritize the procurement of high-volume stock-keeping units. The elevated sales levels caused Accounts receivable, net to grow by$157.7 million as compared to the second quarter of fiscal 2020 due to higher sales. In response to the potential impacts of the COVID-19 pandemic, we temporarily borrowed an additional$278.5 million on our$2.1 billion ABL Credit Facility, which we fully repaid in the third quarter of fiscal 2020. These borrowings were made as a precautionary measure to increase our cash position and preserve financial flexibility in light of uncertainty in the global markets resulting from the COVID-19 pandemic. We made additional net payments of$371.2 million on the ABL Credit Facility in the third quarter of fiscal 2020 to further reduce our debt. Our unused credit under our ABL Credit Facility increased$329.7 million as of the end of the third quarter of fiscal 2020 compared to the second quarter of fiscal 2020. Outlook We expect to continue to benefit from sales and margin growth as compared to historical periods while food-at-home expenditures as a percentage of total expenditures remains higher than recent historical precedent. We also expect the favorable year-over-year sales, margin growth and cost leveraging to continue in the near term. We expect fourth quarter of fiscal 2020 gross margin rate to be diluted as compared to last year driven by continued impacts of wholesale customer and product mix changes. We continue to make progress to increase fill rates and service level as our and our vendors' logistics capacity grows, which we expect will result in lower out of stock rates. Trends in increased sales and gross margin benefits may lessen or reverse in the intermediate months if customers alter their purchasing habits. In addition, as discussed below in the sections Impact of Inflation or Deflation and Other Factors Affecting our Business we could also be affected by changes in product mix and product category inflation changes, especially if theU.S. and Canadian economies enter into and maintain an economic recession, and customers change their purchasing habits. These potential developments could impact food-at-home expenditures and prompt consumers to trade down to lower priced product categories or change their purchasing habits in a manner that would impact our wholesale supply to our wholesale customers. However, the expected benefits from food-at-home expenditures remaining elevated and those impacts benefiting our wholesale customers are expected to outweigh product mix changes and other factors as it pertains to our results of operations and cash flows. The ultimate impact on our results is dependent upon the severity and duration of the COVID-19 pandemic, food-at-home purchasing levels, actions taken by governmental authorities and other third parties in response to the pandemic, each of which is uncertain, rapidly changing and difficult to predict. Any of these disruptions could adversely impact our business and results of operations. 43
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We could experience disruptions to our supply chain through the shutdown of one or more of our distribution centers or warehouses, the inability to transport products to serve our customers or the inability of our vendors and contract manufacturers to supply products to us. In addition, the contraction of financial markets may impact our ability to execute transactions to dispose of or acquire real estate or distribution assets, including potential impacts to our ability to divest our retail operations.
CARES Act
The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted
on March 27, 2020 and contains significant business tax provision changes to the
U.S. tax code, including temporary expansion of the limitations to the
deductibility of net operating losses and interest expense and the ability to
treat qualified improvement property as eligible for bonus depreciation. In
addition, the CARES Act changed the required filing of our federal income tax
return from May 2020 to July 2020 , and allows remittances of employer FICA
payments previously due March 2020 to December 2020 to be deferred until
December 2021 and December 2022 . Prior to the application of the CARES Act, we
had a deferred tax asset related to $203 million of federal net operating losses
that were available for unlimited carryforward (but no carryback) pursuant to
provisions of the 2017 Tax Cuts and Jobs Act, which permitted taxpayers to
carryforward net operating losses indefinitely. The CARES Act provides us the
ability to carry these losses back at a 35% federal tax rate during the carry
back periods, as opposed to the current 21% federal tax rate. This resulted in a
tax benefit of approximately $28.4 million , which we recorded in the third
quarter of fiscal 2020. This estimated tax benefit will be finalized in the
fourth quarter of fiscal 2020 as the 2019 tax return due July 2020 is finalized.
The entire tax benefit associated with the net operating loss carry back has
been recorded as a current tax receivable in the third quarter of fiscal 2020.
Distribution Center Network
Network Optimization and Construction
Within thePacific Northwest , we are transferring the volume of five distribution centers and the related supporting off-site storage facilities into two distribution centers. This transition and operational consolidation is expected to be completed during fiscal 2020, after which we expect to achieve synergies and cost savings by eliminating inefficiencies, including incurring lower operating, shrink and off-site storage expenses. The optimization of thePacific Northwest distribution network will also help deliver meaningful synergies contemplated in the Supervalu acquisition. This plan includes expanding theRidgefield, WA distribution center to enhance customer product offerings, create more efficient inventory management, streamline operations and incorporate greater technology to deliver a better customer experience. TheRidgefield distribution center will deploy a warehouse automation solution that supports our slow-moving stock-keeping unit portfolio. The operational start-up of theCentralia, WA distribution center began in the fourth quarter of fiscal 2019 and is expected to be completed in the fourth quarter of fiscal 2020. We ceased operations in ourTacoma, WA ,Auburn, WA andAuburn, CA distribution centers and have transitioned to supplying customers served by these locations to ourCentralia, WA ,Ridgefield, WA andGilroy, CA distribution centers. We expect to incur incremental expenses related to the network realignment and are working to both minimize these costs and obtain new business to further improve the efficiency of our transforming distribution network.
In connection with our consolidation of distribution centers in the
To support our continued growth within southernCalifornia , we began operating a newly leased facility with approximately 1.1 million square feet upon completion of its construction in the fourth quarter of fiscal 2020. This facility provides significant capacity to service our customers in this market and provides us the future flexibility to potentially monetize existing owned facilities in the southernCalifornia market. OnFebruary 24, 2020 , we executed a purchase option to acquire the real property of a distribution center agreeing to pay approximately$156.9 million for the facility, subject to finalization. We expect to engage a real estate partner to monetize the real property of this location, including through a sale-leaseback transaction that would ultimately reduce rents paid for this property from current rents, which we expect would occur on or beforeJune 2022 . Distribution Center Sales In the fourth quarter of fiscal 2019, we entered into an agreement to sell ourTacoma, WA distribution center related to ourPacific Northwest consolidation strategy. We closed on the sale in the fourth quarter of fiscal 2020 and received consideration of$42.3 million in the form of a$38.0 million note receivable and cash. As ofMay 2, 2020 , the facility is classified as held for sale within Prepaid expenses and other current assets of continuing operations on our Condensed Consolidated Balance Sheets. As we consolidate our distribution networks, we may sell additional owned facilities or exit leased facilities. 44
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In the third quarter of fiscal 2020, we sold a warehouse in
Operating Efficiency As part of our "one company" approach, we are in the process of converting to a single national warehouse management and procurement system to integrate our existing facilities, including acquired Supervalu facilities, onto one nationalized platform across the organization. We continue to be focused on the automation of our new or expanded distribution centers that are at different stages of construction and implementation. These steps and others are intended to promote operational efficiencies and improve operating expenses as a percentage of net sales.
