================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 31, 2002 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 000-21531 UNITED NATURAL FOODS, INC. (Exact name of Registrant as Specified in Its Charter) Delaware 05-0376157 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 260 Lake Road Dayville, CT 06241 (Address of Principal Executive Offices) Registrant's Telephone Number, Including Area Code: (860) 779-2800 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes |X| No |_| As of December 3, 2002 there were 19,111,067 shares of the Registrant's Common Stock, $0.01 par value per share, outstanding. ================================================================================
UNITED NATURAL FOODS, INC. FORM 10-Q FOR THE QUARTER ENDED OCTOBER 31, 2002 TABLE OF CONTENTS Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets as of October 31, 2002 and July 31, 2002 3 Consolidated Statements of Operations for the quarters ended October 31, 2002 and 2001 4 Consolidated Statements of Cash Flows for the quarters ended October 31, 2002 and 2001 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Item 3. Quantitative and Qualitative Disclosure About Market Risk 18 Item 4. Controls and Procedures 18 Part II. Other Information Item 6. Exhibits and Reports on Form 8-K 19 Signatures 20 2
PART I. FINANCIAL INFORMATION Item 1. Financial Statements UNITED NATURAL FOODS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> October 31, July 31, (In thousands, except per share amounts) 2002 2002 <S> <C> <C> ASSETS Current assets: Cash $ 4,399 $ 11,184 Accounts receivable, net 86,418 84,303 Notes receivable, trade 474 513 Inventories 150,386 131,932 Prepaid expenses 6,144 4,493 Deferred income taxes 4,612 4,612 Refundable income taxes -- 58 --------- --------- Total current assets 252,433 237,095 Property & equipment, net 92,415 82,702 Other assets: Notes receivable, trade, net 1,365 956 Goodwill 45,049 31,399 Covenants not to compete, net 221 248 Deferred taxes 800 800 Other, net 1,453 1,257 --------- --------- Total assets $ 393,736 $ 354,457 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable - line of credit $ 118,186 $ 106,109 Current installments of long-term debt 1,593 1,658 Current installment of obligations under capital leases 783 1,037 Accounts payable 67,566 52,789 Accrued expenses 20,225 18,185 Financial instruments 7,326 5,620 Income taxes payable 1,838 -- --------- --------- Total current liabilities 217,517 185,398 Long-term debt, excluding current installments 10,867 7,677 Obligations under capital leases, excluding current installments 936 995 --------- --------- Total liabilities 229,320 194,070 --------- --------- Stockholders' equity: Preferred stock, $.01 par value, authorized 5,000 shares, none issued and outstanding -- -- Common stock, $.01 par value, authorized 50,000 shares, issued and outstanding 19,110 at October 31, 2002; issued and outstanding 19,106 at July 31, 2002 191 191 Additional paid-in capital 79,716 79,711 Unallocated shares of ESOP (2,054) (2,094) Retained earnings 86,563 82,579 --------- --------- Total stockholders' equity 164,416 160,387 --------- --------- Total liabilities and stockholders' equity $ 393,736 $ 354,457 ========= ========= </TABLE> See notes to consolidated financial statements. 3
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Quarter Ended October 31, ----------- (In thousands, except per share data) 2002 2001 ---- ---- Net sales $ 310,993 $280,315 Cost of sales 250,157 225,314 --------- -------- Gross profit 60,836 55,001 Operating expenses 50,843 45,024 Amortization of intangibles 38 64 Operating expenses 50,881 45,088 --------- -------- Operating income 9,955 9,913 --------- -------- Other expense (income): Interest expense 1,847 1,746 Change in fair value of financial instruments 1,706 3,787 Other, net (238) 44 --------- -------- Total other expense 3,315 5,577 --------- -------- Income before income taxes 6,640 4,336 Income taxes 2,656 1,734 --------- -------- Net income $ 3,984 $ 2,602 ========= ======== Per share data (basic): Net income $ 0.21 $ 0.14 ========= ======== Weighted average shares of common stock 19,106 18,665 ========= ======== Per share data (diluted): Net income $ 0.20 $ 0.14 ========= ======== Weighted average shares of common stock 19,434 19,060 ========= ======== See notes to consolidated financial statements. 4
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Quarter Ended October 31, ----------- (In thousands) 2002 2001 ---- ---- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,984 $ 2,602 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,370 1,814 Change in fair value of financial instruments 1,706 3,787 Gain (loss) on disposals of property and equipment 9 (3) Deferred income tax benefit -- (287) Provision for doubtful accounts 1,060 513 Changes in assets and liabilities: Accountsreceivable (227) (9,487) Inventory (4,111) (14,208) Prepaidexpenses (1,404) (643) Refundableincometaxes 58 366 Otherassets 758 (727) Notesreceivable,trade 95 141 Accountspayable 9,303 19,532 Accruedexpenses 750 6,038 Incometaxespayable 1,805 2,006 -------------------- Net cash provided by operating activities 16,156 11,444 -------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of acquired businesses, net of cash acquired (29,960) -- Proceeds from sale of property and equipment 33 16 Capital expenditures (4,313) (4,360) -------------------- Net cash used in investing activities (34,240) (4,344) -------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under note payable 12,077 12,184 Repayments of long-term debt (470) (20,188) Principal payments of capital lease obligations (312) (299) Proceeds from exercise of stock options 4 119 -------------------- Net cash provided by (used in) financing activities 11,299 (8,184) -------------------- NET DECREASE IN CASH (6,785) (1,084) Cash at beginning of period 11,184 6,393 -------------------- Cash at end of period $ 4,399 $ 5,309 ==================== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 1,823 $ 1,629 ==================== Income taxes $ 819 $ 196 ==================== </TABLE> In the quarter ended October 31, 2002 and 2001, the Company incurred $0 and $628, respectively, of capital lease obligations. See notes to consolidated financial statements. 5
