UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 000-21531
UNITED NATURAL FOODS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 05-0376157
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
260 Lake Road Dayville, CT 06241
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (860) 779-2800
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
As of December 1, 2003 there were 19,546,792 shares of the Registrant's Common
Stock, $0.01 par value per share, outstanding.
UNITED NATURAL FOODS, INC.
FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 31, 2003
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited) 3
Condensed Consolidated Statements of Income (unaudited) 4
Condensed Consolidated Statements of Cash Flows (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosure About Market Risk 22
Item 4. Controls and Procedures 22
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
October 31, July 31,
(In thousands, except per share amounts) 2003 2003
----------- ----------
ASSETS
Current assets:
Cash $ 10,149 $ 3,645
Accounts receivable, net 93,891 90,111
Notes receivable, trade 594 585
Inventories 175,869 158,263
Prepaid expenses 5,593 5,706
Deferred income taxes 6,004 6,455
Refundable income taxes -- 704
--------- ---------
Total current assets 292,100 265,469
Property & equipment, net 100,900 101,238
Other assets:
Notes receivable, trade, net 1,609 1,261
Goodwill 57,744 57,400
Intangible assets, net 878 1,014
Other, net 3,232 3,717
--------- ---------
Total assets $ 456,463 $ 430,099
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable - line of credit $ 95,587 $ 96,170
Current installments of long-term debt 4,136 4,459
Current installment of obligations under capital leases 889 903
Accounts payable 89,761 67,187
Accrued expenses 22,207 26,347
Financial instruments 5,800 6,104
Income taxes payable 3,230 --
--------- ---------
Total current liabilities 221,610 201,170
Long-term debt, excluding current installments 37,816 38,507
Deferred income taxes 2,247 2,247
Obligations under capital leases, excluding current
installments 338 612
--------- ---------
Total liabilities 262,011 242,536
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value, authorized 5,000 shares;
none issued and outstanding -- --
Common stock, $0.01 par value, authorized 50,000 shares;
19,546 and 19,510 issued and outstanding at October 31, 2003
and July 31, 2003, respectively 195 195
Additional paid-in capital 86,531 86,068
Unallocated shares of ESOP (1,890) (1,931)
Accumulated other comprehensive income 40 432
Retained earnings 109,576 102,799
--------- ---------
Total stockholders' equity 194,452 187,563
--------- ---------
Total liabilities and stockholders' equity $ 456,463 $ 430,099
========= =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Quarters ended October 31,
(In thousands, except per share data) 2003 2002
---------- ----------
Net sales $ 381,382 $ 310,993
Cost of sales 305,209 247,568
---------- ----------
Gross profit 76,173 63,425
Operating expenses 62,932 53,432
Amortization of intangibles 232 38
---------- ----------
Total operating expenses 63,164 53,470
---------- ----------
Operating income 13,009 9,955
---------- ----------
Other expense (income):
Interest expense 2,320 1,847
Change in fair value of financial instruments (304) 1,706
Other, net (117) (238)
---------- ----------
Total other expense 1,899 3,315
---------- ----------
Income before income taxes 11,110 6,640
Income taxes 4,333 2,656
---------- ----------
Net income $ 6,777 $ 3,984
========== ==========
Per share data (basic):
Net income $ 0.35 $ 0.21
========== ==========
Weighted average shares of common stock 19,526 19,106
========== ==========
Per share data (diluted):
Net income $ 0.34 $ 0.20
========== ==========
Weighted average shares of common stock 20,182 19,434
========== ==========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Quarters ended October 31,
(In thousands) 2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,777 $ 3,984
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,744 2,370
Change in fair value of financial instruments (304) 1,706
Gain on disposals of property and equipment 2 9
Deferred income tax benefit 451 --
Provision for doubtful accounts 570 1,060
Changes in assets and liabilities:
Accounts receivable (4,350) (227)
Inventory (17,606) (4,111)
Prepaid expenses and other assets 951 (588)
Notes receivable, trade (357) 95
Accounts payable 22,574 9,303
Accrued expenses (4,140) 750
Income taxes payable 3,230 1,805
Tax effect of stock option exercises 97 --
-------- --------
Net cash provided by operating activities 10,639 16,156
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of acquired businesses, net of cash acquired (344) (29,960)
Proceeds from sale of property and equipment 57 33
Capital expenditures (2,329) (4,313)
-------- --------
Net cash used in investing activities (2,616) (34,240)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings under note payable (583) 12,077
Repayments of long-term debt (1,014) (470)
Principal payments of capital lease obligations (288) (312)
Proceeds from exercise of stock options 366 4
-------- --------
Net cash provided by (used in) financing activities (1,519) 11,299
-------- --------
NET INCREASE (DECREASE) IN CASH 6,504 (6,785)
Cash at beginning of period 3,645 11,184
-------- --------
Cash at end of period $ 10,149 $ 4,399
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 2,220 $ 1,823
======== ========
Income taxes $ 388 $ 819
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
5
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2003 (UNAUDITED)
1. BASIS OF PRESENTATION
United Natural Foods, Inc. (the "Company") is a distributor and retailer of
natural and organic products. The Company sells its products throughout the
United States.
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation. Certain prior
year amounts have been reclassified to conform to the current year's
presentation.
The accompanying unaudited condensed consolidated financial statements have been
prepared pursuant to rules and regulations of the Securities and Exchange
Commission for interim financial information, including the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and
footnote disclosures normally required in complete financial statements prepared
in accordance with accounting principles generally accepted in the United States
of America have been condensed or omitted. In our opinion, these financial
statements include all adjustments necessary for a fair presentation of the
results of operations for the interim periods presented. The results of
operations for interim periods, however, may not be indicative of the results
that may be expected for a full year. These financial statements should be read
in conjunction with the consolidated financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended July 31,
2003.