Goodwill Impairment Review
During the first quarter of fiscal 2020, we changed our management structure and internal financial reporting to combine the Supervalu Wholesale reporting unit and the legacy Company Wholesale reporting unit into oneU.S. Wholesale reporting unit, and experienced a further sustained decline in market capitalization and enterprise value. As a result of the change in reporting units and the sustained decline in market capitalization and enterprise value, we performed an interim quantitative impairment review of goodwill for the Wholesale reporting unit, which included a determination of the fair value of all reporting units. Based on this analysis, we determined that the carrying value of ourU.S. Wholesale reporting unit exceeded its fair value by an amount that exceeded its assigned goodwill. As a result, we recorded a goodwill impairment charge of$421.5 million in the first quarter of fiscal 2020. The goodwill impairment charge is reflected inGoodwill and asset impairment charges in the Condensed Consolidated Statements of Operations. The goodwill impairment charge reflects the impairment of all of theU.S. Wholesale's reporting unit goodwill. Quantitatively, the goodwill impairment was driven by the incorporation of the negative value associated with the legacy Supervalu wholesale reporting unit that was combined into the legacy Company Wholesale goodwill reporting unit and a decrease in estimated long-range cash flows required to be prepared as part of the quantitative assessment. The goodwill impairment review indicated that the estimated fair value of the Canada Wholesale reporting, which had goodwill of$9.9 million as ofNovember 2, 2019 , exceeded its carrying values by approximately 13%. Other continuing operations reporting units, which had goodwill of$9.9 million as ofNovember 2, 2019 , were substantially in excess of their carrying value. If circumstances indicate that the value of one of these other reporting units has decreased, we may be required to perform additional reviews of goodwill and incur additional impairment charges. The first quarter of fiscal 2020 quantitative goodwill impairment review included a reconciliation of all of the reporting units' fair value to our market capitalization and enterprise value.
Divestiture of Retail Operations
We have announced our intention to thoughtfully and economically divest our retail businesses acquired as part of the Supervalu acquisition as soon as practical in an efficient and economic manner in order to focus on our core wholesale distribution business. We plan to maximize value as part of the divestiture process, including limiting liabilities and stranded costs associated with these divestitures. We expect to obtain ongoing supply relationships with the purchasers of some of these retail operations, but we anticipate some reductions in supply volume will result from the divestiture of certain of these retail operations. Actions associated with retail divestitures and adjustments to our core cost structure for our wholesale food distribution business are expected to result in headcount reductions and other costs and charges. These costs and charges, which may be material, include multiemployer plan charges, severance costs, store closure charges, and related costs. A withdrawal from a multiemployer pension plan may result in an obligation to make material payments over an extended period of time. The extent of these costs and charges will be determined based on outcomes achieved under the divestiture process. At this time, however, we are unable to make an estimate with reasonable certainty of the amount or type of costs and charges expected to be incurred in connection with the foregoing actions. Our discontinued operations as of the end of third quarter of fiscal 2020 includeCub Foods and Shoppers disposal groups, and our historical results of discontinued operations include Hornbacher's and Shop 'n Save, which were divested in the second and third quarters of fiscal 2019, respectively. In addition, discontinued operations includes certain real estate related to historical retail operations. These retail assets have been classified as held for sale as of the Supervalu acquisition date, and the results of operations, financial position and cash flows directly attributable to these operations are reported within discontinued operations in our Condensed Consolidated Financial Statements for all periods presented. As of the acquisition date, retail assets and liabilities were recorded at their estimated fair value less costs to sell, and subsequent to the acquisition date, we review the fair value less costs to sell of these disposal groups. 45
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In the second quarter of fiscal 2020, we entered into agreements to sell 13 Shoppers stores and decided to close six locations, and in the third quarter of fiscal 2020 we closed on the sale of 12 of these Shoppers stores. During fiscal 2020 year-to-date, in the aggregate between discontinued operations and continuing operations we incurred approximately$57.3 million of pre-tax aggregate costs and charges related to Shoppers, consisting of$33.3 million of lease asset impairment and property and equipment charges, including lease termination charges and charges related to impairment reviews,$14.2 million of operating losses and transaction costs during the period of wind-down,$8.7 million of severance costs and$1.1 million of losses on sale of assets. We may incur additional related costs and charges in the fourth quarter of fiscal 2020. In the second and third quarter of fiscal 2020, we reviewed the recoverability of the remaining assets held for sale and assessed the remaining composition of the Shoppers disposal group based on updated fair values.
As of
Subsequent to the end of the third quarter of fiscal 2020, we determined it was no longer probable that a sale of Remaining Retail would occur within one year. As a result, we determined we no longer met the criteria to classify Remaining Retail as discontinued operations. In the fourth quarter of fiscal 2020, we expect to present Remaining Retail as held and used as part of continuing operations in our fiscal 2020 Consolidated Financial Statements based on this assessment. This expected change in financial statement presentation will require us to restate the presentation and classification of Remaining Retail within our Consolidated Financial Statements for fiscal 2019, which will result in Remaining Retail's results of operations, financial position, cash flows and related disclosures being within continuing operations. In the fourth quarter of fiscal 2020, we expect to record an adjustment to the carrying value of certain long-lived assets, including property and equipment and intangible assets, to record the assets at the carrying amount at the acquisition date adjusted for any depreciation expense that would have been recognized had the assets been held and used as part of continuing operations since their acquisition date. We estimate the adjustment to account for the incremental depreciation and amortization expense required to be recorded in the fourth quarter of fiscal 2020 will be approximately$48 million , which reflects an estimate of depreciation and amortization from the date of the Supervalu acquisition date through fiscal 2020 based on useful lives assigned to the underlying retail assets expected to be brought back into continuing operations. As discussed in Note 3-Revenue Recognition, certain sales from the Wholesale segment to the retail discontinued operations are presented within Net sales. In order to present Remaining Retail's results of operations within continuing operations these Wholesale sales to retail discontinued operations will be eliminated upon consolidation, resulting in no consolidated effect on Net sales resulting from our Wholesale segment. Remaining Retail's net sales will be included in the Net sales line of the Consolidated Statement of Operations. As discussed in Note 3-Revenue Recognition, we currently hold Shoppers stores for sale without an expectation of a supply agreement and therefore no Wholesale sales were recorded within continuing operations. Within the restatement of our segment financial information, we expect to recognize Wholesale segment sales to the majority of the remainder of the Shoppers locations, which will be eliminated upon consolidation as described above. Subsequent to the restatement of our Consolidated Financial Statements, we expect consolidated net sales, gross profit and operating expenses to increase compared to the current presentation, and expect our consolidated gross profit as a percentage of net sales to increase, which we expect will be partially offset by an increase in operating expenses as a percent of net sales. We may incur additional costs and charges in the future related to the divesture of Remaining Retail if these locations are subsequently sold, indicators exist that the business may be impaired, or if we incur additional wind-down or employee-related costs or charges.