UNITED NATURAL FOODS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OCTOBER 31, 2002 (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of United Natural Foods, Inc. (the "Company") and its wholly owned subsidiaries. The Company is a distributor and retailer of natural and organic foods and related products and sells its products throughout the United States. The financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission for interim financial information, including the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally required in complete financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. In our opinion, these financial statements include all adjustments necessary for a fair presentation of the results of operations for the interim periods presented. The results of operations for interim periods, however, may not be indicative of the results that may be expected for a full year. 2. INTEREST RATE SWAP AGREEMENTS In October 1998, the Company entered into an interest rate swap agreement that provides for it to pay interest for a five-year period at a fixed rate of 5% on a notional principal amount of $60 million while receiving interest for the same period at the LIBOR rate on the same notional principal amount. This swap has been entered into as a hedge against LIBOR interest rate movements on current variable rate indebtedness totaling $60 million at LIBOR plus 1.50%, thereby fixing its effective rate at 6.50%. The five-year term of the swap agreement may be extended to seven years at the option of the counter party, which prohibits accounting for the swap as an effective hedge under Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." The Company entered into an additional interest rate swap agreement effective August 1, 2001. The additional agreement provides for it to pay interest for a four-year period at a fixed rate of 4.81% on a notional principal amount of $30 million while receiving interest for the same period at the LIBOR rate on the same notional principal amount. The swap has been entered into as a hedge against LIBOR interest rate movements on current variable rate indebtedness totaling $30 million at LIBOR plus 1.50%, thereby fixing its effective rate on the notional amount at 6.31%. If LIBOR exceeds 6.0% in a given period, the agreement is suspended for that period. The four-year term of the swap agreement may be extended to six years at the option of the counter party, which prohibits accounting for the swap as an effective hedge under SFAS No. 133. The Company recorded $1.7 million and $3.8 million of expense for the quarters ended October 31, 2002 and October 31, 2001, respectively, on its interest rate swap agreements and related option agreements to reflect the change in fair value of the financial instruments. 3. STOCK OPTION PLANS The Company has adopted Statement of Financial Accounting Standards No. 123, ("SFAS 123"), "Accounting for Stock-Based Compensation." Under SFAS No. 123, companies can elect to account for stock-based compensation using a fair value based method or continue to measure compensation expense using the intrinsic value method. The Company has elected to continue to apply Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees". If the fair value method of accounting had been used for the periods ended October 31, 2002 and October 31, 2001, net income would have been $3.2 million and $2.0 million, respectively, basic earnings per share would have been $0.17 and $0.11, respectively, and diluted earnings per share would have been $0.17 and $0.11, respectively. The fair value of each option grant was estimated using the Black-Sholes Option Pricing Model with the following weighted average assumptions for the periods ended October 31, 2002 and October 31, 2001: dividend yields of 0.0% for both periods, risk free interest rates of 3.3% and 4.7%, respectively, and expected lives of five years for both periods. The expected volatility was 63.0% and 64.0%, respectively. The effects of applying SFAS No. 123 in this pro forma disclosure are not necessarily indicative of future amounts. 6
The Board of Directors adopted and the stockholders approved the 2002 Stock Incentive Plan of the Company, which provides for grants of stock options to employees, officers, directors and others, on October 2, 2002 and December 3, 2002, respectively. These options are intended to either qualify as incentive stock options within the meaning of Section 422 of the Internal Revenue Code or be "non-statutory stock options". A total of 1,400,000 shares of common stock may be issued upon the exercise of options granted under the 2002 Stock Option Plan. In the quarter ended October 31, 2002, the Company granted 25,000 shares under the 1996 Stock Option Plan. On December 3, 2002, the Company granted approximately 490,000 under the 2002 Stock Incentive Plan. 4. EARNINGS PER SHARE Following is a reconciliation of the basic and diluted number of shares used in computing earnings per share: Quarter Ended October 31, ----------- (In thousands) 2002 2001 ---- ---- Basic weighted average shares outstanding 19,106 18,665 Net effect of dilutive stock options based upon the treasury stock method 328 395 ------ ------ Diluted weighted average shares outstanding 19,434 19,060 ====== ====== Antidilutive stock options were 0 and 150 for the quarters ended October 31, 2002 and 2001, respectively. 