2. INTEREST RATE SWAP AGREEMENTS
In October 1998, the Company entered into an interest rate swap agreement that
provides for the Company to pay interest for a five-year period at a fixed rate
of 5% on a notional principal amount of $60 million while receiving interest for
the same period at the LIBOR rate on the same notional principal amount. This
swap has been entered into as a hedge against LIBOR interest rate movements on
current and anticipated variable rate indebtedness totaling $60 million at LIBOR
plus 1.50%, thereby fixing the effective rate at 6.50%. In October 2003, the
counter party exercised its option to extend the original five-year term of the
swap agreement to seven years. The inclusion of this option prohibits accounting
for the swap as an effective hedge under Statement of Financial Accounting
Standards ("SFAS") No. 133 ("SFAS 133"), Accounting for Derivative Instruments
and Hedging Activities.
The Company entered into an additional interest rate swap agreement effective
August 2001. The additional agreement provides for the Company to pay interest
for a four-year period at a fixed rate of 4.81% on a notional principal amount
of $30 million while receiving interest for the same period at the LIBOR rate on
the same notional principal amount. The four-year term of the swap agreement may
be extended to six years at the option of the counter party, which prohibits
accounting for the swap as an effective hedge under SFAS 133. The swap has been
entered into as a hedge against LIBOR interest rate movements on current and
anticipated variable rate indebtedness totaling $30 million at LIBOR plus 1.50%,
thereby fixing the effective rate on the notional amount at 6.31%. If LIBOR
exceeds 6.0% in a given period, the agreement is suspended for that period.
The Company recorded $0.3 million of income and $1.7 million of expense for the
quarters ended October 31, 2003 and 2002, respectively, on its interest rate
swap agreements and related option agreements to reflect the change in fair
value of the financial instruments.
The Company also entered into an interest rate swap agreement effective May
2003. The agreement provides for it to pay interest for a seven-year period at a
fixed rate of 3.68% on a notional principal amount of $30 million while
receiving interest for the same period at the LIBOR rate 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 $30.0
million at LIBOR plus 1.50%, thereby fixing its effective rate on the notional
amount at 5.18%. The swap agreement qualifies as an "effective" hedge under SFAS
133, and the Company recorded a long-term asset of $40,000 as of
6
October 31, 2003, and a corresponding credit to accumulated other comprehensive
income in the statement of stockholders' equity.
3. STOCK OPTION PLANS
The Company grants stock options for a fixed number of shares to employees and
certain other individuals with exercise prices equal to the fair value of the
shares at the dates of grant. The Company has adopted the disclosure only
provisions of SFAS No. 123 ("SFAS 123"), Accounting for Stock-based
Compensation, and will continue to account for its stock option plans in
accordance with the provisions of Accounting Principles Board Opinion 25,
Accounting for Stock Issued to Employees. In addition, the Company has made the
appropriate disclosures as required under SFAS No. 148 ("SFAS 148"), Accounting
for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provision of SFAS 123 and
SFAS 148 to stock-based employee compensation:
Quarters ended October 31,
--------------------------
2003 2002
- --------------------------------------------------------------------------------
Net income - as reported $ 6,777 $ 3,984
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (671) (812)
--------- ---------
Net income - pro forma $ 6,106 $ 3,172
--------- ---------
Basic earnings per share
As reported $ 0.35 $ 0.21
--------- ---------
Pro forma $ 0.31 $ 0.17
--------- ---------
Diluted earnings per share
As reported $ 0.34 $ 0.20
--------- ---------
Pro forma $ 0.31 $ 0.17
--------- ---------
The Company estimates the fair value of each option as of the date of grant
using the Black-Scholes pricing model with the following weighted average
assumptions used for grants in the quarters ended October 31, 2003 and 2002:
Quarters ended October 31,
2003 2002
---------- ----------
Expected volatility 60.5% 63.0%
Dividend yield 0.0% 0.0%
Risk free interest rate 3.55% 3.3%
Expected life 5 years 5 years
The Board of Directors adopted and the stockholders approved the 2002 Stock
Incentive Plan of the Company, which provides for grants of stock options to
employees, officers, directors and others, on October 2, 2002 and December 3,
2002, respectively. These options are intended to either qualify as incentive
stock options within the meaning of Section 422 of the Internal Revenue Code or
be "non-statutory stock options." A total of 1,400,000 shares of common stock
may be issued upon the exercise of options granted under the 2002 Stock
Incentive Plan. In the quarter ended October 31, 2003, the Company granted 5,000
shares under the 2002 Stock Incentive Plan. On December 3, 2003, the Company
granted 380,000 shares under the 2002 Stock Incentive Plan.
7
4. EARNINGS PER SHARE
Following is a reconciliation of the basic and diluted number of shares used in
computing earnings per share:
Quarters ended
October 31,
-------------------
(In thousands) 2003 2002
------ ------
Basic weighted average shares outstanding 19,526 19,106
Net effect of dilutive stock options
based upon the treasury stock method 656 328
------ ------
Diluted weighted average shares outstanding 20,182 19,434
====== ======
There were 2,500 and 0 anti-dilutive stock options for the quarters ended
October 31, 2003 and 2002, respectively.
5. COMPREHENSIVE INCOME
Total comprehensive income for the three month period ended October 31, 2003
amounted to $6,385,000 as compared to $3,984,000 in the same period in the prior
year. Comprehensive income is comprised of net income plus the increase/decrease
in the fair value of the May 2003 swap agreement discussed in Note 2.
