UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended May 2, 2020
or
For the transition period from to
Commission File Number: 001-15723
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) | ||
(Address of principal executive offices) | (Zip Code) | |||
Registrant’s telephone number, including area code: (401 ) 528-8634
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered |
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer | ☐ | ||
Non-accelerated filer | ☐ | Smaller reporting company | ||
Emerging growth company | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of June 5, 2020 there were 54,686,954 shares of the registrant’s common stock, $0.01 par value per share, outstanding.
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands, except for per share data)
May 2, 2020 | August 3, 2019 | |||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Accounts receivable, net | ||||||||
Inventories | ||||||||
Prepaid expenses and other current assets | ||||||||
Current assets of discontinued operations | ||||||||
Total current assets | ||||||||
Property and equipment, net | ||||||||
Operating lease assets | ||||||||
Goodwill | ||||||||
Intangible assets, net | ||||||||
Deferred income taxes | ||||||||
Other assets | ||||||||
Long-term assets of discontinued operations | ||||||||
Total assets | $ | $ | ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Accounts payable | $ | $ | ||||||
Accrued expenses and other current liabilities | ||||||||
Accrued compensation and benefits | ||||||||
Current portion of operating lease liabilities | ||||||||
Current portion of long-term debt and finance lease liabilities | ||||||||
Current liabilities of discontinued operations | ||||||||
Total current liabilities | ||||||||
Long-term debt | ||||||||
Long-term operating lease liabilities | ||||||||
Long-term finance lease liabilities | ||||||||
Pension and other postretirement benefit obligations | ||||||||
Deferred income taxes | ||||||||
Other long-term liabilities | ||||||||
Long-term liabilities of discontinued operations | ||||||||
Total liabilities | ||||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.01 par value, authorized 5,000 shares; none issued or outstanding | ||||||||
Common stock, $0.01 par value, authorized 100,000 shares; 55,292 shares issued and 54,677 shares outstanding at May 2, 2020; 53,501 shares issued and 52,886 shares outstanding at August 3, 2019 | ||||||||
Additional paid-in capital | ||||||||
Treasury stock at cost | ( | ) | ( | ) | ||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
Retained earnings | ||||||||
Total United Natural Foods, Inc. stockholders’ equity | ||||||||
Noncontrolling interests | ( | ) | ( | ) | ||||
Total stockholders' equity | ||||||||
Total liabilities and stockholders’ equity | $ | $ | ||||||
See accompanying Notes to Condensed Consolidated Financial Statements.
3
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In thousands, except for per share data)
13-Week Period Ended | 39-Week Period Ended | |||||||||||||||
May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||||
Net sales | $ | $ | $ | $ | ||||||||||||
Cost of sales | ||||||||||||||||
Gross profit | ||||||||||||||||
Operating expenses | ||||||||||||||||
Goodwill and asset impairment (adjustment) charges | ( | ) | ||||||||||||||
Restructuring, acquisition and integration related expenses | ||||||||||||||||
Operating income (loss) | ( | ) | ( | ) | ||||||||||||
Other expense (income): | ||||||||||||||||
Net periodic benefit income, excluding service cost | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Interest expense, net | ||||||||||||||||
Other, net | ( | ) | ( | ) | ||||||||||||
Total other expense, net | ||||||||||||||||
Income (loss) from continuing operations before income taxes | ( | ) | ( | ) | ||||||||||||
Benefit for income taxes | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Net income (loss) from continuing operations | ( | ) | ( | ) | ||||||||||||
Income from discontinued operations, net of tax | ||||||||||||||||
Net income (loss) including noncontrolling interests | ( | ) | ( | ) | ||||||||||||
Less net (income) loss attributable to noncontrolling interests | ( | ) | ( | ) | ( | ) | ||||||||||
Net income (loss) attributable to United Natural Foods, Inc. | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Basic earnings (loss) per share: | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Discontinued operations | $ | $ | $ | $ | ||||||||||||
Basic earnings (loss) per share | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Diluted earnings (loss) per share: | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Discontinued operations | $ | $ | $ | $ | ||||||||||||
Diluted earnings (loss) per share | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | ||||||||||||||||
Diluted | ||||||||||||||||
See accompanying Notes to Condensed Consolidated Financial Statements.
4
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (unaudited)
(In thousands)
13-Week Period Ended | 39-Week Period Ended | |||||||||||||||
May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||||
Net income (loss) including noncontrolling interests | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Other comprehensive (loss) income: | ||||||||||||||||
Recognition of pension and other postretirement benefit obligations, net of tax(1) | ( | ) | ||||||||||||||
Recognition of interest rate swap cash flow hedges, net of tax(2) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Total other comprehensive loss | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Less comprehensive (income) loss attributable to noncontrolling interests | ( | ) | ( | ) | ( | ) | ||||||||||
Total comprehensive income (loss) attributable to United Natural Foods, Inc. | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
(1) | Amounts are net of tax (benefit) expense of $( |
(2) | Amounts are net of tax (benefit) expense of $( |
See accompanying Notes to Condensed Consolidated Financial Statements.
5
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
For the 13-week periods ended May 2, 2020 and April 27, 2019
(In thousands)
Common Stock | Treasury Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Retained Earnings | Total United Natural Foods, Inc. Stockholders’ Equity | Noncontrolling Interests | Total Stockholders’ Equity | ||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||
Balances at February 1, 2020 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
Restricted stock vestings and stock option exercises | — | — | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||||
Share-based compensation | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | ( | ) | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Distributions to noncontrolling interests | — | — | — | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||
Proceeds from issuance of common stock, net | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | |||||||||||||||||||||||||||||||
Balances at May 2, 2020 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
Balances at January 26, 2019 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
Restricted stock vestings and stock option exercises | — | — | — | ( | ) | — | — | ( | ) | — | ( | ) | |||||||||||||||||||||||||
Share-based compensation | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | ( | ) | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Proceeds from issuance of common stock, net | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | |||||||||||||||||||||||||||||||
Balances at April 27, 2019 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
See accompanying Notes to Condensed Consolidated Financial Statements
6
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
For the 39-week periods ended May 2, 2020 and April 27, 2019
(In thousands)
Common Stock | Treasury Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Loss | Retained Earnings | Total Stockholders’ Equity | Noncontrolling Interests | Total Stockholders’ Equity | ||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||
Balances at August 3, 2019 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
Cumulative effect of change in accounting principle | — | — | — | — | — | — | ( | ) | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Restricted stock vestings and stock option exercises | — | — | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||||
Share-based compensation | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | ( | ) | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Distributions to noncontrolling interests | — | — | — | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||
Proceeds from issuance of common stock, net | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Net loss | — | — | — | — | — | — | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||||||
Balances at May 2, 2020 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
Balances at July 28, 2018 | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||
Cumulative effect of change in accounting principle | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Restricted stock vestings and stock option exercises, net of tax | — | — | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||||
Share-based compensation | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Other/share-based compensation | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | ( | ) | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Acquisition of noncontrolling interests | — | — | — | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||
Distributions to noncontrolling interests | — | — | — | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||
Proceeds from issuance of common stock, net | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Net loss | — | — | — | — | — | — | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||||
Balances at April 27, 2019 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||||
See accompanying Notes to Condensed Consolidated Financial Statements.
7
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
39-Week Period Ended | ||||||||
(In thousands) | May 2, 2020 | April 27, 2019 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net loss including noncontrolling interests | $ | ( | ) | $ | ( | ) | ||
Income from discontinued operations, net of tax | ||||||||
Net loss from continuing operations | ( | ) | ( | ) | ||||
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities: | ||||||||
Depreciation and amortization | ||||||||
Share-based compensation | ||||||||
Loss (gain) on disposition of assets | ( | ) | ||||||
Closed property and other restructuring charges | ||||||||
Goodwill and asset impairment charges | ||||||||
Net pension and other postretirement benefit income | ( | ) | ( | ) | ||||
Deferred income tax benefit | ( | ) | ( | ) | ||||
LIFO charge | ||||||||
Provision for doubtful accounts, net | ||||||||
Loss on debt extinguishment | ||||||||
Non-cash interest expense | ||||||||
Changes in operating assets and liabilities, net of acquired businesses | ( | ) | ( | ) | ||||
Net cash provided by operating activities of continuing operations | ||||||||
Net cash provided by operating activities of discontinued operations | ||||||||
Net cash provided by operating activities | ||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Capital expenditures | ( | ) | ( | ) | ||||
Purchases of acquired businesses, net of cash acquired | ( | ) | ||||||
Proceeds from dispositions of assets | ||||||||
Proceeds from disposal of investments | ||||||||
Payments for long-term investment | ( | ) | ||||||
Payments of company owned life insurance premiums | ( | ) | ||||||
Other | ( | ) | ||||||
Net cash used in investing activities of continuing operations | ( | ) | ( | ) | ||||
Net cash provided by investing activities of discontinued operations | ||||||||
Net cash used in investing activities | ( | ) | ( | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Proceeds from borrowings of long-term debt | ||||||||
Proceeds from borrowings under revolving credit line | ||||||||
Proceeds from issuance of other loans | ||||||||
Repayments of borrowings under revolving credit line | ( | ) | ( | ) | ||||
Repayments of long-term debt and finance leases | ( | ) | ( | ) | ||||
Proceeds from the issuance of common stock and exercise of stock options | ||||||||
Payment of employee restricted stock tax withholdings | ( | ) | ( | ) | ||||
Payments for debt issuance costs | ( | ) | ||||||
Net cash (used in) provided by financing activities of continuing operations | ( | ) | ||||||
Net cash used in financing activities of discontinued operations | ( | ) | ( | ) | ||||
Net cash (used in) provided by financing activities | ( | ) | ||||||
EFFECT OF EXCHANGE RATE CHANGES ON CASH | ( | ) | ( | ) | ||||
NET INCREASE IN CASH AND CASH EQUIVALENTS | ||||||||
Cash and cash equivalents, at beginning of period | ||||||||
Cash and cash equivalents at end of period | ||||||||
Less: cash and cash equivalents of discontinued operations | ( | ) | ( | ) | ||||
Cash and cash equivalents | $ | $ | ||||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for interest | $ | $ | ||||||
Cash (refunds) payments for federal and state income taxes, net | $ | ( | ) | $ | ||||
See accompanying Notes to Condensed Consolidated Financial Statements.
8
UNITED NATURAL FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
NOTE 1—SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
United Natural Foods, Inc. and its subsidiaries (the “Company” or “UNFI”) is a leading distributor of natural, organic, specialty, produce and conventional grocery and non-food products, and provider of support services. The Company sells its products primarily throughout the United States and Canada.
Fiscal Year
The Company’s fiscal years end on the Saturday closest to July 31 and contain either 52 or 53 weeks. References to the third quarter of fiscal 2020 and 2019 relate to the 13-week fiscal quarters ended May 2, 2020 and April 27, 2019, respectively. References to fiscal 2020 and 2019 year-to-date relate to the 39-week fiscal periods ended May 2, 2020 and April 27, 2019, respectively.
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation, with the exception of sales transactions from continuing to discontinued operations for wholesale supply discussed further in Note 3—Revenue Recognition. Unless otherwise indicated, references to the Condensed Consolidated Statements of Operations, the Condensed Consolidated Balance Sheets and the Notes to the Condensed Consolidated Financial Statements exclude all amounts related to discontinued operations. Refer to Note 18—Discontinued Operations for additional information about discontinued operations.
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial information, including the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and note disclosures normally required in complete financial statements prepared in conformity with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted. In the Company’s opinion, these Condensed Consolidated Financial Statements include all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. However, the results of operations for interim periods may not be indicative of the results that may be expected for a full year. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 3, 2019 (the “Annual Report”). Except as described for lease accounting below, there were no material changes in significant accounting policies from those described in the Company’s Annual Report.
Use of Estimates
The preparation of the Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments with original maturities of three months or less. The Company’s banking arrangements allow it to fund outstanding checks when presented to the financial institution for payment. The Company funds all intraday bank balance overdrafts during the same business day. Checks outstanding in excess of bank balances create book overdrafts, which are recorded in Accounts payable in the Condensed Consolidated Balance Sheets and are reflected as an operating activity in the Condensed Consolidated Statements of Cash Flows. As of May 2, 2020 and August 3, 2019, the Company had net book overdrafts of $290.3 million and $236.9 million, respectively.
9
Inventories, Net
Inventories are valued at the lower of cost or market. Substantially all of the Company’s inventories consist of finished goods and a substantial portion of its inventories have a last-in, first-out (“LIFO”) reserve applied. Interim LIFO calculations are based on the Company’s estimates of expected year-end inventory levels and costs, as the actual valuation of inventory under the LIFO method is computed at the end of each fiscal year based on the inventory levels and costs at that time. If the first-in, first-out method had been used, Inventories, net would have been higher by approximately $43.4 million and $24.1 million at May 2, 2020 and August 3, 2019, respectively.
Leases
At the inception or modification of a contract, the Company determines whether a lease exists and classifies its leases as an operating or finance lease at commencement. Subsequent to commencement, lease classification is only reassessed upon a change to the expected lease term or contract modification. Finance and operating lease assets represent the Company’s right to use an underlying asset as lessee for the lease term, and lease obligations represent the Company’s obligation to make lease payments arising from the lease. These assets and obligations are recognized at the lease commencement date based on the present value of lease payments, net of incentives, over the lease term. Incremental borrowing rates are estimated based on the Company’s borrowing rate as of the lease commencement date to determine the present value of lease payments, when lease contracts do not provide a readily determinable implicit rate. Incremental borrowing rates are determined by using the yield curve based on the Company’s credit rating adjusted for the Company’s specific debt profile and secured debt risk. The lease asset also reflects any prepaid rent, initial direct costs incurred and lease incentives received. The Company’s lease terms include option extension periods when it is reasonably certain that those options will be exercised. Leases with an initial expected term of 12 months or less are not recorded in the consolidated balance sheets and the related lease expense is recognized on a straight-line basis over the lease term. For all classes of underlying assets, the Company has elected to not separate fixed lease components from the fixed nonlease components.
The Company recognizes contractual obligations and receipts on a gross basis, such that the related lease obligation to the landlord is presented separately from the sublease created by the lease assignment to the assignee. As a result, the Company continues to recognize on its Condensed Consolidated Balance Sheets the operating lease assets and liabilities, and finance lease assets and obligations, for assigned leases.
The Company records operating lease expense and income using the straight-line method within Operating expenses, and lease income on a straight-line method for leases with its customers within Net sales. Finance lease expense is recognized as amortization expense within Operating expenses, and interest expense within Interest expense, net. For operating leases with step rent provisions whereby the rental payments increase over the life of the lease, and for leases where the Company receives rent-free periods, the Company recognizes expense and income based on a straight-line basis based on the total minimum lease payments to be made or lease receipts expected to be received over the expected lease term, including rent-free periods. The Company is generally obligated for property tax, insurance and maintenance expenses related to leased properties, which often represent variable lease expenses. For contractual obligations on properties where the Company remains the primary obligor upon assignment of the lease and does not obtain a release from landlords or retain the equity interests in the legal entities with the related rent contracts, the Company continues to recognize rent expense and rent income within Operating expenses.
Operating and finance lease assets are reviewed for impairment based on an ongoing review of circumstances that indicate the assets may no longer be recoverable, such as closures of retail stores, distribution centers and other properties that are no longer being utilized in current operations, and other factors. The Company calculates operating and finance lease impairments using a discount rate to calculate the present value of estimated subtenant rentals that could be reasonably obtained for the property. Lease impairment charges are recorded as a component of Restructuring, acquisition and integration related expenses in the Condensed Consolidated Statements of Operations.
The calculation of lease impairment charges requires significant judgments and estimates, including estimated subtenant rentals, discount rates and future cash flows based on the Company’s experience and knowledge of the market in which the property is located, previous efforts to dispose of similar assets and the assessment of existing market conditions. Impairments are recognized as a reduction of the carrying value of the right of use asset and are reflected as a reduction to Operating lease assets. Refer to Note 11—Leases for additional information.
10
NOTE 2—RECENTLY ADOPTED AND ISSUED ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued accounting standards update (“ASU”) No. 2016-02, Leases (Topic 842), which provides new comprehensive lease accounting guidance that supersedes previous lease guidance. The objective of this ASU is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. Criteria for distinguishing between finance and operating leases are substantially similar to criteria for distinguishing between capital and operating leases in previous lease guidance. Lease agreements that are 12 months or less are permitted to be excluded from the balance sheet. In addition, this ASU expands the disclosure requirements of lease arrangements. The Company adopted this standard in the first quarter of fiscal 2020 on August 4, 2019, the effective and initial application date, using the additional transition method under ASU 2018-11, which allows for a cumulative effect adjustment within retained earnings in the period of adoption. In addition, the Company elected the “package of three” practical expedients which allows companies to not reassess whether arrangements contain leases, the classification of leases, and the capitalization of initial direct costs. The impact of the adoption to the Company’s Condensed Consolidated Balance Sheets includes the recognition of operating lease liabilities of $1.1 billion with corresponding right-of-use assets of approximately the same amount based on the present value of the remaining lease payments for existing operating leases. The difference between the amount of right-of-use assets and lease liabilities recognized is primarily related to adjustments to prepaid rent, deferred rent, lease intangible assets/liabilities, and closed property reserves. In addition, the adoption of the standard resulted in the derecognition of existing property and equipment for certain properties that did not previously qualify for sale accounting because the Company was determined to be the accounting owner during the construction phase and did not qualify for sale-leaseback accounting upon completion of the construction. At the transition date, the Company was constructing one facility, which was completed in the fourth quarter of fiscal 2020. The Company exercised a purchase option for the facility in the third quarter of fiscal 2020, which resulted in the Company continuing to account for the facility as its accounting owner. For properties where the Company was deemed the accounting owner during construction for which construction has been completed, the difference between the assets and liabilities derecognized, net of the deferred tax impact, was recorded as an adjustment to retained earnings. Lessor accounting guidance remained largely unchanged from previous guidance. Adoption of this standard did not have a material impact to the Company’s Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Stockholders’ Equity or Condensed Consolidated Statements of Cash Flows. The Company has revised its accounting policies, processes and controls, and systems as applicable to comply with the provisions and disclosure requirements of the standard.
The effects of the changes, including those discussed above, made to the Company’s Condensed Consolidated Balance Sheets as of August 3, 2019 for the adoption of the new lease guidance were as follows (in thousands):
Balance at August 3, 2019 | Adjustments due to adoption of the new lease guidance | Adjusted Balance at August 4, 2019 | ||||||||||
Assets | ||||||||||||
Prepaid expenses and other current assets | $ | $ | ( | ) | $ | |||||||
Property and equipment, net | ( | ) | ||||||||||
Operating lease assets | ||||||||||||
Intangible assets, net | ( | ) | ||||||||||
Deferred income taxes | $ | $ | ||||||||||
Total increase to assets | $ | |||||||||||
Liabilities and Stockholders’ Equity | ||||||||||||
Accrued expense and other current liabilities | $ | $ | ( | ) | $ | |||||||
Current portion of operating lease liabilities | ||||||||||||
Current portion of long-term debt and finance lease liabilities | ( | ) | ||||||||||
Long-term operating lease liabilities | ||||||||||||
Long-term finance lease obligations | ( | ) | ||||||||||
Other long-term liabilities | ( | ) | ||||||||||
Total stockholders’ equity | $ | ( | ) | $ | ||||||||
Total increase to liabilities and stockholders’ equity | $ | |||||||||||
In October 2018, the FASB issued authoritative guidance under ASU No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This ASU adds the Overnight Index Swap (OIS) rate based on Secured Overnight Financing Rate (SOFR) as a benchmark interest rate for hedge accounting purposes. This ASU is effective for public companies with interim and fiscal years beginning after December 15, 2018, which for the Company was the first quarter of fiscal year 2020. The Company adopted this standard in the first quarter of fiscal 2020 with no impact to the Company’s consolidated financial statements as LIBOR is still being used as benchmark interest rate.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017. This ASU is effective for all entities for annual and interim periods in fiscal years beginning after December 15, 2018. The Company adopted this ASU in the first quarter of fiscal 2020. The adoption of this ASU had no impact to Accumulated other comprehensive loss or Retained earnings.
In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326 Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825. This ASU clarifies the accounting treatment for the measurement of credit losses under ASC 236 and provides further clarification on previously issued updates including ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities and ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. Since the Company adopted ASU 2017-12 in the fourth quarter of fiscal 2018, the amendments in ASU 2019-04 related to clarifications on Accounting for Hedging Activities have been adopted by the Company in the first quarter of fiscal 2020. The remaining amendments within ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, which for the Company is the first quarter of fiscal 2021. Early adoption is permitted. The Company adopted the relevant portions of this standard in the first quarter of fiscal 2020 with no impact to Accumulated other comprehensive loss or Retained earnings for fiscal 2020, as the Company did not have separately measured ineffectiveness related to its cash flow hedges.
In March 2020, the FASB issued ASU 2020-04, Reference rate reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional expedients and exceptions for a limited period of time to ease the potential burden in accounting for contracts, hedging relationships, and other transactions affected by reference rate reform. The Company adopted this ASU in the third quarter of fiscal 2020, which is effective on a prospective basis. The adoption of this ASU did not have a material impact on the consolidated financial statements. The Company has elected the expedient to assert probability of its hedged interest rate transactions, which is effective March 12, 2020 until superseded by subsequent documentation or December 31, 2022, whichever occurs first.
Recently Issued Accounting Pronouncements
In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. ASU 2018-05 requires implementation costs incurred by customers in cloud computing arrangements (i.e. hosting arrangements) to be capitalized under the same premises as authoritative guidance for internal-use software, and deferred over the noncancellable term of the cloud computing arrangements plus any option renewal periods that are reasonably certain to be exercised by the customer or for which the exercise is controlled by the service provider. The Company is required to adopt this new guidance in the first quarter of fiscal 2021. The Company has outstanding cloud computing arrangements and continues to incur costs that it believes would be required to be capitalized under ASU 2018-05. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans. ASU 2018-14 eliminates requirements for certain disclosures and requires additional disclosures under defined benefit pension plans and other postretirement plans. The Company is required to adopt this guidance in the first quarter of fiscal 2022. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and subsequent amendments to the initial guidance: ASU 2018-19, ASU 2019-04, ASU 2019-05, and ASU 2019-11 (collectively, “Topic 326”). Topic 326 changes the impairment model for most financial assets and certain other instruments. For trade and other receivables, guarantees and other instruments, entities will be required to use a new forward-looking “expected loss” model that will replace the current “incurred loss” model and generally will result in the earlier recognition of credit losses. The Company is required to adopt this new guidance in the first quarter of fiscal 2021 on a modified-retrospective basis as required by the standard by means of a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial position and stockholders’ equity as of the effective date. The Company is currently reviewing the provisions of the new standard, establishing revised processes and controls to estimate expected losses for trade and other receivables, guarantees and other instruments, and evaluating its impact on the Company’s consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. ASU 2019-12 eliminates certain exceptions to Topic 740’s general principles. The amendments also improve consistent application and simplifies its application. The Company is required to adopt this guidance in the first quarter of fiscal 2022. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
NOTE 3—REVENUE RECOGNITION
Disaggregation of Revenues
The Company records revenue to four customer channels, which are described below:
• | Supermarkets, which include accounts that also carry conventional products, and include chain accounts, supermarket independents, and gourmet and ethnic specialty stores. |
• | Supernatural, which consists of chain accounts that are national in scope and carry primarily natural products, and currently consists solely of Whole Foods Market. |
• | Independents, which include single store and chain accounts (excluding supernatural, as defined above), which carry primarily natural products and buying clubs of consumer groups joined to buy products. |
• | Other, which includes conventional military business, international customers outside of Canada, as well as sales to Amazon.com, Inc., e-commerce, and foodservice. |
11
The following tables detail the Company’s revenue recognition for the periods presented by customer channel for each of its segments. The Company does not record its revenues within its wholesale reportable segment for financial reporting purposes by product group, and it is therefore impracticable for it to report them accordingly.