5. ACQUISITION On October 11, 2002, the Company acquired substantially all of the assets and assumed substantially all of the liabilities of Blooming Prairie Cooperative ("Blooming Prairie"), a distributor of natural foods and related products in the Midwest region of the United States, for cash consideration of $30 million. The acquisition was financed by proceeds from the Company's line of credit. The operating results of Blooming Prairie have been included in the accompanying condensed consolidated financial statements of the Company beginning with the acquisition date. Based on a preliminary purchase price allocation, the Company has recorded goodwill of $13.7 million related to this acquisition. 6. BUSINESS SEGMENTS The Company has several operating segments aggregated under the distribution segment, which is the Company's only reportable segment. These operating segments have similar products and services, customer types, distribution methods and historical margins. The distribution segment is engaged in national distribution of natural foods, produce and related products in the United States. Other operating segments include the retail segment, which engages in the sale of natural foods and related products to the general public through retail storefronts on the east coast of the United States, and a segment engaged in importing, roasting and packaging of nuts, seeds, dried fruit and snack items. These other operating segments do not meet the quantitative thresholds for reportable segments and are therefore included in an "Other" caption in the segment information. The "Other" caption also includes corporate expenses that are not allocated to operating segments. 7
Following is business segment information for the periods indicated: <TABLE> <CAPTION> Distribution Other Eliminations Consolidated ------------ ----- ------------ ------------ <S> <C> <C> <C> <C> Quarter Ended October 31, 2002 Net sales $299,087 $ 16,890 $ (4,984) $310,993 Operating income (loss) $ 11,415 $ (1,411) $ (49) $ 9,955 Depreciation and amortization $ 2,046 $ 324 $ -- $ 2,370 Capital expenditures $ 3,914 $ 399 $ -- $ 4,313 Total assets $525,210 $ 46,841 $(178,315) $393,736 Quarter Ended October 31, 2001 Net sales $269,992 $ 15,501 $ (5,178) $280,315 Operating income (loss) $ 10,423 $ (506) $ (4) $ 9,913 Depreciation and amortization $ 1,571 $ 243 $ -- $ 1,814 Capital expenditures $ 3,994 $ 366 $ -- $ 4,360 Total assets $466,034 $ 2,187 $(141,328) $326,893 </TABLE> Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview We are the leading national distributor of natural and organic foods and related products in the United States. In recent years, our sales to existing and new customers have increased through the acquisition of or merger with natural products distributors, the expansion of existing distribution centers and the continued growth of the natural products industry in general. Through these efforts, we believe that we have been able to broaden our geographic penetration, expand our customer base, enhance and diversify our product selections and increase our market share. Our distribution operations are divided into four principal units: United Natural Foods, Inc in the Eastern Region, Mountain People's Warehouse, Inc. and Rainbow Natural Foods, Inc in the Western Region, Blooming Prairie in the Midwest and Albert's Organics in various markets in the United States. Through our subsidiary, the Natural Retail Group, we also own and operate 12 natural products retail stores located primarily in Florida. We believe our retail business serves as a natural complement to our distribution business, enabling us to develop new marketing programs and improve customer service. In addition, our Hershey Import subsidiary is a business that specializes in the international trading, roasting and packaging of nuts, seeds, dried fruits and snack items. We are continually integrating certain operating functions in order to improve operating efficiencies, including: (i) expanding marketing and customer service programs across the four regions; (ii) expanding national purchasing opportunities; (iii) consolidating systems applications among physical locations and regions; (iv) integrating administrative and accounting functions; and (v) reducing geographic overlap between regions. In addition, our continued growth has created the need for expansion and relocation of existing facilities to achieve maximum operating efficiencies and to assure adequate space for future needs. We have made considerable capital expenditures and incurred considerable expenses in connection with the expansion of our facilities located in Auburn, California, New Oxford, Pennsylvania, Los Angeles, California, and the relocation of our Atlanta, Georgia facility. At the end of fiscal year 2002, the increased capacity of our distribution centers was approximately 1,000,000 square feet greater than it was five years ago. We are in the process of expanding our Chesterfield, New Hampshire distribution facility from its existing 117,000 square feet to 289,000 square feet. This will enable us to service existing and new customers, integrate our pending acquisition of Northeast Cooperatives into existing facilities, provide more product diversity, and enable us to better balance products among our distribution centers in our Eastern Region. While operating margins may be affected in periods in which these expenses are incurred, over the long term we expect to benefit from the increased absorption of our expenses over a larger sales base. In addition, we continue to increase our leading market share of the growing natural products industry by expanding our customer base, increasing our share of existing customers' business and continuing to expand and further penetrate new distribution territories, particularly in the Midwest and Texas 8