6. ACQUISITIONS
On December 31, 2002, the Company acquired by merger privately held Northeast
Cooperative, a natural food distributor, headquartered in Brattleboro, Vermont,
which serviced customers in the Northeast and Midwest regions of the United
States, for cash consideration of $14.1 million. The acquisition was financed by
proceeds from the Company's line of credit. The operating results of Northeast
Cooperative have been included in the consolidated financial statements of the
Company beginning with the acquisition date. The Company has recorded goodwill
of $14.0 million related to this purchase acquisition, reflecting the cost of
the acquisition and additional liabilities recorded.
On October 11, 2002, the Company acquired substantially all of the assets and
assumed substantially all of the liabilities of Blooming Prairie Cooperative
("Blooming Prairie"), a distributor of natural foods and related products in the
Midwest region of the United States, for cash consideration of $29.6 million.
The acquisition was financed by proceeds from the Company's line of credit. The
operating results of Blooming Prairie have been included in the consolidated
financial statements of the Company beginning with the acquisition date. The
Company recorded goodwill of $13.7 million related to this purchase acquisition.
The following presents the unaudited pro forma results assuming that the
acquisitions discussed above had occurred as of the beginning of fiscal 2002.
These pro forma results are not necessarily indicative of the results that will
occur in future periods.
8
Quarter ended
(in thousands, except per share data) October 31,
2002
-----------
Net sales $369,495
========
Income before income taxes $ 6,040
========
Net income $ 3,625
========
Earnings per common share:
Basic $ 0.19
========
Diluted $ 0.19
========
7. BUSINESS SEGMENTS
The Company has several operating divisions aggregated under the distribution
segment, which is the Company's only reportable segment. These operating
divisions have similar products and services, customer types, distribution
methods and historical margins. The distribution segment is engaged in national
distribution of natural foods, produce and related products in the United
States. Other operating divisions include a retail segment, which engages in the
sale of natural foods and related products to the general public through retail
storefronts on the east coast of the United States, and a manufacturing segment,
which engages in importing, roasting and packaging of nuts, seeds, dried fruit
and snack items. These other operating divisions do not meet the quantitative
thresholds for reportable segments and are, therefore, included in an "Other"
caption in the segment information. The "Other" caption also includes corporate
expenses that are not allocated to operating divisions.
Following is business segment information for the periods indicated:
Unallocated
Distribution Other Eliminations Expenses Consolidated
------------ ----- ------------ -------- ------------
Quarter Ended October 31, 2003
Net sales $371,157 $17,872 $ (7,647) $381,382
Operating income (loss) 14,341 (1,252) (80) 13,009
Interest expense $2,320 2,320
Other, net (421) (421)
Income before income taxes 11,110
Amortization and depreciation 2,445 299 -- 2,744
Capital expenditures 2,259 70 -- 2,329
Total assets 611,121 40,359 (195,017) 456,463
Quarter Ended October 31, 2002
Net sales $299,087 $16,890 $ (4,984) $310,993
Operating income (loss) 11,415 (1,411) (49) 9,955
Interest expense 1,847 1,847
Other, net 1,468 1,468
Income before income taxes 6,640
Amortization and depreciation 2,046 324 -- 2,370
Capital expenditures 3,914 399 -- 4,313
Total assets 525,210 46,841 (178,315) 393,736
9
8. NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board issued SFAS No. 149
("SFAS 149"), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 amends and clarifies financial accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. The Company does not
believe that the adoption of SFAS 149 will have a material impact on the
Company's consolidated financial position or results of operations.
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150
("SFAS 150"), Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity. SFAS 150 requires issuers to classify as
liabilities (or assets in some circumstance) three classes of freestanding
financial instruments that embody obligations for the issuer. Generally, SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003 and is otherwise effective at the beginning of the first interim period
beginning after June 15, 2003. In November 2003, the FASB issued FASB Staff
Position 150-3 which deferred the application of certain provisions of SFAS 150.
The Company adopted the remaining provisions of SFAS 150 on August 1, 2003. The
adoption of SFAS 150 did not have a material impact on the Company's
consolidated financial position or results of operations.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are a leading national distributor of natural and organic foods and related
products in the United States. In recent years, our sales to existing and new
customers have increased through the acquisition of or merger with natural
products distributors, the expansion of existing distribution centers and the
continued growth of the natural products industry in general. Through these
efforts, we believe that we have been able to broaden our geographic
penetration, expand our customer base, enhance and diversify our product
selections and increase our market share. Our distribution operations are
comprised of three principal units:
o Our Eastern Region, which is comprised of United Natural Foods,
United Northeast (formerly Northeast Cooperative) and Blooming
Prairie (formerly Blooming Prairie Cooperative);
o Our Western Region, which is comprised of Mountain People's
Warehouse, Inc. and Rainbow Natural Foods, Inc.; and
o Albert's, which operates in various markets across the United
States.
Through our subsidiary, the Natural Retail Group, we also own and operate 12
natural products retail stores located primarily in Florida. We believe our
retail business serves as a natural complement to our distribution business,
enabling us to develop new marketing programs and improve customer service. In
addition, Hershey Import is a business that specializes in the international
trading, roasting and packaging of nuts, seeds, dried fruits and snack items.
Our net sales consist primarily of sales of natural products to retailers
adjusted for customer volume discounts, returns and allowances. The principal
components of our cost of sales include the amount paid to manufacturers and
growers for product sold, plus the cost of transportation necessary to bring the
product to our distribution facilities. Operating expenses include salaries and
wages, employee benefits (including payments under our Employee Stock Ownership
Plan), warehousing and delivery, selling, occupancy, insurance, administrative,
depreciation and amortization expense. Other expenses (income) include interest
on outstanding indebtedness, interest income, and the change in fair value of
financial instruments and miscellaneous income and expenses.
