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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 April 30, 2004
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 June 10, 2004 there were 39,985,184 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 APRIL 30, 2004
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited) 3
Condensed Consolidated Statements of Income 4
(unaudited)
Condensed Consolidated Statements of Cash Flows 5
(unaudited)
Notes to Condensed Consolidated Financial Statements 6
(unaudited)
Item 2. Management's Discussion and Analysis of Financial 11
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure About Market 26
Risk
Item 4. Controls and Procedures 26
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 26
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
April 30, July 31,
(In thousands, except per share amounts) 2004 2003
--------- ---------
ASSETS
Current assets:
Cash $ 8,802 $ 3,645
Accounts receivable, net 110,094 90,111
Notes receivable, trade 690 585
Inventories 203,715 158,263
Prepaid expenses 5,672 5,706
Deferred income taxes 6,004 6,455
Refundable income taxes -- 704
--------- ---------
Total current assets 334,977 265,469
Property & equipment, net 112,125 101,238
Other assets:
Notes receivable, trade, net 2,264 1,261
Goodwill 57,242 57,400
Intangible assets, net 168 1,014
Other, net 3,532 3,717
--------- ---------
Total assets $ 510,308 $ 430,099
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
---------
Current liabilities:
Notes payable - line of credit $ 114,514 $ 96,170
Current portion of long-term debt 4,597 4,459
Current portion of obligations under capital leases 512 903
Accounts payable 96,531 67,187
Accrued expenses and other current liabilities 24,877 26,347
Financial instruments -- 6,104
Income taxes payable 61 --
--------- ---------
Total current liabilities 241,092 201,170
Long-term debt, excluding current portion 45,367 38,507
Deferred income taxes 2,247 2,247
Obligations under capital leases, excluding current portion 244 612
--------- ---------
Total liabilities 288,950 242,536
--------- ---------
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; 39,877 and 39,020 issued and outstanding
at April 30, 2004 and July 31, 2003, respectively 399 195
Additional paid-in capital 97,211 86,068
Unallocated shares of ESOP (1,809) (1,931)
Accumulated other comprehensive income 335 432
Retained earnings 125,222 102,799
--------- ---------
Total stockholders' equity 221,358 187,563
--------- ---------
Total liabilities and stockholders' equity $ 510,308 $ 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)
Quarter ended April 30, Nine months ended April 30,
(In thousands, except per share data) 2004 2003 2004 2003
--------- --------- ----------- -----------
Net sales $ 448,900 $ 363,611 $ 1,223,530 $ 1,013,050
Cost of sales 361,323 290,056 980,995 807,222
--------- --------- ----------- -----------
Gross profit 87,577 73,555 242,535 205,828
Operating expenses 71,388 61,930 199,706 173,301
Amortization of intangibles 676 130 1,142 234
--------- --------- ----------- -----------
Total operating expenses 72,064 62,060 200,848 173,535
--------- --------- ----------- -----------
Operating income 15,513 11,495 41,687 32,293
--------- --------- ----------- -----------
Other expense (income):
Interest expense 1,536 1,811 5,990 5,729
Change in fair value of financial instruments -- 360 (704) 1,839
Other, net (128) (142) (358) (562)
--------- --------- ----------- -----------
Total other expense 1,408 2,029 4,928 7,006
--------- --------- ----------- -----------
Income before income taxes 14,105 9,466 36,759 25,287
Income taxes 5,501 3,692 14,336 10,020
--------- --------- ----------- -----------
Net income $ 8,604 $ 5,774 $ 22,423 $ 15,267
========= ========= =========== ===========
Per share data (basic):
Net income $ 0.22 $ 0.15 $ 0.57 $ 0.40
========= ========= =========== ===========
Weighted average shares of common stock 39,648 38,483 39,296 38,310
========= ========= =========== ===========
Per share data (diluted):
Net income $ 0.21 $ 0.15 $ 0.55 $ 0.39
========= ========= =========== ===========
Weighted average shares of common stock 41,344 39,500 40,813 39,271
========= ========= =========== ===========
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)
Nine months ended April 30,
(In thousands) 2004 2003
---------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 22,423 $ 15,267
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 8,807 7,663
Change in fair value of financial instruments (704) 1,839
Gain on disposals of property and equipment (61) (18)
Provision for doubtful accounts 2,521 1,952
Changes in assets and liabilities:
Accounts receivable (22,504) (2,279)
Inventory (45,345) (6,575)
Prepaid expenses and other assets 1,050 (2,154)
Notes receivable, trade (1,108) 31
Accounts payable 29,344 9,606
Accrued expenses and other liabilities (968) 806
Income taxes payable 61 2,651
Financial instruments (5,400) --
Tax effect of stock option exercises 3,870 846
-----------------------
Net cash (used in) provided by operating activities (8,014) 29,635
-----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of acquired businesses, net of cash acquired (6) (43,964)
Proceeds from sale of property and equipment 202 60
Capital expenditures (18,989) (14,975)
-----------------------
Net cash used in investing activities (18,793) (58,879)
-----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under note payable 18,344 (9,267)
Net proceeds from issuance of long-term debt 10,204 30,954
Repayments of long-term debt (3,302) (1,282)
Principal payments of capital lease obligations (759) (1,002)
Proceeds from exercise of stock options 7,477 3,613
-----------------------
Net cash provided by financing activities 31,964 23,016
-----------------------
NET INCREASE (DECREASE) IN CASH 5,157 (6,228)
Cash at beginning of period 3,645 11,184
-----------------------
Cash at end of period $ 8,802 $ 4,956
=======================
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 5,788 $ 5,591
=======================
Income taxes $ 9,686 $ 4,598
=======================
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
APRIL 30, 2004 (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
provided 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 had 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 prohibited
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 provided 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
could have been extended to six years at the option of the counter party, which
prohibited accounting for the swap as an effective hedge under SFAS 133. The
swap had 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 exceeded 6.0% in a given period, the agreement was suspended for that
period.
