It is our policy to record the self-insured portions of our workers’ compensation and automobile liabilities based upon actuarial methods of estimating the future cost of claims and related expenses that have been reported but not settled, and that have been incurred but not yet reported. Any projection of losses concerning workers’ compensation and automobile liability is subject to a considerable degree of variability. Among the causes of this variability are unpredictable external factors affecting litigation trends, benefit level changes and claim settlement patterns. If actual claims incurred are greater than those anticipated, our reserves may be insufficient and additional costs could be recorded in the consolidated financial statements.
The following table presents, for the periods indicated, certain income and expense items expressed as a percentage of net sales:
Three Months Ended October 28, 2006 Compared To Three Months Ended October 29, 2005
Net Sales
Our net sales increased approximately 12.3%, or $70.8 million, to $646.4 million for the three months ended October 28, 2006, from $575.6 million for the three months ended October 29, 2005. This increase was primarily due to organic growth in our wholesale division. Our organic growth is due to the continued growth of the natural products industry in general, increased market share through our focus on service and value added services, and the opening of new distribution centers, which allows us to carry a broader selection of products.
In the three months ended October 28, 2006, Whole Foods Market, Inc. (“Whole Foods Market”) comprised approximately 25.5% of net sales and Wild Oats Markets, Inc. (“Wild Oats Markets”) comprised approximately 9.2% of net sales. In the three months ended October 29, 2005, Whole Foods Market comprised approximately 25.5% of net sales and Wild Oats Markets comprised approximately 10.1% of net sales.
The following table lists the percentage of sales by customer type for the quarters ended October 28, 2006 and October 29, 2005:
Customer type | Percentage of Net Sales |
| 2006 | 2005 |
Independently owned natural products retailers | 45% | 46% |
Supernatural chains | 35% | 36% |
Conventional supermarkets | 16% | 14% |
Other | 4% | 4% |
Sales by channel has been adjusted to properly reflect changes in customer types resulting from a review of our customer lists. As a result of this review, sales to the independents sales channel decreased 1.5% and 0.7% for the quarters ended October 28, 2006 and October 29, 2005, respectively and sales to the supermarket sales channel increased 1.5% and 0.7% for the quarters ended October 28, 2006 and October 29, 2005, respectively.
Gross Profit
Our gross profit increased approximately 12.1%, or $13.3 million, to $123.6 million for the three months ended October 28, 2006, from $110.3 million for the three months ended October 29, 2005. Our gross profit as a percentage of net sales was 19.1 % and 19.2% for the three months ended October 28, 2006 and October 29, 2005, respectively. The decrease in gross profit as a percentage of net sales was due primarily to the low gross margin at our Albert's Organics location in Greenwood, Indiana. Due to the slower than anticipated improvement in results, we elected to close the Albert’s Organics operations at this facility and began serving this market from Albert’s Organics’ Minneapolis, Minnesota facility effective October 31, 2006.
Operating Expenses
Our total operating expenses, excluding special items, increased approximately 9.9%, or $9.0 million, to $100.4 million for the three months ended October 28, 2006, from $91.4 million for the three months ended October 29, 2005. Total operating expenses, including special items, increased approximately 4.9%, or $4.7 million, to $100.4 million for the three months ended October 28, 2006, from $95.7 million for the three months ended October 29, 2005. Special items are discussed below under “Special Items.” The increase in total operating expenses, excluding special items, for the three months ended October 28, 2006 was due to increased spending to improve and expand our infrastructure to support our continued sales growth. In addition, operating expenses during the quarter were negatively impacted by an operating loss of $0.6 million related to the Greenwood, Indiana location of our Albert's Organics division. As a result, management decided to close these operations and we began serving this market from the Albert's Organics' Minneapolis, Minnesota facility, effective October 31, 2006. The three months ended October 28, 2006 includes share-based compensation expense of $1.0 million. Share-based compensation expense for the three months ended October 29, 2005 was $2.5 million, of which $1.5 million related to the expense for share-based payment awards and $1.0 million related to the accelerated vesting of certain options pursuant to the employment transition agreement we entered into during the first quarter of fiscal 2006 with our former President and Chief Executive Officer, which was treated as a special item.