In order to maintain our market leadership and improve our operating
efficiencies, we are continually:
o expanding marketing and customer service programs across the
regions;
10
o expanding national purchasing opportunities;
o consolidating systems applications among physical locations and
regions;
o integrating administrative and accounting functions; and
o reducing geographic overlap between regions.
In addition, our continued growth has created the need for expansion of existing
facilities to achieve maximum operating efficiencies and to assure adequate
space for future needs. We have made considerable capital expenditures and
incurred considerable expenses in connection with the expansion of our
facilities, including the expansion of our facilities located in Atlanta,
Georgia and Fontana, California. We completed the expansion of our Chesterfield,
New Hampshire distribution facility in June 2003. This expansion included the
consolidation of our operations from Brattleboro, Vermont to Chesterfield, New
Hampshire. We now operate a 289,000 square foot facility that provides more
product diversity and enables us to better serve customers in our Eastern
Region.
We are currently expanding our Iowa City, Iowa distribution facility from its
existing 120,000 square feet to 260,000 square feet. This will enable us to
provide enhanced service levels to our customers in the Midwest market and
continue to grow our sales base in that market. We are also currently expanding
our Dayville, Connecticut distribution facility from its existing 245,000 square
feet to 315,000 square feet. The additional storage space in our Iowa City and
Dayville facilities allows for more product diversity and the elimination of
outside storage expenses. While we anticipate incremental short-term costs
during the first half of fiscal 2004, we expect the efficiencies created by
expanding our Iowa City and Dayville facilities to lower our expenses relative
to sales over the long-term. Upon completion of the Iowa City and Dayville
facilities' expansions, we will have added approximately 1,037,500 square feet
to our distribution centers in the last 5 years, which represents a 75% increase
in our distribution capacity.
While operating margins may be affected in periods in which these expenses are
incurred, over the long term, we expect to benefit from the increased absorption
of our expenses over a larger sales base. In addition, we continue to increase
our leading market share of the growing natural products industry by expanding
our customer base, increasing our share of existing customers' business and
continuing to expand and further penetrate new distribution territories,
particularly in the Midwest and Texas markets. To this end, on October 11, 2002
we acquired substantially all the assets of Blooming Prairie Cooperative, the
largest volume distributor of natural foods and products in the Midwest region
of the United States. The acquisition of Blooming Prairie Cooperative's Iowa
City, Iowa and Mounds View, Minnesota distribution facilities has provided us
with an immediate physical base and growth platform with which to broaden our
presence in the fast growing Midwest market.
Critical Accounting Policies
The preparation of our consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. The U.S. Securities and Exchange Commission has defined critical
accounting policies as those that are both most important to the portrayal of
our financial condition and results and require our most difficult, complex or
subjective judgments or estimates. Based on this definition, we believe our
critical accounting policies include the following: (i) determining our
allowance for doubtful accounts, (ii) determining our insurance reserves and
(iii) valuing goodwill and intangible assets. For all financial statement
periods presented, there have been no material modifications to the application
of these critical accounting policies.
Allowance for doubtful accounts
We analyze customer creditworthiness, accounts receivable balances,
payment history, payment terms and historical bad debt levels when evaluating
the adequacy of our allowance for doubtful accounts. In instances where a
reserve has been recorded for a particular customer, future sales to the
customer are conducted using either cash-on-delivery terms, or the account is
11
closely monitored so that as agreed upon payments are received, orders are
released; a failure to pay results in held or cancelled orders. Our accounts
receivable balance was $93.9 million and $90.1 million, net of the allowance for
doubtful accounts of $6.5 million and $5.1 million, as of October 31, 2003 and
July 31, 2003, respectively. Our notes receivable balances were $2.2 million and
$1.8 million, net of the allowance of doubtful accounts of $1.9 million and $2.8
million, as of October 31, 2003 and July 31, 2003, respectively.
Insurance reserves
It is our policy to record the self-insured portion of our workers'
compensation, health insurance and automobile liabilities based upon actuarial
methods of estimating of 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.
Valuation of goodwill and intangible assets
Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill
and Other Intangible Assets requires that companies no longer amortize goodwill,
but instead test goodwill for impairment at least annually and between annual
tests if events occur or circumstances change that would more likely than not
reduce the fair value of a reporting unit below its carrying amount. We have
elected to perform our annual tests for indications of goodwill impairment as of
July 31 of each year. Impairment losses are determined based upon the excess of
carrying amounts over discounted expected future cash flows of the underlying
business. The assessment of the recoverability of long-lived assets will be
impacted if estimated future cash flows are not achieved. For reporting units
that indicated potential impairment, we determined the implied fair value of
that reporting unit using a discounted cash flow analysis and compared such
values to the respective reporting units' carrying amounts.
Total goodwill as of October 31, 2003 was $57.7 million, with goodwill
for the Distribution operating segment totaling $46.1 million and $45.7 million
as of October 31, 2003 and July 31, 2003, respectively.