On December 29, 2003, the Company assigned and transferred all of its
obligations of its two "ineffective" interest rate swaps to a third party at a
cost of $5.4 million plus accrued interest. As a result of this assignment,
these "ineffective" swaps will no longer be included as a special item for
future fiscal periods. These "ineffective" swaps were included as special items
for the first two quarters of fiscal 2004.
The Company recorded no expense and $0.4 million of expense for the quarters
ended April 30, 2004 and 2003, respectively, and $0.7 million of income and $1.8
million of expense for the nine months ended April 30, 2004 and 2003,
respectively, on these 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 the Company 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
million at LIBOR plus 1.50%, thereby fixing the Company's effective rate on the
notional amount at 5.18%. The swap agreement qualifies as an "effective" hedge
under SFAS 133. The Company recorded an asset of $0.3 million as of April 30,
2004, and a corresponding amount to accumulated other comprehensive income in
the statement of stockholders' equity to reflect the fair value of the
instrument.
6
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:
Quarter ended Nine months ended
April 30, April 30,
2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------------------
Net income -- as reported $8,604 $5,774 $22,423 $15,267
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects 895 922 2,294 2,596
------------ ------------ ----------- -----------
Net income -- pro forma $7,709 $4,852 $20,129 $12,671
------------ ------------ ----------- -----------
Basic earnings per share
As reported $0.22 $0.15 $0.57 $0.40
------------ ------------ ----------- -----------
Pro forma $0.20 $0.13 $0.52 $0.33
------------ ------------ ----------- -----------
Diluted earnings per share
As reported $0.21 $0.15 $0.55 $0.39
------------ ------------ ----------- -----------
Pro forma $0.19 $0.12 $0.50 $0.32
------------ ------------ ----------- -----------
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 and the nine months ended April 30,
2004 and 2003:
Quarter ended April 30, Nine months ended April 30,
2004 2003 2004 2003
----------------------------- ------------------------------
Expected volatility 45.8% 62.0% 49.7% 62.0%
Dividend yield 0.0% 0.0% 0.0% 0.0%
Risk free interest rate 3.01% 3.3% 3.70% 3.3%
Expected life 3.25 years 5 years 3.27 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 nine months ended April 30, 2004, the Company granted
options for the purchase of 775,000 shares under its stock incentive plans.
7
4. EARNINGS PER SHARE
Following is a reconciliation of the basic and diluted number of shares used in
computing earnings per share:
Quarter ended Nine months ended
April 30, April 30,
-------------------- ---------------------
(In thousands) 2004 2003 2004 2003
--------- -------- --------- ---------
Basic weighted average shares
outstanding 39,648 38,483 39,296 38,310
Net effect of dilutive stock
options based upon
the treasury stock method 1,696 1,017 1,517 961
--------- -------- --------- ---------
Diluted weighted average shares
outstanding 41,344 39,500 40,813 39,271
========= ======== ========= =========
There were 0 and 949,500 anti-dilutive stock options excluded from the diluted
earnings per share calculation for the quarters ended April 30, 2004 and 2003,
respectively. For the nine months ended April 30, 2004 and 2003, there were
2,080 and 530,861 anti-dilutive stock options, respectively.
5. COMPREHENSIVE INCOME
Total comprehensive income for the three-month period ended April 30, 2004
amounted to $9,131,000 as compared to $5,774,000 in the same period in the prior
year. For the nine months ended April 30, 2004 and 2003, comprehensive income
amounted to $22,326,000 and $15,267,000, respectively. 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 $13.5 million related to this purchase acquisition.
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.
8
The following presents the unaudited pro forma results assuming that the
acquisitions discussed above had occurred as of the beginning of fiscal 2003.
These pro forma results are not necessarily indicative of the results that will
occur in future periods.