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As a percentage of net sales, total operating expenses, excluding special items, decreased to approximately 15.5% for the three months ended October 28, 2006, from approximately 15.9% for the three months ended October 29, 2005. As a percentage of net sales, total operating expenses, including special items, decreased to approximately 15.5% for the three months ended October 28, 2006, from approximately 16.6% for the three months ended October 29, 2005. The decrease in operating expenses as a percentage of net sales was primarily attributable to increased efficiencies due to our recent distribution facility openings, offset by operating losses related to the Albert’s Organics Greenwood, Indiana location (which operations were transferred to the Albert’s Organics Minneapolis, Minnesota facility effective October 31, 2006).
There were no special items for the three months ended October 28, 2006. As discussed below under “Special Items,” total operating expenses for the three months ended October 29, 2005 included special items related to incremental and redundant costs incurred during the transition from our former warehouses and outside storage facility in Auburn, California into our new larger facility in Rocklin, California of $0.7 million, certain incremental costs associated with the opening of our Greenwood, Indiana facility of $0.1 million and certain cash and non-cash expenses of $3.5 million incurred in accordance with the employment transition agreement we entered into during the first quarter of fiscal 2006 with our former President and Chief Executive Officer.
Operating Income
Operating income, excluding the special items discussed below under “Special Items,” increased approximately 22.5%, or $4.3 million, to $23.1 million for the three months ended October 28, 2006, from $18.9 million for the three months ended October 29, 2005. As a percentage of net sales, operating income, excluding special items, was 3.6% for the three months ended October 28, 2006, compared to 3.3% for the three months ended October 29, 2005. Operating income, including special items, increased approximately 58.4%, or $8.5 million, to $23.1 million, or 3.6% of net sales, for the three months ended October 28, 2006, from $14.6 million, or 2.5% of net sales, for the three months ended October 29, 2005.
Other Expense (Income)
Other expense (income) increased $0.5 million to $2.8 million for the three months ended October 28, 2006 from $2.2 million for the three months ended October 29, 2005. Interest expense for the three months ended October 28, 2006 increased to $2.9 million from $2.4 million in the three months ended October 29, 2005. The increase in interest expense was due to rising interest rates, partially offset by our lower debt levels during the quarter ended October 28, 2006 than during the quarter ended October 29, 2005.
Provision for Income Taxes
Our effective income tax rate was 39.0% and 38.0% for the three months ended October 28, 2006 and October 29, 2005, respectively. The effective rate was higher than the federal statutory rate primarily due to state and local income taxes. The increase in the effective tax rate was primarily due to share-based compensation for incentive stock options and the timing of disqualifying dispositions of certain share-based compensation awards. SFAS123(R) provides that the tax effect of the book compensation cost previously recognized for the incentive stock option that an employee does not retain for the minimum holding period required by the Internal Revenue Code (“disqualified disposition”) is recognized as a tax benefit in the period the disqualifying disposition occurs. Our effective income tax rate will continue to be effected by the tax impact related to incentive stock options and the timing of tax benefits related to disqualifying dispositions.
Net Income
Net income, excluding special items, increased $2.1 million to $12.4 million, or $0.29 per diluted share, for the three months ended October 28, 2006, compared to $10.3 million, or $0.24 per diluted share, for the three months ended October 29, 2005. Net income, including special items, increased $4.8 million to $12.4 million, or $0.29 per diluted share, for the three months ended October 28, 2006, compared to $7.7 million, or $0.18 per diluted share, for the three months ended October 29, 2005.
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Special Items
There were no special items for three months ended October 28, 2006. Special items for three months ended October 29, 2005 included: (i) incremental and redundant costs incurred during the transition from our former warehouses and outside storage facility in Auburn, California into our new facility in Rocklin, California, (ii) certain costs associated with opening our Greenwood, Indiana facility, and (iii) non-recurring cash and non-cash expenses incurred in accordance with the employment transition agreement we entered into during the quarter with Steven H. Townsend.