12
Results of Operations
The following table presents, for the periods indicated, certain income and
expense items expressed as a percentage of net sales:
Quarters ended
October 31,
-----------------
2003 2002
------ ------
Net sales 100.0% 100.0%
Cost of sales 80.0% 79.6%
------ ------
Gross profit 20.0% 20.4%
------ ------
Operating expenses 16.5% 17.2%
Amortization of intangibles 0.1% 0.0%
------ ------
Total operating expenses 16.6% 17.2%
------ ------
Operating income 3.4% 3.2%
------ ------
Other expense (income):
Interest expense 0.6% 0.6%
Change in fair value of financial instruments (0.1)% 0.5%
Other, net (0.0)% (0.1)%
------ ------
Total other expense 0.5% 1.1%
------ ------
Income before income taxes 2.9% 2.1%
Income taxes 1.1% 0.9%
------ ------
Net income 1.8% 1.3%
====== ======
Quarter Ended October 31, 2003 Compared To Quarter Ended October 31, 2002
Net Sales
Our net sales increased approximately 22.6%, or $70.4 million, to $381.4 million
for the quarter ended October 31, 2003 from $311.0 million for the quarter ended
October 31, 2002. This increase was primarily due to sales from the acquired
businesses, resulting in growth in the independently owned natural products
retailers and mass market distribution channels of approximately 30.1% and
19.4%, respectively, compared to the same period in the prior year. We acquired
Blooming Prairie Cooperative, a distributor of natural foods and products in the
Midwest region of the United States, in October 2002, and Northeast Cooperative,
a distributor of natural foods and products in the Northeast region of the
United States, in December 2002. Growth in the supernaturals distribution
channel was approximately 9.2% compared to the same period in the prior year.
The lower growth in the percentage of sales to supernaturals was due primarily
to the expiration of our contract as primary distributor to Wild Oats Markets,
Inc. ("Wild Oats") in August 2002. Fiscal 2004 sales growth to supernaturals,
excluding the effect of sales to Wild Oats, was approximately 26.7%. Sales to
our largest customer, Whole Foods Market, Inc. ("Whole Foods") represented
approximately 24.2% and 22.8% of net sales for the quarters ended October 31,
2003 and 2002, respectively. Wild Oats represented approximately 6.1% of net
sales for the quarter ended October 31, 2002. Our current distribution
arrangement with Whole Foods expires on August 31, 2004.
Gross Profit
Our gross profit increased approximately 20.1%, or $12.7 million, to $76.2
million for the quarter ended October 31, 2003 from $63.4 million for the
quarter ended October 31, 2002. Our gross profit as a percentage of net sales
was 20.0% and 20.4% for the quarters ended October 31, 2003 and October 31,
2002, respectively. The decrease in gross profit as a percentage of net sales in
comparison to the quarter ended October 31, 2002 was due in part to lost
discounts in the first two months of the quarter resulting from an accounts
payable systems implementation.
13
Operating Expenses
Operating expenses, excluding special items, increased approximately 19.4%, or
$10.3 million, to $63.2 million for the quarter ended October 31, 2003 from
$52.9 million for the quarter ended October 31, 2002. As a percentage of net
sales, operating expenses, excluding special items, decreased to approximately
16.6% for the quarter ended October 31, 2003 from approximately 17.0% for the
quarter ended October 31, 2002. The approximately $10.3 million increase in
operating expenses for the quarter ended October 31, 2003 was due primarily to
the inclusion of a full quarter of expenses related to the two businesses
acquired during fiscal 2003. Operating expenses for the quarter ended October
31, 2002 included special items of $0.6 million related to the transition of
Wild Oats to a new primary distributor and consisted primarily of severance and
expenses related to the transfer of private label inventory. Operating expenses
for the quarter ended October 31, 2003 did not include any special items.
Operating expenses, including special items, increased approximately 18.1%, or
$9.7 million, to $63.2 million from $53.5 million for the quarter ended October
31, 2002. As a percentage of sales, operating expenses, including special items,
decreased to 16.6% for the quarter ended October 31, 2003 from 17.2% for the
quarter ended October 31, 2002.
Operating Income
Operating income, excluding special items, increased $2.5 million to $13.0
million for the quarter ended October 31, 2003 from $10.5 million for the
quarter ended October 31, 2002. As a percentage of sales, operating income,
excluding special items, was consistent at 3.4% for the quarters ended October
31, 2003 and 2002. Operating income for the quarter ended October 31, 2002
included special items of $0.6 million related to the transition of Wild Oats to
a new primary distributor and consisted primarily of severance and expenses
related to the transfer of private label inventory. Operating income for the
quarter ended October 31, 2003 did not include any special items. Operating
income, including special items, was $13.0 million for the quarter ended October
31, 2003 and $10.0 million for the quarter October 31, 2002. Operating income,
including special items, as a percentage of sales, increased to 3.4% for the
quarter ended October 31, 2003 compared to 3.2% for the quarter ended October
31, 2002.
Other Expense (Income)
Other expense, excluding special items, increased $0.6 million to $2.2 million
for the quarter ended October 31, 2003 from $1.6 million for the quarter ended
October 31, 2002. Interest expense for the quarter ended October 31, 2003 was
$2.3 million compared to the $1.8 million for the quarter ended October 31,
2002. This increase in interest expense was primarily due to higher debt levels
following our two business acquisitions in fiscal 2003. Other expense (income)
for the quarters ended October 31, 2003 and 2002 included special items of $0.3
million in income and $1.7 million in expense, respectively, related to the
change in the fair value of financial instruments. Other expense (income),
including special items, decreased $2.0 million to income of $0.3 million for
the quarter ended October 31, 2003 from expense of $1.7 million for the quarter
ended October 31, 2002. This decrease was primarily due to the decrease in the
change in the fair value on our interest rate swap agreements and related option
agreements. We will continue to recognize either income or expense quarterly for
the duration of the swap agreement until either October 2005 for the swap
agreement entered into in October 1998, and either August 2005 or 2007 for the
swap agreement entered into in August 2001, depending on whether the agreement
is extended by the counter party. In October 2003, the counter party to the
October 1998 swap exercised its right to extend the agreement until October
2005. The recognition of income or expense in any given quarter, and the
magnitude of that item, is dependent on interest rates and the remaining term of
the contracts. Upon expiration of any such contract, the cumulative earnings
impact from the changes in fair value of the instruments will be zero.