Nine months
(in thousands, except per ended
share data) April 30, 2003
Pro forma
----------------
Net sales $1,093,334
================
Income before income taxes $ 24,557
================
Net income $ 14,829
================
Earnings per common share:
Basic $0.39
================
Diluted $0.38
================
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. The Company has additional operating divisions that do not meet the
quantitative thresholds for reportable segments. Therefore, these operating
divisions are aggregated under the caption of "Other" with corporate operating
expenses that are not allocated to operating divisions. "Other" includes a
retail division, 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 division, which engages in importing, roasting and
packaging of nuts, seeds, dried fruit and snack items. Non-operating expenses
that are not allocated to the operating divisions are under the caption of
"Unallocated Expenses."
Following is business segment information for the periods indicated:
Unallocated
Distribution Other Eliminations Expenses Consolidated
Nine months ended April 30, 2004:
Net sales $1,192,161 $54,149 $(22,780) $1,223,530
Operating income (loss) 45,073 (3,389) 3 41,687
Interest expense $5,990 5,990
Other, net (1,062) (1,062)
Income before income taxes 36,759
Amortization and depreciation 7,921 886 8,807
Capital expenditures 18,538 451 18,989
Total assets 663,845 41,132 (194,669) 510,308
Nine months ended April 30, 2003:
Net sales $979,151 $49,660 $(15,761) $1,013,050
Operating income (loss) 36,794 (4,455) (46) 32,293
Interest expense $5,729 5,729
Other, net 1,277 1,277
Income before income taxes 25,287
Amortization and depreciation 6,707 956 7,663
Capital expenditures 14,383 592 14,975
Total assets 586,627 40,896 (192,258) 435,265
9
Unallocated
Distribution Other Eliminations Expenses Consolidated
Three months ended April 30, 2004:
Net sales $438,455 $18,355 $(7,910) $448,900
Operating income (loss) 16,756 (1,351) 108 15,513
Interest expense $1,536 1,536
Other, net (128) (128)
Income before income taxes 14,105
Amortization and depreciation 2,997 279 3,276
Capital expenditures 9,430 224 9,654
Total assets 663,845 41,132 (194,669) 510,308
Three months ended April 30, 2003:
Net sales $352,908 $16,451 $ (5,748) $363,611
Operating income (loss) 12,878 (1,376) (7) 11,495
Interest expense $1,811 1,811
Other, net 218 218
Income before income taxes 9,466
Amortization and depreciation 2,308 304 2,612
Capital expenditures 3,729 25 3,754
Total assets 586,627 40,896 (192,258) 435,265
8. STOCK SPLIT
On March 17, 2004, the Company's Board of Directors approved a two-for-one split
of the Company's common stock that was payable in the form of a stock dividend.
Stockholders received one additional share of the Company's common stock for
each share of common stock held on the record date of March 29, 2004. The split
became effective on April 20, 2004. The applicable share and per-share data for
all periods included herein have been restated to give effect to this stock
split. The par value of the common stock was not affected by the stock split and
remains at $0.01 per share.
9. NOTES PAYABLE
On April 30, 2004, the Company 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. The new credit facility replaced an existing $150 million
revolving credit facility. The amended and restated secured revolving credit
facility allows for borrowing up to $250 million, on which interest accrues at
the banks' London Interbank Offered Rate ("LIBOR") plus 1.25%. The $250 million
credit facility matures on March 31, 2008. As of April 30, 2004, the Company's
outstanding borrowings under the credit agreement totaled $114.5 million with an
availability of $98.7 million.
10. NEW ACCOUNTING PRONOUNCEMENTS
The Company has determined that there are no recently issued accounting
standards that are expected to have a material impact on the Company's
consolidated financial position or results of operations.
10
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 continued growth of the natural products
industry in general, our acquisition of or merger with natural products
distributors, and the expansion of existing distribution centers. 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 Organics, a produce only division, 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, our Hershey Import division 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;
o expanding national purchasing opportunities;
o consolidating systems applications among physical locations and regions;
o concentrating on expanding into other channels of business;
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 current expansion of our facilities located in Iowa
City, Iowa and Dayville, Connecticut. In June 2003, we completed the expansion
of our Chesterfield, New Hampshire distribution facility to 289,000 square feet.
This expansion included the consolidation of our operations from Brattleboro,
Vermont to Chesterfield, New Hampshire.
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 will experience incremental short-term costs
11
during 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.
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 market. 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. The expansion of our Chesterfield, New Hampshire distribution
facility has enabled us to service existing and new customers, to provide more
product diversity, and to better balance products among our distribution centers
in our Eastern Region.
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) assessing 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
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 $110.1 million and $90.1 million, net of the allowance
for doubtful accounts of $6.4 million and $5.1 million, as of April 30, 2004 and
July 31, 2003, respectively. Our notes receivable balances were $3.0 million and
$1.8 million, net of the allowance of doubtful accounts of $3.2 million and $2.8
million, as of April 30, 2004 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 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.
Assessing goodwill and intangible assets valuation
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.