The following table presents a reconciliation of net income and per share amounts, excluding special items (non-GAAP basis), to net income and per share amounts, including special items (GAAP basis), for the three months ended October 29, 2005:
Three Months Ended October 29, 2005 (in thousands, except per share data) | Pretax
Income | Net of Tax | Per diluted
share |
| | | |
Income, excluding special items: | $16,646 | $10,320 | $0.24 |
| | | |
Special items – (Expense) | | | |
Employment transition agreement costs
(included in operating expenses) | (3,512) | (2,177) | (0.05) |
Rocklin, CA facility relocation costs
(included in operating expenses) | (672) | (416) | (0.01) |
Greenwood, IN facility openings costs
(included in operating expenses) | (92) | (57) | (0.00) |
| | | |
Income, including special items: | $12,371* | $7,670 | $0.18 |
* Total reflects rounding
A description of our use of non-GAAP information is provided under “Use of Non-GAAP Results” below.
Liquidity and Capital Resources
We finance operations and growth primarily with cash flows from operations, borrowings under our credit facility, operating leases, trade payables, bank indebtedness and the sale of equity and debt securities.
On April 30, 2004, we entered into an amended and restated four-year $250 million revolving credit facility with a bank group that was led by Bank of America Business Capital (formerly Fleet Capital Corporation) as the administrative agent. Our amended and restated credit facility provides for improved terms and conditions that provide us with more financial and operational flexibility, reduced costs and increased liquidity. The credit facility replaced an existing $150 million revolving credit facility. We further amended this facility effective as of January 1, 2006, reducing the rate at which interest accrues on LIBOR borrowings from one-month LIBOR plus 0.90% to one-month LIBOR plus 0.75%. Our amended and restated credit facility, which matures on March 31, 2008, supports our working capital requirements in the ordinary course of business and provides capital to grow our business organically or through acquisitions. As of October 28, 2006, our borrowing base, based on accounts receivable and inventory levels, was $250.0 million, with remaining availability of $119.9 million.
In April 2003, we executed a term loan agreement in the principal amount of $30 million, secured by certain real property that was released from the lien under our amended and restated credit facility in accordance with an amendment to the loan and security agreement related to that facility. The term loan is repayable over seven years based on a fifteen-year amortization schedule. Interest on the term loan accrued at LIBOR plus 1.50%. In December 2003, we amended this term loan agreement by increasing the principal amount from $30 million to $40 million under the existing terms and conditions. On July 29, 2005, we entered into an amended term loan agreement which further increased the principal amount of this term loan from $40 million to up to $75 million and decreased the rate at which interest accrues to LIBOR plus 1.00%. As of October 28, 2006, $70 million was outstanding under the term loan agreement.
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We believe that our capital requirements for fiscal 2007 will be between $40 and $45 million. We will finance these requirements with cash generated from operations and the use of our existing credit facilities. These projects will provide both expanded facilities and technology that we believe will provide us with the capacity to continue to support the growth and expansion of our customer base. We believe that our future capital requirements will be higher than our anticipated fiscal 2007 requirements, as a percentage of net sales, as we plan to continue to invest in our growth by upgrading our infrastructure and expanding our facilities. Future investments in acquisitions that we may pursue will be financed through either equity or long-term debt negotiated at the time of the potential acquisition.
Net cash used in operations was $17.2 million for the three months ended October 28, 2006, which reflected a $43.0 million investment in inventory that was partially offset by net income and a change in cash paid to vendors, net of cash collected from customers. Days in inventory decreased to 48 days at October 28, 2006, compared to 50 days at October 29, 2005. Days sales outstanding improved to 22 days at October 28, 2006, compared to 23 days at October 29, 2005. Net cash used in operations was $5.8 million for the three months ended October 29, 2005, primarily due to a $34.7 million investment in inventory that was partially offset by net income and a change in cash paid to vendors, net of cash collected from customers. Working capital increased by $18.6 million, or 10.2%, to $201.5 million at October 28, 2006, compared to working capital of $182.9 million at July 29, 2006.
Net cash used in investing activities decreased $3.4 million to $4.8 million for the three months ended October 28, 2006, compared to $8.2 million for the same period in fiscal 2006. The decrease was primarily due to lower capital expenditures in the three months ended October 28, 2006. The three months ended October 29, 2005 included capital expenditures related to the opening of the Rocklin, California facility.