Income Taxes
Our accrued income tax rate was 39.0% and 40.0% for the quarters ended October
31, 2003 and 2002, respectively. The effective rates were higher than the
federal statutory rate primarily due to state and local income taxes.
14
Net income, excluding special items, increased $1.2 million to $6.6 million, or
$0.33 per diluted share, for the quarter ended October 31, 2003, compared to
$5.4 million, or $0.28 per diluted share, for the quarter ended October 31,
2002. Net income, including special items, increased $2.8 million to $6.8
million, or $0.34 per diluted share, for the quarter ended October 31, 2003,
compared to $4.0 million, or $0.20 per diluted share, for the quarter ended
October 31, 2002. We expect earnings per diluted share in the range of
$1.42-$1.46 for fiscal 2004, excluding any potential special items. As
previously announced by Wild Oats, Wild Oats and their primary distributor have
mutually agreed to terminate their primary distribution relationship and Wild
Oats plans to transition their primary distribution business to us. When this
transition occurs, we would anticipate incurring start up costs in the second
quarter of fiscal 2004 related to the Wild Oats transition and achieving revenue
consistent with a primary distribution relationship during the fourth quarter of
fiscal 2004. We will provide revised guidance for fiscal 2004 after the primary
distribution agreement with Wild Oats has been executed.
Special Items
The following table presents, for the periods indicated, a reconciliation of
income and per share items excluding special items to income and per share items
including special items:
- -------------------------------------------------------------------------------------------------
Quarter ended October 31, 2003 Pretax Per diluted
(in thousands, except per share data) income Net of tax share
-------------------------------------------
Income, excluding special items: $10,806 $6,591 $0.33
Special items - Income (Expense):
Interest rate swap agreement (change
in fair value of financial instruments) 304 186 0.01
- -------------------------------------------------------------------------------------------------
Income, including special items: $11,110 $6,777 $0.34
=================================================================================================
- -------------------------------------------------------------------------------------------------
Quarter ended October 31, 2002 Pretax Per diluted
(in thousands, except per share data) income Net of tax share
-------------------------------------------
Income, excluding special items: $8,920 $5,352 $0.28
Special items - Income (Expense):
Interest rate swap agreements (change
in fair value of financial instruments) (1,706) (1,023) (0.05)
Costs related to loss of major customer
(included in operating expenses) (574) (345) (0.02)
- -------------------------------------------------------------------------------------------------
Income, including special items: $6,640 $3,984 $0.20*
=================================================================================================
* Total reflects rounding
The non-cash items from the change in fair value on interest rate swap
agreements were caused by favorable and unfavorable changes in interest rate
yield curves during the quarters ended October 31, 2003 and 2002, respectively.
The costs related to the transition of a major customer, Wild Oats Markets, Inc.
("Wild Oats"), to a new primary distributor consisted primarily of severance and
expenses related to the transfer of Wild Oats' private label inventory.
We entered into interest rate swap agreements in October 1998, August 2001 and
May 2003. The October 1998 and August 2001 agreements are "ineffective" hedges
as a result of the options held by the counter parties that may extend the
original term of the interest rate swap agreements. Applicable accounting
treatment requires that we record the changes in fair value of the October 1998
and August 2001 agreements in our consolidated statement of income, rather than
15
within "other comprehensive income" in our statement of stockholders' equity.
The changes in fair value are dependent upon the forward looking yield curves
for each swap. The May 2003 agreement is an "effective" hedge and therefore does
not require this treatment. We believe that our October 1998 and August 2001
agreements are special items that are excludable as non-recurring items. First,
we only intend to enter into "effective" hedges going forward. This stated
intention began with the May 2003 agreement. Second, we believe that the October
1998 and August 2001 agreements may distort and confuse investors if the change
in fair value cannot be treated as a special item because their inclusion
directly impacts our reported earnings per share. A change in fair value,
whether positive or negative, can significantly increase or decrease our
reported earnings per share. For example, we recorded a positive change in fair
value for the first quarter of fiscal 2004 that increased our diluted earnings
per share by $0.01, and in the first quarter of fiscal 2003, we recorded a
negative change in fair value that decreased our diluted earnings per share by
$0.05. If we were prohibited from excluding this item as a special item, it
would artificially inflate our reported earnings per share and thereby mislead
investors as to our results of operations and our financial condition.
Liquidity and Capital Resources
We finance operations and growth primarily with cash flows from operations,
borrowings under our credit facility, operating and capital leases, trade
payables, bank indebtedness and the sale of equity and debt securities. In
September 2001, we entered into an agreement to increase our secured revolving
credit facility to $150 million from $100 million at an interest rate of LIBOR
plus 1.50% maturing on June 30, 2005. This additional access to capital provides
for working capital requirements in the normal course of business and the
opportunity to grow our business organically or through acquisitions. As of
October 31, 2003, our borrowing base, based on accounts receivable and inventory
levels, was $150.0 million with remaining availability of $45.7 million. In
April 2003, we executed an amendment to our loan and security agreement, which
released and discharged real estate mortgages on certain real property.
Additionally, in April 2003 we executed a term loan agreement in the principal
amount of $30.0 million secured by the real property that was released in
accordance with the aforementioned amendment. The $30.0 million 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%. Proceeds received from
the term loan were used to reduce the outstanding balance on our $150.0 million
credit facility on which interest accrues at the New York Prime Rate or the
banks' London Interbank Offered Rate ("LIBOR") plus 1.50%.
We continue to believe that our capital requirements for fiscal 2004 will be in
the $24 to $28 million range, and that we will finance these requirements with
cash generated from operations and the use of our existing credit facilities.