Net Sales for the 13-Week Period Ended | ||||||||||||||||
(in millions) | May 2, 2020 | |||||||||||||||
Customer Channel | Wholesale | Other | Eliminations | Consolidated | ||||||||||||
Supermarkets | $ | $ | $ | $ | ||||||||||||
Supernatural | ||||||||||||||||
Independents | ||||||||||||||||
Other | ( | ) | ||||||||||||||
Total | $ | $ | $ | ( | ) | $ | ||||||||||
Net Sales for the 13-Week Period Ended | ||||||||||||||||
(in millions) | April 27, 2019(1) | |||||||||||||||
Customer Channel | Wholesale | Other | Eliminations | Consolidated | ||||||||||||
Supermarkets | $ | $ | $ | $ | ||||||||||||
Supernatural | ||||||||||||||||
Independents | ||||||||||||||||
Other | ( | ) | ||||||||||||||
Total | $ | $ | $ | ( | ) | $ | ||||||||||
Net Sales for the 39-Week Period Ended | ||||||||||||||||
(in millions) | May 2, 2020(1) | |||||||||||||||
Customer Channel | Wholesale | Other | Eliminations | Consolidated | ||||||||||||
Supermarkets | $ | $ | $ | $ | ||||||||||||
Supernatural | ||||||||||||||||
Independents | ||||||||||||||||
Other | ( | ) | ||||||||||||||
Total | $ | $ | $ | ( | ) | $ | ||||||||||
Net Sales for the 39-Week Period Ended | ||||||||||||||||
(in millions) | April 27, 2019(1) | |||||||||||||||
Customer Channel | Wholesale | Other | Eliminations | Consolidated | ||||||||||||
Supermarkets | $ | $ | $ | $ | ||||||||||||
Supernatural | ||||||||||||||||
Independents | ||||||||||||||||
Other | ( | ) | ||||||||||||||
Total | $ | $ | $ | ( | ) | $ | ||||||||||
(1) | During the first quarter of fiscal 2020, the presentation of net sales by customer channel was adjusted to reflect reclassification of customer types resulting from management’s determination that a customer serviced by both legacy Supervalu and UNFI should be classified as a Supermarket customer given that customer’s operations. During the second quarter of fiscal 2020, the presentation of net sales by customer channel was adjusted to reflect conventional military sales within Other instead of Independents based on management’s determination to better reflect the focus of its ongoing business and the definition of customer channels above. There was no impact to the Condensed Consolidated Statements of Operations as a result of the reclassification of customer types. As a result of these adjustments, net sales to the Company’s Supermarkets channel for the third quarter of fiscal 2019 and for fiscal 2019 year-to-date increased approximately $ |
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The Company serves customers in the United States and Canada, as well as customers located in other countries. However, all of the Company’s revenue is earned in the U.S. and Canada, as international distribution occurs through freight-forwarders. The Company does not have any performance obligations related to international shipments subsequent to delivery to the domestic port.
Sales from the Company’s Wholesale segment to its retail discontinued operations are presented within Net sales when the Company holds the business for sale as of the end of the reporting period with a supply agreement that it anticipates the sale of the retail banner to include upon the disposal of the business. The Company recorded $273.2 million and $227.1 million within Net sales from continuing operations attributable to discontinued operations inter-company product purchases in the third quarters of fiscal 2020 and 2019, respectively, and $756.9 million and $505.5 million for fiscal 2020 and 2019 year-to-date, respectively, which the Company expects will continue subsequent to the sale of certain retail banners. These amounts were recorded at gross margin rates consistent with sales to other similar wholesale customers of the acquired Supervalu business. No sales were recorded within continuing operations for purchases by retail banners that the Company expects to dispose of without a supply agreement, which were eliminated upon consolidation within continuing operations and amounted to $99.3 million and $134.9 million in the third quarters of fiscal 2020 and 2019, respectively, and $320.0 million and $308.0 million in fiscal 2020 and 2019 year-to-date, respectively.
Contract Balances
Accounts and notes receivable are as follows:
(in thousands) | May 2, 2020 | August 3, 2019 | ||||||
Customer accounts receivable | $ | $ | ||||||
Allowance for uncollectible receivables | ( | ) | ( | ) | ||||
Other receivables, net | ||||||||
Accounts receivable, net | $ | $ | ||||||
Customer notes receivable, net, included within Prepaid expenses and other current assets | $ | $ | ||||||
Long-term notes receivable, net, included within Other assets | $ | $ | ||||||
NOTE 4—ACQUISITIONS
Supervalu Acquisition
On July 25, 2018, the Company entered into an agreement and plan of merger to acquire all of the outstanding equity securities of Supervalu, which was then the largest publicly traded conventional grocery distributor in the United States. The acquisition of Supervalu diversifies the Company’s customer base, further enables cross-selling opportunities, expands market reach and scale, enhances technology, capacity and systems, and is expected to deliver significant synergies and accelerate potential growth. The merger was completed on October 22, 2018 (the “Closing Date”). At the effective time of the acquisition, each share of Supervalu common stock, par value $0.01 per share, issued and outstanding, was canceled and converted into the right to receive a cash payment equal to $32.50 per share, without interest. Total consideration related to this acquisition was $2.3 billion, $1.3 billion of which was paid in cash to Supervalu shareholders and $1.0 billion of which was used to satisfy Supervalu’s outstanding debt obligations. Included in the liabilities assumed in the Supervalu acquisition were the Supervalu Senior Notes with a fair value of $546.6 million. These Senior Notes were redeemed in the second quarter of fiscal 2019 following the required 30-day notice period, resulting in their satisfaction and discharge.
The assets and liabilities of Supervalu were recorded in the Company’s Consolidated Financial Statements on a preliminary basis at their estimated fair values as of the acquisition date. In conjunction with the Supervalu acquisition, the Company announced its plan to sell the remaining acquired retail operations of Supervalu. Refer to Note 18—Discontinued Operations for more information on discontinued operations.
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The following table summarizes the final consideration, fair value of assets acquired and liabilities assumed, and the resulting goodwill.
(in thousands) | Final Acquisition Date Fair Values | |||
Consideration: | ||||
Outstanding shares | $ | |||
Outstanding debt, excluding acquired senior notes | ||||
Equity-based awards | ||||
Total consideration | $ | |||
Fair value of assets acquired and liabilities assumed: | ||||
Cash and cash equivalents | $ | |||
Accounts receivable | ||||
Inventories | ||||
Prepaid expenses and other current assets | ||||
Current assets of discontinued operations | ||||
Property, plant and equipment | ||||
Goodwill | ||||
Intangible assets | ||||
Other assets | ||||
Long-term assets of discontinued operations | ||||
Accounts payable | ( | ) | ||
Current portion of long-term debt and finance lease obligations | ( | ) | ||
Other current liabilities | ( | ) | ||
Current liabilities of discontinued operations | ( | ) | ||
Long-term debt | ( | ) | ||
Long-term finance lease obligations | ( | ) | ||
Pension and other postretirement benefit obligations | ( | ) | ||
Deferred income taxes | ( | ) | ||
Other long-term liabilities | ( | ) | ||
Long-term liabilities of discontinued operations | ( | ) | ||
Noncontrolling interests | ||||
Total consideration | ||||
Less: Cash and cash equivalents(1) | ( | ) | ||
Total consideration, net of cash and cash equivalents acquired | $ | |||
(1) | Includes cash and cash equivalents acquired attributable to continuing operations and discontinued operations. |
Goodwill represents the future economic benefits arising largely from the synergies expected from combining the operations of the Company and Supervalu that could not be individually identified and separately recognized. A substantial portion of goodwill is deductible for income tax purposes. Goodwill from the acquisition was attributed to the Company’s Supervalu Wholesale reporting unit and the legacy Company Wholesale reporting unit, which in the first quarter of fiscal 2020 was reorganized into a single U.S. Wholesale reporting unit, as discussed further in Note 6—Goodwill and Intangible Assets. No goodwill was attributed to the Company’s Retail reporting unit within discontinued operations.
During the first quarter of fiscal 2020, the Company finalized its fair value estimates of its net assets, primarily by completing income tax returns and reviews of carrying values of other assets and liabilities. There were no material changes to preliminary amounts previously reported.
14
The following table summarizes the identifiable intangible assets and liabilities recorded based on final valuations. The identifiable intangible assets are expected to be amortized on a straight-line basis over the estimated useful lives indicated. The fair value of identifiable intangible assets acquired was determined using income approaches. Significant assumptions utilized in the income approach were based on Company-specific information and projections, which are not observable in the market and are thus considered Level 3 measurements as defined by authoritative guidance.
Final Acquisition Date Fair Values | |||||||||
(in thousands) | Estimated Useful Life | Continuing Operations | Discontinued Operations | ||||||
Customer relationship assets | 10-17 years | $ | $ | ||||||
Favorable operating leases | 1-19 years | ||||||||
Leases in place | 1-8 years | ||||||||
Tradenames | 2-9 years | ||||||||
Pharmacy prescription files | 5-7 years | ||||||||
Non-compete agreement | |||||||||
Unfavorable operating leases | 1-12 years | ( | ) | ||||||
Total | $ | $ | |||||||
The accompanying Condensed Consolidated Statements of Operations include the results of operations of Supervalu from October 22, 2018. Supervalu’s net sales from discontinued operations for this time period are reported in Note 18—Discontinued Operations.
The following table presents unaudited supplemental pro forma consolidated Net sales and Net loss from continuing operations based on the Company’s historical reporting periods as if the acquisition of Supervalu had occurred as of July 30, 2017:
13-Week Period Ended | 39-Week Period Ended | ||||||||||
(in thousands, except per share data) | April 28, 2018(1) | April 27, 2019(2) | April 28, 2018(3) | ||||||||
Net sales | $ | $ | $ | ||||||||
Net income (loss) from continuing operations | $ | $ | ( | ) | $ | ||||||
Basic net income (loss) from continuing operations per share | $ | $ | ( | ) | $ | ||||||
Diluted net income (loss) from continuing operations per share | $ | $ | ( | ) | $ | ||||||
(1) | Includes 13 weeks of pro forma Supervalu results for the period ended April 28, 2018. |
(2) | Includes 12 weeks of pro forma Supervalu results for the period ended September 8, 2018. |
(3) | Includes 39 weeks of pro forma Supervalu results for the period ended April 28, 2018 and 19 weeks of pro forma Associated Grocers of Florida, Inc. results, which was acquired by Supervalu on December 8, 2017. |
These unaudited pro forma results are presented for informational purposes only and are not necessarily indicative of what the actual results of operations of the combined companies would have been had the acquisitions occurred at the beginning of the periods being presented, nor are they indicative of future results of operations.
NOTE 5—RESTRUCTURING, ACQUISITION AND INTEGRATION RELATED EXPENSES
Restructuring, acquisition and integration related expenses incurred were as follows:
13-Week Period Ended | 39-Week Period Ended | ||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||
2019 SUPERVALU INC. restructuring expenses | $ | $ | $ | $ | |||||||||||
Acquisition and integration costs | |||||||||||||||
Closed property charges and costs | |||||||||||||||
Total | $ | $ | $ | $ | |||||||||||
15
Restructuring Programs
The following is a summary of the current period activity within restructuring reserves by program included in the Condensed Consolidated Balance Sheets, primarily within Accrued compensation and benefits for severance and other employee separation costs and related tax payments.
(in thousands) | 2019 SUPERVALU INC. | 2018 Earth Origins Market | 2017 Cost Saving and Efficiency Initiatives | Total | |||||||||||
Balances at August 3, 2019 | $ | $ | $ | $ | |||||||||||
Restructuring program charge | |||||||||||||||
Cash payments | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Balances at May 2, 2020 | $ | $ | $ | $ | |||||||||||
Cumulative program charges incurred from inception to date | $ | $ | $ | $ | |||||||||||
2019 SUPERVALU INC.
NOTE 6—GOODWILL AND INTANGIBLE ASSETS
The Company accounts for acquired businesses using the purchase method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the acquisition date at their respective estimated fair values. Goodwill represents the excess acquisition cost over the fair value of net assets acquired in a business combination. Goodwill is assigned to the reporting units that are expected to benefit from the synergies of the business combination that generated the goodwill. The Company has five goodwill reporting units, two of which represent separate operating segments and are aggregated within the Wholesale reportable segment (U.S. Wholesale and Canada Wholesale), two of which are separate operating segments (Woodstock Farms and Blue Marble Brands) that do not meet the criteria for being disclosed as separate reportable segments, and a single retail reporting unit, which is included within discontinued operations. The Canada Wholesale operating segment, which is aggregated with Wholesale, would not meet the quantitative thresholds for separate reporting if it did not meet the aggregation criteria. The composition of goodwill reporting units is evaluated for events or changes in circumstances indicating a goodwill reporting unit has changed. Relative fair value allocations are performed when components of an aggregated goodwill reporting unit become separate reporting units or move from one reporting unit to another.
The Company reviews goodwill for impairment at least annually and more frequently if events or changes in circumstances indicate it is more likely than not that the fair value of a reporting unit is below its carrying amount. The annual review for goodwill impairment is performed as of the first day of the fourth quarter of each fiscal year. The Company tests for goodwill impairment at the reporting unit level, which is at or one level below the operating segment level.
Supervalu Acquisition Goodwill
In conjunction with the acquisition of Supervalu, goodwill resulting from the acquisition was assigned to the previous Supervalu Wholesale reporting unit and the previous legacy Company Wholesale reporting unit, as both of these reporting units were expected to benefit from the synergies of the business combination. The assignment was based on the relative synergistic value estimated as of the acquisition date. This systematic approach utilized the relative cash flow contributions and value created from the acquisition to each reporting unit on a stand-alone basis. As of the acquisition date, approximately $80.9 million was attributed to the legacy Company Wholesale reporting unit.
16
As discussed in Note 7—Goodwill and Intangible Assets in the Consolidated Financial Statements of the Annual Report, the Company impaired all goodwill attributed to the Supervalu Wholesale reporting unit prior to the finalization of its purchase accounting within the opening balance sheet. In the first quarter of fiscal 2020, as discussed further in Note 4—Acquisitions the Company finalized purchase accounting and the opening balance sheet related to the Supervalu acquisition. Adjustments to the opening balance sheet goodwill in the first quarter of fiscal 2020, resulted in an additional goodwill impairment charge of $2.5 million.
Fiscal 2020 Goodwill Impairment Review
During the first quarter of fiscal 2020, the Company changed its management structure and internal financial reporting to combine the Supervalu Wholesale reporting unit and the legacy Company Wholesale reporting unit into one U.S. Wholesale reporting unit, and experienced a further sustained decline in market capitalization and enterprise value. As a result of the change in reporting units and the sustained decline in market capitalization and enterprise value, the Company performed an interim quantitative impairment review of goodwill for the Wholesale reporting unit, which included a determination of the fair value of all reporting units.
The Company estimated the fair values of all reporting units using both the market approach, applying a multiple of earnings based on observable multiples for guideline publicly traded companies, and the income approach, discounting projected future cash flows based on management’s expectations of the current and future operating environment for each reporting unit. The calculation of the impairment charge includes substantial fact-based determinations and estimates including weighted average cost of capital, future revenue, profitability, cash flows and fair values of assets and liabilities. The rates used to discount projected future cash flows under the income approach reflect a weighted average cost of capital of 8.5 %, which considered observable data about guideline publicly traded companies, an estimated market participant’s expectations about capital structure and risk premiums, including those reflected in the Company’s market capitalization. The Company corroborated the reasonableness of the estimated reporting unit fair values by reconciling to its enterprise value and market capitalization. Based on this analysis, the Company determined that the carrying value of its U.S. Wholesale reporting unit exceeded its fair value by an amount that exceeded its assigned goodwill. As a result, the Company recorded a goodwill impairment charge of $421.5 million in the first quarter of fiscal 2020. The goodwill impairment charge is reflected in Goodwill and asset impairment charges in the Condensed Consolidated Statements of Operations. The goodwill impairment charge reflects the impairment of all of the U.S. Wholesale reporting unit’s goodwill.
Goodwill and Intangible Assets Changes
Changes in the carrying value of Goodwill by reportable segment that have goodwill consisted of the following:
(in thousands) | Wholesale | Other | Total | ||||||||
Goodwill as of August 3, 2019 | $ | (1) | $ | (2) | $ | ||||||
Goodwill adjustment for prior fiscal year business combinations | |||||||||||
Impairment charges | ( | ) | ( | ) | ( | ) | |||||
Change in foreign exchange rates | ( | ) | ( | ) | |||||||
Goodwill as of May 2, 2020 | $ | (1) | $ | (2) | $ | ||||||
(1) | Amounts are net of accumulated goodwill impairment charges of $ |
(2) | Amounts are net of accumulated goodwill impairment charges of $ |
17
Identifiable intangible assets consisted of the following:
May 2, 2020 | August 3, 2019 | ||||||||||||||||||||||
(in thousands) | Gross Carrying Amount | Accumulated Amortization | Net | Gross Carrying Amount | Accumulated Amortization | Net | |||||||||||||||||
Amortizing intangible assets: | |||||||||||||||||||||||
Customer relationships | $ | $ | $ | $ | $ | $ | |||||||||||||||||
Non-compete agreements | |||||||||||||||||||||||
Operating lease intangibles | |||||||||||||||||||||||
Trademarks and tradenames | |||||||||||||||||||||||
Total amortizing intangible assets | |||||||||||||||||||||||
Indefinite lived intangible assets: | |||||||||||||||||||||||
Trademarks and tradenames | |||||||||||||||||||||||
Intangible assets, net | $ | $ | $ | $ | $ | $ | |||||||||||||||||
Amortization expense was $21.9 million and $19.5 million for the third quarters of fiscal 2020 and 2019, respectively, and $65.5 million and $44.1 million for fiscal 2020 and 2019 year-to-date, respectively. The estimated future amortization expense for each of the next five fiscal years and thereafter on definite lived intangible assets existing as of May 2, 2020 is shown below:
Fiscal Year: | (In thousands) | ||
Remaining fiscal 2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
2025 and thereafter | |||
$ | |||
NOTE 7—FAIR VALUE MEASUREMENTS OF FINANCIAL INSTRUMENTS
Recurring Fair Value Measurements
The following table provides the fair value hierarchy for financial assets and liabilities measured on a recurring basis:
Fair Value at May 2, 2020 | ||||||||||||||
(In thousands) | Balance Sheet Location | Level 1 | Level 2 | Level 3 | ||||||||||
Assets: | ||||||||||||||
Foreign exchange derivatives not designated as hedging instruments | Prepaid expenses and other current assets | $ | $ | $ | ||||||||||
Mutual funds | Other assets | $ | $ | $ | ||||||||||
Liabilities: | ||||||||||||||
Fuel derivatives not designated as hedging instruments | Accrued expenses and other current liabilities | $ | $ | $ | ||||||||||
Interest rate swaps designated as hedging instruments | Accrued expenses and other current liabilities | $ | $ | $ | ||||||||||
Interest rate swaps designated as hedging instruments | Other long-term liabilities | $ | $ | $ | ||||||||||
18
Fair Value at August 3, 2019 | ||||||||||||||
(in thousands) | Balance Sheet Location | Level 1 | Level 2 | Level 3 | ||||||||||
Assets: | ||||||||||||||
Interest rate swaps designated as hedging instruments | Prepaid expenses and other current assets | $ | $ | $ | ||||||||||
Mutual funds | Prepaid expenses and other current assets | $ | $ | $ | ||||||||||
Interest rate swaps designated as hedging instruments | Other assets | $ | $ | $ | ||||||||||
Mutual funds | Other assets | $ | $ | $ | ||||||||||
Liabilities: | ||||||||||||||
Interest rate swaps designated as hedging instruments | Prepaid expenses and other current assets | $ | $ | $ | ||||||||||
Interest rate swaps designated as hedging instruments | Other long-term liabilities | $ | $ | $ | ||||||||||
Interest Rate Swap Contracts
The fair values of interest rate swap contracts are measured using Level 2 inputs. The interest rate swap contracts are valued using an income approach interest rate swap valuation model incorporating observable market inputs including interest rates, LIBOR swap rates and credit default swap rates. As of May 2, 2020, a 100 basis point increase in forward LIBOR interest rates would increase the fair value of the interest rate swaps by approximately $65.5 million; a 100 basis point decrease in forward LIBOR interest rates would decrease the fair value of the interest rate swaps by approximately $63.5 million. Refer to Note 8—Derivatives for further information on interest rate swap contracts.
Mutual Funds
Mutual fund assets consist of balances held in investments to fund certain deferred compensation plans. The fair values of mutual fund assets are based on quoted market prices of the mutual funds held by the plan at each reporting period. Mutual funds traded in active markets are classified within Level 1 of the fair value hierarchy.
Fuel Supply Agreements and Derivatives
To reduce diesel price risk, the Company has entered into derivative financial instruments and/or forward purchase commitments for a portion of its projected monthly diesel fuel requirements at fixed prices. The fair values of fuel derivative agreements are measured using Level 2 inputs. As of August 3, 2019, the Company had no outstanding fuel supply agreements and derivative agreements.
Foreign Exchange Derivatives
To reduce foreign exchange risk, the Company has entered into derivative financial instruments for a portion of its projected monthly foreign currency requirements at fixed prices. The fair values of foreign exchange derivatives are measured using Level 2 inputs. As of August 3, 2019, the Company’s outstanding foreign currency forward contracts were immaterial.
Fair Value Estimates
For certain of the Company’s financial instruments including cash and cash equivalents, receivables, accounts payable, accrued vacation, compensation and benefits, and other current assets and liabilities the fair values approximate carrying amounts due to their short maturities. The fair value of notes receivable is estimated by using a discounted cash flow approach calculated by applying a market rate for similar instruments using Level 3 inputs. The fair value of debt is estimated based on market quotes, where available, or market values for similar instruments, using Level 2 and 3 inputs. In the table below, the carrying value of the Company’s long-term debt is net of original issue discounts and debt issuance costs.
19
May 2, 2020 | August 3, 2019 | |||||||||||||||
(In thousands) | Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||
Notes receivable, including current portion | $ | $ | $ | $ | ||||||||||||
Long-term debt, including current portion | $ | $ | $ | $ | ||||||||||||
NOTE 8—DERIVATIVES
Management of Interest Rate Risk
The Company enters into interest rate swap contracts from time to time to mitigate its exposure to changes in market interest rates as part of its overall strategy to manage its debt portfolio to achieve an overall desired position of notional debt amounts subject to fixed and floating interest rates. Interest rate swap contracts are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. The Company’s interest rate swap contracts are designated as cash flow hedges at May 2, 2020. Interest rate swap contracts are reflected at their fair values in the Condensed Consolidated Balance Sheets. Refer to Note 7—Fair Value Measurements of Financial Instruments for further information on the fair value of interest rate swap contracts.