Net cash provided by financing activities was $10.4 million for the three months ended October 28, 2006, primarily due to $10.0 million in proceeds from the increase in borrowings under our term loan agreement, the increase in our bank overdraft and proceeds from the exercise of stock options. This increase was offset by $8.5 million in net repayments on our amended and restated credit facility and long-term debt. Net cash provided by financing activities was $11.2 million for the three months ended October 29, 2005, primarily due to $15.4 million in borrowings under our amended and restated credit facility offset by the decrease in our bank overdraft.
On December 1, 2004, our Board of Directors authorized the repurchase of up to $50 million of common stock from time to time in the open market or in privately negotiated transactions. As part of the stock repurchase program, we have purchased an aggregate of 228,800 shares of our common stock for our treasury at an aggregate cost of approximately $6.1 million. All shares were purchased at prevailing market prices. We may continue or, from time to time, suspend repurchases of shares under our stock repurchase program, depending on prevailing market conditions, alternate uses of capital and other factors. Whether and when to initiate and/or complete any purchase of common stock and the amount of common stock purchased will be determined in our complete discretion.
In August 2005, we entered into an interest rate swap agreement effective July 29, 2005. This agreement provides for us to pay interest for a seven-year period at a fixed rate of 4.70% on a notional principal amount of $50 million while receiving interest for the same period at LIBOR on the same notional principal amount. The swap has been entered into as a hedge against LIBOR interest rate movements on current variable rate indebtedness totaling $50 million at one-month LIBOR plus 1.00%, thereby fixing our effective rate on the notional amount at 5.70%. LIBOR was 5.32% as of October 28, 2006. The swap agreement qualifies as an “effective” hedge under SFAS 133.
We entered into commodity swap agreements to reduce price risk associated with anticipated purchases of diesel fuel. The outstanding commodity swap agreements hedge a portion of our expected fuel usage for the periods set forth in the agreements. We monitor the commodity (NYMEX #2 Heating oil) used in our swap agreements to determine that the correlation between the commodity and diesel fuel is deemed to be “highly effective.” At October 28, 2006, we had two outstanding commodity swap agreements which mature on October 31, 2006 and June 30, 2007.
There have been no material changes to our commitments and contingencies from those disclosed in our Annual Report on Form 10-K for the year ended July 29, 2006.
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SEASONALITY
Generally, we do not experience any material seasonality. However, our sales and operating results may vary significantly from quarter to quarter due to factors such as changes in our operating expenses, management's ability to execute our operating and growth strategies, personnel changes, demand for natural products, supply shortages and general economic conditions.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. FIN 48 will be effective for fiscal years beginning after December 15, 2006 and the provisions of FIN 48 will be applied to all tax positions upon initial adoption of the Interpretation. The cumulative effect of applying the provisions of this Interpretation will be reported as an adjustment to the opening balance of retained earnings for that fiscal year. We will adopt FIN 48 in fiscal 2008 and are currently evaluating whether the adoption of FIN 48 will have a material effect on our consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standard No. (“SFAS”) 157, "Fair Value Measurements" (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements under other accounting pronouncements, but does not change the existing guidance as to whether or not an instrument is carried at fair value. The statement is effective for fiscal years beginning after November 15, 2007. We are currently evaluating this statement and its effect on our consolidated financial statements.
In September 2006, the SEC staff issued SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. We are currently evaluating this statement and its effect on our consolidated financial statements.
Use of Non-GAAP Results
Financial measures included in this Management's Discussion and Analysis of Financial Condition and Results of Operations that are not in accordance with GAAP are referred to as “non-GAAP financial measures”. To supplement our financial statements presented on a GAAP basis, we use non-GAAP financial measures of operating results, net income and earnings per share adjusted to exclude special charges and/or share-based compensation. We believe that the use of these additional measures is appropriate to enhance an overall understanding of our past financial performance and also our prospects for the future as these special charges are not expected to be part of our ongoing business. The adjustments to our GAAP results are made with the intent of providing both management and investors with a more complete understanding of the underlying operational results and trends and our marketplace performance. For example, these adjusted non-GAAP results are among the primary indicators our management uses as a basis for our planning and forecasting of future periods. The presentation of this additional information is not meant to be considered in isolation or as a substitute for net earnings or diluted earnings per share prepared in accordance with GAAP. A comparison and reconciliation from non-GAAP to GAAP results is included in the tables under “Special Items” above.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Our exposure to market risks results primarily from fluctuations in interest rates on our borrowings. As more fully described in the notes to the condensed consolidated financial statements, we use interest rate swap agreements to modify variable rate obligations to fixed rate obligations for a portion of our debt. There have been no material changes to our exposure to market risks from those disclosed in our Annual Report on Form 10-K for the year ended July 29, 2006.