markets. To this end, on October 11, 2002, we acquired substantially all of the assets of Blooming Prairie, the largest volume distributor of natural foods and products in the Midwest region of the United States. The acquisition of Blooming Prairie's Iowa City, Iowa and Mounds View, Minnesota distribution facilities has provided us with an immediate physical base and growth platform with which to broaden our presence in the fast growing Midwest market. On October 23, 2002, we signed an agreement to purchase Northeast Cooperatives, a distributor of natural foods and products in the Eastern United States. Northeast Cooperatives, headquartered in Brattleboro, Vermont, and in business since 1973, had approximately $125 million in sales for the latest twelve months. Consummation of the transaction is contingent upon customary closing conditions, approval by the members of Northeast Cooperatives, and approval from Northeast Cooperatives' lenders by December 14, 2002. Our net sales consist primarily of sales of natural products to retailers adjusted for customer volume discounts, returns and allowances. The principal components of our cost of sales include the amount paid to manufacturers and growers for product sold, plus the cost of transportation necessary to bring the product to our distribution facilities. Operating expenses include salaries and wages, employee benefits (including payments under our Employee Stock Ownership Plan), warehousing and delivery, selling, occupancy, insurance, administrative, depreciation and amortization expense. Other expenses (income) include interest on outstanding indebtedness, interest income, the change in fair value of financial instruments and miscellaneous income and expenses. Critical Accounting Policies The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The U.S. Securities and Exchange Commission has defined critical accounting policies as those that are both most important to the portrayal of our financial condition and results, and require our most difficult, complex or subjective judgments or estimates. Based on this definition, we believe our critical accounting policies include the policies of accounts receivable valuation and the valuation of goodwill and intangible assets. For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies. Allowance for doubtful accounts We analyze customer creditworthiness, accounts receivable and notes receivable balances, payment history, payment terms and historical bad debt levels when evaluating the adequacy of our allowance for doubtful accounts. Our accounts receivable balance was $86.4 million, net of allowance for doubtful accounts of $6.5 million, and $84.3 million, net of allowance for doubtful accounts of $5.8 million, as of October 31, 2002 and July 31, 2002, respectively. Our notes receivable balance was $1.8 million, net of allowance for doubtful accounts of $0.7 million, and $1.5 million, net of allowance of $0.2 million, as of October 31, 2002 and July 31, 2002, respectively. Valuation of goodwill and intangible assets Intangible assets consist principally of goodwill and covenants not to compete. Goodwill represents the excess purchase price over fair value of net assets acquired in connection with purchase business combinations. Covenants not to compete are initially recorded at fair value, and are amortized using the straight-line method over the lives of the respective agreements, generally five years. We adopted the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets" on August 1, 2001. Goodwill is no longer amortized and is tested annually for impairment. There can be no assurance that at our annual review a material impairment charge will not be recorded. 9
Results of Operations The following table presents, for the periods indicated, certain income and expense items expressed as a percentage of net sales: Quarter Ended October 31, ------------------ 2002 2001 ------------------ Net sales 100.0% 100.0% Cost of sales 80.4% 80.4% ------------------ Gross profit 19.6% 19.6% ------------------ Operating expenses 16.3% 16.1% ------------------ Total operating expenses 16.4% 16.1% ------------------ Operating income 3.2% 3.5% ------------------ Other expense (income): Interest expense 0.6% 0.6% Change in value of financial instruments 0.5% 1.4% Other, net (0.1)% 0.0% ------------------ Total other expense 1.1% 2.0% ------------------ Income before income taxes 2.1% 1.5% Income taxes 0.9% 0.6% ------------------ Net income 1.3% 0.9% ================== The following table presents, for the periods indicated, a reconciliation of income and per share items including special items to income and per share items excluding special items: - -------------------------------------------------------------------------------- Quarter Ended October 31, 2002 Pretax Per diluted (in thousands, except per share data) Income Net of Tax share Income, excluding special items: $8,920 $5,352 $0.28 Less: special items Interest rate swap agreements (change in value of financial instruments) 1,706 1,023 0.05 Costs related to loss of major customer (included in operating expenses) 574 345 0.02 - -------------------------------------------------------------------------------- Income, including special items: $6,640 $3,984 $0.20 ================================================================================ - -------------------------------------------------------------------------------- Quarter Ended October 31, 2001 Pretax Per diluted (in thousands, except per share data) Income Net of Tax share Income, excluding special items: $8,180 $4,908 $0.26 Less: special items Interest rate swap agreement (change in value of financial instruments) 3,787 2,272 0.12 Costs related to relocating distribution center (included in operating expenses) 57 34 -- - -------------------------------------------------------------------------------- Income, including special items: $4,336 $2,602 $0.14 ================================================================================ 10