Approximately $10 million of the capital required for the expansion of our
distribution facilities will be financed through additional long term debt with
terms and conditions similar to the existing $30 million term loan, with the
same financial institutions. We believe that our future capital requirements
will be similar to our anticipated fiscal 2004 requirements, as we continue to
invest in our growth by upgrading our infrastructure and expanding our
facilities. Future investments in major acquisitions will be financed through
either equity or long term debt negotiated at the time of the potential
acquisition.
Net cash provided by operations was $10.6 million for the quarter ended October
31, 2003 and was the result of the change in cash collected from customers net
of cash paid to vendors, partially offset by a $17.6 million investment in
inventory. The increases in inventory levels relate to supporting increased
sales with wider product assortment combined with our ability to capture
purchasing efficiency opportunities in excess of total carrying costs, as well
as our acquisitions of Blooming Prairie Cooperative and Northeast Cooperative.
Days in inventory decreased to 50 days at October 31, 2003 compared to 52 days
at October 31, 2002. Days sales outstanding at October 31, 2003 improved to 24
days compared to 27 days at October 31, 2002. Net cash provided by operations
was $16.2 million for the quarter ended October 31, 2002 and was also due to the
change in cash collected from customers, net of cash paid to vendors, exceeding
our investments in inventory of $4.1 million. Working capital increased by $6.2
million, or 9.6%, to $70.5 million at October 31, 2003 compared to working
capital of $64.3 million at July 31, 2003.
Net cash used in investing activities was $2.6 million for the quarter ended
October 31, 2003 and was due primarily to costs incurred in the expansion of our
Iowa City, Iowa and Dayville, Connecticut facilities, compared to $34.2 million
for the same period last year that was due primarily to the purchase of
substantially all the assets of Blooming Prairie Cooperative, headquartered in
Iowa City, Iowa, and the initial costs of the expansion of our Chesterfield, New
Hampshire facility.
16
Net cash used in financing activities was $1.5 million for the quarter ended
October 31, 2003 due to repayments of long-term debt and repayments on our $150
million secured revolving credit facility, partially offset by proceeds from the
exercise of stock options. Net cash provided by financing activities was $11.3
million for the quarter ended October 31, 2002, due to increased borrowings on
our line of credit and our equipment financing lines, offset by repayment of
long-term debt.
In October 1998, we entered into an interest rate swap agreement. The agreement
provides for us to pay interest for a five-year period at a fixed rate of 5% on
a notional principal amount of $60 million while receiving interest for the same
period at the LIBOR rate on the same notional principal amount. This interest
rate swap agreement also included an option in favor of the counter party to
extend the original five-year term to seven years. The swap has been entered
into as a hedge against LIBOR interest rate movements on current and anticipated
variable rate indebtedness totaling $60 million at LIBOR plus 1.50%, thereby
fixing our effective rate at 6.50%. In October 2003, the counter party exercised
its option to extend the original five-year term of the swap agreement to seven
years. The inclusion of this option prohibits accounting for the swap as an
effective hedge under SFAS No. 133 ("SFAS 133"), Accounting for Derivative
Instruments and Hedging Activities. We entered into an additional interest rate
swap agreement effective August 1, 2001. The additional agreement provides for
us to pay interest for a four-year period at a fixed rate of 4.81% on a notional
principal amount of $30 million while receiving interest for the same period at
the LIBOR rate on the same notional principal amount. The swap has been entered
into as a hedge against LIBOR interest rate movements on current and anticipated
variable rate indebtedness totaling $30 million at LIBOR plus 1.50%, thereby
fixing our effective rate on the notional amount at 6.31%. If LIBOR exceeds 6.0%
in a given period the agreement is suspended for that period. LIBOR was 1.10% as
of July 31, 2003. The four-year term of the swap agreement may be extended to
six years at the option of the counter party, which prohibits accounting for the
swap as an effective hedge under SFAS 133.
In May 2003, we entered into an additional interest rate swap agreement. The
agreement provides for us to pay interest for a seven-year period at a fixed
rate of 3.68% on a notional principal amount of $30 million while receiving
interest for the same period at the LIBOR rate 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 $30.0 million at LIBOR
plus 1.50%, thereby fixing our effective rate on the notional amount at 5.18%.
The swap agreement qualifies as an "effective" hedge under SFAS No. 133.
IMPACT OF INFLATION
Historically, we have been able to pass along inflation-related increases.
Consequently, inflation has not had a material impact upon the results of our
operations or profitability.
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 April 2003, the Financial Accounting Standards Board issued SFAS No. 149
("SFAS 149"), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 amends and clarifies financial accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. We do not believe that
the adoption of SFAS 149 will have a material impact on our consolidated
financial position or results of operations.
17
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150 ("SFAS
150"), Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. SFAS 150 requires issuers to classify as liabilities (or
assets in some circumstance) three classes of freestanding financial instruments
that embody obligations of the issuer. Generally, SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003 and is
otherwise effective at the beginning of the first interim period beginning after
June 15, 2003. We adopted the provisions of SFAS 150 on August 1, 2003. The
adoption of SFAS 150 did not have a material impact on our consolidated
financial position or results of operations.
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
generally accepted accounting principles ("GAAP") are referred to as non-GAAP
financial measures. To supplement our financial statements presented on a GAAP
basis, we use non-GAAP additional measures of operating results, net earnings
and earnings per share adjusted to exclude special items. 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 items 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 its marketplace performance.
For example, these adjusted non-GAAP results are among the primary indicators
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 generally accepted accounting principles in the
United States. A comparison and reconciliation from non-GAAP to GAAP results is
included in the tables above.