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Item 4. Controls and Procedures
| (a) | | Evaluation of disclosure controls and procedures. We carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report on Form 10-Q (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in timely reporting material information required to be included in our periodic reports filed with the Securities and Exchange Commission. |
| (b) | | Changes in internal controls. There has been no change in our internal control over financial reporting that occurred during the first fiscal quarter of 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. |
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 1A. Risk Factors
The statements in this item describe the major risks to our business and should be considered carefully. We provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our business. These are factors that, individually or in the aggregate, we think could cause our actual results to differ materially from expected and historical results. Our business, financial condition or results of operations could be materially adversely affected by any of these risks.
We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. See “Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Acquisitions
We continually evaluate opportunities to acquire other companies. We believe that there are risks related to acquiring companies, including overpaying for acquisitions, losing key employees of acquired companies and failing to achieve potential synergies. Additionally, our business could be adversely affected if we are unable to integrate our acquisitions and mergers.
A significant portion of our historical growth has been achieved through acquisitions of or mergers with other distributors of natural products. Successful integration of merger partners is critical to our future operating and financial performance. Integration requires, among other things:
| | • | | maintaining the customer base; |
| | • | | optimizing of delivery routes; |
| | • | | coordinating administrative, distribution and finance functions; and |
| | • | | integrating management information systems and personnel. |
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The integration process has and could divert the attention of management and any difficulties or problems encountered in the transition process could have a material adverse effect on our business, financial condition or results of operations. In addition, the process of combining companies has caused and could cause the interruption of, or a loss of momentum in, the activities of the respective businesses, which could have an adverse effect on their combined operations. We cannot assure you that we will realize any of the anticipated benefits of mergers.
We may have difficulty in managing our growth
The growth in the size of our business and operations has placed and is expected to continue to place a significant strain on our management. Our future growth is limited in part by the size and location of our distribution centers. We cannot assure you that we will be able to successfully expand our existing distribution facilities or open new distribution facilities in new or existing markets to facilitate growth. In addition, our growth strategy to expand our market presence includes possible additional acquisitions. To the extent our future growth includes acquisitions, we cannot assure you that we will successfully identify suitable acquisition candidates, consummate and integrate such potential acquisitions or expand into new markets. Our ability to compete effectively and to manage future growth, if any, will depend on our ability to continue to implement and improve operational, financial and management information systems on a timely basis and to expand, train, motivate and manage our work force. We cannot assure you that our personnel, systems, procedures and controls will be adequate to support our operations. Our inability to manage our growth effectively could have a material adverse effect on our business, financial condition or results of operations.
Increased Fuel Costs
Increased fuel costs may have a negative impact on our results of operations. The high cost of diesel fuel can also increase the price we pay for products as well as the costs we incur to deliver products to our customers. These factors, in turn, may negatively impact our net sales, margins, operating expenses and operating results. To manage this risk, we have in the past periodically entered, and may in the future periodically enter, into heating oil derivative contracts to hedge a portion of our projected diesel fuel requirements. Heating crude oil prices have a highly correlated relationship to fuel prices, making these derivatives effective in offsetting changes in the cost of diesel fuel. We do not enter into fuel hedge contracts for speculative purposes.
We have significant competition from a variety of sources
We operate in competitive markets, and our future success will be largely dependent on our ability to provide quality products and services at competitive prices. Our competition comes from a variety of sources, including other distributors of natural products as well as specialty grocery and mass market grocery distributors. We cannot assure you that mass market grocery distributors will not increase their emphasis on natural products and more directly compete with us or that new competitors will not enter the market. These distributors may have been in business longer than us, may have substantially greater financial and other resources than us and may be better established in their markets. We cannot assure you that our current or potential competitors will not provide services comparable or superior to those provided by us or adapt more quickly than we do to evolving industry trends or changing market requirements. It is also possible that alliances among competitors may develop and rapidly acquire significant market share or that certain of our customers will increase distribution to their own retail facilities. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could materially adversely affect our business, financial condition or results of operations. We cannot assure you that we will be able to compete effectively against current and future competitors.