Quarter Ended October 31, 2002 Compared To Quarter Ended October 31, 2001 Net Sales. Our net sales increased approximately 10.9%, or $30.7 million, to $311.0 million for the quarter ended October 31, 2002 from $280.3 million for the quarter ended October 31, 2001. This increase was due primarily to growth in the independent and mass-market distribution channels of approximately 11.8% and 21.4%, respectively. The supernatural distribution channel increased approximately 5.5%. Included in these increases are sales from the Blooming Prairie division, acquired on October 11, 2002, and Boulder Fruit Express, acquired on November 7, 2001. Sales growth for the quarter, excluding the effect of acquisitions, was 6.5%. Sales growth was also impacted by the transition of the Company's second-largest customer, Wild Oats, Inc., to a new primary distributor. Sales growth excluding these acquisitions and the impact of this transition was 16.5%. Sales to our two largest customers, Whole Foods Market, Inc. and Wild Oats, Inc., represented approximately 22.8% and 6.1%, respectively, of net sales for the quarter ended October 31, 2002. Whole Foods Market, Inc. represented approximately 17.7% and Wild Oats, Inc. represented approximately 14.3% of net sales for the quarter ended October 31, 2001. Whole Foods Market, Inc. has extended its current distribution arrangement through August 31, 2004. In addition, Whole Foods Market, Inc. is a member of Blooming Prairie Cooperative Warehouse, which we recently acquired, and we expect Whole Foods Market, Inc. to represent approximately 25% of our total sales in fiscal 2003. Our contract as primary distributor to Wild Oats, Inc. was not renewed past its expiration date of August 31, 2002. However, we continue to distribute to Wild Oats, Inc. and expect revenue of approximately $12 million to $20 million in fiscal 2003. We believe sales growth for the quarter ending January 31, 2003 will be in the 9% to 12% range. We believe sales growth excluding acquisitions and the effects of losing Wild Oats to a new primary distributor will be in the mid-teens. Gross Profit. Our gross profit increased approximately 10.6%, or $5.8 million, to $60.8 million for the quarter ended October 31, 2002 from $55.0 million for the quarter ended October 31, 2001. Our gross profit as a percentage of net sales was 19.6% for the quarters ended October 31, 2002 and October 31, 2001. We expect our gross margin as a percentage of sales to be in the mid- to high 19% range for the remainder of fiscal 2003. Operating Expenses. Our total operating expenses, excluding special charges, increased approximately 11.7%, or $5.3 million, to $50.3 million for the quarter ended October 31, 2002 from $45.0 million for the quarter ended October 31, 2001. As a percentage of net sales, operating expenses, excluding special charges, increased to 16.2% for the quarter ended October 31, 2002 from 16.1% for the quarter ended October 31, 2001. The increase in operating expenses was due primarily to lower productivity and higher than expected operating expenses since relocating the operations at our Hershey Import division during our last fiscal quarter. We also experienced increases in workers' compensation and commercial automobile insurance premiums. The insurance premium market is somewhat volatile, and whether there is improvement or deterioration in future quarters is largely dependent on our ability to control our automobile and workers' compensation losses, which are retained risks. Operating expenses for the quarter ended October 31, 2002 11
included special charges of $0.6 million related to the transition of our second largest customer to a new primary distributor and consisted primarily of severance and expenses related to the transfer of private label inventory. Operating expenses for the quarter ended October 31, 2001 included special charges of $0.1 million related to the relocation of our Atlanta, Georgia distribution facility. Operating expenses, including special charges, increased approximately 12.8%, or $5.8 million, to $50.9 million from $45.1 million for the quarter ended October 31, 2001. As a percentage of sales, operating expenses, including special charges, increased to 16.4% for the quarter ended October 31, 2002 from 16.1% for the quarter ended October 31, 2001. We expect operating expenses as a percentage of sales to be in the low to mid-16% range for the fiscal year 2003 due to absorption of fixed costs over a lower sales base as our Wild Oats, Inc. business is reduced and we integrate our Blooming Prairie acquisition. We expect to incur additional special charges as we increase our warehouse capacity. Operating Income. Operating income, excluding the special charges discussed above, increased $0.5 million to $10.5 million for the quarter ended October 31, 2002 from $10.0 million for the quarter ended October 31, 2001. As a percentage of sales, operating income, excluding special charges, decreased to 3.4% for the quarter ended October 31, 2002 compared to 3.6% for the quarter ended October 31, 2001. Operating income, including special charges, was $10.0 million for the quarter ended October 31, 2002 and $9.9 million for the quarter October 31, 2001. Other Expense (Income). Other expense, excluding the change in fair value of financial instruments, decreased $0.2 million to $1.6 million for the quarter ended October 31, 2002 from $1.8 million for the quarter ended October 31, 2001. Interest expense for the quarter ended October 31, 2002 was $1.8 million compared to $1.7 million for the quarter ended October 31, 2001. This increase in interest expense is due to higher debt levels substantially offset by lower interest rates. Other expense, including the change in fair value of financial instruments, decreased $2.3 million to $3.3 million for the quarter ended October 31, 2002 from $5.6 million for the quarter ended October 31, 2001. This decrease was