Supervalu Professional Services Agreements
In connection with the sale of Save-A-Lot onDecember 5, 2016 , Supervalu entered into a services agreement (the "Services Agreement") withMoran Foods, LLC , the entity that operates the Save-A-Lot business. Pursuant to the Services Agreement, we provide certain technical, human resources, finance and other operational services to Save-A-Lot for a term of five years, on the terms and subject to the conditions set forth therein. The initial annual base charge under the Services Agreement is$30 million , subject to adjustments. If services are no longer provided under the Services Agreement after the initial term, we would lose the revenue associated with this agreement, and if we are not able to eliminate fixed or variable costs associated with servicing this agreement concurrent with the decline in revenue, we would incur a decrease in operating profit. 46
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Impact of Inflation or Deflation
We monitor product cost inflation and deflation and evaluate whether to absorb cost increases or decreases, or pass on pricing changes to our customers. We experienced a mix of inflation and deflation across product categories during the third quarter of fiscal 2020. In the aggregate across all of our legacy businesses and taking into account the mix of products, management estimates our businesses experienced cost inflation in the low single digits in the third quarter of fiscal 2020. Cost inflation and deflation estimates are based on individual like items sold during the periods being compared. Changes in merchandising, customer buying habits and competitive pressures create inherent difficulties in measuring the impact of inflation and deflation on Net sales and Gross profit. Absent any changes in units sold or the mix of units sold, deflation has the effect of decreasing sales. Under the LIFO method of inventory accounting, product cost increases are recognized within Cost of sales based on expected year end inventory quantities and costs, which has the effect of decreasing Gross profit and the carrying value of inventory.
Other Factors Affecting our Business
We are also impacted by macroeconomic and demographic trends, and changes in the food distribution market structure. Over the past several decades, total food expenditures on a constant dollar basis withinthe United States has continued to increase in total, and the focus in recent decades on natural, organic and specialty foods have benefited us; however, consumer spending in the food-away-from-home industry has increased steadily as a percentage of total food expenditures. This trend paused during the 2008 recession, and then continued to increase. In fiscal 2020, the COVID-19 impact has caused a significant increase in food-at-home expenditures as a percentage of total food expenditures. We expect that food-at-home expenditures as a percentage of total food expenditures will remain higher than recent years during time periods that shelter-in-place orders exist until businesses are allowed to fully reopen and any related economic recession has ended. We are also impacted by changes in food distribution trends to our wholesale customers, such as direct store deliveries and other methods of distribution. Our wholesale customers manage their businesses independently and operate in a competitive environment. We seek to obtain security interests and other credit support in connection with the financial accommodations we extend; however, we may incur additional credit or inventory charges related to our customers, as we expect the competitive environment to continue. The magnitude of these risks increases as the size of our wholesale customers increases.
Business Performance Assessment and Composition of Condensed Consolidated Statements of Operations
Net sales Our net sales consist primarily of sales of natural, organic, specialty, produce and conventional grocery and non-food products, and support services to retailers, adjusted for customer volume discounts, vendor incentives when applicable, returns and allowances, and professional services revenue. Net sales also include amounts charged by us to customers for shipping and handling and fuel surcharges. Cost of sales and Gross profit The principal components of our cost of sales include the amounts paid to suppliers for product sold, plus the cost of transportation necessary to bring the product to, or move product between, our various distribution centers, partially offset by 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 offset by consideration received from suppliers in connection with the purchase or promotion of the suppliers' products. 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. Operating expenses Operating expenses include salaries and wages, employee benefits, warehousing and delivery, selling, occupancy, insurance, administrative, share-based compensation, depreciation, and amortization expense. These expenses relate to warehousing and delivery expenses including purchasing, receiving, selecting and outbound transportation expenses. Restructuring, acquisition and integration expenses Restructuring, acquisition and integration expenses reflect expenses resulting from restructuring activities, including severance costs, change-in-control related charges, share-based compensation acceleration charges, facility closure charges, and acquisition and integration expenses. Interest expense, net Interest expense, net includes primarily interest expense on long-term debt, net of capitalized interest, interest expense on capital and direct financing lease obligations, and amortization of financing costs and discounts. 47
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Net periodic benefit income, excluding service cost Net periodic benefit income, excluding service cost reflects the recognition of expected returns on benefit plan assets in excess of interest costs.
Adjusted EBITDA Our Condensed Consolidated Financial Statements are prepared and presented in accordance with generally accepted accounting principles inthe United States ("GAAP"). In addition to the GAAP results, we consider certain non-GAAP financial measures to assess the performance of our business and understand the underlying operating performance and core business trends, which we use to facilitate operating performance comparisons of our business on a consistent basis over time. Adjusted EBITDA is provided as a supplement to our results of operations and related analysis, and should not be considered superior to, a substitute for or an alternative to any financial measure of performance prepared and presented in accordance with GAAP. Adjusted EBITDA excludes certain items because they are non-cash items or are items that do not reflect management's assessment of on-going business performance. We believe Adjusted EBITDA is useful to investors and financial institutions because it provides additional understanding of factors and trends affecting our business, which are used in the business planning process to understand expected operating performance, to evaluate results against those expectations, and as the primary compensation performance measure under certain compensation programs and plans. We believe Adjusted EBITDA is reflective of factors that affect our underlying operating performance and facilitate operating performance comparisons of our business on a consistent basis over time. Investors are cautioned that there are material limitations associated with the use of non-GAAP financial measures as an analytical tool. Certain adjustments to our GAAP financial measures reflected below exclude items that may be considered recurring in nature and may be reflected in our financial results for the foreseeable future. These measurements and items may be different from non-GAAP financial measures used by other companies. Adjusted EBITDA should be reviewed in conjunction with our results reported in accordance with GAAP in this Quarterly Report.
There are significant limitations to using Adjusted EBITDA as a financial measure including, but not limited to, it not reflecting the cost of cash expenditures for capital assets or certain other contractual commitments, finance lease obligation and debt service expenses, income taxes, and any impacts from changes in working capital.