We depend heavily on our principal customers
Our ability to maintain close, mutually beneficial relationships with our two largest customers, Whole Foods Market and Wild Oats Markets, is an important element to our continued growth. In October 2006, we announced a seven-year distribution agreement with Whole Foods Market, which commenced on September 26, 2006, under which we will continue to serve as the primary U.S. distributor to Whole Foods Market in the regions where we previously served. In November 2006, we entered into an amendment to that distribution agreement, under which we were named the primary wholesale natural grocery distributor to Whole Foods Market’s Southern Pacific region, which includes Southern California, Arizona and Southern Nevada, and is a region we did not previously serve. Whole Foods Market accounted for approximately 25.5% of our net sales in the quarter ended October 28, 2006. In January 2004, we entered into a five-year primary distribution agreement with Wild Oats Markets. We had previously served as primary distributor for Wild Oats Markets through August 2002. Wild Oats Markets accounted for approximately 9.2% of our net sales in the quarter ended October 28, 2006. As a result of this concentration of our customer base, the loss or cancellation of business from either of these customers including from increased distribution to their own facilities, could materially and adversely affect our business, financial condition or results of operations. We sell products under purchase orders, and we generally have no agreements with or commitments from our customers for the purchase of products. We cannot assure you that our customers will maintain or increase their sales volumes or orders for the products supplied by us or that we will be able to maintain or add to our existing customer base.
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Our profit margins may decrease due to consolidation in the grocery industry
The grocery distribution industry generally is characterized by relatively high volume with relatively low profit margins. The continuing consolidation of retailers in the natural products industry and the growth of supernatural chains may reduce our profit margins in the future as more customers qualify for greater volume discounts, and we experience pricing pressures from both ends of the supply chain.
Our operations are sensitive to economic downturns
The grocery industry is also sensitive to national and regional economic conditions and the demand for our products may be adversely affected from time to time by economic downturns. In addition, our operating results are particularly sensitive to, and may be materially adversely affected by:
| | • | | difficulties with the collectibility of accounts receivable; |
| | • | | difficulties with inventory control; |
| | • | | competitive pricing pressures; and |
| | • | | unexpected increases in fuel or other transportation-related costs. |
We cannot assure you that one or more of such factors will not materially adversely affect our business, financial condition or results of operations.
We are dependent on a number of key executives
Management of our business is substantially dependent upon the services of Richard Antonelli (Executive Vice President, Chief Operating Officer and President of Distribution), Daniel V. Atwood (Executive Vice President, Chief Marketing Officer, and President of United Natural Brands), Michael D. Beaudry (President of the Eastern Region), Thomas A. Dziki (National Vice President of Real Estate and Construction), Michael S. Funk (President and Chief Executive Officer), Gary A. Glenn (Vice President of Information Technology), Randle Lindberg (President of the Western Region), Mark E. Shamber (Vice President, Chief Financial Officer and Treasurer), and other key management employees. Loss of the services of any officers or any other key management employee could have a material adverse effect on our business, financial condition or results of operations.
Our operating results are subject to significant fluctuations
Our net sales and operating results may vary significantly from period to period due to:
| | • | | demand for natural products; |
| | • | | changes in our operating expenses, including in fuel and insurance; |
| | • | | management’s ability to execute our business and growth strategies; |
| | • | | changes in customer preferences and demands for natural products, including levels of enthusiasm for health, fitness and environmental issues; |
| | • | | fluctuation of natural product prices due to competitive pressures; |
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| | • | | general economic conditions; |
| | • | | lack of an adequate supply of high-quality agricultural products due to poor growing conditions, natural disasters or otherwise; |
| | • | | volatility in prices of high-quality agricultural products resulting from poor growing conditions, natural disasters or otherwise; and |
| | • | | future acquisitions, particularly in periods immediately following the consummation of such acquisition transactions while the operations of the acquired businesses are being integrated into our operations. |
Due to the foregoing factors, we believe that period-to-period comparisons of our operating results may not necessarily be meaningful and that such comparisons cannot be relied upon as indicators of future performance.