Certain Factors That May Affect Future Results
This Form 10-Q and the documents incorporated by reference in this Form 10-Q
contain forward-looking statements 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," "should," "will," and "would," or similar words. You
should read statements that contain these words carefully because they discuss
future expectations contain projections of future results of operations or of
financial position or state other "forward-looking" information. The important
factors listed below as well as any cautionary language in this Form 10-Q,
provide examples of risks, uncertainties and events that may cause our actual
results to differ materially from the expectations described in these
forward-looking statements. You should be aware that the occurrence of the
events described in the risk factors below and elsewhere in this Form 10-Q could
have an adverse effect on our business, results of operations and financial
position.
Any forward-looking statements in this Form 10-Q and the documents incorporated
by reference in this Form 10-Q are not guarantees of futures performance, and
actual results, developments and business decisions may differ from those
envisaged by such forward-looking statements, possibly materially. We disclaim
any duty to update any forward-looking statements, all of which are expressly
qualified by the statement in this section, until the effective date of our
future reports required by applicable laws. Any projections of future results of
operations should not be construed in any manner as a guarantee that such
results will in fact occur. These projections are subject to change and could
differ materially from final reported results. We may from time to time update
these publicly announced projections, but we are not obligated to do so.
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.
18
A significant portion of our historical growth has been achieved through
acquisitions of or mergers with other distributors of natural products.
Successful integration of mergers is critical to our future operating and
financial performance. Integration requires, among other things: o maintaining
the customer base;
o the optimization of delivery routes;
o coordination of administrative, distribution and finance functions;
and
o the integration of management information systems and personnel.
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 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.
There can be no assurance 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.
There can be no assurance 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, there can be no assurance 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. There can be no assurance 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.
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. There can be no assurance 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. There can be no assurance 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. There can be no
assurance that we will be able to compete effectively against current and future
competitors.
19
We depend heavily on our principal customer
Our current distribution arrangement with our top customer, Whole Foods
Market, is effective through August 31, 2004. Whole Foods Market accounted for
approximately 24.2% and 22.8% of our net sales during the quarters ended October
31, 2003 and 2002, respectively. As a result of this concentration of our
customer base, the loss or cancellation of business from Whole Foods Market
including from increased distribution from its 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. No assurance can
be given 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.
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 super natural
chains may reduce our profit margins in the future as more customers qualify for
greater volume discounts.
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:
o difficulties with the collectibility of accounts receivable;
o difficulties with inventory control;
o competitive pricing pressures; and
o unexpected increases in fuel or other transportation-related costs.
There can be no assurance 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, President of our Eastern Region (President of our Western
Region effective January 1, 2004) and Director, Dan Atwood, President of United
Natural Brands, Senior Vice President and Secretary, Rick D. Puckett, Chief
Financial Officer, Steven H. Townsend, Chair of the Board of Directors,
President and Chief Executive Officer (and interim President of our Eastern
Region effective January 1, 2004), 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:
o demand for natural products;
o changes in our operating expenses, including in fuel and insurance;
20
o management's ability to execute our business and growth strategies;
o changes in customer preferences and demands for natural products,
including levels of enthusiasm for health, fitness and environmental
issues;
o fluctuation of natural product prices due to competitive pressures;
o personnel changes;
o supply shortages;
o general economic conditions;
o lack of an adequate supply of high-quality agricultural products due
to poor growing conditions, natural disasters or otherwise;
o volatility in prices of high-quality agricultural products resulting
from poor growing conditions, natural disasters or otherwise; and
o 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:
o our products are subject to inspection by the U.S. Food and Drug
Administration;
o our warehouse and distribution facilities are subject to inspection
by the U.S. Department of Agriculture and state health authorities;
and
o 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 31, 2003, we had approximately 3,460 full and part-time
employees. An aggregate of approximately 260, or 8%, of the employees at our
Auburn, Washington, Iowa City, Iowa and Edison, New Jersey facilities are
covered by collective bargaining agreements. These agreements expire in March
2006, June 2006 and June 2005, respectively. 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, 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.
21
Access to capital and the cost of that capital
We have a secured revolving credit facility with available credit under it
of $150.0 million at an interest rate of LIBOR plus 1.5% maturing on June 30,
2005. As of October 31, 2003, our borrowing base, based on accounts receivable
and inventory levels, was $150.0 million with remaining availability of $45.7
million. In April 2003, we executed a term loan agreement in the principal
amount of $30.0 million secured by real property that was released in accordance
with an amendment to the loan and security agreement related to the revolving
credit facility. The $30.0 million 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 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 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
consolidated financial statements, we use interest rate swap agreements to
modify variable rate obligations to fixed rate obligations. 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 31, 2003.
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-14 and 15d-14 of the Securities Exchange Act of 1934, as
amended) as of a date within 90 days prior to the filing date of this
quarterly report (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. Since the Evaluation Date, there have not
been any significant changes to our internal controls or in other factors
that could significantly affect those internal controls.
22
PART II. OTHER INFORMATION
Items 1, 2, 3, 4 and 5 are not applicable and have been omitted.
Item 6. Exhibits and Reports on Form 8-K
Exhibits
- --------------------------------------------------------------------------------
Exhibit No. Description Page
- --------------------------------------------------------------------------------
3.1 Amended Certificate of Designation of Preferences
and Rights of Series A Preferred Stock of
United Natural Foods, 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
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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
- --------------------------------------------------------------------------------
Reports on Form 8-K
August 5, 2003 The Company announced that it would be taking certain
charges against income for its fiscal quarter and year
ended July 31, 2003.
September 2, 2003 The Company announced its financial results for the
fiscal year ended July 31, 2003.
October 10, 2003 The Company announced certain management appointments
and promotions.
* * *
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.
/s/ Rick D. Puckett
-----------------------------
Rick D. Puckett
Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: December 12, 2003
24