We define Adjusted EBITDA as a consolidated measure inclusive of continuing and
discontinued operations results, which we reconcile by adding Net (loss) income
from continuing operations, plus Total other expense, net and (Benefit)
provision for income taxes, plus Depreciation and amortization calculated in
accordance with GAAP, plus non-GAAP adjustments for Share-based compensation,
Restructuring, acquisition and integration related expenses, goodwill and asset
impairment charges, certain legal charges and gains, certain other non-cash
charges or items, as determined by management, plus Adjusted EBITDA of
discontinued operations calculated in manner consistent with the results of
continuing operations, outlined above.
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Assessment of Our Business Results
The following table sets forth a summary of our results of operations and Adjusted EBITDA for the periods indicated:
13-Week Period Ended 39-Week Period Ended
(in thousands) May 2, 2020 April 27, 2019 Change May 2, 2020 April 27, 2019 Change
Net sales $ 6,667,681 $ 5,962,620 $ 705,061 $ 18,824,870 $ 14,979,982 $ 3,844,888
Cost of sales 5,811,151 5,174,070 637,081 16,421,838 13,017,318 3,404,520
Gross profit 856,530 788,550 67,980 2,403,032 1,962,664 440,368
Operating expenses 774,376 737,681 36,695 2,300,635 1,852,768 447,867
Goodwill and asset
impairment (adjustment)
charges - (38,250 ) 38,250 425,405 332,621 92,784
Restructuring,
acquisition and
integration related
expenses 10,449 19,438 (8,989 ) 54,385 134,567 (80,182 )
Operating income (loss) 71,705 69,681 2,024 (377,393 ) (357,292 ) (20,101 )
Other expense (income):
Net periodic benefit
income, excluding service
cost (12,758 ) (10,941 ) (1,817 ) (27,419 ) (22,691 ) (4,728 )
Interest expense, net 47,108 54,917 (7,809 ) 145,247 121,149 24,098
Other, net (973 ) 958 (1,931 ) (1,539 ) 231 (1,770 )
Total other expense, net 33,377 44,934 (11,557 ) 116,289 98,689 17,600
Income (loss) from
continuing operations
before income taxes 38,328 24,747 13,581 (493,682 ) (455,981 ) (37,701 ) Benefit for income taxes (14,849 )
(8,027 ) (6,822 ) (106,330 ) (104,091 ) (2,239 ) Net income (loss) from continuing operations 53,177
32,774 20,403 (387,352 ) (351,890 ) (35,462 )
Income from discontinued
operations, net of tax 37,192 24,370 12,822 64,253 47,847 16,406
Net income (loss)
including noncontrolling
interests 90,369 57,144 33,225 (323,099 ) (304,043 ) (19,056 )
Less net (income) loss
attributable to
noncontrolling interests (2,238 ) (52 ) (2,186 ) (3,407 ) 116 (3,523 )
Net income (loss)
attributable to United
Natural Foods, Inc. $ 88,131 $ 57,092 $ 31,039 $ (326,506 ) $ (303,927 ) $ (22,579 )
Adjusted EBITDA $ 222,208 $ 168,175 $ 54,033 $ 475,012 $ 396,942 $ 78,070
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The following table reconciles Adjusted EBITDA to Net income (loss) from continuing operations and to Income from discontinued operations, net of tax.
13-Week Period Ended 39-Week Period Ended
(in thousands) May 2, 2020 April 27, 2019 May 2, 2020 April 27, 2019
Net income (loss) from continuing
operations $ 53,177 $ 32,774 $ (387,352 ) $ (351,890 )
Adjustments to continuing
operations net income (loss):
Total other expense, net 33,377 44,934 116,289 98,689
Benefit for income taxes(1) (14,849 ) (8,027 ) (106,330 ) (104,091 )
Depreciation and amortization 69,642 71,787 214,002 169,780
Share-based compensation 12,755 9,251 21,307 27,763
Restructuring, acquisition and
integration related expenses(2) 10,449 19,438 54,385 134,567
Goodwill and asset impairment
(adjustment) charges(3) - (38,250 ) 425,405 332,621
Note receivable charges(4) - - 12,516 -
Inventory fair value adjustment(5) - - - 10,463
Legal reserve charge, net of
settlement income(6) - 2,200 1,196 2,200
Adjusted EBITDA of discontinued
operations(7) 57,657 34,068 123,594 76,840
Adjusted EBITDA $ 222,208 $ 168,175 $ 475,012 $ 396,942
Income from discontinued
operations, net of tax(7) $ 37,192 $ 24,370 $ 64,253 $ 47,847
Adjustments to discontinued
operations net income:
Less net (income) loss attributable
to noncontrolling interests (2,238 ) (52 ) (3,407 ) 116
Total other expense, net 2,242 (369 ) 1,192 (957 )
Provision for income taxes 12,071 7,772 20,447 13,759
Other expense - 591 - 829
Share-based compensation 238 774 744 1,306
Restructuring, store closure and
other charges, net(8) 8,152 982 40,365 13,940
Adjusted EBITDA of discontinued
operations(7) $ 57,657 $ 34,068 $
123,594
(1) Fiscal 2020 includes the tax benefit from the CARES Act, which includes
the impact of tax loss carrybacks to 35% tax years allowed under the CARES
Act.
(2) Primarily reflects expenses resulting from the acquisition of Supervalu,
including severance costs, store closure charges, and acquisition and
integration expenses. Fiscal 2020 year-to-date primarily reflects
integration charges, closed property reserve charges and administrative
and operational restructuring costs. Fiscal 2019 year-to-date primarily
reflects expenses resulting from the acquisition of Supervalu and
acquisition and integration expenses, including employee-related costs.
Refer to Note 5-Restructuring, Acquisition and Integration Related
Expenses in Part I, Item 1 of this Quarterly Report on Form 10-Q for
additional information.
(3) Fiscal 2020 year-to-date reflects a goodwill impairment chargeattributable to a reorganization of our reporting units and a sustained
decrease in market capitalization and enterprise value of the Company,
resulting in a decline in the estimated fair value of the
reporting unit. In addition, this charge includes a goodwill finalization
charge attributable to the Supervalu acquisition and an asset impairment
charge. Fiscal 2019 year-to-date reflects a goodwill impairment charge
attributable to the Supervalu acquisition. Refer to Note 6-Goodwill and
Intangible Assets in Part I, Item 1 of this Quarterly Report on Form 10-Q
for additional information.
(4) Reflects reserves and charges for notes receivable issued by the Supervalu
business prior to its acquisition to finance the purchase of stores by its
customers.