12
Total goodwill as of April 30, 2004 and July 31, 2003 was $57.2 million
and $57.4 million, respectively, with goodwill for the Distribution operating
segment totaling $45.6 million and $45.7 million as of April 30, 2004 and July
31, 2003, respectively.
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 Nine Months Ended
April 30, April 30,
----------------------------- ------------- --------------
2004 2003 2004 2003
----------------------------- ------------- --------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 80.5% 79.8% 80.2% 79.7%
----------------------------- ------------- --------------
Gross profit 19.5% 20.2% 19.8% 20.3%
----------------------------- ------------- --------------
Operating expenses 15.9% 17.0% 16.3% 17.1%
Amortization of intangibles 0.2% 0.0% 0.1% 0.0%
----------------------------- ------------- --------------
Total operating expenses 16.1% 17.1%* 16.4% 17.1%
----------------------------- ------------- --------------
Operating income 3.5% 3.2% 3.4% 3.2%
----------------------------- ------------- --------------
Other expense (income):
Interest expense 0.3% 0.5% 0.5% 0.6%
Change in fair value of financial
instruments 0.0% 0.1% (0.1)% 0.2%
Other, net (0.0)% (0.0)% (0.0)% (0.1)%
----------------------------- ------------- --------------
Total other expense 0.3% 0.6% 0.4% 0.7%
----------------------------- ------------- --------------
Income before income taxes 3.1%* 2.6% 3.0% 2.5%
Income taxes 1.2% 1.0% 1.2% 1.0%
----------------------------- ------------- --------------
Net income 1.9% 1.6% 1.8% 1.5%
============================= ============= ==============
* Total reflects rounding
Quarter Ended April 30, 2004 Compared To Quarter Ended April 30, 2003
Net Sales
Our net sales increased approximately 23.5%, or $85.3 million, to $448.9 million
for the quarter ended April 30, 2004 from $363.6 million for the quarter ended
April 30, 2003. This increase was due to our organic growth and the
implementation of our primary distributor agreement with Wild Oats Markets, Inc.
("Wild Oats Markets") during the quarter. For the quarter, growth in the
independently owned natural products retailers and mass market distribution
channels was approximately 9% and 20%, respectively, compared to the same period
in the prior year. Growth in the supernaturals distribution channel was
approximately 44% compared to the same period in the prior year. Sales to our
largest customer, Whole Foods Market, Inc. ("Whole Foods Market") represented
approximately 24% of net sales for the quarters ended April 30, 2004 and 2003.
Our current distribution arrangement with Whole Foods Market expires on August
31, 2004. We are currently in discussions with Whole Foods Market to continue
our relationship upon expiration of the existing agreement.
Gross Profit
Our gross profit increased approximately 19.1%, or $14.0 million, to $87.6
million for the quarter ended April 30, 2004 from $73.6 million for the quarter
ended April 30, 2003. Our gross profit as a percentage of net sales was 19.5%
and 20.2% for the quarters ended April 30, 2004 and 2003, respectively. This
decrease in gross profit as a percentage of net sales in comparison to the
quarter ended April 30, 2003 was primarily the result of the change in our sales
mix to supernaturals, as we implemented our primary distributor agreement with
Wild Oats Markets during the quarter.
13
Operating Expenses
Operating expenses, excluding special items, increased approximately 14.2%, or
$8.8 million, to $70.4 million for the quarter ended April 30, 2004 from $61.6
million for the quarter ended April 30, 2003. As a percentage of net sales,
operating expenses, excluding special items, decreased to approximately 15.7%
for the quarter ended April 30, 2004 from approximately 16.9% for the quarter
ended April 30, 2003. The approximately $8.8 million increase in operating
expenses, excluding special items, for the quarter ended April 30, 2004 was due
primarily to an increase in our infrastructure to support our continued growth.
Operating expenses for the quarter ended April 30, 2004 included a special item
of $1.0 million in start-up and transition costs for certain equipment rental
and labor costs incurred in connection with the implementation of our primary
distribution agreement with Wild Oats Markets, which had staggered effective
dates up to and including March 15, 2004. Operating expenses for the quarter
ended April 30, 2003 included special items of $0.3 million in costs incurred
related to the expansion of our Chesterfield, New Hampshire distribution center.
Operating expenses, including special items, increased approximately 15.3%, or
$9.5 million, to $71.4 million from $61.9 million for the quarter ended April
30, 2003. As a percentage of sales, operating expenses, including special items,
decreased to 15.9% for the quarter ended April 30, 2004 from 17.0% for the
quarter ended April 30, 2003.