20
Details of outstanding swap contracts as of May 2, 2020, which are all pay fixed and receive floating, are as follows:
Effective Date | Swap Maturity | Outstanding Notional Value (in millions) | Pay Fixed Rate | Receive Floating Rate(7) | Floating Rate Reset Terms | ||||||||
March 21, 2019 | May 15, 2020 | $ | % | One-Month LIBOR | Monthly | ||||||||
October 26, 2018 | October 31, 2020 | % | One-Month LIBOR | Monthly | |||||||||
June 9, 2016 | April 29, 2021 | % | One-Month LIBOR | Monthly | |||||||||
June 24, 2016 | April 29, 2021 | % | One-Month LIBOR | Monthly | |||||||||
January 23, 2019 | April 29, 2021 | % | One-Month LIBOR | Monthly | |||||||||
April 2, 2019 | June 30, 2021 | % | One-Month LIBOR | Monthly | |||||||||
June 10, 2019 | June 30, 2021 | % | One-Month LIBOR | Monthly | |||||||||
November 30, 2018 | October 29, 2021 | % | One-Month LIBOR | Monthly | |||||||||
March 21, 2019 | April 15, 2022 | % | One-Month LIBOR | Monthly | |||||||||
April 2, 2019 | June 30, 2022 | % | One-Month LIBOR | Monthly | |||||||||
June 28, 2019 | June 30, 2022 | % | One-Month LIBOR | Monthly | |||||||||
August 3, 2015(1) | August 15, 2022 | % | One-Month LIBOR | Monthly | |||||||||
August 3, 2015(2) | August 15, 2022 | % | One-Month LIBOR | Monthly | |||||||||
October 26, 2018 | October 31, 2022 | % | One-Month LIBOR | Monthly | |||||||||
January 11, 2019 | October 31, 2022 | % | One-Month LIBOR | Monthly | |||||||||
January 23, 2019 | October 31, 2022 | % | One-Month LIBOR | Monthly | |||||||||
October 30, 2020(3) | October 31, 2022 | % | One-Month LIBOR | Monthly | |||||||||
November 16, 2018 | March 31, 2023 | % | One-Month LIBOR | Monthly | |||||||||
January 23, 2019 | March 31, 2023 | % | One-Month LIBOR | Monthly | |||||||||
April 29, 2021(4) | April 28, 2023 | % | One-Month LIBOR | Monthly | |||||||||
June 30, 2021(5) | June 30, 3023 | % | One-Month LIBOR | Monthly | |||||||||
November 30, 2018 | September 30, 2023 | % | One-Month LIBOR | Monthly | |||||||||
October 29, 2021(6) | October 20, 2023 | % | One-Month LIBOR | Monthly | |||||||||
October 26, 2018 | October 31, 2023 | % | One-Month LIBOR | Monthly | |||||||||
January 11, 2019 | March 28, 2024 | % | One-Month LIBOR | Monthly | |||||||||
January 23, 2019 | March 28, 2024 | % | One-Month LIBOR | Monthly | |||||||||
November 30, 2018 | October 31, 2024 | % | One-Month LIBOR | Monthly | |||||||||
January 11, 2019 | October 31, 2024 | % | One-Month LIBOR | Monthly | |||||||||
January 24, 2019 | October 31, 2024 | % | One-Month LIBOR | Monthly | |||||||||
October 26, 2018 | October 22, 2025 | % | One-Month LIBOR | Monthly | |||||||||
November 16, 2018 | October 22, 2025 | % | One-Month LIBOR | Monthly | |||||||||
November 16, 2018 | October 22, 2025 | % | One-Month LIBOR | Monthly | |||||||||
January 24, 2019 | October 22, 2025 | % | One-Month LIBOR | Monthly | |||||||||
$ | |||||||||||||
(1) | On March 31, 2015, the Company amended the original contract to reduce the beginning notional principal amount from $ |
(2) | The swap contract has an amortizing notional principal amount which is reduced by $ |
(3) | This forward starting swap contract has a notional principal amount of $ |
(4) | This forward starting swap contract has a notional principal amount of $ |
(5) | This forward starting swap contract has a notional principal amount of $ |
(6) | This forward starting swap contract has a notional principal amount of $ |
(7) | For these swap contracts that are indexed to LIBOR, the Company is monitoring and evaluating risks related to the expected future cessation of LIBOR. |
21
The Company performs an initial quantitative assessment of hedge effectiveness using the “Hypothetical Derivative Method” in the period in which the hedging transaction is entered. Under this method, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. In future reporting periods, the Company performs a qualitative analysis for quarterly prospective and retrospective assessments of hedge effectiveness. The Company also monitors the risk of counterparty default on an ongoing basis and noted that the counterparties are reputable financial institutions. The entire change in the fair value of the derivative is initially reported in Other comprehensive income (outside of earnings) in the Condensed Consolidated Statements of Comprehensive Loss and subsequently reclassified to earnings in Interest expense, net in the Condensed Consolidated Statements of Operations when the hedged transactions affect earnings.
The location and amount of gains or losses recognized in the Condensed Consolidated Statements of Operations for interest rate swap contracts for each of the periods, presented on a pretax basis, are as follows:
13-Week Period Ended | 39-Week Period Ended | |||||||||||||||
May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||||
(In thousands) | Interest Expense, net | Interest Expense, net | ||||||||||||||
Total amounts of expense line items presented in the Condensed Consolidated Statements of Operations in which the effects of cash flow hedges are recorded | $ | $ | $ | $ | ||||||||||||
(Loss) or gain on cash flow hedging relationships: | ||||||||||||||||
(Loss) or gain reclassified from comprehensive income into income | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
Gain or (loss) on interest rate swap contracts not designated as hedging instruments: | ||||||||||||||||
Gain or (loss) recognized as interest expense | $ | $ | $ | $ | ( | ) | ||||||||||
NOTE 9—LONG-TERM DEBT
The Company’s long-term debt consisted of the following:
(in thousands) | Average Interest Rate at May 2, 2020 | Calendar Maturity Year | May 2, 2020 | August 3, 2019 | |||||||
Term Loan Facility | 2025 | $ | $ | ||||||||
ABL Credit Facility | 2023 | ||||||||||
Other secured loans | 2023-2024 | ||||||||||
Debt issuance costs, net | ( | ) | ( | ) | |||||||
Original issue discount on debt | ( | ) | ( | ) | |||||||
Long-term debt, including current portion | |||||||||||
Less: current portion of long-term debt | ( | ) | ( | ) | |||||||
Long-term debt | $ | $ | |||||||||
ABL Credit Facility
On August 30, 2018, the Company entered into a loan agreement (as amended by that certain First Amendment to Loan Agreement, dated as of October 19, 2018, and as further amended by that certain Second Amendment to Loan Agreement, dated January 24, 2019, the “ABL Loan Agreement”), by and among the Company and United Natural Foods West, Inc. (together with the Company, the “U.S. Borrowers”) and UNFI Canada, Inc. (the “Canadian Borrower” and, together with the U.S. Borrowers, the “Borrowers”), the financial institutions that are parties thereto as lenders (collectively, the “ABL Lenders”), Bank of America, N.A. as administrative agent for the ABL Lenders (the “ABL Administrative Agent”), Bank of America, N.A. (acting through its Canada branch), as Canadian agent for the ABL Lenders, and the other parties thereto.
22
The ABL Loan Agreement provides for a secured asset-based revolving credit facility (the “ABL Credit Facility” and the loans thereunder, the “ABL Loans”), of which up to (i) $2,050.0 million is available to the U.S. Borrowers and (ii) $50.0 million is available to the Canadian Borrower. The ABL Loan Agreement also provides for (i) a $125.0 million sublimit of availability for letters of credit of which there is a further $5.0 million sublimit for the Canadian Borrower, and (ii) a $100.0 million sublimit for short-term borrowings on a swingline basis of which there is a further $3.5 million sublimit for the Canadian Borrower. The ABL Credit Facility replaced the Company’s $900.0 million prior asset-based revolving credit facility. In addition, $1,475.0 million of proceeds from the ABL Credit Facility were drawn to finance the Supervalu acquisition and related transaction costs on the Supervalu acquisition date (the “Closing Date”).
Under the ABL Loan Agreement, the Borrowers may, at their option, increase the aggregate amount of the ABL Credit Facility in an amount of up to $600.0 million without the consent of any ABL Lenders not participating in such increase, subject to certain customary conditions and applicable lenders committing to provide the increase in funding. There is no assurance that additional funding would be available.
The Borrowers’ obligations under the ABL Credit Facility are guaranteed by most of the Company’s wholly-owned subsidiaries who are not also Borrowers (collectively, the “ABL Guarantors”), subject to customary exceptions and limitations. The Borrowers’ obligations under the ABL Credit Facility and the ABL Guarantors’ obligations under the related guarantees are secured by (i) a first-priority lien on all of the Borrowers’ and ABL Guarantors’ accounts receivable, inventory and certain other assets arising therefrom or related thereto (including substantially all of their deposit accounts, collectively, the “ABL Assets”) and (ii) a second-priority lien on all of the Borrowers’ and ABL Guarantors’ assets that do not constitute ABL Assets, in each case, subject to customary exceptions and limitations.
Availability under the ABL Credit Facility is subject to a borrowing base (the “Borrowing Base”), which is based on 90 % of eligible accounts receivable, plus 90 % of eligible credit card receivables, plus 90 % of the net orderly liquidation value of eligible inventory, plus 90 % of eligible pharmacy receivables, plus certain pharmacy scripts availability of the Borrowers, after adjusting for customary reserves. The aggregate amount of the ABL Loans made and letters of credit issued under the ABL Credit Facility shall at no time exceed the lesser of the aggregate commitments under the ABL Credit Facility (currently $2,100.0 million or, if increased at the Borrowers’ option as described above, up to $2,700.0 million) or the Borrowing Base. To the extent that the Borrowers’ Borrowing Base declines, the availability under the ABL Credit Facility may decrease below $2,100.0 million.
As of May 2, 2020, the U.S. Borrowers’ Borrowing Base, net of $239.0 million of reserves, was $2,027.2 million, which is below the $2,050.0 million limit of availability to the U.S. Borrowers under the ABL Credit Facility. As of May 2, 2020, the Canadian Borrower’s Borrowing Base, net of $4.0 million of reserves, was $37.8 million, which is below the $50.0 million limit of availability to the Canadian Borrower under the ABL Credit facility, resulting in total availability of $2,065.0 million for ABL Loans and letters of credit under the ABL Credit Facility. As of May 2, 2020, the U.S. Borrowers had $816.0 million of ABL Loans outstanding, which are presented net of debt issuance costs of $10.6 million and are included in Long-term debt in the Condensed Consolidated Balance Sheets, and the Canadian Borrower had no ABL Loans outstanding under the ABL Credit Facility. As of May 2, 2020, the U.S. Borrowers had $95.1 million in letters of credit and the Canadian Borrower had no letters of credit outstanding under the ABL Credit Facility. The Company’s resulting remaining availability under the ABL Credit Facility was $1,153.9 million as of May 2, 2020.
The ABL Loans of the U.S. Borrowers under the ABL Credit Facility bear interest at rates that, at the U.S. Borrowers’ option, can be either: (i) a base rate and an applicable margin, or (ii) a LIBOR rate and an applicable margin. As of May 2, 2020, the applicable margin for base rate loans was 0.25 %, and the applicable margin for LIBOR loans was 1.25 %. The ABL Loan Agreement contains provisions for the establishment of an alternative rate of interest in the event that LIBOR is no longer available. The ABL Loans of the Canadian Borrower under the ABL Credit Facility bear interest at rates that, at the Canadian Borrower’s option, can be either: (i) prime rate and an applicable margin, or (ii) a Canadian dollar bankers’ acceptance equivalent rate and an applicable margin. As of May 2, 2020, the applicable margin for prime rate loans was 0.25 %, and the applicable margin for Canadian dollar bankers’ acceptance equivalent rate loans was 1.25 %. Commencing on the first day of the calendar month following the ABL Administrative Agent’s receipt of the Company’s aggregate availability calculation for the prior fiscal quarter, the applicable margins for borrowings by the U.S. Borrowers and Canadian Borrower will be subject to adjustment based upon the aggregate availability under the ABL Credit Facility. Unutilized commitments under the ABL Credit Facility are subject to a per annum fee of (i) 0.375 % if the average daily total outstandings were less than 25% of the aggregate commitments during the preceding fiscal quarter or (ii) 0.25% if such average daily total outstandings were 25% or more of the aggregate commitments during the preceding fiscal quarter. As of May 2, 2020, the unutilized commitment fee was 0.25 % per annum. The Borrowers are also required to pay a letter of credit fronting fee to each letter of credit issuer equal to 0.125 % per annum of the amount available to be drawn under each such letter of credit, as well as a fee to all lenders equal to the applicable margin for LIBOR or Canadian dollar bankers’ acceptance equivalent rate loans, as applicable, times the average daily amount available to be drawn under all outstanding letters of credit.
23
The ABL Loan Agreement subjects the Company to a fixed charge coverage ratio (as defined in the ABL Loan Agreement) of at least 1.0 to 1.0 calculated at the end of each fiscal quarter on a rolling four quarter basis when the adjusted aggregate availability (as defined in the ABL Loan Agreement) is less than the greater of (i) $235.0 million and (ii) 10 % of the aggregate borrowing base. The Company has not been subject to the fixed charge coverage ratio covenant under the ABL Loan Agreement, including through the filing date of this Quarterly Report.
The assets included in the Condensed Consolidated Balance Sheets securing the outstanding obligations under the ABL Credit Facility on a first-priority basis, and the unused credit and fees under the ABL Credit Facility, were as follows:
Assets securing the ABL Credit Facility (in thousands)(1): | May 2, 2020 | ||
Certain inventory assets included in Inventories and Current assets of discontinued operations | $ | ||
Certain receivables included in Accounts receivables, net and Current assets of discontinued operations | $ | ||
(1) | The ABL Credit Facility is also secured by all of the Company’s pharmacy scripts, which are included in Long-term assets of discontinued operations in the Condensed Consolidated Balance Sheets as of May 2, 2020. |
Unused credit and fees under the ABL Credit Facility (in thousands, except percentages): | May 2, 2020 | ||
Outstanding letters of credit | $ | ||
Letter of credit fees | % | ||
Unused credit | $ | ||
Unused facility fees | % | ||
The ABL Loan Agreement contains other customary affirmative and negative covenants and customary representations and warranties that must be accurate in order for the Borrowers to borrow under the ABL Credit Facility. The ABL Loan Agreement also contains customary events of default, including, but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, failure of any guaranty or security document supporting the ABL Credit Facility to be in full force and effect, and a change of control. If an event of default occurs and is continuing, the Borrowers may be required immediately to repay all amounts outstanding under the ABL Loan Agreement.
Term Loan Facility
On the Closing Date, the Company entered into a new term loan agreement (the “Term Loan Agreement”), by and among the Company and Supervalu (collectively, the “Term Borrowers”), the financial institutions that are parties thereto as lenders (collectively, the “Term Lenders”), Goldman Sachs Bank USA, as administrative agent for the Lenders, and the other parties thereto. The Term Loan Agreement provides for senior secured first lien term loans in an aggregate principal amount of $1,950.0 million, consisting of a $1,800.0 million seven year tranche (the “Term B Tranche”) and a $150.0 million 364 -day tranche (the “364-day Tranche” and, together with the Term B Tranche, collectively, the “Term Loan Facility”). The entire amount of the net proceeds from the Term Loan Facility was used to finance the Supervalu acquisition and related transaction costs.
The loans under the Term B Tranche will be payable in full on October 22, 2025; provided that if on or prior to December 31, 2024 that certain Agreement for Distribution of Products, dated as of October 30, 2015, by and between Whole Foods Market Distribution, Inc., a Delaware corporation, and the Company has not been extended until at least October 23, 2025 on terms not materially less favorable, taken as a whole, to the Company and its subsidiaries than those in effect on the Closing Date, then the loans under the Term B Tranche will be payable in full on December 31, 2024.
In fiscal year-to-date 2020, the Company made mandatory prepayments and voluntary prepayments of $15.3 million and $5.8 million, respectively, on the 364-day Tranche with asset sale proceeds. In connection with the prepayments, the Company incurred a loss on debt extinguishment related to unamortized debt issuance costs of $0.1 million, which was recorded within Interest expense, net in the Condensed Consolidated Statements of Operations for the first quarter of fiscal 2020.
The loans under the 364-day Tranche were then paid in full on October 21, 2019. The Company funded the scheduled maturity of the $52.8 million outstanding borrowings under the 364-day Tranche with incremental borrowings under the ABL Credit Facility on October 21, 2019.
24
Under the Term Loan Agreement, the Term Borrowers may, at their option, increase the amount of the Term B Tranche, add one or more additional tranches of term loans or add one or more additional tranches of revolving credit commitments, without the consent of any Term Lenders not participating in such additional borrowings, up to an aggregate amount of $656.3 million plus additional amounts based on satisfaction of certain leverage ratio tests, subject to certain customary conditions and applicable lenders committing to provide the additional funding. There can be no assurance that additional funding would be available.
The Term Borrowers’ obligations under the Term Loan Facility are guaranteed by most of the Company’s wholly-owned domestic subsidiaries who are not also Term Borrowers (collectively, the “Term Guarantors”), subject to customary exceptions and limitations, including an exception for immaterial subsidiaries designated by the Company from time to time. The Term Borrowers’ obligations under the Term Loan Facility and the Term Guarantors’ obligations under the related guarantees are secured by (i) a first-priority lien on substantially all of the Term Borrowers’ and the Term Guarantors’ assets other than the ABL Assets and (ii) a second-priority lien on substantially all of the Term Borrowers’ and the Term Guarantors’ ABL Assets, in each case, subject to customary exceptions and limitations, including an exception for owned real property with net book values of less than $10.0 million. As of May 2, 2020, there was $649.9 million of owned real property pledged as collateral that was included in Property and equipment, net in the Condensed Consolidated Balance Sheets.
The loans under the Term Loan Facility may be voluntarily prepaid, subject to certain minimum payment thresholds and the payment of breakage or other similar costs. Under the Term Loan Facility, the Company is required, subject to certain exceptions and customary reinvestment rights, to apply 100 percent of Net Cash Proceeds (as defined in the Term Loan Agreement) from certain types of asset sales to prepay the loans outstanding under the Term Loan Facility. Commencing with the fiscal year ending August 1, 2020, the Company must also prepay loans outstanding under the Term Loan Facility no later than 130 days after the fiscal year end in an aggregate principal amount equal to a specified percentage (which percentage ranges from 0 to 75 percent depending on the Consolidated First Lien Net Leverage Ratio (as defined in the Term Loan Agreement) as of the last day of such fiscal year) of Excess Cash Flow (as defined in the Term Loan Agreement) in excess of $10 million for the fiscal year then ended, minus any voluntary prepayments of the loans under the Term Loan Facility, the ABL Credit Facility (to the extent they permanently reduce commitments under the ABL Facility) and certain other indebtedness made during such fiscal year. The potential amount of prepayment from Excess Cash Flow in fiscal 2020 that may be required in fiscal 2021 is not reasonably estimable as of May 2, 2020.
The borrowings under the Term B Tranche of the Term Loan Facility bear interest at rates that, at the Term Borrowers’ option, can be either: (i) a base rate and a margin of 3.25 % or (ii) a LIBOR rate and a margin of 4.25 %; provided that the LIBOR rate shall never be less than 0.0 %. The Term Loan Agreement contains provisions for the establishment of an alternative rate of interest in the event that LIBOR is no longer available.
The Term Loan Agreement does not include any financial maintenance covenants but contains other customary affirmative and negative covenants and customary representations and warranties. The Term Loan Agreement also contains customary events of default, including, but not limited to, payment defaults, breaches of representations and warranties, covenant defaults, events of bankruptcy and insolvency, failure of any guaranty or security document supporting the Term Loan Facility to be in full force and effect, and a change of control. If an event of default occurs and is continuing, the Term Borrowers may be required immediately to repay all amounts outstanding under the Term Loan Agreement.
As of May 2, 2020, the Company had borrowings of $1,777.5 million and no amounts outstanding under the Term B Tranche and 364-day Tranche, respectively, which are presented net of debt issuance costs of $37.4 million and an original issue discount on debt of $36.6 million. As of May 2, 2020, $18.0 million of the Term B Tranche was classified as current, excluding debt issuance costs and original issue discount on debt.
25
NOTE 10—COMPREHENSIVE (LOSS) INCOME AND ACCUMULATED OTHER COMPREHENSIVE LOSS
Changes in Accumulated other comprehensive loss by component net of tax for fiscal 2020 year-to-date are as follows:
(in thousands) | Benefit Plans | Foreign Currency | Swap Agreements | Total | |||||||||||
Accumulated other comprehensive loss at August 3, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
Other comprehensive gain (loss) before reclassifications | ( | ) | ( | ) | ( | ) | |||||||||
Amortization of amounts included in net periodic benefit income | ( | ) | ( | ) | |||||||||||
Amortization of cash flow hedge | |||||||||||||||
Pension settlement charge | |||||||||||||||
Net current period Other comprehensive income (loss) | ( | ) | ( | ) | ( | ) | |||||||||
Accumulated other comprehensive loss at May 2, 2020 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
Changes in Accumulated other comprehensive loss by component net of tax for fiscal 2019 year-to-date are as follows:
(in thousands) | Foreign Currency | Swap Agreements | Total | ||||||||
Accumulated other comprehensive (loss) income at July 28, 2018 | $ | ( | ) | $ | $ | ( | ) | ||||
Other comprehensive loss before reclassifications | ( | ) | ( | ) | ( | ) | |||||
Amortization of cash flow hedge | ( | ) | ( | ) | |||||||
Net current period Other comprehensive loss | ( | ) | ( | ) | ( | ) | |||||
Accumulated other comprehensive loss at April 27, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||
Items reclassified out of Accumulated other comprehensive loss had the following impact on the Condensed Consolidated Statements of Operations:
13-Week Period Ended | 39-Week Period Ended | Affected Line Item on the Condensed Consolidated Statements of Operations | |||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||||
Pension and postretirement benefit plan obligations: | |||||||||||||||||
Amortization of amounts included in net periodic benefit income(1) | $ | ( | ) | $ | $ | ( | ) | $ | Net periodic benefit income, excluding service cost | ||||||||
Pension settlement charge | Net periodic benefit income, excluding service cost | ||||||||||||||||
Total reclassifications | ( | ) | |||||||||||||||
Income tax (expense) benefit | ( | ) | Benefit for income taxes | ||||||||||||||
Total reclassifications, net of tax | $ | ( | ) | $ | $ | $ | |||||||||||
Swap agreements: | |||||||||||||||||
Amortization of cash flow hedge expense (income) | $ | $ | ( | ) | $ | $ | ( | ) | Interest expense, net | ||||||||
Income tax benefit (expense) | ( | ) | Benefit for income taxes | ||||||||||||||
Total reclassifications, net of tax | $ | $ | ( | ) | $ | $ | ( | ) | |||||||||
(1) |
As of May 2, 2020, the Company expects to reclassify $45.8 million of pre-tax accumulated other comprehensive loss into Interest expense, net during the succeeding twelve-month period.
26
The Company leases certain of its distribution centers, retail stores, office facilities, transportation equipment, and other operating equipment from third parties. Many of these leases include renewal options. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Lease assets and liabilities are as follows (in thousands):
Lease Type | Balance Sheet Location | May 2, 2020 | ||||
Operating lease assets | Operating lease assets | $ | ||||
Finance lease assets | Property and equipment, net | |||||
Total lease assets | $ | |||||
Operating liabilities | Current portion of operating lease liabilities | $ | ||||
Finance liabilities | Current portion of long-term debt and finance lease liabilities | |||||
Operating liabilities | Long-term operating lease liabilities | |||||
Finance liabilities | Long-term finance lease liabilities | |||||
Total lease liabilities | $ | |||||
Lease assets and liabilities presented in the table above include lease contracts related to our discontinued operations, as the Company expects to remain primarily obligated under these leases.