(5) Reflects a non-cash charge related to the step-up of inventory values as
part of purchase accounting.
(6) Reflects a charge to settle a legal proceeding and a charge related to our
assessment of legal proceedings, net of income received to settle a legal
proceeding.
(7) Income from discontinued operations, net of tax and Adjusted EBITDA of
discontinued operations excludes rent expense of
million in the third quarters of fiscal 2020 and 2019, respectively, and
respectively, of operating lease rent expense related to stores within
discontinued operations, but for which GAAP requires the expense to be
included within continuing operations, as we expect to remain primarily
obligated under these leases. Due to these GAAP requirements to show rent
expense, along with other administrative expenses of discontinued
operations within continuing operations, we believe the inclusion ofdiscontinued operations results within Adjusted EBITDA provides investors
a meaningful measure of total performance.
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(8) Amounts represent store closure charges and costs, operational wind-down
and inventory charges, and asset impairment charges related to
discontinued operations.
RESULTS OF OPERATIONS
Our analysis within the Results of Operations section below of Net sales, Gross profit, Operating expenses and Operating loss is presented on a consolidated basis, as our single reportable segment principally comprises the entire operations of our business. The quantification of Supervalu's impact on our results of operations below in our year-to-date analysis is presented to discuss the incremental impact of Supervalu, and provide analysis of our underlying business for year-over-year comparability purposes. Our analysis of Net sales is presented on a customer channel basis inclusive of all segments. References to legacy company results are presented to provide a comparative results analysis excluding the Supervalu acquired business impacts.
Our net sales by customer channel was as follows (in millions):
Net Sales for the 13-Week Period Ended Net Sales for the 39-Week Period Ended
May 2, % of April 27, % of April 27,
Customer Channel 2020
May 2, 2020(1) % of Net Sales 2019(1) % of Net Sales
Supermarkets $ 4,267 64 % $ 3,701 62 % $ 11,915 63 % $ 8,559 57 %
Supernatural 1,279 19 % 1,102 18 % 3,600 19 % 3,229 21 %
Independents 684 10 % 707 12 % 1,983 11 % 2,041 14 %
Other 438 7 % 453 8 % 1,327 7 % 1,151 8 %
Total net sales $ 6,668 100 % $ 5,963 100 % $ 18,825 100 % $ 14,980 100 %
(1) Refer to Note 3-Revenue Recognition in Part 1, Item 1 of this Quarterly
Report on Form 10-Q for additional information regarding adjustments to
net sales by customer channel.
Third Quarter Variances
Our net sales for the third quarter of fiscal 2020 increased approximately$0.71 billion , or 11.8%, to$6.67 billion from$5.96 billion for the third quarter of fiscal 2019. Net sales to our supermarkets channel increased by approximately$566 million , or 15.3%, for the third quarter of fiscal 2020, compared to the third quarter of fiscal 2019, and represented approximately 64% and 62% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The increase in supermarkets net sales is primarily due to an increase in demand for center store and natural products driven by customers response to the COVID-19 pandemic, partially offset by lower sales from previously lost customers and stores prior to the pandemic.Whole Foods Market is our only supernatural customer, and net sales toWhole Foods Market for the third quarter of fiscal 2020 increased by approximately$177 million , or 16.1%, as compared to the third quarter of fiscal 2019, and accounted for approximately 19% and 18% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The increase in net sales toWhole Foods Market is primarily due to increased sales to existing locations and the economic impacts of the COVID-19 pandemic. Net sales within our supernatural channel do not include net sales to Amazon.com, Inc. in either the current period or the prior period, as these net sales are reported in our other channel. Net sales to our independents channel decreased by approximately$23 million , or 3.3%, for the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019, and represented approximately 10% and 12% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The decrease in independents net sales is primarily due to previously lost customers and store closings, partially offset by strong sales growth in existing customer sales driven by the response to the COVID-19 pandemic. Net sales to our other channel decreased by approximately$15 million , or 3.3%, for the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019, and represented approximately 7% and 8% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The decrease in other net sales is primarily due to lower sales to foodservice customers and lower military sales from the resignation of certain business, partially offset by e-commerce sales growth. 51
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Year-to-Date Variances
Our net sales for fiscal 2020 year-to-date increased approximately$3.84 billion , or 25.7%, to$18.82 billion from$14.98 billion for fiscal 2019 year-to-date. Net sales for fiscal 2020 year-to-date included incremental Supervalu net sales from the first quarter of fiscal 2020 of approximately$3.08 billion . Excluding the incremental first quarter of fiscal 2020 Supervalu net sales, net sales increased$768 million , or 5.1%, which was driven primarily by incremental sales resulting from the COVID-19 pandemic and continued growth in our supernatural channel. Net sales to our supermarkets channel for fiscal 2020 year-to-date increased by approximately$3,356 million , or 39.2%, from fiscal 2019 year-to-date, and represented approximately 63% and 57% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The increase in supermarkets net sales is primarily due to an increase of$2,813 million from incremental first quarter of fiscal 2020 net sales attributable to the acquired Supervalu business and a net increase of$543 million , or 6.3% primarily driven by growth in sales to existing customers, including the demand for center store and natural products driven by customers response to the COVID-19 pandemic, partially offset by lower sales from previously lost customers and stores prior to the pandemic. Net sales toWhole Foods Market for fiscal 2020 year-to-date increased by approximately$371 million , or 11.5%, as compared to the prior fiscal year's comparable period, and accounted for approximately 19% and 21% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The increase in net sales toWhole Foods Market is primarily due to increased sales related to the COVID-19 pandemic, growth in new product categories, and increased sales to existing and new stores prior to the pandemic. Net sales to our independents channel decreased by approximately$58 million , or 2.8%, during fiscal 2020 year-to-date compared to fiscal 2019 year-to-date, and accounted for 11% and 14% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The decrease in independents net sales includes an increase of$24 million from incremental first quarter of fiscal 2020 net sales attributable to the acquired Supervalu business, with the remaining decrease of$82 million , or 4.0% being primarily due to lost customers, and lower sales from existing customers and store closings, partially offset by strong sales growth in existing customer sales driven by the response to the COVID-19 pandemic. Net sales to our other channel increased by approximately$176 million , or 15.3%, during fiscal 2020 year-to-date compared to fiscal 2019 year-to-date, and represented approximately 7% and 8% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The increase in other net sales is primarily due to an increase of$240 million from incremental first quarter of fiscal 2020 net sales attributable to the acquired Supervalu business, partially offset by a decrease of$64 million , or 5.6%, primarily due to lower sales to foodservice customers and lower military sales from the resignation of certain business, partially offset by e-commerce sales growth.