We are subject to significant governmental regulation
Our business is highly regulated at the federal, state and local levels and our products and distribution operations require various licenses, permits and approvals. In particular:
| | • | | our products are subject to inspection by the U.S. Food and Drug Administration; |
| | • | | our warehouse and distribution facilities are subject to inspection by the U.S. Department of Agriculture and state health authorities; and |
| | • | | the U.S. Department of Transportation and the U.S. Federal Highway Administration regulate our trucking operations. |
The loss or revocation of any existing licenses, permits or approvals or the failure to obtain any additional licenses, permits or approvals in new jurisdictions where we intend to do business could have a material adverse effect on our business, financial condition or results of operations.
Union-organizing activities could cause labor relations difficulties
As of October 28, 2006, we had approximately 4,570 full and part-time employees. An aggregate of 8% of our total employees, or approximately 350 of the employees at our Auburn, Washington, Iowa City, Iowa and Edison, New Jersey facilities, are covered by collective bargaining agreements. The Edison, New Jersey and Auburn, Washington agreements expire in June 2008 and February 2009, respectively. The Iowa City, Iowa agreement expired in June 2006. We are continuing to negotiate with these employees and expect to reach agreement in the first quarter of calendar 2007. We have in the past been the focus of union-organizing efforts. As we increase our employee base and broaden our distribution operations to new geographic markets, our increased visibility could result in increased or expanded union-organizing efforts. Although we have not experienced a work stoppage to date, if additional employees were to unionize or we are not successful in reaching agreement with these employees, we could be subject to work stoppages and increases in labor costs, either of which could materially adversely affect our business, financial condition or results of operations.
Access to capital and the cost of that capital
We have an amended and restated secured revolving credit facility, with available credit under it of $250 million at an interest rate of one-month LIBOR plus 0.75% maturing on March 31, 2008. As of October 28, 2006, our borrowing base, based on accounts receivable and inventory levels, was $250 million, with remaining availability of $119.9 million. In April 2003, we executed a term loan agreement in the principal amount of $30 million secured by certain real property that was released from the lien under our amended and restated credit facility in accordance with an amendment to the loan and security agreement related to that facility. The term loan is repayable over seven years based on a fifteen-year amortization schedule. Interest on the term loan accrues at LIBOR plus 1.50%. In December 2003, we amended this term loan agreement by increasing the principal amount from $30 million to $40 million under the existing terms and conditions. In July 2005, we further amended the term loan agreement, which further increased the principal amount from $40 million to a maximum of up to $75 million. The amended term loan accrues interest at one-month LIBOR plus 1.00%, and is repayable over seven years based on a fifteen-year amortization schedule, with all other terms and conditions remaining unchanged. As of October 28, 2006, $70 million was outstanding under the term loan agreement.
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In order to maintain our profit margins, we rely on strategic investment buying initiatives, such as discounted bulk purchases, which require spending significant amounts of working capital. In the event that our cost of capital increases or our ability to borrow funds or raise equity capital is limited, we could suffer reduced profit margins and be unable to grow our business organically or through acquisitions, which could have a material adverse effect on our business, financial condition or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
Exhibits
Exhibit No. | Description |
10.1* | Distribution Agreement between the Registrant and Whole Foods Market, Inc. |
31.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – CEO |
31.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – CFO |
32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – CEO |
32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – CFO |
* | Certain confidential portions of this exhibit were omitted by means of redacting a portion of the text. This exhibit has been filed separately with the Securities and Exchange Commission accompanied by a confidential treatment request pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. |
* * *
We would be pleased to furnish a copy of this Form 10-Q to any stockholder who requests it by writing to:
United Natural Foods, Inc.
Investor Relations
260 Lake Road
Dayville, CT 06241
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| UNITED NATURAL FOODS, INC. |
| Mark E. Shamber
Chief Financial Officer
(Principal Financial and Accounting Officer) |
Dated: December 7, 2006
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