The Company’s lease cost under ASC 842 is as follows:
(in thousands) | Statement of Operations Location | 13-Week Period Ended | 39-Week Period Ended | |||||||
May 2, 2020 | May 2, 2020 | |||||||||
Operating lease cost | Operating expenses(2) | $ | $ | |||||||
Short-term lease cost | Operating expenses | |||||||||
Variable lease cost | Operating expenses(2) | |||||||||
Sublease income | Operating expenses(2) | ( | ) | ( | ) | |||||
Sublease income | Net sales | ( | ) | ( | ) | |||||
Net operating lease cost(1) | ||||||||||
Amortization of leased assets | Operating expenses | |||||||||
Interest on lease liabilities | Interest expense, net | |||||||||
Finance lease cost | ||||||||||
Total net lease cost | $ | $ | ||||||||
(1) | Rent expense as presented here includes $ |
(2) | Includes certain lease expense or income that is recorded within Restructuring, acquisition and integration related expenses for surplus, non-operating properties for which the Company is restructuring its obligations and which are not separately material. |
27
The Company leases certain property to third parties and receives lease and subtenant rental payments under operating leases, including assigned leases for which the Company has future minimum lease payment obligations. Future minimum lease payments (“Lease Liabilities”) to be made by the Company or certain third parties in the case of assigned leases for noncancellable operating leases and finance leases have not been reduced for future minimum lease and subtenant rentals (“Lease Receipts”) under certain operating subleases, including lease assignments for stores sold to third parties, which they operate. As of May 2, 2020, these Lease Liabilities and Lease Receipts consisted of the following (in thousands):
Maturity of Lease Liabilities and Lease Receipts | Lease Liabilities | Lease Receipts | Net Lease Obligations | ||||||||||||||||||||
Fiscal Year | Operating Leases(1) | Finance Leases(2) | Operating Leases | Finance Leases | Operating Leases | Finance Leases | |||||||||||||||||
Remaining fiscal 2020 | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||
2021 | ( | ) | |||||||||||||||||||||
2022 | ( | ) | |||||||||||||||||||||
2023 | ( | ) | |||||||||||||||||||||
2024 | ( | ) | |||||||||||||||||||||
Thereafter | ( | ) | |||||||||||||||||||||
Total undiscounted lease liabilities and receipts | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||
Less interest (3) | ( | ) | ( | ) | |||||||||||||||||||
Present value of lease liabilities | |||||||||||||||||||||||
Less current lease liabilities | ( | ) | ( | ) | |||||||||||||||||||
Long-term lease liabilities | $ | $ | |||||||||||||||||||||
(1) | Operating lease payments include $ |
(2) | Finance lease payments include $ |
(3) | Calculated using the interest rate for each lease. |
As of August 3, 2019, future minimum lease payments to be made by the Company or certain third parties in the case of assigned leases for noncancellable operating leases and finance leases, which have not been reduced for future minimum subtenant rentals under certain operating subleases, including assignments, consisted of the following amounts (in thousands):
Lease Obligations | Lease Receipts | Net Lease Obligations | ||||||||||||||||||||||
Fiscal Year | Operating Leases | Capital Leases | Operating Leases | Capital Leases | Operating Leases | Capital Leases | ||||||||||||||||||
2020 | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | ||||||||||||||
2021 | ( | ) | ||||||||||||||||||||||
2022 | ( | ) | ||||||||||||||||||||||
2023 | ( | ) | ||||||||||||||||||||||
2024 | ( | ) | ||||||||||||||||||||||
Thereafter | ( | ) | ||||||||||||||||||||||
Total future minimum obligations (receipts) | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | ||||||||||||||
Less interest | ( | ) | ||||||||||||||||||||||
Present value of capital lease obligations | ||||||||||||||||||||||||
Less current capital lease obligations | ( | ) | ||||||||||||||||||||||
Long-term capital lease obligations | $ | |||||||||||||||||||||||
28
The following tables provide other information required by ASC 842:
Lease Term and Discount Rate | May 2, 2020 | ||
Weighted-average remaining lease term (years) | |||
Operating leases | |||
Finance leases | |||
Weighted-average discount rate | |||
Operating leases | % | ||
Finance leases | % | ||
Other Information | 39-Week Period Ended | |||
(in thousands) | May 2, 2020 | |||
Cash paid for amounts included in the measurement of lease liabilities | ||||
Operating cash flows from operating leases | $ | |||
Operating cash flows from finance leases | ||||
Financing cash flows from finance leases | ||||
Leased assets obtained in exchange for new finance lease liabilities | ||||
Leased assets obtained in exchange for new operating lease liabilities | ||||
NOTE 12—SHARE-BASED AWARDS
During the second quarter of fiscal 2020, the Company authorized for issuance and registered 7.2 million shares of common stock for issuance under the 2020 Equity Incentive Plan. In addition, the remaining shares that were available for issuance under the Company’s Amended and Restated 2012 Equity Incentive Plan may be issued under the 2020 Equity Incentive Plan. In the second quarter of fiscal 2020, the Company granted restricted stock units and performance share units representing a right to receive an aggregate of 5.8 million shares to its directors, executive officers and certain employees. As of May 2, 2020, there were 2.6 million shares available for issuance under the 2020 Equity Incentive Plan.
During the third quarter of fiscal 2020, the Company issued approximately 1.1 million shares of common stock at an average market price of $11.12 per share for $12.2 million of cash. Proceeds from these issuances were received in the third and fourth quarters of fiscal 2020 and were used to fund settlement of replacement award obligations.
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NOTE 13—BENEFIT PLANS
Net periodic benefit (income) cost and contributions to defined benefit pension and other post-retirement benefit plans consisted of the following:
13-Week Period Ended | |||||||||||||||
Pension Benefits | Other Postretirement Benefits | ||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||
Net Periodic Benefit (Income) Cost | |||||||||||||||
Service cost | $ | $ | $ | $ | |||||||||||
Interest cost | |||||||||||||||
Expected return on plan assets | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Amortization of net actuarial loss (gain) | ( | ) | |||||||||||||
Net periodic benefit (income) cost | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | |||||
Contributions to benefit plans | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
39-Week Period Ended | |||||||||||||||
Pension Benefits | Other Postretirement Benefits | ||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | |||||||||||
Net Periodic Benefit (Income) Cost | |||||||||||||||
Service cost | $ | $ | $ | $ | |||||||||||
Interest cost | |||||||||||||||
Expected return on plan assets | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Amortization of net actuarial loss (gain) | ( | ) | |||||||||||||
Pension settlement charge | |||||||||||||||
Net periodic benefit (income) cost | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | |||||
Contributions to benefit plans | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
Pension Contributions
No minimum pension contributions are required to be made to the SUPERVALU Retirement Plan in fiscal 2020. Minimum pension contributions of $8.25 million are required to be made under the Unified Grocers, Inc. Cash Balance Plan under the Employee Retirement Income Security Act of 1974, as amended, (“ERISA”) in fiscal 2020. The Company expects to contribute approximately $0.0 million and $6.0 million to its other defined benefit pension plans and postretirement benefit plans, respectively, in fiscal 2020.
Multiemployer Pension Plans
The Company contributed $12.3 million and $13.8 million in the third quarters of fiscal 2020 and 2019, respectively, and $38.4 million and $27.4 million in fiscal 2020 and 2019 year-to-date, respectively, to continuing and discontinued operations multiemployer pension plans.
In connection with the Company’s consolidation of distribution centers in the Pacific Northwest, during the second quarter of fiscal 2020, the Company recorded a $10.6 million multiemployer pension plan withdrawal liability, under which payments will be made over a one-year period beginning in fiscal 2022. The withdrawal liability is included in Other long-term liabilities and the withdrawal charge was recorded within Restructuring, acquisition and integration related expenses.
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Lump Sum Pension Settlement
On August 1, 2019, the Company amended the SUPERVALU Retirement Plan to provide for a lump sum settlement window. On August 2, 2019, the Company sent plan participants lump sum settlement election offerings that committed the plan to pay certain deferred vested pension plan participants and retirees, who make such an election, a lump sum payment in exchange for their rights to receive ongoing payments from the plan. The lump sum payment amounts are equal to the present value of the participant’s pension benefits, and were made to certain former (i) retired associates and beneficiaries who are receiving their monthly pension benefit payment and (ii) terminated associates who are deferred vested in the plan, had not yet begun receiving monthly pension benefit payments and who are not eligible for any prior lump sum offerings under the plan. Benefit obligations associated with the lump sum offering have been incorporated into the funded status utilizing the actuarially determined lump sum payments based on estimated offer acceptances. The plan made aggregate lump sum settlement payments of $664.0 million to plan participants during the second quarter of fiscal 2020. The lump sum settlement payments resulted in a non-cash pension settlement charge of $10.3 million in the second quarter of fiscal 2020 from the acceleration of a portion of the accumulated unrecognized actuarial loss, which was based on the fair value of SUPERVALU Retirement Plan assets and remeasured liabilities. As a result of the settlement payments, the SUPERVALU Retirement Plan obligations were remeasured using a discount rate of 3.1 percent and the MP-2019 mortality improvement scale. This remeasurement resulted in a $1.5 million decrease to Accumulated other comprehensive loss.
NOTE 14—INCOME TAXES
The effective income tax rate for continuing operations was a benefit of 38.7 % compared to a benefit of 32.4 % on pre-tax income for the third quarter of fiscal 2020 and 2019, respectively. The change in the effective income tax rate for the third quarter of fiscal 2020 was primarily driven by a tax benefit recorded on net operating loss deferred tax assets in the third quarter of fiscal 2020 in connection with the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), discussed below. The tax provision included $26.9 million and $3.2 million of discrete tax benefit for the third quarter of fiscal 2020 and fiscal 2019, respectively. The discrete tax benefit for the third quarter of fiscal 2020 was primarily due to a tax benefit of approximately $28.4 million driven by a tax benefit recorded on net operating loss deferred tax assets in the third quarter of fiscal 2020 in connection with the CARES Act, discussed below.
The effective income tax rate for continuing operations was a benefit of 21.5 % compared to a benefit of 22.8 % on pre-tax losses for fiscal 2020 year-to-date and fiscal 2019 year-to-date, respectively. The decrease in the effective income tax benefit rate was primarily driven by a tax benefit of approximately $8.3 million recorded in fiscal 2019 for the release of unrecognized tax positions that did not recur in fiscal 2020, as well as a goodwill impairment benefit of approximately $72.2 million recorded in fiscal 2019 compared to a goodwill impairment benefit of approximately $66.4 million recorded in fiscal 2020. In addition, effective income tax rate for fiscal 2020 includes a benefit of approximately $28.4 million related to revaluation of net operating loss deferred tax assets in connection with the CARES Act.
The CARES Act was enacted on March 27, 2020 and contains significant business tax provision changes to the U.S. tax code, including temporary expansion of the limitations to the deductibility of net operating losses and interest expense and the ability to treat qualified improvement property as eligible for bonus depreciation. In addition, the CARES Act changed the required filing of the Company’s federal income tax return from May 2020 to July 2020, and allows remittances of employer FICA payments previously due March 2020 to December 2020 to be deferred until December 2021 and December 2022. Prior to the application of the CARES Act, the Company had a deferred tax asset related to $203 million of federal net operating losses that were available for unlimited carryforward (but no carryback) pursuant to provisions of the 2017 Tax Cuts and Jobs Act, which permitted taxpayers to carryforward net operating losses indefinitely. The CARES Act provides the Company the ability to carry these losses back at a 35 % federal tax rate during the carry back periods, as opposed to the current 21 % federal tax rate. This resulted in a tax benefit of approximately $28.4 million, which the Company recorded in the third quarter of fiscal 2020. This estimated tax benefit will be finalized in the fourth quarter of fiscal 2020 as the 2019 tax return due July 2020 is finalized. The entire tax benefit associated with the net operating loss carry back has been recorded as a current tax receivable in the third quarter of fiscal 2020.
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NOTE 15—EARNINGS PER SHARE
The following is a reconciliation of the basic and diluted number of shares used in computing earnings per share:
13-Week Period Ended | 39-Week Period Ended | |||||||||||||||
(in thousands, except per share data) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | ||||||||||||
Basic weighted average shares outstanding | ||||||||||||||||
Net effect of dilutive stock awards based upon the treasury stock method | ||||||||||||||||
Diluted weighted average shares outstanding | ||||||||||||||||
Basic earnings (loss) per share: | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Discontinued operations | $ | $ | $ | $ | ||||||||||||
Basic earnings (loss) per share | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Diluted earnings (loss) per share: | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Discontinued operations(1) | $ | $ | $ | $ | ||||||||||||
Diluted earnings (loss) per share | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
Anti-dilutive stock-based awards excluded from the calculation of diluted earnings per share | ||||||||||||||||
(1) | The computation of diluted earnings per share from discontinued operations is calculated using diluted weighted average shares outstanding, which includes the net effect of dilutive stock awards and |
NOTE 16—BUSINESS SEGMENTS
The Company has two operating segments aggregated under the Wholesale reportable segment: U.S. Wholesale and Canada Wholesale. In addition, the Company’s Retail operating segment is a separate reportable segment, which consists of discontinued operations disposal groups. The U.S. Wholesale and Canada Wholesale operating segments have similar products and services, customer channels, distribution methods and economic characteristics. The Wholesale reportable segment is engaged in the national distribution of natural, organic, specialty, produce, and conventional grocery and non-food products, and is also a provider of support services in the United States and Canada. The Company has additional operating segments that do not meet the quantitative thresholds for reportable segments and are therefore aggregated under the caption of Other. Other includes a manufacturing division, which engages in the importing, roasting, packaging, and distributing of nuts, dried fruit, seeds, trail mixes, granola, natural and organic snack items and confections, and the Company’s branded product lines. Other also includes certain corporate operating expenses that are not allocated to operating segments, which include, among other expenses, restructuring, acquisition, and integration related expenses, share-based compensation, and salaries, retainers, and other related expenses of certain officers and all directors. The Company allocates certain corporate capital expenditures and identifiable assets to its business segments and retains certain depreciation expense related to those assets within Other. In the first quarter of fiscal 2020, the Company changed its measurement of segment profit, which resulted in additional corporate expenses that were previously included in Other now being attributed to the Wholesale business. Prior period amounts have been recast to reflect this new measurement approach. Non-operating expenses that are not allocated to the operating segments are under the caption of Unallocated (Income)/Expenses.
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(in thousands) | Wholesale | Other | Eliminations | Unallocated (Income)/Expenses | Consolidated | |||||||||||||||
13-Week Period Ended May 2, 2020: | ||||||||||||||||||||
Net sales(1) | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
Restructuring, acquisition and integration related expenses | ||||||||||||||||||||
Operating income (loss) | ( | ) | ( | ) | ||||||||||||||||
Total other expense, net | — | — | — | |||||||||||||||||
Income (loss) from continuing operations before income taxes | ||||||||||||||||||||
Depreciation and amortization | ||||||||||||||||||||
Capital expenditures | ||||||||||||||||||||
Total assets of continuing operations | ( | ) | ||||||||||||||||||
13-Week Period Ended April 27, 2019: | ||||||||||||||||||||
Net sales(2) | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
Goodwill and asset impairment (adjustment) charges | ( | ) | ( | ) | ||||||||||||||||
Restructuring, acquisition and integration related expenses | ||||||||||||||||||||
Operating income (loss) | ( | ) | ( | ) | ||||||||||||||||
Total other expense, net | — | — | — | |||||||||||||||||
Income (loss) from continuing operations before income taxes | ||||||||||||||||||||
Depreciation and amortization | ||||||||||||||||||||
Capital expenditures | ||||||||||||||||||||
Total assets of continuing operations | ( | ) | ||||||||||||||||||
(1) | For the third quarter of fiscal 2020, the Company recorded $ |
(2) | For the third quarter of fiscal 2019, the Company recorded $ |
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(in thousands) | Wholesale | Other | Eliminations | Unallocated (Income)/Expenses | Consolidated | |||||||||||||||
39-Week Period Ended May 2, 2020: | ||||||||||||||||||||
Net sales(1) | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
Goodwill and asset impairment (adjustment) charges | ||||||||||||||||||||
Restructuring, acquisition and integration related expenses | ||||||||||||||||||||
Operating income (loss) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
Total other expense, net | — | — | — | |||||||||||||||||
Income (loss) from continuing operations before income taxes | ( | ) | ||||||||||||||||||
Depreciation and amortization | ||||||||||||||||||||
Capital expenditures | ||||||||||||||||||||
39-Week Period Ended April 27, 2019: | ||||||||||||||||||||
Net sales(2) | $ | $ | $ | ( | ) | $ | ||||||||||||||
Goodwill and asset impairment (adjustment) charges | ||||||||||||||||||||
Restructuring, acquisition and integration related expenses | ||||||||||||||||||||
Operating income (loss) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
Total other expense, net | — | — | — | |||||||||||||||||
Income (loss) from continuing operations before income taxes | ( | ) | ||||||||||||||||||
Depreciation and amortization | ||||||||||||||||||||
Capital expenditures | ||||||||||||||||||||
(1) | For fiscal 2020 year-to-date, the Company recorded $ |
(2) | For fiscal 2019 year-to-date, the Company recorded $ |
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NOTE 17—COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET ARRANGEMENTS
Guarantees and Contingent Liabilities
The Company has outstanding guarantees related to certain leases, fixture financing loans and other debt obligations of various retailers as of May 2, 2020. These guarantees were generally made to support the business growth of wholesale customers. The guarantees are generally for the entire terms of the leases, fixture financing loans or other debt obligations with remaining terms that range from less than one year to ten years , with a weighted average remaining term of approximately six years . For each guarantee issued, if the wholesale customer or other third-party defaults on a payment, the Company would be required to make payments under its guarantee. Generally, the guarantees are secured by indemnification agreements or personal guarantees of the primary obligor/retailer.
The Company reviews performance risk related to its guarantee obligations based on internal measures of credit performance. As of May 2, 2020, the maximum amount of undiscounted payments the Company would be required to make in the event of default of all guarantees was $32.9 million ($25.8 million on a discounted basis). Based on the indemnification agreements, personal guarantees and results of the reviews of performance risk, the Company believes the likelihood that it will be required to assume a material amount of these obligations is remote. Accordingly, no amount has been recorded in the Condensed Consolidated Balance Sheets for these contingent obligations under the Company’s guarantee arrangements as the fair value has been determined to be de minimis.
The Company is contingently liable for leases that have been assigned to various third parties in connection with facility closings and dispositions. The Company could be required to satisfy the obligations under the leases if any of the assignees are unable to fulfill their lease obligations. Due to the wide distribution of the Company’s lease assignments among third parties, and various other remedies available, the Company believes the likelihood that it will be required to assume a material amount of these obligations is remote. For leases that have been assigned, the Company has recorded the associated right of use operating lease assets and obligations within the Condensed Consolidated Balance Sheets. No associated lessor receivables are reflected on the Condensed Consolidated Balance Sheets; however, within Note 11—Leases expected cash flows from lease receipts reflecting the assignees payments to the landlord are reflected as Lease Receipts within the future maturity table, along with the Wholesale customers future Lease Receipts. For the Company’s lease guarantee arrangements, no amounts have been recorded within the Condensed Consolidated Balance Sheets as the fair value has been determined to be de minimis.
The Company is a party to a variety of contractual agreements under which it may be obligated to indemnify the other party for certain matters in the ordinary course of business, which indemnities may be secured by operation of law or otherwise. These agreements primarily relate to the Company’s commercial contracts, service agreements, contracts entered into for the purchase and sale of stock or assets, operating leases and other real estate contracts, financial agreements, agreements to provide services to the Company and agreements to indemnify officers, directors and employees in the performance of their work. While the Company’s aggregate indemnification obligations could result in a material liability, the Company is not aware of any matters that are expected to result in a material liability. No amount has been recorded in the Condensed Consolidated Balance Sheets for these contingent obligations as the fair value has been determined to be de minimis.
In connection with Supervalu’s sale of New Albertson’s, Inc. (“NAI”) on March 21, 2013, the Company remains contingently liable with respect to certain self-insurance commitments and other guarantees as a result of parental guarantees issued by Supervalu with respect to the obligations of NAI that were incurred while NAI was Supervalu’s subsidiary. Based on the expected settlement of the self-insurance claims that underlie the Company’s commitments, the Company believes that such contingent liabilities will continue to decline. Subsequent to the sale of NAI, NAI collateralized most of these obligations with letters of credit and surety bonds to numerous state governmental authorities. Because NAI remains a primary obligor on these self-insurance and other obligations and has collateralized most of the self-insurance obligations for which the Company remains contingently liable, the Company believes that the likelihood that it will be required to assume a material amount of these obligations is remote. Accordingly, no amount has been recorded in the Condensed Consolidated Balance Sheets for these guarantees, as the fair value has been determined to be de minimis.
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Agreements with Save-A-Lot and Onex
The Agreement and Plan of Merger pursuant to which Supervalu sold the Save-A-Lot business in 2016 (the “SAL Merger Agreement”) contains customary indemnification obligations of each party with respect to breaches of their respective representations, warranties and covenants, and certain other specified matters, on the terms and subject to the limitations set forth in the SAL Merger Agreement. Similarly, Supervalu entered into a Separation Agreement (the “Separation Agreement”) with Moran Foods, LLC d/b/a Save-A-Lot (“Moran Foods”), which contains indemnification obligations and covenants related to the separation of the assets and liabilities of the Save-A-Lot business from the Company. The Company also entered into a Services Agreement with Moran Foods (the “Services Agreement”), pursuant to which the Company is providing Save-A-Lot various technical, human resources, finance and other operational services for a term of five years , subject to termination provisions that can be exercised by each party. The initial annual base charge under the Services Agreement is $30 million, subject to adjustments. The Services Agreement generally requires each party to indemnify the other party against third-party claims arising out of the performance of or the provision or receipt of services under the Services Agreement. While the Company’s aggregate indemnification obligations to Save-A-Lot and Onex, the purchaser of Save-A-Lot, could result in a material liability, the Company is not aware of any matters that are expected to result in a material liability. The Company has recorded the fair value of the guarantee in the Condensed Consolidated Balance Sheets within Other long-term liabilities.
Other Contractual Commitments
In the ordinary course of business, the Company enters into supply contracts to purchase products for resale, and service contracts for fixed asset and information technology systems. These contracts typically include either volume commitments or fixed expiration dates, termination provisions and other standard contractual considerations. As of May 2, 2020, the Company had approximately $252.0 million of non-cancelable future purchase obligations.
Legal Proceedings
In December 2008, a class action complaint was filed in the United States District Court for the Western District of Wisconsin against Supervalu alleging that a 2003 transaction between Supervalu and C&S Wholesale Grocers, Inc. (“C&S”) was a conspiracy to restrain trade and allocate markets. As previously disclosed, the Company settled with the certain plaintiffs in November 2017. The remaining plaintiff (the “New England plaintiff”) was not a party to the settlement and pursued its individual claims and potential class action claims against Supervalu. On February 15, 2018, Supervalu filed a summary judgment and Daubert motion and the New England plaintiff filed a motion for class certification and on July 27, 2018, the District Court granted Supervalu’s motions. The New England plaintiff appealed to the 8th Circuit on August 15, 2018, and a hearing was held on October 15, 2019. In the second quarter of fiscal 2020, the 8th Circuit Court of Appeals denied the appeal.
The Company is one of dozens of companies that have been named in various lawsuits alleging that drug manufacturers, retailers and distributors contributed to the national opioid epidemic. Currently, UNFI, primarily through its subsidiary, Advantage Logistics, is named in approximately 38 suits pending in the United States District Court for the Northern District of Ohio where over 1,800 cases have been consolidated as Multi-District Litigation (“MDL”). In accordance with the Stock Purchase Agreement dated January 10, 2013, between New Albertson’s Inc. and the Company (the “Stock Purchase Agreement”), New Albertson’s Inc. is defending and indemnifying UNFI in a majority of the cases under a reservation of rights as those cases relate to New Albertson’s pharmacies. In one of the MDL cases, MDL No. 2804 filed by The Blackfeet Tribe of the Blackfeet Indian Reservation, all defendants were ordered to Answer the Complaint, which UNFI did on July 26, 2019. To date, no discovery has been conducted against UNFI in any of the actions. UNFI is vigorously defending these matters, which it believes are without merit.