Cost of Sales and Gross Profit
Our gross profit increased$68.0 million , or 8.6%, to$856.5 million for the third quarter of fiscal 2020, from$788.6 million for the third quarter of fiscal 2019. Our gross profit as a percentage of net sales decreased to 12.85% for the third quarter of fiscal 2020 compared to 13.22% for the third quarter of fiscal 2019. The decrease in gross margin rate was primarily driven by a mix shift toward lower margin conventional products and lower levels of vendor funding, partially offset by lower levels of inventory shrink. Our gross profit increased$440.4 million , or 22.4%, to$2,403.0 million for fiscal 2020 year-to-date, from$1,962.7 million for fiscal 2019 year-to-date. Our gross profit as a percentage of net sales decreased to 12.77% for fiscal 2020 year-to-date compared to 13.10% for fiscal 2019 year-to-date. Our Gross profit dollar increase for fiscal 2020 year-to-date when compared to fiscal 2019 year-to-date is primarily due to an estimated incremental 12 weeks of gross profit from the acquired Supervalu business of approximately$347.9 million , net of its related LIFO inventory charge. The remaining increase in Gross profit was$92.5 million , which included a fiscal 2019 year-to-date inventory charge related to a step-up of acquired Supervalu inventory of$10.5 million . Gross profit as a percentage of net sales decreased primarily due to lower gross profit rates on conventional products and margin dilution from the faster growth of the supernatural channel relative to the other customer channels, offset in part by lower inbound freight expense. We recorded a LIFO charge of$19.3 million and$13.7 million for fiscal 2020 and 2019 year-to-date, respectively. 52
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Operating Expenses
Operating expenses increased$36.7 million , or 5.0%, to$774.4 million , or 11.61% of net sales, for the third quarter of fiscal 2020 compared to$737.7 million , or 12.37% of net sales, for the third quarter of fiscal 2019. Operating expenses for the third quarter of fiscal 2020 included$1.4 million of surplus property depreciation expense. The decrease in Operating expenses as a percent of net sales was driven by leveraging fixed operating and administrative expenses and the benefit of synergy and integration efforts, partially offset by incremental costs related to COVID-19, including the impact of temporary pandemic-related incentives and additional costs for safety protocols and procedures at the Company's distribution centers. Total operating expenses also included share-based compensation expense of$12.8 million and$9.3 million for the third quarter of fiscal 2020 and 2019, respectively. Operating expenses increased$447.9 million , or 24.2%, to$2,300.6 million , or 12.22% of net sales, for fiscal 2020 year-to-date compared to$1,852.8 million , or 12.37% of net sales, for fiscal 2019 year-to-date. The increase in Operating expenses in fiscal 2020 year-to-date primarily reflects the incremental contribution from the Supervalu business for an additional 12 weeks when compared to fiscal 2019 year-to-date. Operating expenses for fiscal 2020 year-to-date included$26.8 million of customer bankruptcy bad debt expense. In addition, Operating expenses in fiscal 2020 year-to-date included$12.5 million of notes receivable charges,$6.6 million of surplus property depreciation expense and a$1 million legal reserve charge. The decrease in operating expenses, as a percent of net sales, was driven by fixed and variable expense leveraging and the mix impact from the acquired Supervalu business and lower employee costs, including the impact of cost synergies, partially offset by higher bad debt, occupancy and depreciation expenses. Total operating expenses also included share-based compensation expense of$21.3 million and$27.8 million for fiscal 2020 and 2019 year-to-date, respectively.
A goodwill impairment adjustment of$38.3 million was recorded in the third quarter of fiscal 2019, which was attributable to changes in the preliminary fair value of net assets, which affected the initial goodwill resulting from the Supervalu acquisition.Goodwill and asset impairment charges of$425.4 million were recorded for fiscal 2020 year-to-date, which reflects$421.5 million from an impairment charge on the remaining goodwill attributable to theU.S. Wholesale goodwill reporting unit,$2.5 million related to purchase accounting adjustments to finalize the opening balance sheet goodwill and$1.4 million of property and equipment asset impairment charges.Goodwill and asset impairment charges of$332.6 million were recorded for fiscal 2019 year-to-date, which reflects a portion of the goodwill recorded from the Supervalu acquisition.
Refer to the Executive Overview section above, and Note 6-
Restructuring, Acquisition and Integration Related Expenses
Restructuring, acquisition and integration related expenses were$10.4 million for the third quarter of fiscal 2020, which included$8.4 million of closed property reserve charges and costs primarily related to lease asset impairments,$1.5 million of restructuring costs and$0.6 million of integration costs. Expenses incurred were$19.4 million for the third quarter of fiscal 2019, which included$12.3 million of employee related costs and charges due to severance, settlement of outstanding equity awards and benefits costs, and$6.1 million of other acquisition and integration related costs and$1.1 million of closed property reserve charges related to the divestiture of retail banners. Restructuring, acquisition and integration related expenses were$54.4 million for fiscal 2020 year-to-date and primarily included$25.3 million of integration costs including a multiemployer pension plan withdrawal obligation,$25.1 million of closed property reserve charges and costs primarily related to lease asset impairments on surplus properties and Shoppers store lease exits and$4.0 million of restructuring costs. Expenses incurred in fiscal 2019 year-to-date were$134.6 million and primarily included$66.4 million of employee related costs due to change-in-control payments made to satisfy outstanding equity awards, severance costs, and benefits costs,$47.5 million of other acquisition and integration related costs, and$20.6 million closed property reserve charges related to the divestiture of retail banners.
We may incur additional integration and restructuring costs through the remainder of fiscal 2020 related to our operational and administrative restructuring to achieve cost synergies and supply chain efficiencies of continuing operations. In addition, further restructuring costs may be incurred related to the divestiture of retail operations.