Operating Income
Operating income, excluding special items, increased $4.7 million to $16.5
million for the quarter ended April 30, 2004 from $11.8 million for the quarter
ended April 30, 2003. As a percentage of sales, operating income, excluding
special items, improved from 3.3% for the quarter ended April 30, 2003 to 3.7%
for the quarter ended April 30, 2004. Operating income for the quarter ended
April 30, 2004 included a special item of $1.0 million of start-up and
transition costs for certain equipment rental and labor costs incurred in
connection with the implementation of our primary distribution agreement with
Wild Oats Markets. Operating income for the quarter ended April 30, 2003
included special items of $0.3 million related to the expansion of our
Chesterfield, New Hampshire distribution center. Operating income, including
special items, was $15.5 million for the quarter ended April 30, 2004 and $11.5
million for the quarter April 30, 2003. Operating income, including special
items, as a percentage of sales, improved to 3.5% for the quarter ended April
30, 2004 compared to 3.2% for the quarter ended April 30, 2003.
Other Expense (Income)
Other expense, excluding special items, decreased $0.3 million to $1.4 million
for the quarter ended April 30, 2004 from $1.7 million for the quarter ended
April 30, 2003. At $1.5 million, interest expense for the quarter ended April
30, 2004 was $0.3 million lower than for the quarter ended April 30, 2003. The
decrease in interest expense was due to the novation of two of our interest rate
swap agreements in December 2003, which served to lower our effective interest
rate, partially offset by higher debt levels in fiscal 2004 as a result of our
acquisitions of Blooming Prairie and Northeast Cooperative in fiscal 2003 and an
increase in inventory levels to support the growth in the business. Other
expense (income) for the quarter ended April 30, 2003 included special items of
$0.4 million in expense, related to the change in the fair value of financial
instruments. Other income, including special items, remained relatively
consistent for the quarters ended April 30, 2004 and 2003, at $0.1 million.
Other expense, including special items, decreased from $2.0 million for the
quarter ended April 30, 2003 to $1.4 million for the quarter ended April 30,
2004, a decrease of $0.6 million, or 30.6%. 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. On December 29, 2003, we assigned and
transferred all of our obligations of our two "ineffective" interest rate swaps
to a third party at a cost of $5.4 million plus accrued interest. As a result of
this assignment, these "ineffective" swaps will no longer be included as a
special item for future fiscal periods. These "ineffective" swaps were included
as a special item through the second quarter of fiscal 2004.
Income Taxes
Our effective income tax rate was 39.0% for the quarters ended April 30, 2004
and 2003. The effective rate was higher than the federal statutory rate
primarily due to state and local income taxes.
14
Net Income
Net income, excluding special items, increased $3.0 million to $9.2 million, or
$0.22 per diluted share, for the quarter ended April 30, 2004, compared to $6.2
million, or $0.16 per diluted share, for the quarter ended April 30, 2003.
Net income, including special items, increased $2.8 million to $8.6 million, or
$0.21 per diluted share, for the quarter ended April 30, 2004, compared to $5.8
million, or $0.15 per diluted share, for the quarter ended April 30, 2003. As we
announced on June 1, 2004, we have updated our guidance for our fiscal year
ending July 31, 2004 to reflect the implementation of our primary distribution
agreement with Wild Oats Markets, the novation of certain of our interest rate
swap transactions and the continued growth of our business.
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 April 30, 2004 Pretax Per diluted
(in thousands, except per share data) income Net of tax share
----------------------------------
Income, excluding special items: $ 15,115 $ 9,220 $0.22
Special items - Income (Expense):
Wild Oats Markets, Inc. primary
distributorship start-up and
transition related costs
(included in operating expenses) (1,010) (616) (0.01)
- -------------------------------------------------------------------------
Income, including special items: $ 14,105 $ 8,604 $0.21
=========================================================================
- ------------------------------------------------------------------------
Quarter ended April 30, 2003 Pretax Per diluted
(in thousands, except per share data) income Net of tax share
---------------------------------
Income, excluding special items: $ 10,162 $ 6,199 $0.16
Special items - Income (Expense):
Interest rate swap agreements
(change in fair value
of financial instruments) (360) (220) (0.01)
Costs related to the expansion of
our Chesterfield,
New Hampshire distribution center
(included in operating expenses) (336) (205) (0.01)
- -------------------------------------------------------------------------
Income, including special items: $ 9,466 $ 5,774 $0.15*
=========================================================================
* Total reflects rounding
The start-up and transition costs of the new Wild Oats Markets primary
distributorship were for certain equipment rental and labor costs. The non-cash
items from the change in fair value on interest rate swap agreements were caused
by unfavorable changes in interest rate yield curves. The costs related to the
expansion of the Chesterfield facility were primarily labor related.
On December 29, 2003, we assigned and transferred all of our obligations of our
two "ineffective" interest rate swaps to a third party at a cost of $5.4 million
plus accrued interest. As a result of this novation, these "ineffective" swaps
will no longer be included as a special item for future fiscal periods. These
"ineffective" swaps were included as a special item through the second quarter
of fiscal 2004.
We entered into interest rate swap agreements in October 1998, August 2001 and
May 2003. The October 1998 and August 2001 agreements were "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
within "other comprehensive income" in our statement of stockholders' equity.
15
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.