UNFI is currently subject to a qui tam action alleging violations of the False Claims Act (“FCA”). In United States ex rel. Schutte and Yarberry v. Supervalu, New Albertson’s, Inc., et al, which is pending in the U.S. District Court for the Central District of Illinois, the relators allege that defendants overcharged government healthcare programs by not providing the government, as a part of usual and customary prices, the benefit of discounts given to customers purchasing prescription medication who requested that defendants match competitor prices. The complaint was originally filed under seal and amended on November 30, 2015. The government previously investigated the relators' allegations and declined to intervene. Violations of the FCA are subject to treble damages and penalties of up to a specified dollar amount per false claim. Relators elected to pursue the case on their own and have alleged FCA damages against Supervalu and New Albertsons in excess of $100 million, not including trebling and statutory penalties. For the majority of the relevant period Supervalu and New Albertson’s operated as a combined company. In March 2013, Supervalu divested New Albertson’s (and related assets) pursuant the Stock Purchase Agreement. Based on the claims that are currently pending and the Stock Purchase Agreement, Supervalu’s share of a potential award (at the currently claimed value by relators) would be approximately $24 million, not including trebling and statutory penalties. Both sides moved for summary judgment. Discovery is complete, and trial will be set after the Court rules on the pending motions. On August 5, 2019, the Court
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granted one of relators’ summary judgment motions finding that defendants’ lower matched prices are the usual and customary prices and that Medicare Part D and Medicaid were entitled to those prices. There are additional pending motions for summary judgment filed by defendants and relators that await rulings by the Court, including on key FCA elements of materiality and knowledge. On August 30, 2019, defendants filed a motion with the District Court seeking certification of the summary judgment decision for interlocutory appeal and on November 7, 2019, the District Court denied the motion. UNFI is vigorously defending this matter and believes that it should be successful on the merits, however, in light of the most recent summary judgment decision, the Company now believes the risk of loss is reasonably possible. However, management is unable to estimate a range of reasonably possible loss because there are several disputed factual and legal matters that have not yet been resolved, including fundamentally whether any FCA violations actually occurred (which defendants still strongly believe and continue to argue did not), and the appropriate methodology of determining potential damages, if any.
In November 2018, a putative nationwide class action was filed in Rhode Island state court, which the Company removed to U.S. District Court for the District of Rhode Island. In North Country Store v. United Natural Foods, Inc., plaintiff asserts that the Company made false representations about the nature of fuel surcharges charged to customers and asserts claims for alleged violations of Connecticut’s Unfair Trade Practices Act, breach of contract, unjust enrichment and breach of the covenant of good faith and fair dealing arising out of the Company’s fuel surcharge practices. On March 5, 2019, the Company answered the complaint denying the allegations. At a court-ordered mediation on October 15, 2019, the Company reached an agreed resolution, which was immaterial in amount, to avoid costs and uncertainty of litigation. The potential settlement must go through the Court approval and notice process, which will take several months.
From time to time, the Company receives notice of claims or potential claims, becomes involved in litigation, alternative dispute resolution such as arbitration, or other legal and regulatory proceedings that arise in the ordinary course of its business, including investigations and claims regarding employment law; pension plans; labor union disputes, including unfair labor practices, such as claims for back-pay it the context of labor contract negotiations; supplier, customer and service provider contract terms and claims including matters related to supplier or customer insolvency or general inability to pay obligations as they become due; real estate and environmental matters, including claims in connection with the Company’s ownership and lease of a substantial amount of real property, both neutral and warehouse properties; and antitrust. Other than as described above, there are no pending material legal proceedings to which the Company is a party or to which its property is subject.
Predicting the outcomes of claims and litigation and estimating related costs and exposures involves substantial uncertainties that could cause actual outcomes, costs and exposures to vary materially from current expectations. The Company regularly monitors its exposure to the loss contingencies associated with these matters and may from time to time change its predictions with respect to outcomes and estimates with respect to related costs and exposures. As of May 2, 2020, no material accrued obligations, individually or in the aggregate, have been recorded for these legal proceedings.
Although management believes it has made appropriate assessments of potential and contingent loss in each of these cases based on current facts and circumstances, and application of prevailing legal principles, there can be no assurance that material differences in actual outcomes from management’s current assessments, costs and exposures relative to current predictions and estimates, or material changes in such predictions or estimates will not occur. The occurrence of any of the foregoing, could have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
NOTE 18—DISCONTINUED OPERATIONS
In conjunction with the Supervalu acquisition, the Company announced its plan to sell the remaining acquired retail operations of Supervalu (“Retail”). The results of operations, financial position and cash flows of Cub Foods, Hornbacher’s, Shoppers and Shop ‘n Save St. Louis and Shop ‘n Save East retail operations have been presented as discontinued operations and the related assets and liabilities have been classified as held-for-sale.
As of May 2, 2020, the Company held the remaining Shoppers stores and the Cub Foods business for sale. As discussed in more detail in Note 19—Subsequent Events, subsequent to the end of the third quarter of fiscal 2020, the Company determined it would no longer classify the Cub Foods business and the majority of the remaining Shoppers locations (collectively “Remaining Retail”) as discontinued operations. The Company may incur additional costs and charges in the future related to the Remaining Retail business if these locations are subsequently sold, if indicators exist that the business may be impaired while classified as held and used as continuing operations, or if the Company incurs additional wind-down or employee-related costs or charges.
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In the second quarter of fiscal 2020, the Company entered into agreements to sell 13 Shoppers stores and decided to close six locations. During fiscal 2020 year-to-date, within discontinued operations the Company incurred approximately $39.1 million in pre-tax aggregate costs and charges related to Shoppers, consisting of $14.2 million of operating losses and transaction costs during the period of wind-down, $15.1 million of property and equipment impairment charges related to impairment reviews, $8.7 million of severance costs and $1.1 million of losses on sale. The Company expects to incur additional related costs and charges in the fourth quarter of fiscal 2020. In the second and third quarters of fiscal 2020, the Company reviewed the recoverability of the remaining assets held for sale and assessed the remaining composition of the Shoppers disposal group based on updated fair values.
In fiscal 2019, the Company completed the sale of seven of its eight Hornbacher's locations, as well as Hornbacher’s newest store in West Fargo, North Dakota, to Coborn's Inc. (“Coborn’s”). The Company did not incur a gain or loss on the sale of this disposal group. The Hornbacher’s store in Grand Forks, North Dakota was not included in the sale to Coborn’s and has closed pursuant to the terms of the definitive agreement. As part of the sale, Coborn's entered into a long-term agreement for the Company to serve as the primary supplier of the Hornbacher’s locations and expand its existing supply arrangements for other Coborn’s locations.
In the fourth quarter of fiscal 2019, the Company completed the sale of the pharmacy prescription files and inventory of the Shoppers disposal group. As of May 2, 2020, only the Cub Foods and Shoppers disposal groups continue to be classified as operations held for sale as discontinued operations.
Operating results of discontinued operations are summarized below:
13-Week Period Ended | 39-Week Period Ended | ||||||||||||||
(In thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019(1) | |||||||||||
Net sales | $ | $ | $ | $ | |||||||||||
Cost of sales | |||||||||||||||
Gross profit | |||||||||||||||
Operating expenses | |||||||||||||||
Restructuring expenses and charges | |||||||||||||||
Operating income | |||||||||||||||
Other expense (income), net | ( | ) | ( | ) | |||||||||||
Income from discontinued operations before income taxes | |||||||||||||||
Income tax provision | |||||||||||||||
Income from discontinued operations, net of tax | $ | $ | $ | $ | |||||||||||
(1) | These results reflect retail operations from the Supervalu acquisition date of October 22, 2018 to April 27, 2019. |
The Company recorded $273.2 million and $227.1 million within Net sales from continuing operations attributable to discontinued operations inter-company product purchases in the third quarters of fiscal 2020 and 2019, respectively, and $756.9 million and $505.5 million in fiscal 2020 and 2019 year-to-date, respectively, which the Company expects will continue subsequent to the sale of certain retail banners. These amounts were recorded at gross margin rates consistent with sales to other similar wholesale customers of the acquired Supervalu business. No sales were recorded within continuing operations for retail banners that the Company expects to dispose of without a supply agreement, which were eliminated upon consolidation within continuing operations and amounted to $99.3 million and $134.9 million in the third quarters of fiscal 2020 and 2019, respectively, and $320.0 million and $308.0 million in fiscal 2020 and 2019 year-to-date, respectively.
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The carrying amounts (in thousands) of major classes of assets and liabilities that were classified as held-for-sale on the Condensed Consolidated Balance Sheets follows in the table below.
(In thousands) | May 2, 2020 | August 3, 2019 | ||||||
Current assets | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Receivables, net | ||||||||
Inventories | ||||||||
Other current assets | ||||||||
Total current assets of discontinued operations | ||||||||
Long-term assets | ||||||||
Property and equipment | ||||||||
Intangible assets | ||||||||
Other assets | ||||||||
Total long-term assets of discontinued operations | ||||||||
Total assets of discontinued operations | $ | $ | ||||||
Current liabilities | ||||||||
Accounts payable | $ | $ | ||||||
Accrued compensation and benefits | ||||||||
Other current liabilities | ||||||||
Total current liabilities of discontinued operations | ||||||||
Long-term liabilities | ||||||||
Other long-term liabilities | ||||||||
Total liabilities of discontinued operations | ||||||||
Net assets of discontinued operations | $ | $ | ||||||
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NOTE 19—SUBSEQUENT EVENTS
Subsequent to the end of the third quarter of fiscal 2020, the Company determined it was no longer probable that a sale of Remaining Retail would occur within one year. As a result, the Company determined it no longer met the criteria to classify Remaining Retail as discontinued operations. In the fourth quarter of fiscal 2020, the Company expects to present Remaining Retail as held and used as part of continuing operations in its fiscal 2020 Consolidated Financial Statements based on this assessment. This expected change in financial statement presentation will require the Company to restate the presentation and classification of Remaining Retail within its Consolidated Financial Statements for fiscal 2019, which will result in Remaining Retail’s results of operations, financial position, cash flows and related disclosures being within continuing operations.
In the fourth quarter of fiscal 2020, the Company expects to record an adjustment to the carrying value of certain long-lived assets, including property and equipment and intangible assets, to record the assets at the carrying amount at the acquisition date adjusted for any depreciation expense that would have been recognized had the assets been held and used as part of continuing operations since their acquisition date.
As discussed in Note 3—Revenue Recognition, certain sales from the Wholesale segment to the retail discontinued operations are presented within Net sales. In order to present Remaining Retail’s results of operations within continuing operations these Wholesale sales to retail discontinued operations will be eliminated upon consolidation. Remaining Retail’s net sales will be included in the Net sales line of the Consolidated Statement of Operations. As discussed in Note 3—Revenue Recognition, the Company currently holds Shoppers stores for sale without an expectation of a supply agreement and therefore no Wholesale sales were recorded within continuing operations. Within the restatement of the Company’s segment financial information, the Company expects to recognize Wholesale segment sales to the majority of the remainder of the Shoppers locations, which will be eliminated upon consolidation as described above.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENTS FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
This Quarterly Report and the documents incorporated by reference in this Quarterly Report contain forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Exchange Act, that involve substantial risks and uncertainties. In some cases you can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” “should,” “will,” and “would,” or similar words. Statements that contain these words and other statements that are forward-looking in nature should be read carefully because they discuss future expectations, contain projections of future results of operations or of financial positions or state other “forward-looking” information.
Forward-looking statements involve inherent uncertainty and may ultimately prove to be incorrect or false. These statements are based on our management’s beliefs and assumptions, which are based on currently available information. These assumptions could prove inaccurate. You are cautioned not to place undue reliance on forward-looking statements. Except as otherwise may be required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or actual operating results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including, but not limited to:
• | the impact and duration of the COVID-19 outbreak; |
• | our dependence on principal customers; |
• | the potential for additional asset impairment charges; |
• | our sensitivity to general economic conditions including changes in disposable income levels and consumer spending trends; |
• | our ability to realize anticipated benefits of our acquisitions and dispositions, in particular, our acquisition of SUPERVALU INC. (“Supervalu”); |
• | the possibility that restructuring, asset impairment, and other charges and costs we may incur in connection with the sale or closure of our retail operations will exceed our current expectations; |
• | our reliance on the continued growth in sales of our higher margin natural and organic foods and non-food products in comparison to lower margin conventional grocery products; |
• | increased competition in our industry as a result of increased distribution of natural, organic and specialty products, and direct distribution of those products by large retailers and online distributors; |
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• | increased competition as a result of continuing consolidation of retailers in the natural product industry and the growth of supernatural chains; |
• | our ability to timely and successfully deploy our warehouse management system throughout our distribution centers and our transportation management system across the Company and to achieve efficiencies and cost savings from these efforts; |
• | the addition or loss of significant customers or material changes to our relationships with these customers; |
• | volatility in fuel costs; |
• | volatility in foreign exchange rates; |
• | our sensitivity to inflationary and deflationary pressures; |
• | the relatively low margins and economic sensitivity of our business; |
• | the potential for disruptions in our supply chain or our distribution capabilities by circumstances beyond our control, including a health epidemic (such as the recent outbreak of COVID-19, or the novel coronavirus); |
• | the risk of interruption of supplies due to lack of long-term contracts, severe weather, work stoppages or otherwise; |
• | moderated supplier promotional activity, including decreased forward buying opportunities; |
• | union-organizing activities that could cause labor relations difficulties and increased costs; and |
• | our ability to identify and successfully complete asset or business acquisitions. |
You should carefully review the risks described under “Part II. Item 1A Risk Factors” of this Quarterly Report on Form 10-Q and under “Part I. Item 1A Risk Factors” of our Annual Report on Form 10-K for the year ended August 3, 2019 as well as any other cautionary language in this Quarterly Report, as the occurrence of any of these events could have an adverse effect, which may be material, on our business, results of operations, financial condition or cash flows.
EXECUTIVE OVERVIEW
Business Overview
As a leading distributor of natural, organic, specialty, produce and conventional grocery and non-food products, and provider of support services in the United States and Canada, we believe we are uniquely positioned to provide the broadest array of products and services to customers throughout North America. We offer more than 250,000 products consisting of national, regional and private label brands grouped into six product categories: grocery and general merchandise; produce; perishables and frozen foods; nutritional supplements and sports nutrition; bulk and food service products; and personal care items. Through our October 2018 acquisition of Supervalu, we are transforming into North America’s premier wholesaler with 59 distribution centers and warehouses representing approximately 30 million square feet of warehouse space. We believe our total product assortment and service offerings are unmatched by our wholesale competitors. We plan to aggressively pursue new business opportunities to independent retailers who operate diverse formats, regional and national chains, as well as international customers with wide-ranging needs.
Our Strategy
A key component of our business and growth strategy has been to acquire wholesalers differentiated by product offerings, service offerings and market area. In fiscal 2019, the acquisition of Supervalu accelerated our “build out the store” strategy, diversified our customer base, enabled cross-selling opportunities, expanded our market reach and scale, enhanced our technology, capacity and systems, and is expected to deliver significant synergies and accelerate potential growth.
We believe our significant scale and footprint will generate long-term shareholder value by positioning us to continue to grow sales of natural, organic, specialty, produce and conventional grocery and non-food products, including our Private Brands Business and professional services across our network. We believe we will realize significant cost and revenue synergies from the acquisition of Supervalu by leveraging the scale and resources of the combined company, cross-selling to our customers, integrating our merchandising offerings into existing warehouses, optimizing our network footprint to lower our cost structure, and eliminating redundant administrative costs.
We maintain long-standing customer relationships with customers in our supernatural, supermarket, independent and other channels. Some of these long-standing customer relationships are established through contracts with our customers in the form of distribution agreements.
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We currently operate approximately 76 retail grocery stores acquired in the Supervalu acquisition. We intend to thoughtfully and economically divest these stores over the long-term; however, as discussed below within Divestiture of Retail Operations, we have determined that we no longer expect to divest the Cub Foods business and the majority of the remaining Shoppers locations (collectively “Remaining Retail”) within one year. Accordingly, we will present the Remaining Retail business within continuing operations beginning in the fourth quarter of fiscal 2020. In our third quarter fiscal 2020 Condensed Consolidated Financial Statements included in this Quarterly Report, Remaining Retail is presented within Discontinued Operations, as the determination to change the plan of sale occurred subsequent to the end of the third quarter of fiscal 2020. As described below we entered into agreements to sell 13 retail stores and closed six additional stores. In the third quarter of fiscal 2020, we closed on the sale of 12 of these Shoppers stores.
We have been the primary distributor to Whole Foods Market for more than 20 years. We continue to serve as the primary distributor to Whole Foods Market in all of its regions in the United States pursuant to a distribution agreement that expires on September 28, 2025.
COVID-19 Impact
Impact and Response
Consistent with our values, with the spread of COVID-19 and continuing impacts created by the virus, we remain focused on the safety and well-being of our associates, customers and end consumers and supporting our wholesale customers.
As COVID-19 spread in March 2020, shelter-in-place orders and national and state emergencies were issued in the U.S., our business was designated as an essential business to enable us to continue to serve our customers during the COVID-19 pandemic. We experienced an initial surge in demand and sales in March and April of 2020 as consumers undertook efforts to stock their pantries and our related wholesale customer purchases surged. During the initial spreading of the virus and implementation of shelter-in-place and restaurant closures, we experienced a surge in demand, which impacted fill and service rates and depleted inventory levels. Based on historical purchasing levels, temporary customer supply allocation limits were put in place to ensure continued service to our wholesale customers’ locations, which were removed as we added capacity. In response to the surge in demand, in the third quarter of fiscal 2020, we took immediate actions to respond to the pandemic, to support our associates’ safety and wellbeing, and maximize our logistics network to serve the communities we supply, while delivering operational and financial results. These actions included:
• | hiring over 2,000 associates, and providing existing associates with temporary state of emergency wage increases and increased overtime to warehouse, driver and in-store associates; |
• | implementing heightened associate safety protocols to keep our workforce healthy, including social distancing practices, implementing extensive safety protocols at our retail locations to protect associates and customers, and engaging additional professional cleaning companies in our facilities; |
• | enhancing employee benefits, including wellbeing resources and covering COVID-19 testing expenses and providing coverage for COVID-19 illness or quarantine directed by the Company or a regulatory agency; |
• | expanding warehouse operational hours and entering into service provider agreements to facilitate the transportation of our products to meet heightened demand and increase service levels; |
• | donating over six million pounds of food and essential items to food banks across the country; |
• | working with suppliers to prioritize the procurement and sale of high-volume stock-keeping units; |
• | implementing enhanced high food safety standards for customers and consumers; and |
• | reassuring the public that the supply chain remains intact, and that food and essential products are available and safe. |
We believe the Supervalu acquisition allowed us to better serve our wholesale customers’ needs and compete in the current environment by providing additional warehouse and transportation capacity, as well as providing a broader array of products to our customers. As one of the largest wholesale grocery distributors in North America and in light of the continued expansion of our distribution network and build-out-the-store initiative, we believe we are well positioned to leverage our infrastructure in the current economic and social environment to continue to serve our customers and the communities in which they operate.
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We experienced the following impacts from COVID-19 in the third quarter of fiscal 2020:
• | Sales. Our increase in sales in the third quarter was primarily driven by higher sales volume due to the increase in food-at-home expenditures from the economic impacts created by the COVID-19 pandemic, partially offset by previously lost business. |
• | Gross Profit. Gross profit rates were impacted negatively by mix shifts toward lower margin products and lower vendor promotions, which was partially offset by lower levels of inventory shrink. |
• | Operating Expenses. Operating expense rates were positively impacted by our ability to leverage fixed operating and administrative expenses, which were partially offset by incremental costs related to COVID-19, including the impact of temporary pandemic related incentives and additional costs for safety protocols and procedures at the Company’s distribution centers and retail stores. When COVID-19 related health and safety requirements are eased, we expect these costs to subside. These costs were necessary to protect our employees, product quality standards, and wholesale and retail customers. We estimate we incurred approximately $20 million of incremental operating expenses within continuing operations related to our response to the pandemic and operating our business at a higher through-put capacity. |
• | Operating Earnings. Our business model drives sales leverage, and provided growth in operating earnings margin, as we leveraged the fixed and variable costs of our supply chain network and administrative expenses. Despite incremental labor and operating costs, incremental volume through our distribution network and retail stores drove higher leverage on fixed facility costs, semi-variable costs and general and administrative expenses. |
Working Capital and Liquidity
Reflecting the initial impact from the COVID-19 pandemic, working capital was reduced in the third quarter of fiscal 2020 by $214.5 million, as compared to the second quarter of fiscal 2020, which provided a strong source of cash flows from operating activities in the quarter. The surge in demand during the quarter discussed above initially depleted inventory levels of continuing operations, which ended $109.2 million lower in the quarter compared to the second quarter of fiscal 2020. Our Accounts payable fluctuated greatly during the quarter related to swings in Inventories, net, ending the quarter $253.4 million higher as compared to the second quarter of fiscal 2020, as we worked to respond to our customers’ modified purchase patterns and prioritize the procurement of high-volume stock-keeping units. The elevated sales levels caused Accounts receivable, net to grow by $157.7 million as compared to the second quarter of fiscal 2020 due to higher sales.
In response to the potential impacts of the COVID-19 pandemic, we temporarily borrowed an additional $278.5 million on our $2.1 billion ABL Credit Facility, which we fully repaid in the third quarter of fiscal 2020. These borrowings were made as a precautionary measure to increase our cash position and preserve financial flexibility in light of uncertainty in the global markets resulting from the COVID-19 pandemic. We made additional net payments of $371.2 million on the ABL Credit Facility in the third quarter of fiscal 2020 to further reduce our debt. Our unused credit under our ABL Credit Facility increased $329.7 million as of the end of the third quarter of fiscal 2020 compared to the second quarter of fiscal 2020.
Outlook
We expect to continue to benefit from sales and margin growth as compared to historical periods while food-at-home expenditures as a percentage of total expenditures remains higher than recent historical precedent. We also expect the favorable year-over-year sales, margin growth and cost leveraging to continue in the near term. We expect fourth quarter of fiscal 2020 gross margin rate to be diluted as compared to last year driven by continued impacts of wholesale customer and product mix changes. We continue to make progress to increase fill rates and service level as our and our vendors’ logistics capacity grows, which we expect will result in lower out of stock rates.
Trends in increased sales and gross margin benefits may lessen or reverse in the intermediate months if customers alter their purchasing habits. In addition, as discussed below in the sections Impact of Inflation or Deflation and Other Factors Affecting our Business we could also be affected by changes in product mix and product category inflation changes, especially if the U.S. and Canadian economies enter into and maintain an economic recession, and customers change their purchasing habits. These potential developments could impact food-at-home expenditures and prompt consumers to trade down to lower priced product categories or change their purchasing habits in a manner that would impact our wholesale supply to our wholesale customers. However, the expected benefits from food-at-home expenditures remaining elevated and those impacts benefiting our wholesale customers are expected to outweigh product mix changes and other factors as it pertains to our results of operations and cash flows. The ultimate impact on our results is dependent upon the severity and duration of the COVID-19 pandemic, food-at-home purchasing levels, actions taken by governmental authorities and other third parties in response to the pandemic, each of which is uncertain, rapidly changing and difficult to predict. Any of these disruptions could adversely impact our business and results of operations.