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Operating Income (Loss)
Reflecting the factors described above, operating income increased$2.0 million to$71.7 million for the third quarter of fiscal 2020, from$69.7 million for the third quarter of fiscal 2019. The operating income increase was primarily driven by an increase in gross profit and lower restructuring, acquisition and integration related expenses, partially offset by the goodwill impairment adjustment. Reflecting the factors described above, operating loss increased$20.1 million , to an operating loss of$377.4 million for fiscal 2020 year-to-date, from$357.3 million for fiscal 2019 year-to-date. The increase in operating loss was primarily driven by the increase in goodwill impairment charges and increases in operating expenses in excess of gross profit increases, partially offset by lower restructuring, acquisition and integration related expenses. The operating loss for the third quarter and year-to-date of fiscal 2020 includes$9.1 million and$33.5 million , respectively, of operating lease rent expense and$0.9 million and$4.6 million , respectively, of depreciation and amortization expenses related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations, as we expect to remain primarily obligated under these leases. In addition, continuing operations operating loss includes certain retail related overhead costs that are related to retail but are required to be presented within continuing operations. Total Other Expense, Net 13-Week Period Ended 39-Week Period Ended (in thousands) May 2, 2020 April 27, 2019 May 2, 2020 April 27, 2019 Net periodic benefit income, excluding service cost$ (12,758 ) $ (10,941 ) $ (27,419 ) $ (22,691 ) Interest expense on long-term debt, net of capitalized interest 41,512 45,594 127,781 96,442 Interest expense on finance and direct financing lease obligations 2,974 4,455 7,238 10,488 Amortization of financing costs and discounts 3,837 4,666 11,570 10,181 Debt refinancing costs and unamortized financing charges - 395 73 4,561 Interest income (1,215 ) (193 ) (1,415 ) (523 ) Interest expense, net 47,108 54,917 145,247 121,149 Other, net (973 ) 958 (1,539 ) 231 Total other expense, net$ 33,377 $ 44,934 $
116,289
Net periodic benefit income, excluding service costs reflects the recognition of expected returns on benefit plan assets in excess of interest costs. Net periodic benefit income for fiscal 2020 year-to-date includes a$10.3 million non-cash pension settlement charge from the lump sum pension settlement offering completed in the second quarter of fiscal 2020. Fiscal 2019 year-to-date net periodic benefit income reflects a partial year due to the acquisition of Supervalu near the end of the first quarter of fiscal 2019. The decrease in interest expense on long-term debt in the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019 was primarily due to lower average amounts of outstanding debt and lower average interest rates. The increase in interest expense on long-term debt for fiscal 2020 year-to-date compared to fiscal 2019 year-to-date was primarily due to an increase in average outstanding debt driven by Supervalu acquisition financing executed near the end of the first quarter of fiscal 2019. Interest on finance and direct financing leases primarily reflects lease obligations related to retail stores of discontinued operations acquired in the Supervalu acquisition, but for which GAAP requires the expense to be included within continuing operations, as we expect to remain primarily obligated under these leases until settlement with the respective landlords. Beginning in the third quarter of fiscal 2020, interest on financing leases includes interest related to a distribution center for which we executed a purchase option with a delayed purchase provision. 54
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Benefit for Income Taxes
The effective income tax rate for continuing operations was a benefit of 38.7% compared to a benefit of 32.4% on pre-tax income for the third quarters of fiscal 2020 and 2019, respectively. The change in the effective income tax rate for the third quarter of fiscal 2020 was primarily driven by a tax benefit recorded on net operating loss deferred tax assets in the third quarter of fiscal 2020 in connection with the CARES Act, discussed above. The tax provision included$26.9 million and$3.2 million of discrete tax benefit for the third quarter of fiscal 2020 and fiscal 2019, respectively. The discrete tax benefit for the third quarter of fiscal 2020 was primarily due to a tax benefit of approximately$28.4 million driven by a tax benefit recorded on net operating loss deferred tax assets in the third quarter of fiscal 2020 in connection with the CARES Act, discussed above. The effective income tax rate for continuing operations was a benefit of 21.5% compared to a benefit of 22.8% on pre-tax losses for fiscal 2020 year-to-date and fiscal 2019 year-to-date, respectively. The decrease in the effective income tax benefit rate was primarily driven by a tax benefit of approximately$8.3 million recorded in fiscal 2019 for the release of unrecognized tax positions that did not recur in fiscal 2020, as well as a goodwill impairment benefit of approximately$72.2 million recorded in fiscal 2019 compared to a goodwill impairment benefit of approximately$66.4 million recorded in fiscal 2020. In addition, effective income tax rate for fiscal 2020 includes a benefit of approximately$28.4 million related to revaluation of net operating loss deferred tax assets in connection with the CARES Act.
Income from Discontinued Operations, Net of Tax
The results of operations for the third quarter of fiscal 2020 reflect net sales of$667.0 million for which we recognized$187.8 million of gross profit and Income from discontinued operations, net of tax of$37.2 million . As noted above, pre-tax income for the third quarter of fiscal 2020 from discontinued operations excludes$9.1 million of operating lease rent expense related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations. In addition, store closure charges related to leases are recorded within continuing operations. Discontinued operations included$8.1 million of restructuring expenses primarily related to store closures charges and expenses related to exited locations, and asset impairment charges related to store exits and impairment reviews discussed above. Net sales and gross profit of discontinued operations increased$26.9 million and$10.9 million , respectively, for the third quarter of fiscal 2020 as compared to last year primarily due to an increase in identical store sales results driven by the impacts of the COVID-19 pandemic, which was partially offset by the lower store base operating in the third quarter of fiscal 2020 compared to last year. The results of operations for fiscal 2020 year-to-date reflect net sales of$1,891.5 million for which we recognized$520.3 million of gross profit and Income from discontinued operations, net of tax of$64.3 million . As noted above, pretax income for fiscal 2020 year-to-date excludes$33.5 million of operating lease rent expense related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations. In addition, store closure charges related to leases are recorded within continuing operations. Discontinued operations included$40.3 million of primarily related to store closures charges and expenses, and asset impairment charges related to exited locations. Net sales and gross profit of discontinued operations increased$477.8 million and$137.9 million , respectively, for the fiscal 2020 year-to-date as compared to last year primarily due the incremental twelve weeks of discontinued operations and an increase in identical store sales resulting driven by the impacts of the COVID-19 pandemic, which was partially offset by the lower store base operating during fiscal 2020 year-to-date compared to last year.
Refer to the section above Executive Overview-Divestiture of Retail Operations and to Note 18-Discontinued Operations in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional financial information regarding these discontinued operations.