primarily due to the decrease in the change in fair value on our interest rate swap agreements and related option agreements. We will continue to recognize either income or expense quarterly for the duration of the swap agreement until either October 2003 or 2005 for the swap agreement entered into in October 1998, and either August 2005 or 2007 for the swap agreement entered into in August 2001, depending on whether the agreements are extended by the counter party. The recognition of income or expense in any given quarter, and the magnitude of that item, is dependent on interest rates and the remaining term of the contracts. Upon expiration of any such contract, the cumulative earnings impact from the changes in fair value of the instruments will be zero. Income Taxes. Our effective income tax rate was 40.0% for the quarters ended October 31, 2002 and 2001. The effective rates were higher than the federal statutory rate primarily due to state and local income taxes. Net Income. As a result of the foregoing, net income, excluding special items, increased $0.5 million to $5.4 million, or $0.28 per diluted share, for the quarter ended October 31, 2002, compared to $4.9 million, or $0.26 per diluted share, for the quarter ended October 31, 2001. Net income, including special charges, increased $1.4 million to $4.0 million, or $0.20 per diluted share, for the quarter ended October 31, 2002, compared to $2.6 million, or $0.14 per diluted share, for the quarter ended October 31, 2001. We expect earnings per diluted share, excluding any special items, to be in the range of $0.26 to $0.28 for the second quarter of fiscal 2003, and to be in the range of $1.18 to $1.20 for all of fiscal 2003. 12
Liquidity and Capital Resources We finance operations and growth primarily with cash flows from operations, borrowings under our credit facility, seller financing of acquisitions, operating and capital leases, trade payables, bank indebtedness and the sale of equity and debt securities. Our secured revolving credit facility is $150 million. Interest accrues, at the Company's option, either at the New York Prime Rate or 1.50% above the banks' London Interbank Offered Rate. On October 23, 2002, we arranged for a temporary borrowing base increase of $15.0 million secured by real estate which increased our net borrowing base to $150 million with an unused availability of $25.1 million. Additionally, we expect to procure $30.0 million in additional long-term financing secured by our real estate during our second quarter. Net cash provided by operations was $16.2 million for the quarter ended October 31, 2002, and was the result of cash collected from customers net of cash paid to vendors, partially offset by investments in inventory. The increases in inventory levels relate to supporting increased sales with wider product assortment combined with our ability to capture purchasing efficiency opportunities in excess of total carrying costs. Days in inventory increased to 52 days at October 31, 2002 from 48 days at October 31, 2001. Days sales outstanding at October 31, 2002 was 29 days compared to 31 days at October 31, 2001. Net cash provided by operations was $11.4 million for the quarter ended October 31, 2001 and was due to cash collected from customers, net of cash paid to vendors, exceeding our investments in accounts receivable and inventory. Working capital at October 31, 2002 was $35.0 million. Net cash used in investing activities was $34.2 million for the quarter ended October 31, 2002, and was due primarily to the purchase of substantially all the assets of Blooming Prairie, headquartered in Iowa City, Iowa, and the initial costs of the expansion of our Chesterfield, New Hampshire facility. Net cash used in investing activities was $4.3 million for the same period last year, and was due primarily to the development of our new Atlanta and Los Angeles facilities. Net cash provided by financing activities was $11.3 million for the quarter ended October 31, 2002, due to increased borrowings on our line of credit and our equipment financing lines, offset by repayment of long-term debt. Net cash used in financing activities was $8.2 million for the quarter ended October 31, 2001, due to increased borrowings on our line of credit offset by repayment of long-term debt as a result of the establishment of our $150 million secured revolving credit facility. In October 1998, we entered into an interest rate swap agreement. The agreement provides for us to pay interest for a five-year period at a fixed rate of 5% on a notional principal amount of $60 million, while receiving interest for the same period at the LIBOR rate on the same notional principal amount. The swap has been entered into as a hedge against LIBOR interest rate movements on current variable rate indebtedness totaling $60 million at LIBOR plus 1.50%, thereby fixing the Company's effective rate at 6.50%. The five-year term of the swap agreement may be extended to seven years at the option of the counter party, which prohibits accounting for the swap as an effective hedge under SFAS No.133, "Accounting for Derivative Instruments and Hedging Activities." We entered into an additional interest rate swap agreement effective August 1, 2001. The additional agreement provides for us to pay interest for a four-year period at a fixed rate of 4.81% on a notional principal amount of $30 million, while receiving interest for the same period at the LIBOR rate on the same notional principal amount. The swap has been entered into as a hedge against LIBOR interest rate movements on current variable rate indebtedness totaling $30 million at LIBOR plus 1.50%, thereby fixing our effective rate on the notional amount at 6.31%. If LIBOR exceeds 6.0% in a given period, the agreement is suspended for that period. LIBOR was 1.81% as of July 31, 2002. The four-year term of the swap agreement may be extended to six years at the option of the counter party, which prohibits accounting for the swap as an effective hedge under SFAS No. 133. 13