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We could experience disruptions to our supply chain through the shutdown of one or more of our distribution centers or warehouses, the inability to transport products to serve our customers or the inability of our vendors and contract manufacturers to supply products to us. In addition, the contraction of financial markets may impact our ability to execute transactions to dispose of or acquire real estate or distribution assets, including potential impacts to our ability to divest our retail operations.
CARES Act
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020 and contains significant business tax provision changes to the U.S. tax code, including temporary expansion of the limitations to the deductibility of net operating losses and interest expense and the ability to treat qualified improvement property as eligible for bonus depreciation. In addition, the CARES Act changed the required filing of our federal income tax return from May 2020 to July 2020, and allows remittances of employer FICA payments previously due March 2020 to December 2020 to be deferred until December 2021 and December 2022. Prior to the application of the CARES Act, we had a deferred tax asset related to $203 million of federal net operating losses that were available for unlimited carryforward (but no carryback) pursuant to provisions of the 2017 Tax Cuts and Jobs Act, which permitted taxpayers to carryforward net operating losses indefinitely. The CARES Act provides us the ability to carry these losses back at a 35% federal tax rate during the carry back periods, as opposed to the current 21% federal tax rate. This resulted in a tax benefit of approximately $28.4 million, which we recorded in the third quarter of fiscal 2020. This estimated tax benefit will be finalized in the fourth quarter of fiscal 2020 as the 2019 tax return due July 2020 is finalized. The entire tax benefit associated with the net operating loss carry back has been recorded as a current tax receivable in the third quarter of fiscal 2020.
Distribution Center Network
Network Optimization and Construction
Within the Pacific Northwest, we are transferring the volume of five distribution centers and the related supporting off-site storage facilities into two distribution centers. This transition and operational consolidation is expected to be completed during fiscal 2020, after which we expect to achieve synergies and cost savings by eliminating inefficiencies, including incurring lower operating, shrink and off-site storage expenses. The optimization of the Pacific Northwest distribution network will also help deliver meaningful synergies contemplated in the Supervalu acquisition. This plan includes expanding the Ridgefield, WA distribution center to enhance customer product offerings, create more efficient inventory management, streamline operations and incorporate greater technology to deliver a better customer experience. The Ridgefield distribution center will deploy a warehouse automation solution that supports our slow-moving stock-keeping unit portfolio. The operational start-up of the Centralia, WA distribution center began in the fourth quarter of fiscal 2019 and is expected to be completed in the fourth quarter of fiscal 2020. We ceased operations in our Tacoma, WA, Auburn, WA and Auburn, CA distribution centers and have transitioned to supplying customers served by these locations to our Centralia, WA, Ridgefield, WA and Gilroy, CA distribution centers. We expect to incur incremental expenses related to the network realignment and are working to both minimize these costs and obtain new business to further improve the efficiency of our transforming distribution network.
In connection with our consolidation of distribution centers in the Pacific Northwest, during the second quarter of fiscal 2020, we recorded a $10.6 million multiemployer pension plan withdrawal liability, under which payments will be made over a one-year period beginning in fiscal 2022.
To support our continued growth within southern California, we began operating a newly leased facility with approximately 1.1 million square feet upon completion of its construction in the fourth quarter of fiscal 2020. This facility provides significant capacity to service our customers in this market and provides us the future flexibility to potentially monetize existing owned facilities in the southern California market. On February 24, 2020, we executed a purchase option to acquire the real property of a distribution center agreeing to pay approximately $156.9 million for the facility, subject to finalization. We expect to engage a real estate partner to monetize the real property of this location, including through a sale-leaseback transaction that would ultimately reduce rents paid for this property from current rents, which we expect would occur on or before June 2022.
Distribution Center Sales
In the fourth quarter of fiscal 2019, we entered into an agreement to sell our Tacoma, WA distribution center related to our Pacific Northwest consolidation strategy. We closed on the sale in the fourth quarter of fiscal 2020 and received consideration of $42.3 million in the form of a $38.0 million note receivable and cash. As of May 2, 2020, the facility is classified as held for sale within Prepaid expenses and other current assets of continuing operations on our Condensed Consolidated Balance Sheets. As we consolidate our distribution networks, we may sell additional owned facilities or exit leased facilities.
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In the third quarter of fiscal 2020, we sold a warehouse in Stockton, CA for $4.8 million.
Operating Efficiency
As part of our “one company” approach, we are in the process of converting to a single national warehouse management and procurement system to integrate our existing facilities, including acquired Supervalu facilities, onto one nationalized platform across the organization. We continue to be focused on the automation of our new or expanded distribution centers that are at different stages of construction and implementation. These steps and others are intended to promote operational efficiencies and improve operating expenses as a percentage of net sales.
Goodwill Impairment Review
During the first quarter of fiscal 2020, we changed our management structure and internal financial reporting to combine the Supervalu Wholesale reporting unit and the legacy Company Wholesale reporting unit into one U.S. Wholesale reporting unit, and experienced a further sustained decline in market capitalization and enterprise value. As a result of the change in reporting units and the sustained decline in market capitalization and enterprise value, we performed an interim quantitative impairment review of goodwill for the Wholesale reporting unit, which included a determination of the fair value of all reporting units. Based on this analysis, we determined that the carrying value of our U.S. Wholesale reporting unit exceeded its fair value by an amount that exceeded its assigned goodwill. As a result, we recorded a goodwill impairment charge of $421.5 million in the first quarter of fiscal 2020. The goodwill impairment charge is reflected in Goodwill and asset impairment charges in the Condensed Consolidated Statements of Operations. The goodwill impairment charge reflects the impairment of all of the U.S. Wholesale’s reporting unit goodwill.
Quantitatively, the goodwill impairment was driven by the incorporation of the negative value associated with the legacy Supervalu wholesale reporting unit that was combined into the legacy Company Wholesale goodwill reporting unit and a decrease in estimated long-range cash flows required to be prepared as part of the quantitative assessment. The goodwill impairment review indicated that the estimated fair value of the Canada Wholesale reporting, which had goodwill of $9.9 million as of November 2, 2019, exceeded its carrying values by approximately 13%. Other continuing operations reporting units, which had goodwill of $9.9 million as of November 2, 2019, were substantially in excess of their carrying value. If circumstances indicate that the value of one of these other reporting units has decreased, we may be required to perform additional reviews of goodwill and incur additional impairment charges. The first quarter of fiscal 2020 quantitative goodwill impairment review included a reconciliation of all of the reporting units’ fair value to our market capitalization and enterprise value.
Divestiture of Retail Operations
We have announced our intention to thoughtfully and economically divest our retail businesses acquired as part of the Supervalu acquisition as soon as practical in an efficient and economic manner in order to focus on our core wholesale distribution business. We plan to maximize value as part of the divestiture process, including limiting liabilities and stranded costs associated with these divestitures. We expect to obtain ongoing supply relationships with the purchasers of some of these retail operations, but we anticipate some reductions in supply volume will result from the divestiture of certain of these retail operations. Actions associated with retail divestitures and adjustments to our core cost structure for our wholesale food distribution business are expected to result in headcount reductions and other costs and charges. These costs and charges, which may be material, include multiemployer plan charges, severance costs, store closure charges, and related costs. A withdrawal from a multiemployer pension plan may result in an obligation to make material payments over an extended period of time. The extent of these costs and charges will be determined based on outcomes achieved under the divestiture process. At this time, however, we are unable to make an estimate with reasonable certainty of the amount or type of costs and charges expected to be incurred in connection with the foregoing actions.
Our discontinued operations as of the end of third quarter of fiscal 2020 include Cub Foods and Shoppers disposal groups, and our historical results of discontinued operations include Hornbacher’s and Shop ‘n Save, which were divested in the second and third quarters of fiscal 2019, respectively. In addition, discontinued operations includes certain real estate related to historical retail operations. These retail assets have been classified as held for sale as of the Supervalu acquisition date, and the results of operations, financial position and cash flows directly attributable to these operations are reported within discontinued operations in our Condensed Consolidated Financial Statements for all periods presented. As of the acquisition date, retail assets and liabilities were recorded at their estimated fair value less costs to sell, and subsequent to the acquisition date, we review the fair value less costs to sell of these disposal groups.
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In the second quarter of fiscal 2020, we entered into agreements to sell 13 Shoppers stores and decided to close six locations, and in the third quarter of fiscal 2020 we closed on the sale of 12 of these Shoppers stores. During fiscal 2020 year-to-date, in the aggregate between discontinued operations and continuing operations we incurred approximately $57.3 million of pre-tax aggregate costs and charges related to Shoppers, consisting of $33.3 million of lease asset impairment and property and equipment charges, including lease termination charges and charges related to impairment reviews, $14.2 million of operating losses and transaction costs during the period of wind-down, $8.7 million of severance costs and $1.1 million of losses on sale of assets. We may incur additional related costs and charges in the fourth quarter of fiscal 2020. In the second and third quarter of fiscal 2020, we reviewed the recoverability of the remaining assets held for sale and assessed the remaining composition of the Shoppers disposal group based on updated fair values.
As of May 2, 2020, we held the remaining Shoppers stores and the Cub Foods business for sale.
Subsequent to the end of the third quarter of fiscal 2020, we determined it was no longer probable that a sale of Remaining Retail would occur within one year. As a result, we determined we no longer met the criteria to classify Remaining Retail as discontinued operations. In the fourth quarter of fiscal 2020, we expect to present Remaining Retail as held and used as part of continuing operations in our fiscal 2020 Consolidated Financial Statements based on this assessment. This expected change in financial statement presentation will require us to restate the presentation and classification of Remaining Retail within our Consolidated Financial Statements for fiscal 2019, which will result in Remaining Retail’s results of operations, financial position, cash flows and related disclosures being within continuing operations.
In the fourth quarter of fiscal 2020, we expect to record an adjustment to the carrying value of certain long-lived assets, including property and equipment and intangible assets, to record the assets at the carrying amount at the acquisition date adjusted for any depreciation expense that would have been recognized had the assets been held and used as part of continuing operations since their acquisition date. We estimate the adjustment to account for the incremental depreciation and amortization expense required to be recorded in the fourth quarter of fiscal 2020 will be approximately $48 million, which reflects an estimate of depreciation and amortization from the date of the Supervalu acquisition date through fiscal 2020 based on useful lives assigned to the underlying retail assets expected to be brought back into continuing operations.
As discussed in Note 3—Revenue Recognition, certain sales from the Wholesale segment to the retail discontinued operations are presented within Net sales. In order to present Remaining Retail’s results of operations within continuing operations these Wholesale sales to retail discontinued operations will be eliminated upon consolidation, resulting in no consolidated effect on Net sales resulting from our Wholesale segment. Remaining Retail’s net sales will be included in the Net sales line of the Consolidated Statement of Operations. As discussed in Note 3—Revenue Recognition, we currently hold Shoppers stores for sale without an expectation of a supply agreement and therefore no Wholesale sales were recorded within continuing operations. Within the restatement of our segment financial information, we expect to recognize Wholesale segment sales to the majority of the remainder of the Shoppers locations, which will be eliminated upon consolidation as described above.
Subsequent to the restatement of our Consolidated Financial Statements, we expect consolidated net sales, gross profit and operating expenses to increase compared to the current presentation, and expect our consolidated gross profit as a percentage of net sales to increase, which we expect will be partially offset by an increase in operating expenses as a percent of net sales.
We may incur additional costs and charges in the future related to the divesture of Remaining Retail if these locations are subsequently sold, indicators exist that the business may be impaired, or if we incur additional wind-down or employee-related costs or charges.
Supervalu Professional Services Agreements
In connection with the sale of Save-A-Lot on December 5, 2016, Supervalu entered into a services agreement (the “Services Agreement”) with Moran Foods, LLC, the entity that operates the Save-A-Lot business. Pursuant to the Services Agreement, we provide certain technical, human resources, finance and other operational services to Save-A-Lot for a term of five years, on the terms and subject to the conditions set forth therein. The initial annual base charge under the Services Agreement is $30 million, subject to adjustments. If services are no longer provided under the Services Agreement after the initial term, we would lose the revenue associated with this agreement, and if we are not able to eliminate fixed or variable costs associated with servicing this agreement concurrent with the decline in revenue, we would incur a decrease in operating profit.
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Impact of Inflation or Deflation
We monitor product cost inflation and deflation and evaluate whether to absorb cost increases or decreases, or pass on pricing changes to our customers. We experienced a mix of inflation and deflation across product categories during the third quarter of fiscal 2020. In the aggregate across all of our legacy businesses and taking into account the mix of products, management estimates our businesses experienced cost inflation in the low single digits in the third quarter of fiscal 2020. Cost inflation and deflation estimates are based on individual like items sold during the periods being compared. Changes in merchandising, customer buying habits and competitive pressures create inherent difficulties in measuring the impact of inflation and deflation on Net sales and Gross profit. Absent any changes in units sold or the mix of units sold, deflation has the effect of decreasing sales. Under the LIFO method of inventory accounting, product cost increases are recognized within Cost of sales based on expected year end inventory quantities and costs, which has the effect of decreasing Gross profit and the carrying value of inventory.
Other Factors Affecting our Business
We are also impacted by macroeconomic and demographic trends, and changes in the food distribution market structure. Over the past several decades, total food expenditures on a constant dollar basis within the United States has continued to increase in total, and the focus in recent decades on natural, organic and specialty foods have benefited us; however, consumer spending in the food-away-from-home industry has increased steadily as a percentage of total food expenditures. This trend paused during the 2008 recession, and then continued to increase. In fiscal 2020, the COVID-19 impact has caused a significant increase in food-at-home expenditures as a percentage of total food expenditures. We expect that food-at-home expenditures as a percentage of total food expenditures will remain higher than recent years during time periods that shelter-in-place orders exist until businesses are allowed to fully reopen and any related economic recession has ended.
We are also impacted by changes in food distribution trends to our wholesale customers, such as direct store deliveries and other methods of distribution. Our wholesale customers manage their businesses independently and operate in a competitive environment. We seek to obtain security interests and other credit support in connection with the financial accommodations we extend; however, we may incur additional credit or inventory charges related to our customers, as we expect the competitive environment to continue. The magnitude of these risks increases as the size of our wholesale customers increases.
Business Performance Assessment and Composition of Condensed Consolidated Statements of Operations
Net sales
Our net sales consist primarily of sales of natural, organic, specialty, produce and conventional grocery and non-food products, and support services to retailers, adjusted for customer volume discounts, vendor incentives when applicable, returns and allowances, and professional services revenue. Net sales also include amounts charged by us to customers for shipping and handling and fuel surcharges.
Cost of sales and Gross profit
The principal components of our cost of sales include the amounts paid to suppliers for product sold, plus the cost of transportation necessary to bring the product to, or move product between, our various distribution centers, partially offset by consideration received from suppliers in connection with the purchase or promotion of the suppliers’ products. Cost of sales also includes amounts incurred by us at our manufacturing subsidiary, Woodstock Farms Manufacturing, for inbound transportation costs offset by consideration received from suppliers in connection with the purchase or promotion of the suppliers’ products. Our gross margin may not be comparable to other similar companies within our industry that may include all costs related to their distribution network in their costs of sales rather than as operating expenses.
Operating expenses
Operating expenses include salaries and wages, employee benefits, warehousing and delivery, selling, occupancy, insurance, administrative, share-based compensation, depreciation, and amortization expense. These expenses relate to warehousing and delivery expenses including purchasing, receiving, selecting and outbound transportation expenses.
Restructuring, acquisition and integration expenses
Restructuring, acquisition and integration expenses reflect expenses resulting from restructuring activities, including severance costs, change-in-control related charges, share-based compensation acceleration charges, facility closure charges, and acquisition and integration expenses.
Interest expense, net
Interest expense, net includes primarily interest expense on long-term debt, net of capitalized interest, interest expense on capital and direct financing lease obligations, and amortization of financing costs and discounts.
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Net periodic benefit income, excluding service cost
Net periodic benefit income, excluding service cost reflects the recognition of expected returns on benefit plan assets in excess of interest costs.
Adjusted EBITDA
Our Condensed Consolidated Financial Statements are prepared and presented in accordance with generally accepted accounting principles in the United States (“GAAP”). In addition to the GAAP results, we consider certain non-GAAP financial measures to assess the performance of our business and understand the underlying operating performance and core business trends, which we use to facilitate operating performance comparisons of our business on a consistent basis over time. Adjusted EBITDA is provided as a supplement to our results of operations and related analysis, and should not be considered superior to, a substitute for or an alternative to any financial measure of performance prepared and presented in accordance with GAAP. Adjusted EBITDA excludes certain items because they are non-cash items or are items that do not reflect management’s assessment of on-going business performance.
We believe Adjusted EBITDA is useful to investors and financial institutions because it provides additional understanding of factors and trends affecting our business, which are used in the business planning process to understand expected operating performance, to evaluate results against those expectations, and as the primary compensation performance measure under certain compensation programs and plans. We believe Adjusted EBITDA is reflective of factors that affect our underlying operating performance and facilitate operating performance comparisons of our business on a consistent basis over time. Investors are cautioned that there are material limitations associated with the use of non-GAAP financial measures as an analytical tool. Certain adjustments to our GAAP financial measures reflected below exclude items that may be considered recurring in nature and may be reflected in our financial results for the foreseeable future. These measurements and items may be different from non-GAAP financial measures used by other companies. Adjusted EBITDA should be reviewed in conjunction with our results reported in accordance with GAAP in this Quarterly Report.
There are significant limitations to using Adjusted EBITDA as a financial measure including, but not limited to, it not reflecting the cost of cash expenditures for capital assets or certain other contractual commitments, finance lease obligation and debt service expenses, income taxes, and any impacts from changes in working capital.
We define Adjusted EBITDA as a consolidated measure inclusive of continuing and discontinued operations results, which we reconcile by adding Net (loss) income from continuing operations, plus Total other expense, net and (Benefit) provision for income taxes, plus Depreciation and amortization calculated in accordance with GAAP, plus non-GAAP adjustments for Share-based compensation, Restructuring, acquisition and integration related expenses, goodwill and asset impairment charges, certain legal charges and gains, certain other non-cash charges or items, as determined by management, plus Adjusted EBITDA of discontinued operations calculated in manner consistent with the results of continuing operations, outlined above.
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Assessment of Our Business Results
The following table sets forth a summary of our results of operations and Adjusted EBITDA for the periods indicated:
13-Week Period Ended | 39-Week Period Ended | ||||||||||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | Change | May 2, 2020 | April 27, 2019 | Change | |||||||||||||||||
Net sales | $ | 6,667,681 | $ | 5,962,620 | $ | 705,061 | $ | 18,824,870 | $ | 14,979,982 | $ | 3,844,888 | |||||||||||
Cost of sales | 5,811,151 | 5,174,070 | 637,081 | 16,421,838 | 13,017,318 | 3,404,520 | |||||||||||||||||
Gross profit | 856,530 | 788,550 | 67,980 | 2,403,032 | 1,962,664 | 440,368 | |||||||||||||||||
Operating expenses | 774,376 | 737,681 | 36,695 | 2,300,635 | 1,852,768 | 447,867 | |||||||||||||||||
Goodwill and asset impairment (adjustment) charges | — | (38,250 | ) | 38,250 | 425,405 | 332,621 | 92,784 | ||||||||||||||||
Restructuring, acquisition and integration related expenses | 10,449 | 19,438 | (8,989 | ) | 54,385 | 134,567 | (80,182 | ) | |||||||||||||||
Operating income (loss) | 71,705 | 69,681 | 2,024 | (377,393 | ) | (357,292 | ) | (20,101 | ) | ||||||||||||||
Other expense (income): | |||||||||||||||||||||||
Net periodic benefit income, excluding service cost | (12,758 | ) | (10,941 | ) | (1,817 | ) | (27,419 | ) | (22,691 | ) | (4,728 | ) | |||||||||||
Interest expense, net | 47,108 | 54,917 | (7,809 | ) | 145,247 | 121,149 | 24,098 | ||||||||||||||||
Other, net | (973 | ) | 958 | (1,931 | ) | (1,539 | ) | 231 | (1,770 | ) | |||||||||||||
Total other expense, net | 33,377 | 44,934 | (11,557 | ) | 116,289 | 98,689 | 17,600 | ||||||||||||||||
Income (loss) from continuing operations before income taxes | 38,328 | 24,747 | 13,581 | (493,682 | ) | (455,981 | ) | (37,701 | ) | ||||||||||||||
Benefit for income taxes | (14,849 | ) | (8,027 | ) | (6,822 | ) | (106,330 | ) | (104,091 | ) | (2,239 | ) | |||||||||||
Net income (loss) from continuing operations | 53,177 | 32,774 | 20,403 | (387,352 | ) | (351,890 | ) | (35,462 | ) | ||||||||||||||
Income from discontinued operations, net of tax | 37,192 | 24,370 | 12,822 | 64,253 | 47,847 | 16,406 | |||||||||||||||||
Net income (loss) including noncontrolling interests | 90,369 | 57,144 | 33,225 | (323,099 | ) | (304,043 | ) | (19,056 | ) | ||||||||||||||
Less net (income) loss attributable to noncontrolling interests | (2,238 | ) | (52 | ) | (2,186 | ) | (3,407 | ) | 116 | (3,523 | ) | ||||||||||||
Net income (loss) attributable to United Natural Foods, Inc. | $ | 88,131 | $ | 57,092 | $ | 31,039 | $ | (326,506 | ) | $ | (303,927 | ) | $ | (22,579 | ) | ||||||||
Adjusted EBITDA | $ | 222,208 | $ | 168,175 | $ | 54,033 | $ | 475,012 | $ | 396,942 | $ | 78,070 | |||||||||||
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The following table reconciles Adjusted EBITDA to Net income (loss) from continuing operations and to Income from discontinued operations, net of tax.