Net Income (Loss) Attributable to
Reflecting the factors described in more detail above, net income attributable toUnited Natural Foods, Inc. was$88.1 million , or$1.60 per diluted common share, for the third quarter of fiscal 2020, compared to net income of$57.1 million , or$1.12 per diluted common share, for the third quarter of fiscal 2019. Reflecting the factors described in more detail above, we incurred a net loss attributable toUnited Natural Foods, Inc. of$326.5 million , or$6.10 per diluted common share, for fiscal 2020 year-to-date, compared to net loss of 303.9 million, or$5.99 per diluted common share, for fiscal 2019 year-to-date, primarily due to goodwill impairment charges. As described in more detail in Note 12-Share-Based Awards in Part I, Item I of this Quarterly Report on Form 10-Q, in the second quarter of fiscal 2020, we granted restricted stock units and performance share units representing a right to receive an aggregate of 5.8 million shares of common stock under our 2020 Equity Incentive Plan. 55
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As described in more detail within Note 13-Share-Based Awards in Part II, Item 8 of the Annual Report on Form 10-K, in fiscal 2019 we issued approximately 2.0 million shares of common stock, of which 0.3 million shares were issued through the third quarter of fiscal 2019, to fund the settlement of time-vesting replacement award obligations from the Supervalu acquisition, which has had a dilutive effect on our weighted average earnings per share as compared to last year. During the third quarter of fiscal 2020, the Company issued approximately 1.1 million shares of common stock at an average market price of$11.12 per share for$12.2 million of cash. Proceeds from these issuances were used to fund settlement of replacement award obligations. As ofMay 2, 2020 , we have approximately 1.7 million additional shares authorized for issuance and registered with theSEC in order to satisfy replacement award and option issuance obligations.
LIQUIDITY AND CAPITAL RESOURCES
Highlights
• Total liquidity as of
the following:
• Unused credit under our revolving line of credit was
as of
as of
Credit Facility as cash flow generated from the business was utilized
to reduce outstanding debt.
• Cash and cash equivalents was $56.4 million as of May 2, 2020 , which
increased $14.1 million from $42.4 million as of August 3, 2019 .
• We paid the remaining maturities under our 364-day Term Loan Facility in
the first quarter of fiscal 2020, and as a result, we have no material
scheduled maturities due until fiscal 2024, although prepayments may be
required upon the occurrence of specified events as discussed in Note
9-Long-Term Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q.
• Our total debt decreased $345.6 million to $2,560.9 million as of May 2 ,
2020 from
payments made on the ABL Credit Facility and our 364-day Term Loan
Facility payment.
• Scheduled debt maturities are expected to be $7.6 million for theremainder of fiscal 2020 and payments to reduce finance lease obligations
are expected to be approximately
2020. Proceeds from the sale of any properties mortgaged and encumbered
under our Term Loan Facility are required to, and will, be used to make
additional Term Loan Facility payments.
• We expect to be able to fund near-term debt maturities through fiscal 2023
with internally generated funds, proceeds from asset sales or borrowings
under the ABL Credit Facility.
• Working capital decreased
2020 from
increase in accounts payable resulting from inventory being sold through
faster than payments are made to vendors, the adoption of the new lease
standard from the recognition of a new current portion liability for
operating leases, the payment of a current maturity under the Term LoanFacility and inventory reductions, offset in part by increases in accounts
receivable.
Sources and Uses of Cash
We expect to continue to replenish operating assets and pay down debt
obligations with internally generated funds and sale of surplus and/or non-core
assets. A significant reduction in operating earnings or the incurrence of
operating losses could have a negative impact on our operating cash flow, which
may limit our ability to pay down our outstanding indebtedness as planned. Our
credit facilities are secured by a substantial portion of our total assets.
Our primary sources of liquidity are from internally generated funds and from
borrowing capacity under our credit facilities. Our short-term and long-term
financing abilities are believed to be adequate as a supplement to internally
generated cash flows to satisfy debt obligations and fund capital expenditures
as opportunities arise. Our continued access to short-term and long-term
financing through credit markets depends on numerous factors, including the
condition of the credit markets and our results of operations, cash flows,
financial position and credit ratings.
Primary uses of cash include debt service, capital expenditures, working capital
maintenance and income tax payments. We typically finance working capital needs
with cash provided from operating activities and short-term borrowings.
Inventories are managed primarily through demand forecasting and replenishing
depleted inventories.
We currently do not pay a dividend on our common stock, and have no current
plans to do so. In addition, we are limited in the aggregate amount of dividends
that we may pay under the terms of our Term Loan Facility and our ABL Credit
Facility.
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Long-Term Debt
During fiscal 2020 year-to-date, we repaid a net$264.0 million under the ABL Credit Facility and repaid$87.4 million of scheduled maturities under the Term Loan Facility. Refer to Note 9-Long-Term Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q for a detailed discussion of the provisions of our credit facilities and certain long-term debt agreements and additional information. Our Term Loan Agreement does not include any financial maintenance covenants. Our ABL Loan Agreement subjects us to a fixed charge coverage ratio (as defined in the ABL Loan Agreement) of at least 1.0 to 1.0, calculated at the end of each of our fiscal quarters on a rolling four quarter basis, when the adjusted aggregate availability (as defined in the ABL Loan Agreement) is ever less than the greater of (i)$235.0 million and (ii) 10% of the aggregate borrowing base. We have not been subject to the fixed charge coverage ratio covenant under the ABL Loan Agreement, including through the filing date of this Quarterly Report. The ABL Loan Agreement and the Term Loan Agreement contain certain customary operational and informational covenants. If we fail to comply with any of these covenants, we may be in default under the applicable loan agreement, and all amounts due thereunder may become immediately due and payable.
Derivatives and Hedging Activity
We enter into interest rate swap contracts from time to time to mitigate our exposure to changes in market interest rates as part of our overall strategy to manage our debt portfolio to achieve an overall desired position of notional debt amounts subject to fixed and floating interest rates. Interest rate swap contracts are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. As ofMay 2, 2020 , we had an aggregate of$2.09 billion of notional debt hedged through pay fixed and receive floating interest rate swap contracts to effectively fix the LIBOR component of our floating LIBOR based debt at fixed rates ranging from 0.454% to 2.959%, with maturities betweenMay 2020 andOctober 2025 . The fair values of these interest rate derivatives represents a total net liability of$140.4 million and are subject to volatility based on changes in market interest rates. See Note 8-Derivatives in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information.
From time to time, we enter into fixed price fuel supply agreements and foreign
currency hedges. As of
Capital Expenditures
Our capital expenditures for fiscal 2020 year-to-date were$118.2 million , compared to$137.0 million for fiscal 2019 year-to-date, a decrease of$18.8 million . Fiscal 2020 year-to-date includes capital expenditures for distribution center expansions of approximately$33 million (primarily theRidgefield, WA expansion), new distribution centers of approximately$21 million , and information technology, equipment and other. We estimate we will spend approximately$190 million for fiscal 2020. Fiscal 2020 capital spending is expected to include projects that optimize and expand our distribution network and our technology platform. Longer term, capital spending is expected to be at or below 1.0% of net sales. We expect to finance requirements with cash generated from operations and borrowings under our ABL Credit Facility. Future investments may be financed through long-term debt or borrowings under our ABL Credit Facility. 57
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