IMPACT OF INFLATION Historically, we have been able to pass along inflation-related increases. Consequently, inflation has not had a material impact upon the results of our operations or profitability. SEASONALITY Generally, we do not experience any material seasonality. However, our sales and operating results may vary significantly from quarter to quarter due to factors such as changes in our operating expenses, management's ability to execute our operating and growth strategies, personnel changes, demand for natural products, supply shortages and general economic conditions. RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS In June 2002, the Financial Accounting Standards Board issued SFAS No 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. Certain Factors That May Affect Future Results This Form 10-Q and the documents incorporated by reference in this Form 10-Q contain forward-looking statements that involve substantial risks and uncertainties. In some cases you can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "should," "will," and "would," or similar words. You should read statements that contain these words carefully because they discuss future expectations contain projections of future results of operations or of financial position or state other "forward-looking" information. The important factors listed below as well as any cautionary language in this Form 10-Q, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations described in these forward-looking statements. You should be aware that the occurrence of the events described in the risk factors below and elsewhere in this Form 10-Q could have an adverse effect on our business, results of operations and financial position. Any forward-looking statements in this Form 10-Q and the documents incorporated by reference in this Form 10-Q are not guarantees of future performance, and actual results, developments and business decisions may differ from those envisaged by such forward-looking statements, possibly materially. We disclaim any duty to update any forward-looking statements, all of which are expressly qualified by the statement in this section. 14
Our business could be adversely affected if we are unable to integrate our acquisitions and mergers A significant portion of our historical growth has been achieved through acquisitions of or mergers with other distributors of natural products, including our acquisition of substantially all of the assets of Blooming Prairie Cooperative Warehouse on October 11, 2002. Successful integration of mergers is critical to our future operating and financial performance. Integration requires, among other things: the optimization of delivery routes, coordination of administrative, distribution and finance functions, the integration of management information systems and personnel and maintaining customer base. The integration process could divert the attention of management and any difficulties or problems encountered in the transition process could have a material adverse effect on our business, financial condition or results of operations. In addition, the process of combining companies could cause the interruption of, or a loss of momentum in, the activities of the respective businesses, which could have an adverse effect on their combined operations. We may also lose key employees of the acquired company. There can be no assurance that we will realize any of the anticipated benefits of mergers. Access to capital and the cost of that capital On October 23, 2002, we arranged for a temporary borrowing base increase of $15.0 million secured by real estate which increased our net borrowing base to $150 million with an unused availability of $25.1 million. Additionally, we expect to procure $30.0 million in additional long-term financing secured by our real estate during our second quarter. Future low cash availability levels could restrict our ability to expand our business. In order to maintain our profit margins, we rely on strategic investment buying initiatives, such as discounted bulk purchases, which require spending significant amounts of working capital. In the event that capital market turmoil significantly increases our cost of capital or limits our ability to borrow funds or raise equity capital, we could suffer reduced profit margins and be unable to grow our business organically or through acquisitions, which could have a material adverse effect on our business, financial condition or results of operations. We may have difficulty in managing our growth The growth in the size of our business and operations has placed, and is expected to continue to place, a significant strain on our management. Our future growth is limited in part by the size and location of our distribution centers. There can be no assurance that we will be able to successfully expand our existing distribution facilities or open distribution facilities in new or existing markets to facilitate growth. In addition, our growth strategy to expand our market presence includes possible additional acquisitions. To the extent our future growth includes acquisitions, there can be no assurance that we will successfully identify suitable acquisition candidates, consummate and integrate such potential acquisitions or expand into new markets. Our ability to compete effectively and to manage future growth, if any, will depend on our ability to continue to implement and improve operational, financial and management information systems on a timely basis and to expand, train, motivate and manage our work force. There can be no assurance that our personnel, systems, procedures and controls will be adequate to support our operations. Our inability to manage our growth effectively could have a material adverse effect on our business, financial condition or results of operations. 15