13-Week Period Ended | 39-Week Period Ended | |||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | ||||||||||||
Net income (loss) from continuing operations | $ | 53,177 | $ | 32,774 | $ | (387,352 | ) | $ | (351,890 | ) | ||||||
Adjustments to continuing operations net income (loss): | ||||||||||||||||
Total other expense, net | 33,377 | 44,934 | 116,289 | 98,689 | ||||||||||||
Benefit for income taxes(1) | (14,849 | ) | (8,027 | ) | (106,330 | ) | (104,091 | ) | ||||||||
Depreciation and amortization | 69,642 | 71,787 | 214,002 | 169,780 | ||||||||||||
Share-based compensation | 12,755 | 9,251 | 21,307 | 27,763 | ||||||||||||
Restructuring, acquisition and integration related expenses(2) | 10,449 | 19,438 | 54,385 | 134,567 | ||||||||||||
Goodwill and asset impairment (adjustment) charges(3) | — | (38,250 | ) | 425,405 | 332,621 | |||||||||||
Note receivable charges(4) | — | — | 12,516 | — | ||||||||||||
Inventory fair value adjustment(5) | — | — | — | 10,463 | ||||||||||||
Legal reserve charge, net of settlement income(6) | — | 2,200 | 1,196 | 2,200 | ||||||||||||
Adjusted EBITDA of discontinued operations(7) | 57,657 | 34,068 | 123,594 | 76,840 | ||||||||||||
Adjusted EBITDA | $ | 222,208 | $ | 168,175 | $ | 475,012 | $ | 396,942 | ||||||||
Income from discontinued operations, net of tax(7) | $ | 37,192 | $ | 24,370 | $ | 64,253 | $ | 47,847 | ||||||||
Adjustments to discontinued operations net income: | ||||||||||||||||
Less net (income) loss attributable to noncontrolling interests | (2,238 | ) | (52 | ) | (3,407 | ) | 116 | |||||||||
Total other expense, net | 2,242 | (369 | ) | 1,192 | (957 | ) | ||||||||||
Provision for income taxes | 12,071 | 7,772 | 20,447 | 13,759 | ||||||||||||
Other expense | — | 591 | — | 829 | ||||||||||||
Share-based compensation | 238 | 774 | 744 | 1,306 | ||||||||||||
Restructuring, store closure and other charges, net(8) | 8,152 | 982 | 40,365 | 13,940 | ||||||||||||
Adjusted EBITDA of discontinued operations(7) | $ | 57,657 | $ | 34,068 | $ | 123,594 | $ | 76,840 | ||||||||
(1) | Fiscal 2020 includes the tax benefit from the CARES Act, which includes the impact of tax loss carrybacks to 35% tax years allowed under the CARES Act. |
(2) | Primarily reflects expenses resulting from the acquisition of Supervalu, including severance costs, store closure charges, and acquisition and integration expenses. Fiscal 2020 year-to-date primarily reflects integration charges, closed property reserve charges and administrative and operational restructuring costs. Fiscal 2019 year-to-date primarily reflects expenses resulting from the acquisition of Supervalu and acquisition and integration expenses, including employee-related costs. Refer to Note 5—Restructuring, Acquisition and Integration Related Expenses in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. |
(3) | Fiscal 2020 year-to-date reflects a goodwill impairment charge attributable to a reorganization of our reporting units and a sustained decrease in market capitalization and enterprise value of the Company, resulting in a decline in the estimated fair value of the U.S. Wholesale reporting unit. In addition, this charge includes a goodwill finalization charge attributable to the Supervalu acquisition and an asset impairment charge. Fiscal 2019 year-to-date reflects a goodwill impairment charge attributable to the Supervalu acquisition. Refer to Note 6—Goodwill and Intangible Assets in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. |
(4) | Reflects reserves and charges for notes receivable issued by the Supervalu business prior to its acquisition to finance the purchase of stores by its customers. |
(5) | Reflects a non-cash charge related to the step-up of inventory values as part of purchase accounting. |
(6) | Reflects a charge to settle a legal proceeding and a charge related to our assessment of legal proceedings, net of income received to settle a legal proceeding. |
(7) | Income from discontinued operations, net of tax and Adjusted EBITDA of discontinued operations excludes rent expense of $8.9 million and $11.6 million in the third quarters of fiscal 2020 and 2019, respectively, and $32.5 million and $24.3 million in fiscal 2020 and 2019 year-to-date, respectively, of operating lease rent expense related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations, as we expect to remain primarily obligated under these leases. Due to these GAAP requirements to show rent expense, along with other administrative expenses of discontinued operations within continuing operations, we believe the inclusion of discontinued operations results within Adjusted EBITDA provides investors a meaningful measure of total performance. |
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(8) | Amounts represent store closure charges and costs, operational wind-down and inventory charges, and asset impairment charges related to discontinued operations. |
RESULTS OF OPERATIONS
Our analysis within the Results of Operations section below of Net sales, Gross profit, Operating expenses and Operating loss is presented on a consolidated basis, as our single reportable segment principally comprises the entire operations of our business. The quantification of Supervalu’s impact on our results of operations below in our year-to-date analysis is presented to discuss the incremental impact of Supervalu, and provide analysis of our underlying business for year-over-year comparability purposes. Our analysis of Net sales is presented on a customer channel basis inclusive of all segments. References to legacy company results are presented to provide a comparative results analysis excluding the Supervalu acquired business impacts.
Net Sales
Our net sales by customer channel was as follows (in millions):
Net Sales for the 13-Week Period Ended | Net Sales for the 39-Week Period Ended | |||||||||||||||||||||||||||
Customer Channel | May 2, 2020 | % of Net Sales | April 27, 2019(1) | % of Net Sales | May 2, 2020(1) | % of Net Sales | April 27, 2019(1) | % of Net Sales | ||||||||||||||||||||
Supermarkets | $ | 4,267 | 64 | % | $ | 3,701 | 62 | % | $ | 11,915 | 63 | % | $ | 8,559 | 57 | % | ||||||||||||
Supernatural | 1,279 | 19 | % | 1,102 | 18 | % | 3,600 | 19 | % | 3,229 | 21 | % | ||||||||||||||||
Independents | 684 | 10 | % | 707 | 12 | % | 1,983 | 11 | % | 2,041 | 14 | % | ||||||||||||||||
Other | 438 | 7 | % | 453 | 8 | % | 1,327 | 7 | % | 1,151 | 8 | % | ||||||||||||||||
Total net sales | $ | 6,668 | 100 | % | $ | 5,963 | 100 | % | $ | 18,825 | 100 | % | $ | 14,980 | 100 | % | ||||||||||||
(1) | Refer to Note 3—Revenue Recognition in Part 1, Item 1 of this Quarterly Report on Form 10-Q for additional information regarding adjustments to net sales by customer channel. |
Third Quarter Variances
Our net sales for the third quarter of fiscal 2020 increased approximately $0.71 billion, or 11.8%, to $6.67 billion from $5.96 billion for the third quarter of fiscal 2019.
Net sales to our supermarkets channel increased by approximately $566 million, or 15.3%, for the third quarter of fiscal 2020, compared to the third quarter of fiscal 2019, and represented approximately 64% and 62% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The increase in supermarkets net sales is primarily due to an increase in demand for center store and natural products driven by customers response to the COVID-19 pandemic, partially offset by lower sales from previously lost customers and stores prior to the pandemic.
Whole Foods Market is our only supernatural customer, and net sales to Whole Foods Market for the third quarter of fiscal 2020 increased by approximately $177 million, or 16.1%, as compared to the third quarter of fiscal 2019, and accounted for approximately 19% and 18% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The increase in net sales to Whole Foods Market is primarily due to increased sales to existing locations and the economic impacts of the COVID-19 pandemic. Net sales within our supernatural channel do not include net sales to Amazon.com, Inc. in either the current period or the prior period, as these net sales are reported in our other channel.
Net sales to our independents channel decreased by approximately $23 million, or 3.3%, for the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019, and represented approximately 10% and 12% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The decrease in independents net sales is primarily due to previously lost customers and store closings, partially offset by strong sales growth in existing customer sales driven by the response to the COVID-19 pandemic.
Net sales to our other channel decreased by approximately $15 million, or 3.3%, for the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019, and represented approximately 7% and 8% of our total net sales for the third quarter of fiscal 2020 and 2019, respectively. The decrease in other net sales is primarily due to lower sales to foodservice customers and lower military sales from the resignation of certain business, partially offset by e-commerce sales growth.
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Year-to-Date Variances
Our net sales for fiscal 2020 year-to-date increased approximately $3.84 billion, or 25.7%, to $18.82 billion from $14.98 billion for fiscal 2019 year-to-date. Net sales for fiscal 2020 year-to-date included incremental Supervalu net sales from the first quarter of fiscal 2020 of approximately $3.08 billion. Excluding the incremental first quarter of fiscal 2020 Supervalu net sales, net sales increased $768 million, or 5.1%, which was driven primarily by incremental sales resulting from the COVID-19 pandemic and continued growth in our supernatural channel.
Net sales to our supermarkets channel for fiscal 2020 year-to-date increased by approximately $3,356 million, or 39.2%, from fiscal 2019 year-to-date, and represented approximately 63% and 57% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The increase in supermarkets net sales is primarily due to an increase of $2,813 million from incremental first quarter of fiscal 2020 net sales attributable to the acquired Supervalu business and a net increase of $543 million, or 6.3% primarily driven by growth in sales to existing customers, including the demand for center store and natural products driven by customers response to the COVID-19 pandemic, partially offset by lower sales from previously lost customers and stores prior to the pandemic.
Net sales to Whole Foods Market for fiscal 2020 year-to-date increased by approximately $371 million, or 11.5%, as compared to the prior fiscal year’s comparable period, and accounted for approximately 19% and 21% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The increase in net sales to Whole Foods Market is primarily due to increased sales related to the COVID-19 pandemic, growth in new product categories, and increased sales to existing and new stores prior to the pandemic.
Net sales to our independents channel decreased by approximately $58 million, or 2.8%, during fiscal 2020 year-to-date compared to fiscal 2019 year-to-date, and accounted for 11% and 14% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The decrease in independents net sales includes an increase of $24 million from incremental first quarter of fiscal 2020 net sales attributable to the acquired Supervalu business, with the remaining decrease of $82 million, or 4.0% being primarily due to lost customers, and lower sales from existing customers and store closings, partially offset by strong sales growth in existing customer sales driven by the response to the COVID-19 pandemic.
Net sales to our other channel increased by approximately $176 million, or 15.3%, during fiscal 2020 year-to-date compared to fiscal 2019 year-to-date, and represented approximately 7% and 8% of our total net sales for fiscal 2020 and 2019 year-to-date, respectively. The increase in other net sales is primarily due to an increase of $240 million from incremental first quarter of fiscal 2020 net sales attributable to the acquired Supervalu business, partially offset by a decrease of $64 million, or 5.6%, primarily due to lower sales to foodservice customers and lower military sales from the resignation of certain business, partially offset by e-commerce sales growth.
Cost of Sales and Gross Profit
Our gross profit increased $68.0 million, or 8.6%, to $856.5 million for the third quarter of fiscal 2020, from $788.6 million for the third quarter of fiscal 2019. Our gross profit as a percentage of net sales decreased to 12.85% for the third quarter of fiscal 2020 compared to 13.22% for the third quarter of fiscal 2019. The decrease in gross margin rate was primarily driven by a mix shift toward lower margin conventional products and lower levels of vendor funding, partially offset by lower levels of inventory shrink.
Our gross profit increased $440.4 million, or 22.4%, to $2,403.0 million for fiscal 2020 year-to-date, from $1,962.7 million for fiscal 2019 year-to-date. Our gross profit as a percentage of net sales decreased to 12.77% for fiscal 2020 year-to-date compared to 13.10% for fiscal 2019 year-to-date. Our Gross profit dollar increase for fiscal 2020 year-to-date when compared to fiscal 2019 year-to-date is primarily due to an estimated incremental 12 weeks of gross profit from the acquired Supervalu business of approximately $347.9 million, net of its related LIFO inventory charge. The remaining increase in Gross profit was $92.5 million, which included a fiscal 2019 year-to-date inventory charge related to a step-up of acquired Supervalu inventory of $10.5 million. Gross profit as a percentage of net sales decreased primarily due to lower gross profit rates on conventional products and margin dilution from the faster growth of the supernatural channel relative to the other customer channels, offset in part by lower inbound freight expense. We recorded a LIFO charge of $19.3 million and $13.7 million for fiscal 2020 and 2019 year-to-date, respectively.
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Operating Expenses
Operating expenses increased $36.7 million, or 5.0%, to $774.4 million, or 11.61% of net sales, for the third quarter of fiscal 2020 compared to $737.7 million, or 12.37% of net sales, for the third quarter of fiscal 2019. Operating expenses for the third quarter of fiscal 2020 included $1.4 million of surplus property depreciation expense. The decrease in Operating expenses as a percent of net sales was driven by leveraging fixed operating and administrative expenses and the benefit of synergy and integration efforts, partially offset by incremental costs related to COVID-19, including the impact of temporary pandemic-related incentives and additional costs for safety protocols and procedures at the Company’s distribution centers. Total operating expenses also included share-based compensation expense of $12.8 million and $9.3 million for the third quarter of fiscal 2020 and 2019, respectively.
Operating expenses increased $447.9 million, or 24.2%, to $2,300.6 million, or 12.22% of net sales, for fiscal 2020 year-to-date compared to $1,852.8 million, or 12.37% of net sales, for fiscal 2019 year-to-date. The increase in Operating expenses in fiscal 2020 year-to-date primarily reflects the incremental contribution from the Supervalu business for an additional 12 weeks when compared to fiscal 2019 year-to-date. Operating expenses for fiscal 2020 year-to-date included $26.8 million of customer bankruptcy bad debt expense. In addition, Operating expenses in fiscal 2020 year-to-date included $12.5 million of notes receivable charges, $6.6 million of surplus property depreciation expense and a $1 million legal reserve charge. The decrease in operating expenses, as a percent of net sales, was driven by fixed and variable expense leveraging and the mix impact from the acquired Supervalu business and lower employee costs, including the impact of cost synergies, partially offset by higher bad debt, occupancy and depreciation expenses. Total operating expenses also included share-based compensation expense of $21.3 million and $27.8 million for fiscal 2020 and 2019 year-to-date, respectively.
Goodwill and Asset Impairment (Adjustment) Charges
A goodwill impairment adjustment of $38.3 million was recorded in the third quarter of fiscal 2019, which was attributable to changes in the preliminary fair value of net assets, which affected the initial goodwill resulting from the Supervalu acquisition.
Goodwill and asset impairment charges of $425.4 million were recorded for fiscal 2020 year-to-date, which reflects $421.5 million from an impairment charge on the remaining goodwill attributable to the U.S. Wholesale goodwill reporting unit, $2.5 million related to purchase accounting adjustments to finalize the opening balance sheet goodwill and $1.4 million of property and equipment asset impairment charges. Goodwill and asset impairment charges of $332.6 million were recorded for fiscal 2019 year-to-date, which reflects a portion of the goodwill recorded from the Supervalu acquisition.
Refer to the Executive Overview section above, and Note 6—Goodwill and Intangible Assets in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information on goodwill impairment charges.
Restructuring, Acquisition and Integration Related Expenses
Restructuring, acquisition and integration related expenses were $10.4 million for the third quarter of fiscal 2020, which included $8.4 million of closed property reserve charges and costs primarily related to lease asset impairments, $1.5 million of restructuring costs and $0.6 million of integration costs. Expenses incurred were $19.4 million for the third quarter of fiscal 2019, which included $12.3 million of employee related costs and charges due to severance, settlement of outstanding equity awards and benefits costs, and $6.1 million of other acquisition and integration related costs and $1.1 million of closed property reserve charges related to the divestiture of retail banners.
Restructuring, acquisition and integration related expenses were $54.4 million for fiscal 2020 year-to-date and primarily included $25.3 million of integration costs including a multiemployer pension plan withdrawal obligation, $25.1 million of closed property reserve charges and costs primarily related to lease asset impairments on surplus properties and Shoppers store lease exits and $4.0 million of restructuring costs. Expenses incurred in fiscal 2019 year-to-date were $134.6 million and primarily included $66.4 million of employee related costs due to change-in-control payments made to satisfy outstanding equity awards, severance costs, and benefits costs, $47.5 million of other acquisition and integration related costs, and $20.6 million closed property reserve charges related to the divestiture of retail banners.
We may incur additional integration and restructuring costs through the remainder of fiscal 2020 related to our operational and administrative restructuring to achieve cost synergies and supply chain efficiencies of continuing operations. In addition, further restructuring costs may be incurred related to the divestiture of retail operations.
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Operating Income (Loss)
Reflecting the factors described above, operating income increased $2.0 million to $71.7 million for the third quarter of fiscal 2020, from $69.7 million for the third quarter of fiscal 2019. The operating income increase was primarily driven by an increase in gross profit and lower restructuring, acquisition and integration related expenses, partially offset by the goodwill impairment adjustment.
Reflecting the factors described above, operating loss increased $20.1 million, to an operating loss of $377.4 million for fiscal 2020 year-to-date, from $357.3 million for fiscal 2019 year-to-date. The increase in operating loss was primarily driven by the increase in goodwill impairment charges and increases in operating expenses in excess of gross profit increases, partially offset by lower restructuring, acquisition and integration related expenses.
The operating loss for the third quarter and year-to-date of fiscal 2020 includes $9.1 million and $33.5 million, respectively, of operating lease rent expense and $0.9 million and $4.6 million, respectively, of depreciation and amortization expenses related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations, as we expect to remain primarily obligated under these leases. In addition, continuing operations operating loss includes certain retail related overhead costs that are related to retail but are required to be presented within continuing operations.
Total Other Expense, Net
13-Week Period Ended | 39-Week Period Ended | |||||||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | May 2, 2020 | April 27, 2019 | ||||||||||||
Net periodic benefit income, excluding service cost | $ | (12,758 | ) | $ | (10,941 | ) | $ | (27,419 | ) | $ | (22,691 | ) | ||||
Interest expense on long-term debt, net of capitalized interest | 41,512 | 45,594 | 127,781 | 96,442 | ||||||||||||
Interest expense on finance and direct financing lease obligations | 2,974 | 4,455 | 7,238 | 10,488 | ||||||||||||
Amortization of financing costs and discounts | 3,837 | 4,666 | 11,570 | 10,181 | ||||||||||||
Debt refinancing costs and unamortized financing charges | — | 395 | 73 | 4,561 | ||||||||||||
Interest income | (1,215 | ) | (193 | ) | (1,415 | ) | (523 | ) | ||||||||
Interest expense, net | 47,108 | 54,917 | 145,247 | 121,149 | ||||||||||||
Other, net | (973 | ) | 958 | (1,539 | ) | 231 | ||||||||||
Total other expense, net | $ | 33,377 | $ | 44,934 | $ | 116,289 | $ | 98,689 | ||||||||
Net periodic benefit income, excluding service costs reflects the recognition of expected returns on benefit plan assets in excess of interest costs. Net periodic benefit income for fiscal 2020 year-to-date includes a $10.3 million non-cash pension settlement charge from the lump sum pension settlement offering completed in the second quarter of fiscal 2020. Fiscal 2019 year-to-date net periodic benefit income reflects a partial year due to the acquisition of Supervalu near the end of the first quarter of fiscal 2019.
The decrease in interest expense on long-term debt in the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019 was primarily due to lower average amounts of outstanding debt and lower average interest rates. The increase in interest expense on long-term debt for fiscal 2020 year-to-date compared to fiscal 2019 year-to-date was primarily due to an increase in average outstanding debt driven by Supervalu acquisition financing executed near the end of the first quarter of fiscal 2019.
Interest on finance and direct financing leases primarily reflects lease obligations related to retail stores of discontinued operations acquired in the Supervalu acquisition, but for which GAAP requires the expense to be included within continuing operations, as we expect to remain primarily obligated under these leases until settlement with the respective landlords. Beginning in the third quarter of fiscal 2020, interest on financing leases includes interest related to a distribution center for which we executed a purchase option with a delayed purchase provision.
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Benefit for Income Taxes
The effective income tax rate for continuing operations was a benefit of 38.7% compared to a benefit of 32.4% on pre-tax income for the third quarters of fiscal 2020 and 2019, respectively. The change in the effective income tax rate for the third quarter of fiscal 2020 was primarily driven by a tax benefit recorded on net operating loss deferred tax assets in the third quarter of fiscal 2020 in connection with the CARES Act, discussed above. The tax provision included $26.9 million and $3.2 million of discrete tax benefit for the third quarter of fiscal 2020 and fiscal 2019, respectively. The discrete tax benefit for the third quarter of fiscal 2020 was primarily due to a tax benefit of approximately $28.4 million driven by a tax benefit recorded on net operating loss deferred tax assets in the third quarter of fiscal 2020 in connection with the CARES Act, discussed above.
The effective income tax rate for continuing operations was a benefit of 21.5% compared to a benefit of 22.8% on pre-tax losses for fiscal 2020 year-to-date and fiscal 2019 year-to-date, respectively. The decrease in the effective income tax benefit rate was primarily driven by a tax benefit of approximately $8.3 million recorded in fiscal 2019 for the release of unrecognized tax positions that did not recur in fiscal 2020, as well as a goodwill impairment benefit of approximately $72.2 million recorded in fiscal 2019 compared to a goodwill impairment benefit of approximately $66.4 million recorded in fiscal 2020. In addition, effective income tax rate for fiscal 2020 includes a benefit of approximately $28.4 million related to revaluation of net operating loss deferred tax assets in connection with the CARES Act.
Income from Discontinued Operations, Net of Tax
The results of operations for the third quarter of fiscal 2020 reflect net sales of $667.0 million for which we recognized $187.8 million of gross profit and Income from discontinued operations, net of tax of $37.2 million. As noted above, pre-tax income for the third quarter of fiscal 2020 from discontinued operations excludes $9.1 million of operating lease rent expense related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations. In addition, store closure charges related to leases are recorded within continuing operations. Discontinued operations included $8.1 million of restructuring expenses primarily related to store closures charges and expenses related to exited locations, and asset impairment charges related to store exits and impairment reviews discussed above. Net sales and gross profit of discontinued operations increased $26.9 million and $10.9 million, respectively, for the third quarter of fiscal 2020 as compared to last year primarily due to an increase in identical store sales results driven by the impacts of the COVID-19 pandemic, which was partially offset by the lower store base operating in the third quarter of fiscal 2020 compared to last year.
The results of operations for fiscal 2020 year-to-date reflect net sales of $1,891.5 million for which we recognized $520.3 million of gross profit and Income from discontinued operations, net of tax of $64.3 million. As noted above, pretax income for fiscal 2020 year-to-date excludes $33.5 million of operating lease rent expense related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations. In addition, store closure charges related to leases are recorded within continuing operations. Discontinued operations included $40.3 million of primarily related to store closures charges and expenses, and asset impairment charges related to exited locations. Net sales and gross profit of discontinued operations increased $477.8 million and $137.9 million, respectively, for the fiscal 2020 year-to-date as compared to last year primarily due the incremental twelve weeks of discontinued operations and an increase in identical store sales resulting driven by the impacts of the COVID-19 pandemic, which was partially offset by the lower store base operating during fiscal 2020 year-to-date compared to last year.
Refer to the section above Executive Overview—Divestiture of Retail Operations and to Note 18—Discontinued Operations in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional financial information regarding these discontinued operations.
Net Income (Loss) Attributable to United Natural Foods, Inc.
Reflecting the factors described in more detail above, net income attributable to United Natural Foods, Inc. was $88.1 million, or $1.60 per diluted common share, for the third quarter of fiscal 2020, compared to net income of $57.1 million, or $1.12 per diluted common share, for the third quarter of fiscal 2019.
Reflecting the factors described in more detail above, we incurred a net loss attributable to United Natural Foods, Inc. of $326.5 million, or $6.10 per diluted common share, for fiscal 2020 year-to-date, compared to net loss of 303.9 million, or $5.99 per diluted common share, for fiscal 2019 year-to-date, primarily due to goodwill impairment charges.
As described in more detail in Note 12—Share-Based Awards in Part I, Item I of this Quarterly Report on Form 10-Q, in the second quarter of fiscal 2020, we granted restricted stock units and performance share units representing a right to receive an aggregate of 5.8 million shares of common stock under our 2020 Equity Incentive Plan.
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As described in more detail within Note 13—Share-Based Awards in Part II, Item 8 of the Annual Report on Form 10-K, in fiscal 2019 we issued approximately 2.0 million shares of common stock, of which 0.3 million shares were issued through the third quarter of fiscal 2019, to fund the settlement of time-vesting replacement award obligations from the Supervalu acquisition, which has had a dilutive effect on our weighted average earnings per share as compared to last year. During the third quarter of fiscal 2020, the Company issued approximately 1.1 million shares of common stock at an average market price of $11.12 per share for $12.2 million of cash. Proceeds from these issuances were used to fund settlement of replacement award obligations. As of May 2, 2020, we have approximately 1.7 million additional shares authorized for issuance and registered with the SEC in order to satisfy replacement award and option issuance obligations.