Nine Months Ended April 30, 2004 Compared To Nine Months Ended April 30, 2003
Net Sales
Our net sales increased approximately 20.8%, or $210.4 million, to $1,223.5
million for the nine months ended April 30, 2004 from $1,013.1 million for the
nine months ended April 30, 2003. This increase was primarily due to our organic
growth, as well as sales from the acquired businesses, which resulted in growth
from the independently owned natural products retailers and mass market
distribution channels of approximately 18% and 19%, 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. The higher growth rate in the percentage of sales to supernaturals was due
to the continued growth of business with Whole Foods Market and the
implementation of our primary distributor agreement with Wild Oats Markets
during the third quarter of fiscal 2004. Fiscal 2004 sales growth to
supernaturals for the nine months ended April 30, 2004 was approximately 23%.
Sales to our largest customer, Whole Foods Market represented approximately 25%
and 24% of net sales for the nine months ended April 30, 2004 and 2003,
respectively. Our current distribution arrangement with Whole Foods Market
expires on August 31, 2004. We are currently in discussions with Whole Foods
Market to continue our relationship upon expiration of the existing agreement.
Gross Profit
Our gross profit increased approximately 17.8%, or $36.7 million, to $242.5
million for the nine months ended April 30, 2004 from $205.8 million for the
nine months ended April 30, 2003. Our gross profit as a percentage of net sales
was 19.8% and 20.3% for the nine months ended April 30, 2004 and 2003,
respectively. The decrease in gross profit as a percentage of net sales in
comparison to the nine months ended April 30, 2003 was due in part to lost
discounts in the first two months of the first quarter of fiscal 2004 resulting
from an accounts payable systems implementation, operational issues within
certain regions of our produce division and an increase in the supernaturals
business as part of our overall sales mix.
Operating Expenses
Operating expenses, excluding special items, increased approximately 15.5%, or
$26.7 million, to $199.3 million for the nine months ended April 30, 2004 from
$172.6 million for the nine months ended April 30, 2003. As a percentage of net
sales, operating expenses, excluding special items, decreased to approximately
16.3% for the nine months ended April 30, 2004 from approximately 17.0% for the
nine months ended April 30, 2003. The approximately $26.7 million increase in
operating expenses for the nine months ended April 30, 2004 was due primarily to
the inclusion of approximately two and a half months of operating expenses
related to Blooming Prairie and five months of operating expenses related to
Northeast Cooperative that were not included in fiscal 2003, along with
increased operating expenses associated with the continued growth of our
business. Operating expenses for the nine months ended April 30, 2004 included a
special item of $1.6 million in start-up and transition costs for certain
equipment rental and labor costs incurred in connection with the implementation
of our primary distribution agreement with Wild Oats Markets, which had
staggered effective dates up to and including April 1, 2004. Operating expenses
for the nine months ended April 30, 2003 included special items of $1.0 million
related to the transition of Wild Oats Markets to a new primary distributor,
consisting primarily of severance and expenses related to the transfer of
private label inventory and costs incurred related to the expansion of our
Chesterfield, New Hampshire distribution center. Operating expenses, including
special items, increased approximately 15.7%, or $27.3 million, to $200.8
16
million for the nine months ended April 30, 2004 from $173.5 million for the
nine months ended April 30, 2003. As a percentage of sales, operating expenses,
including special items, decreased to 16.4% for the nine months ended April 30,
2004 from 17.1% for the nine months ended April 30, 2003 as operating expenses
grew at a slower rate than sales.
Operating Income
Operating income, excluding special items, increased $9.9 million to $43.2
million for the nine months ended April 30, 2004 from $33.3 million for the nine
months ended April 30, 2003. As a percentage of sales, operating income,
excluding special items, improved to 3.5% for the nine months ended April 30,
2004 up from operating income of 3.3% for the nine months ended April 30, 2003.
Operating income for the nine months ended April 30, 2004 included a special
item of $1.6 million in start-up and transition costs for certain equipment
rental and labor costs incurred in connection with the implementation of our
primary distribution agreement with Wild Oats Markets, which had staggered
effective dates up to and including April 1, 2004. Operating income for the nine
months ended April 30, 2003 included special items of $1.0 million related to
the transition of Wild Oats Markets to a new primary distributor, consisting
primarily of severance and expenses related to the transfer of private label
inventory and costs incurred related to the expansion of our Chesterfield, New
Hampshire distribution center. Operating income, including special items, was
$41.7 million for the nine months ended April 30, 2004 and $32.3 million for the
nine months ended April 30, 2003. Operating income, including special items, as
a percentage of sales, increased to 3.4% for the nine months ended April 30,
2004 compared to 3.2% for the nine months ended April 30, 2003.