LIQUIDITY AND CAPITAL RESOURCES
Highlights
• | Total liquidity as of May 2, 2020 was $1.21 billion and was comprised of the following: |
◦ | Unused credit under our revolving line of credit was $1,153.9 million as of May 2, 2020, which increased $234.7 million from $919.2 million as of August 3, 2019, primarily due to net payments made on the ABL Credit Facility as cash flow generated from the business was utilized to reduce outstanding debt. |
◦ | Cash and cash equivalents was $56.4 million as of May 2, 2020, which increased $14.1 million from $42.4 million as of August 3, 2019. |
• | We paid the remaining maturities under our 364-day Term Loan Facility in the first quarter of fiscal 2020, and as a result, we have no material scheduled maturities due until fiscal 2024, although prepayments may be required upon the occurrence of specified events as discussed in Note 9—Long-Term Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q. |
• | Our total debt decreased $345.6 million to $2,560.9 million as of May 2, 2020 from $2,906.5 million as of August 3, 2019, primarily related to net payments made on the ABL Credit Facility and our 364-day Term Loan Facility payment. |
• | Scheduled debt maturities are expected to be $7.6 million for the remainder of fiscal 2020 and payments to reduce finance lease obligations are expected to be approximately $3.3 million for the remainder of fiscal 2020. Proceeds from the sale of any properties mortgaged and encumbered under our Term Loan Facility are required to, and will, be used to make additional Term Loan Facility payments. |
• | We expect to be able to fund near-term debt maturities through fiscal 2023 with internally generated funds, proceeds from asset sales or borrowings under the ABL Credit Facility. |
• | Working capital decreased $213.1 million to $1,245.9 million as of May 2, 2020 from $1,459.0 million as of August 3, 2019, primarily due to an increase in accounts payable resulting from inventory being sold through faster than payments are made to vendors, the adoption of the new lease standard from the recognition of a new current portion liability for operating leases, the payment of a current maturity under the Term Loan Facility and inventory reductions, offset in part by increases in accounts receivable. |
Sources and Uses of Cash
We expect to continue to replenish operating assets and pay down debt obligations with internally generated funds and sale of surplus and/or non-core assets. A significant reduction in operating earnings or the incurrence of operating losses could have a negative impact on our operating cash flow, which may limit our ability to pay down our outstanding indebtedness as planned. Our credit facilities are secured by a substantial portion of our total assets.
Our primary sources of liquidity are from internally generated funds and from borrowing capacity under our credit facilities. Our short-term and long-term financing abilities are believed to be adequate as a supplement to internally generated cash flows to satisfy debt obligations and fund capital expenditures as opportunities arise. Our continued access to short-term and long-term financing through credit markets depends on numerous factors, including the condition of the credit markets and our results of operations, cash flows, financial position and credit ratings.
Primary uses of cash include debt service, capital expenditures, working capital maintenance and income tax payments. We typically finance working capital needs with cash provided from operating activities and short-term borrowings. Inventories are managed primarily through demand forecasting and replenishing depleted inventories.
We currently do not pay a dividend on our common stock, and have no current plans to do so. In addition, we are limited in the aggregate amount of dividends that we may pay under the terms of our Term Loan Facility and our ABL Credit Facility.
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Long-Term Debt
During fiscal 2020 year-to-date, we repaid a net $264.0 million under the ABL Credit Facility and repaid $87.4 million of scheduled maturities under the Term Loan Facility. Refer to Note 9—Long-Term Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q for a detailed discussion of the provisions of our credit facilities and certain long-term debt agreements and additional information.
Our Term Loan Agreement does not include any financial maintenance covenants. Our ABL Loan Agreement subjects us to a fixed charge coverage ratio (as defined in the ABL Loan Agreement) of at least 1.0 to 1.0, calculated at the end of each of our fiscal quarters on a rolling four quarter basis, when the adjusted aggregate availability (as defined in the ABL Loan Agreement) is ever less than the greater of (i) $235.0 million and (ii) 10% of the aggregate borrowing base. We have not been subject to the fixed charge coverage ratio covenant under the ABL Loan Agreement, including through the filing date of this Quarterly Report. The ABL Loan Agreement and the Term Loan Agreement contain certain customary operational and informational covenants. If we fail to comply with any of these covenants, we may be in default under the applicable loan agreement, and all amounts due thereunder may become immediately due and payable.
Derivatives and Hedging Activity
We enter into interest rate swap contracts from time to time to mitigate our exposure to changes in market interest rates as part of our overall strategy to manage our debt portfolio to achieve an overall desired position of notional debt amounts subject to fixed and floating interest rates. Interest rate swap contracts are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures.
As of May 2, 2020, we had an aggregate of $2.09 billion of notional debt hedged through pay fixed and receive floating interest rate swap contracts to effectively fix the LIBOR component of our floating LIBOR based debt at fixed rates ranging from 0.454% to 2.959%, with maturities between May 2020 and October 2025. The fair values of these interest rate derivatives represents a total net liability of $140.4 million and are subject to volatility based on changes in market interest rates. See Note 8—Derivatives in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information.
From time to time, we enter into fixed price fuel supply agreements and foreign currency hedges. As of May 2, 2020, we had fixed price fuel contracts outstanding and foreign currency forward agreements outstanding. Gains and losses and the outstanding net asset from these arrangements are insignificant.
Capital Expenditures
Our capital expenditures for fiscal 2020 year-to-date were $118.2 million, compared to $137.0 million for fiscal 2019 year-to-date, a decrease of $18.8 million. Fiscal 2020 year-to-date includes capital expenditures for distribution center expansions of approximately $33 million (primarily the Ridgefield, WA expansion), new distribution centers of approximately $21 million, and information technology, equipment and other. We estimate we will spend approximately $190 million for fiscal 2020. Fiscal 2020 capital spending is expected to include projects that optimize and expand our distribution network and our technology platform. Longer term, capital spending is expected to be at or below 1.0% of net sales. We expect to finance requirements with cash generated from operations and borrowings under our ABL Credit Facility. Future investments may be financed through long-term debt or borrowings under our ABL Credit Facility.
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Cash Flow Information
The following summarizes our Condensed Consolidated Statements of Cash Flows:
39-Week Period Ended | |||||||||||
(in thousands) | May 2, 2020 | April 27, 2019 | Change | ||||||||
Net cash provided by operating activities of continuing operations | $ | 311,138 | $ | 6,374 | $ | 304,764 | |||||
Net cash used in investing activities of continuing operations | (91,599 | ) | (2,249,817 | ) | 2,158,218 | ||||||
Net cash (used in) provided by financing activities of continuing operations | (362,960 | ) | 2,140,607 | (2,503,567 | ) | ||||||
Net cash flows from discontinued operations | 157,185 | 120,627 | 36,558 | ||||||||
Effect of exchange rate on cash | (290 | ) | (226 | ) | (64 | ) | |||||
Net increase in cash and cash equivalents | 13,474 | 17,565 | (4,091 | ) | |||||||
Cash and cash equivalents, at beginning of period | 45,263 | 23,315 | 21,948 | ||||||||
Cash and cash equivalents at end of period | $ | 58,737 | $ | 40,880 | $ | 17,857 | |||||
The increase in net cash provided by operating activities of continuing operations was primarily due to higher amounts of cash provided in fiscal 2020 year-to-date related to working capital benefits from the sell through of inventory and collection of receivables faster than payments were made on accounts payable related to inventory. In fiscal 2019 year-to-date, we benefited from the reduction of the seasonally high levels of inventory and accounts receivable at the time of the Supervalu acquisition; however, these cash inflows were offset in part by decreases from cash payments made in fiscal 2019 year-to-date for assumed liabilities and the payment of transaction costs from the Supervalu acquisition, including transaction-related expenses, accrued employee costs, and restructuring costs associated with reductions in force.
The decrease in net cash used in investing activities of continuing operations was primarily due to $2,282.3 million of cash paid to purchase Supervalu in fiscal 2019 year-to-date, partially offset by $149.7 million of less cash received from the sale of property and equipment, primarily due to cash received from the sale and leaseback of two distribution centers in fiscal 2019 year-to-date, one of which was a short-term lease related to the exit of that facility.
The decrease in net cash provided by financing activities of continuing operations was primarily due to fiscal 2019 year-to-date borrowings on long-term debt to finance the Supervalu acquisition, and a net decrease in cash provided by the revolving credit facility borrowings of $1,270.9 million, which was driven by borrowings to finance the Supervalu acquisition in fiscal 2019 year-to-date, offset in part by net payments made in fiscal 2020 year-to-date from operating activities cash flows in excess of investing activities. These decreases in cash provided by financing activities, were offset in part by a decrease in payments of long-term debt and finance lease obligations of $625.0 million driven by the repayment of acquired senior notes in fiscal 2019 year-to-date and $62.6 million of payments for debt issuance costs in fiscal 2019 year-to-date.
Net cash flows from discontinued operations primarily include operating activity cash flow from operating income of the retail disposal groups. The increase in net cash flows from discontinued operations is primarily due to cash flows generated from operations in fiscal 2020 year-to-date as a result of higher earnings, inventory sell through and an increase in accounts payable, which was partially offset by higher proceeds received in fiscal 2019 year-to-date related to the sale of retail locations, including Hornbacher’s, than proceeds received in fiscal 2020 year-to-date, including proceeds from the sale of a former dedicated retail distribution center and retail stores.
Other
On October 6, 2017, we announced that our Board of Directors authorized a share repurchase program for up to $200.0 million of our outstanding common stock. The repurchase program is scheduled to expire upon our repurchase of shares of our common stock having an aggregate purchase price of $200.0 million. We did not purchase any shares of our common stock in fiscal 2020 and 2019 year-to-date pursuant to the share repurchase program. As of May 2, 2020, we have $175.8 million remaining authorized under the share repurchase program. We do not expect to purchase shares under the share repurchase program during fiscal 2020.
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Pension and Other Postretirement Benefit Obligations
In fiscal 2020, $8.3 million of minimum pension contributions are required to be made under the Unified Grocers, Inc. Cash Balance Plan under Employee Retirement Income Security Act of 1974, as amended (“ERISA”). No minimum pension contributions are required to be made to the SUPERVALU Retirement Plan under ERISA in fiscal 2020. We anticipate fiscal 2020 discretionary pension contributions and required minimum other postretirement benefit plan contributions to be approximately $0.0 million and $6.0 million, respectively. We fund our defined benefit pension plans based on the minimum contribution amount required under ERISA, the Pension Protection Act of 2006 and other applicable laws, as determined by us, including our external actuarial consultant, and additional contributions made at our discretion. We may accelerate contributions or undertake contributions in excess of the minimum requirements from time to time subject to the availability of cash in excess of operating and financing needs or other factors as may be applicable. We assess the relative attractiveness of the use of cash to accelerate contributions considering such factors as expected return on assets, discount rates, cost of debt, reducing or eliminating required Pension Benefit Guaranty Corporation variable rate premiums, or in order to achieve exemption from participant notices of underfunding.
Lump Sum Pension Settlement
On August 1, 2019, the Company amended the SUPERVALU Retirement Plan to provide for a lump sum settlement window. On August 2, 2019, the Company sent plan participants lump sum settlement election offerings that committed the plan to pay certain deferred vested pension plan participants and retirees, who make such an election, a lump sum payment in exchange for their rights to receive ongoing payments from the plan. The lump sum payment amounts are equal to the present value of the participant’s pension benefits, and were made to certain former (i) retired associates and beneficiaries who are receiving their monthly pension benefit payment and (ii) terminated associates who are deferred vested in the plan, had not yet begun receiving monthly pension benefit payments and who are not eligible for any prior lump sum offerings under the plan. Benefit obligations associated with the lump sum offering have been incorporated into the funded status utilizing the actuarially determined lump sum payments based on estimated offer acceptances. The plan made aggregate lump sum settlement payments of $664.0 million to plan participants during the second quarter of fiscal 2020. The lump sum settlement payments resulted in a non-cash pension settlement charge of $10.3 million in the second quarter of fiscal 2020 from the acceleration of a portion of the accumulated unrecognized actuarial loss, which was based on the fair value of SUPERVALU Retirement Plan assets and remeasured liabilities. As a result of the settlement payments, the SUPERVALU Retirement Plan obligations were remeasured using a discount rate of 3.1 percent and the MP-2019 mortality improvement scale. This remeasurement resulted in a $1.5 million decrease to Accumulated other comprehensive loss.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET ARRANGEMENTS
Off-Balance Sheet Arrangements
Guarantees and Contingent Liabilities
We have outstanding guarantees related to certain leases, fixture financing loans and other debt obligations of various retailers as of May 2, 2020. We are contingently liable for leases that have been assigned to various parties in connection with facility closings and dispositions. We are also a party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters in the ordinary course of business, which indemnities may be secured by operation of law or otherwise. Refer to Note 17—Commitments, Contingencies and Off-Balance Sheet Arrangements under the caption Guarantees and Contingent Liabilities in Part I, Item I of this Quarterly Report on Form 10-Q for further information regarding our outstanding guarantees and contingent liabilities.
Multiemployer Benefit Plans
We contribute to various multiemployer pension plans under collective bargaining agreements, primarily defined benefit pension plans. These multiemployer plans generally provide retirement benefits to participants based on their service to contributing employers. The benefits are paid from assets held in trust for that purpose. Plan trustees typically are responsible for determining the level of benefits to be provided to participants as well as the investment of the assets and plan administration. Trustees are appointed in equal number by employers and unions that are parties to the collective bargaining agreement. Based on the assessment of the most recent information available from the multiemployer plans, we believe that most of the plans to which we contribute are underfunded. We are only one of a number of employers contributing to these plans and the underfunding is not a direct obligation or liability to us.
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Our contributions can fluctuate from year to year due to store closures, employer participation within the respective plans and reductions in headcount. Our contributions to these plans could increase in the near term. However, the amount of any increase or decrease in contributions will depend on a variety of factors, including the results of our collective bargaining efforts, investment returns on the assets held in the plans, actions taken by the trustees who manage the plans and requirements under the Pension Protection Act of 2006, the Multiemployer Pension Reform Act and Section 412(e) of the Internal Revenue Code.
Expense is recognized in connection with these plans as contributions are funded, in accordance with GAAP. We made contributions to these plans, and recognized continuing and discontinued operations expense, of $41 million in fiscal 2019. In fiscal 2020, we expect to contribute approximately $37 million related to continuing operations contributions to the multiemployer pension plans, subject to the outcome of collective bargaining and capital market conditions. Furthermore, if we were to significantly reduce contributions, exit certain markets or otherwise cease making contributions to these plans, it could trigger a partial or complete withdrawal that would require us to record a withdrawal liability. Any withdrawal liability would be recorded when it is probable that a liability exists and can be reasonably estimated, in accordance with GAAP. Any triggered withdrawal obligation could result in a material charge and payment obligations that would be required to be made over an extended period of time.
We also make contributions to multiemployer health and welfare plans in amounts set forth in the related collective bargaining agreements. A small minority of collective bargaining agreements contain reserve requirements that may trigger unanticipated contributions resulting in increased healthcare expenses. If these healthcare provisions cannot be renegotiated in a manner that reduces the prospective healthcare cost as we intend, our Operating expenses could increase in the future.
Refer to Note 14—Benefit Plans in Part II, Item 8 of the Annual Report on Form 10-K for additional information regarding the plans in which we participate.
Contractual Obligations
Except as otherwise disclosed in Note 9—Long-Term Debt and Note 11—Leases in Part I, Item 1 of this Quarterly Report on Form 10-Q, there have been no material changes in the Company’s contractual obligations since the end of fiscal 2019. Refer to Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended August 3, 2019 for additional information regarding the Company’s contractual obligations.
Critical Accounting Policies and Estimates
There were no material changes to our critical accounting policies during the period covered by this Quarterly Report on Form 10-Q. Refer to the description of critical accounting policies included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended August 3, 2019.
Seasonality
Generally, we do not experience any material seasonality. However, our inventory levels and related demand for certain products of a seasonal nature may be influenced by holidays, changes in seasons or other annual events. In addition, 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 our products, supply shortages and general economic conditions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk results primarily from fluctuations in interest rates on our borrowings and our interest rate swap agreements, and price increases in diesel fuel. Except as described in Note 8—Derivatives and Note 9—Long-Term Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q, there have been no other material changes to our exposure to market risks from those disclosed in our Annual Report.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. We carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective.
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(b) Changes in internal controls. On October 22, 2018, we completed the acquisition of Supervalu. We have extended our Section 404 compliance program under the Sarbanes-Oxley Act of 2002 and the applicable rules and regulations under such Act to include Supervalu. We will report on its assessment of the effectiveness of internal control over financial reporting for the combined operations as of August 1, 2020. We are currently in process of integrating Supervalu’s internal controls over financial reporting. In the first quarter of fiscal 2020, we adopted ASU 2016-02, Leases, and updated our accounting policies and implemented new internal controls in conjunction with the new lease standard. Except for the ongoing integration of Supervalu and the new lease standard adoption, there has been no change in our internal control over financial reporting that occurred during the third quarter of fiscal 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we are involved in routine litigation or other legal proceedings that arise in the ordinary course of our business, including investigations and claims regarding employment law, pension plans, unfair labor practices, labor union disputes, supplier, customer and service provider contract terms, real estate and antitrust. Other than as set forth below and in Note 17—Commitments, Contingencies and Off-Balance Sheet Arrangements in Part I, Item I of this Quarterly Report on Form 10-Q, there are no pending material legal proceedings to which we are a party or to which our property is subject.
In 2016, as part of a hazardous waste enforcement campaign by the California Attorney General’s Office and local district attorneys, Unified Grocers received a subpoena from the Yolo County District Attorney regarding hazardous waste management and storage at its Stockton and Commerce, California distribution centers. We have provided requested documents and cooperated fully with the investigation. On May 24, 2018, the District Attorney toured the Stockton distribution center and generally found the distribution center to be in compliance, and minor items noted regarding labeling have been addressed. We are in negotiations with the District Attorney to reach a settlement, which we expect will be immaterial in amount but may include penalties of $100,000 or more.
Item 1A. Risk Factors
Except as described below, there have been no material changes to our risk factors contained in Part I, Item 1A. Risk Factors, of our Annual Report on Form 10-K for the fiscal year ended August 3, 2019.
Pandemics or disease outbreaks, such as the COVID-19 pandemic, may disrupt our business, including among other things, increasing our costs, impacting our supply chain, and driving change in customer and consumer demand for our products, and could have a material adverse impact on our business.
The outbreak of COVID-19 in the United States and Canada has had sudden and significant impacts on our industry, including increased demand for the products we distribute as consumers began pantry loading and food-at-home increased due to social distancing and stay-at-home orders. This increased wholesale customer and end-consumer demand may decrease relative to current levels if and when the need for social distancing and stay-at-home mandates decreases, and we are unable to predict the nature and timing of when that impact may occur. These measures have also had an adverse impact on the economies of North America. The ultimate impact of COVID-19 on our business and the economy, and the duration thereof, is uncertain.
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Our business may be negatively impacted as a result of the COVID-19 outbreak. For example, we have incurred, and expect to continue to incur, increased costs, including: labor costs resulting from the payment of temporary state of emergency bonuses that we implemented in March 2020, overtime, paid sick leave, or leaves of absence; costs associated with safety measures throughout our facilities, including enhanced sanitation, social distancing practices, such as partitions, decals, pre-shift temperature screenings, and the provision of personal protective equipment to our associates; and other operating costs due to short-term significant increases in demand spikes. If there were a rapid reduction in demand for the products we distribute, and we were unable to sufficiently reduce these costs, our results may be negatively impacted. We have experienced higher than usual levels of out-of-stocks leading to reduced fill rates, which may result in higher costs, fees, or penalties. We have experienced temporary facility closures due to outbreaks, and we may experience future facility closures due to additional outbreaks, reduced workforce or government mandates. Changes in consumer purchasing habits, including potential reduced sales to our wholesale customer in the future due to previous pantry-loading activities that occurred in the third fiscal quarter of 2020 may negatively impact our results. In addition, our business could be negatively impacted by reduced workforces due to illness or other restrictions related to COVID-19; a shortage of qualified labor to support meeting increased demand; any failure of third parties on which we rely, including our suppliers, contract manufacturers, contractors and external business partners to meet their obligations to us, or significant disruptions in their ability to do so; or diversion of management’s attention, including if any key employee becomes ill, and resources primarily focused on reducing operating expenses may be redirected. We cannot predict the duration of the impact of COVID-19 or any related policies, such as stay-at-home orders or business or school closures. In the near term, we expect our inventory and sales levels to stabilize to higher than pre-COVID levels, and we expect to utilize cash flow to pay down accounts payable, which would result in higher levels of inventory and accounts receivable than prior to the pandemic. If there were a rapid reduction in demand for the products we distribute, our results and cash flows may be negatively impacted if we are unable to monetize working capital.
Any of the foregoing factors, or other effects of the coronavirus pandemic that are not currently foreseeable, could materially increase our costs, negatively impact our sales and damage the Company’s financial condition, results of operations, cash flows and its liquidity position, possibly to a significant degree. Our efforts to manage and mitigate these factors may be unsuccessful, and the effectiveness of these efforts depends on factors beyond our control.
The ultimate impact of the COVID-19 pandemic on our business will depend on many factors, including, among others, the duration of social distancing and stay-at-home mandates and whether additional waves of COVID-19 will affect the United States and Canada, our ability and the ability of our suppliers to continue to operate manufacturing facilities and maintain the supply chain without material disruption, and the extent to which macroeconomic conditions resulting from the pandemic and the pace of the subsequent recovery may impact consumer eating and purchasing habits. We cannot predict the duration or scope of the disruption. Therefore, the ultimate financial impact cannot be reasonably estimated at this time.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On October 6, 2017, we announced that our Board of Directors authorized a share repurchase program for up to $200.0 million of our outstanding common stock. The repurchase program is scheduled to expire upon our repurchase of shares of our common stock having an aggregate purchase price of $200.0 million. Repurchases will be made in accordance with applicable securities laws from time to time in the open market, through privately negotiated transactions, or otherwise. We may also implement all or part of the repurchase program pursuant to a plan or plans meeting the conditions of Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.
(in millions, except shares and per share amounts) | Total Number of Shares Purchased(2) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs(3) | ||||||||||
Period(1): | ||||||||||||||
February 2, 2020 to February 29, 2020 | — | $ | — | — | $ | — | ||||||||
March 1, 2020 to March 28, 2020 | 16,190 | 7.39 | — | — | ||||||||||
March 29, 2020 to May 2, 2020 | 9,754 | 11.94 | — | 175.8 | ||||||||||
Total | 25,944 | $ | 9.10 | — | $ | — | ||||||||
(1) | The reported periods conform to our fiscal calendar. |
(2) | These amounts represent the deemed surrender by participants in our compensatory stock plans of 25,944 shares of our common stock to cover taxes from the vesting of restricted stock awards and restricted stock units granted under such plans. |
(3) | As of May 2, 2020, there was approximately $175.8 million that may yet be purchased under the share repurchase program. There were no share repurchases under the share repurchase program in the third quarter of fiscal 2020. |
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Item 6. Exhibits
Exhibit Index
Exhibit No. | Description |
2.1 | |
2.2 | |
3.1 | |
3.2 | |
10.1** | |
10.2** | |
10.3** | |
10.4** | |
10.5** | |
31.1* | |
31.2* | |
32.1* | |
32.2* | |
101* | The following materials from the United Natural Foods, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended May 2, 2020, formatted in Inline XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Loss, (iv) Condensed Consolidated Statements of Stockholders’ Equity, (v) Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements. |
104 | The cover page from our Quarterly Report on Form 10-Q for the third quarter of fiscal 2020, filed with the SEC on June 10, 2020, formatted in Inline XBRL (included as Exhibit 101). |
______________________________________________
* Filed herewith.
** Denotes a management contract or compensatory plan or arrangement.
* * *
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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/ JOHN W. HOWARD | |
John W. Howard | |
Chief Financial Officer | |
(Principal Financial Officer) | |
Dated: June 10, 2020
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