Other Expense (Income)
Other expense, excluding special items, increased $0.4 million to $5.6 million
for the nine months ended April 30, 2004 from $5.2 million for the nine months
ended April 30, 2003. Interest expense for the nine months ended April 30, 2004
was $6.0 million compared to the $5.7 million for the nine months ended April
30, 2003. This increase in interest expense was primarily due to higher average
debt levels following our acquisitions of Blooming Prairie and Northeast
Cooperative in fiscal 2003 and our increase in inventory levels to support the
growth in the business. Other expense (income) for the nine months ended April
30, 2004 and 2003 included special items of $0.7 million in income and $1.8
million in expense, respectively, related to the change in the fair value of
financial instruments. Other expense (income), including special items, changed
by $2.4 million resulting in income of $1.1 million for the nine months ended
April 30, 2004 in comparison to expense of $1.3 million for the nine months
ended April 30, 2003. 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. On December 29, 2003, we assigned and transferred all of our
obligations of our two "ineffective" interest rate swaps to a third party at a
cost of $5.4 million plus accrued interest. As a result of this assignment,
these "ineffective" swaps will no longer be included as a special item for
future fiscal periods. These "ineffective" swaps were included as a special item
through the second quarter of fiscal 2004.
Income Taxes
Our effective income tax rate was 39.0% and 39.6% for the nine months ended
April 30, 2004 and 2003, respectively. The effective rates were higher than the
federal statutory rate primarily due to state and local income taxes.
Net Income
Net income, excluding special items, increased $5.9 million to $22.9 million, or
$0.56 per diluted share, for the nine months ended April 30, 2004, compared to
$17.0 million, or $0.43 per diluted share, for the nine months ended April 30,
2003. Net income, including special items, increased $7.1 million to $22.4
million, or $0.55 per diluted share, for the nine months ended April 30, 2004,
compared to $15.3 million, or $0.39 per diluted share, for the nine months ended
April 30, 2004.
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:
17
- ------------------------------------------------------ --------------- ------------- -------------
Nine months ended April 30, 2004 Pretax income Per diluted
(in thousands, except per share data) Net of tax share
--------------- ------------- -------------
Income, excluding special items: $37,616 $22,946 $0.56
Special items - Income (Expense):
Wild Oats Markets, Inc. primary distributorship
transition related costs (included in operating
expenses) (1,561) (952) (0.02)
Interest rate swap agreements (change in fair value
of financial instruments) 704 429 0.01
- ------------------------------------------------------ --------------- ------------- -------------
Income, including special items: $36,759 $22,423 $0.55
====================================================== =============== ============= =============
- ------------------------------------------------------ --------------- ------------- -------------
Nine months ended April 30, 2003 Pretax income Net of tax Per diluted
(in thousands, except per share data) share
--------------- ------------- -------------
Income, excluding special items: $28,106 $16,965 $0.43
Special items - Income (Expense):
Interest rate swap agreements (change in fair value
of financial instruments) (1,839) (1,108) (0.03)
Costs related to loss of major customer (included
in operating expenses) (574) (346) (0.01)
Costs related to the expansion of our Chesterfield,
New Hampshire distribution center (included in
operating expenses) (406) (244) (0.01)
- ------------------------------------------------------ --------------- ------------- -------------
Income, including special items: $25,287 $15,267 $0.39*
====================================================== =============== ============= =============
* 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 nine months ended April 30, 2004 and 2003, respectively.
The costs related to the transition of a major customer, Wild Oats Markets, to a
new primary distributor during the nine months ended April 30, 2003 consisted
primarily of severance and expenses related to the transfer of Wild Oats
Markets' private label inventory. For the nine months ended April 30, 2004, the
start-up and transition costs of the new Wild Oats Markets primary
distributorship were for certain equipment rental and labor costs.
On December 29, 2003, we assigned and transferred all of our obligations of our
two "ineffective" interest rate swaps to a third party at a cost of $5.4 million
plus accrued interest. As a result of this novation, these "ineffective" swaps
will no longer be included as a special item for future fiscal periods. These
"ineffective" swaps were included as a special item through the second quarter
of fiscal 2004.
We entered into interest rate swap agreements in October 1998, August 2001 and
May 2003. The October 1998 and August 2001 agreements were "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
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
18
$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 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. The 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 new credit facility replaced an existing $150 million
revolving credit facility. Our amended and restated secured revolving credit
facility allows for borrowing up to $250 million, on which interest accrues at
LIBOR plus 1.25%. The $250 million credit facility matures on March 31, 2008.
This increased credit facility will support our working capital requirements in
the ordinary course of business and provide capital to grow our business
organically or through acquisitions. As of April 30, 2004, our borrowing base,
based on accounts receivable and inventory levels, was $221.9 million, with
remaining availability of $98.7 million. In April 2003, we executed an amendment
to our previous 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 million secured by
the real property that was released in accordance with the aforementioned
amendment. In December 2003, we amended this term loan agreement by increasing
the principal amount by $10 million to $40 million, under the existing terms and
conditions, to fund the expansion of our distribution centers in Iowa City, Iowa
and Dayville, Connecticut. The $40 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 former $150 million credit facility on
which interest accrued at the New York Prime Rate or 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. 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 are expected to be financed through either equity or long term debt
negotiated at the time of the potential acquisition.
Net cash used in operations was $8.0 million for the nine months ended April 30,
2004 and was the result of net income and the change in cash collected from
customers net of cash paid to vendors, offset by a $45.3 million investment in
inventory and a $5.4 payment to novate the "ineffective" swap agreements. The
investment in inventory relates to increasing inventory levels to meet the needs
of Wild Oats Markets and other organic growth as we implemented our primary
distributor agreement with Wild Oats Markets during the third quarter, and
supporting increased sales with wider product assortment, combined with our
ability to capture purchasing efficiency opportunities in excess of total
carrying costs, and our acquisitions of Blooming Prairie and Northeast
Cooperative. Days in inventory improved to 47 days at April 30, 2004 compared to
49 days at April 30, 2003. Days sales outstanding at April 30, 2004 improved to
22 days compared to 23 days at April 30, 2003. Net cash provided by operations
was $29.6 million for the nine months ended April 30, 2003 and was also due to
the change in cash collected from customers, net of cash paid to vendors, and
partially offset by increased inventory levels of $6.6 million as a result of
increased sales. Working capital increased by $29.6 million, or 46.0%, to $93.9
million at April 30, 2004 compared to working capital of $64.3 million at July
31, 2003.
Net cash used in investing activities was $18.8 million for the nine months
ended April 30, 2004 and was due primarily to costs incurred in the expansion of
our Iowa City, Iowa and Dayville, Connecticut facilities, compared to $58.9
million for the same period last year that was due primarily to the purchase of
substantially all the assets of Blooming Prairie and Northeast Cooperative and
the expansion of our Chesterfield, New Hampshire facility.
Net cash provided by financing activities was $32.0 million for the nine months
ended April 30, 2004 due primarily to the $10.2 million in additional long-term
debt and borrowings under our $250 million secured revolving credit facility,
and proceeds from the exercise of stock options, partially offset by $3.3
million in repayments of our long-term debt. Net cash provided by financing
activities was $23.0 million for the nine months ended April 30, 2003, due
primarily to increased borrowings on our line of credit, offset by repayment of
long-term debt of $1.3 million.
19
In October 1998, we entered into an interest rate swap agreement that provided
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 swap had
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 prohibited 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.
We entered into an additional interest rate swap agreement effective August
2001. The additional agreement provided 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 four-year term of the swap agreement could have
been extended to six years at the option of the counter party, which prohibited
accounting for the swap as an effective hedge under SFAS 133. The swap had 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
exceeded 6.0% in a given period, the agreement was suspended for that period.
On December 29, 2003, we assigned and transferred all of our obligations of our
two "ineffective" interest rate swaps to a third party at a cost of $5.4 million
plus accrued interest. As a result of this assignment, these "ineffective" swaps
will no longer be included as a special item for future fiscal periods. These
"ineffective" swaps were included as special items for the first two quarters of
fiscal 2004.
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 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
We have determined that there are no recently issued accounting standards that
are expected to 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
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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.
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.
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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.
We depend heavily on our principal customer
Our current distribution arrangement with our largest customer, Whole
Foods Market, is effective through August 31, 2004. Whole Foods Market accounted
for approximately 24% of our net sales during the quarters ended April 30, 2004
and 2003, and 25% and 24% for the nine months ended April 30, 2004 and 2003,
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. With the implementation of our primary distribution
agreement with Wild Oats Markets during the third quarter of fiscal 2004, our
sales to Whole Foods Markets as a percentage of our total net sales may decline
over the next twelve months, and our sales to Wild Oats Markets may increase as
a percentage of our total net sales over the next twelve months.
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, 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:
o difficulties with the collectibility of accounts receivable;
22
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 Western Region 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, 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;
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.
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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 April 30, 2004, we had approximately 3,765 full and part-time
employees. An aggregate of approximately 398, or 11%, 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.
Access to capital and the cost of that capital
We have a secured revolving credit facility with available credit under it
of $250 million at an interest rate of LIBOR plus 1.25% maturing on March 31,
2008. As of April 30, 2004, our borrowing base, based on accounts receivable and
inventory levels, was $221.9 million with remaining availability of $98.7
million. In April 2003, we executed a term loan agreement in the principal
amount of $30 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 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 December 2003, we amended this term loan agreement to
increase the principal amount from $30 million to $40 million under the existing
terms and conditions.
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.
24
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.
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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
- --------------------------------------------------------------------------------
10.1 Amended and Restated Loan and Security Agreement, dated April
30, 2004, with Fleet Capital Corporation. Certain schedules,
exhibits and similar attachments to this Agreement have not
been filed with this exhibit. The Registrant agrees to furnish
supplementally any omitted schedule, exhibit or similar
attachment to the Securities and Exchange Commission upon
request.
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
Reports on Form 8-K
March 2, 2004 The Company announced its financial results for the
fiscal quarter ended January 31, 2004.
March 19, 2004 The Company announced a two-for-one split of the Company's
common stock.
* * *
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
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: June 14, 2004