We have significant competition from a variety of sources We operate in competitive markets, and our future success will be largely dependent on our ability to provide quality products and services at competitive prices. Our competition comes from a variety of sources, including other distributors of natural products, as well as specialty grocery and mass-market grocery distributors. There can be no assurance that mass-market grocery distributors will not increase their emphasis on natural products and more directly compete with us or that new competitors will not enter the market. These mass-market grocery distributors may have been in business longer than us, may have substantially greater financial and other resources than us and may be better established in their markets. There can be no assurance that our current or potential competitors will not provide services comparable or superior to those provided by us or adapt more quickly than us, to evolving industry trends or changing market conditions. It is also possible that alliances among competitors may develop or that certain of our customers will increase distribution to their own retail facilities. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could materially adversely affect our business, financial condition or results of operations. There can be no assurance that we will be able to compete effectively against current and future competitors. We depend heavily on our principal customers Our current distribution arrangement with our top customer, Whole Foods Market, Inc., is effective through August 31, 2004. On June 19, 2002, we announced that our contract as primary distributor to Wild Oats, Inc. would not be renewed past its expiration date of August 31, 2002. However, we continue to distribute to Wild Oats, Inc. and expect revenue of approximately $12 million to $20 million from such distribution in fiscal 2003. Whole Foods Market, Inc. and Wild Oats, Inc. accounted for approximately 22.8% and 6.1%, respectively, of our net sales during the quarter ended October 31, 2002. On October 11, 2002, we acquired substantially all of the assets of Blooming Prairie, the largest volume distributor of natural foods and products in the Midwest region of the United States. Whole Foods Market, Inc. is a member of Blooming Prairie and we expect Whole Foods Market, Inc. to represent approximately 25% of our total sales in fiscal 2003. As a result of this concentration of our customer base, the loss or cancellation of business from Whole Foods Market, Inc. could materially and adversely affect our business, financial condition or results of operations. We sell products under purchase orders, and we generally have no agreements with or commitments from our customers for the purchase of products. No assurance can be given that our customers will maintain or increase their sales volumes or orders for the products supplied by us or that we will be able to maintain or add to our existing customer base. Our profit margins may decrease due to consolidation in the grocery industry The grocery distribution industry generally is characterized by relatively high volume with relatively low profit margins. The continuing consolidation of retailers in the natural products industry, and the growth of super natural chains, may reduce our profit margins in the future as more customers qualify for greater volume discounts. 16
Our industry is sensitive to economic downturns The grocery industry is sensitive to national and regional economic conditions, and the demand for our products may be adversely affected from time to time by economic downturns. In addition, our operating results are particularly sensitive to, and may be materially adversely affected by: difficulties with the collectibility of accounts receivable, difficulties with inventory control, competitive pricing pressures, and unexpected increases in fuel or other transportation-related costs. There can be no assurance that one or more of such factors will not materially adversely affect our business, financial condition or results of operations. We are dependent on a number of key executives Management of our business is substantially dependent upon the services of Michael S. Funk, Chief Executive Officer, Steven H. Townsend, President, Todd Weintraub, Chief Financial Officer, Kevin Michel, President of the Western Region, Daniel V. Atwood, Senior Vice President and Secretary, Richard Antonelli, Eastern Region President and other key management employees. We announced on December 3, 2002, that Steven H. Townsend has been appointed to the position of President and Chief Executive Officer effective January 1, 2003. Michael S. Funk, currently United Natural Foods' Chief Executive Officer and Vice Chair of the Board, has been elected Chair of the Board of Directors. Loss of the services of any additional officers or any other key management employee could have a material adverse effect on our business, financial condition or results of operations. Our operating results are subject to significant fluctuations Our net sales and operating results may vary significantly from period to period as a result of: changes in our operating expenses, management's ability to execute our business and growth strategies, personnel changes, demand for natural products, supply shortages, general economic conditions, changes in customer preferences and demands for natural products, including levels of enthusiasm for health, fitness and environmental issues, fluctuation of natural product prices due to competitive pressures, lack of an adequate supply of high quality agricultural products due to poor growing conditions, natural disasters or otherwise, volatility in prices of high quality agricultural products resulting from poor growing conditions, natural disasters or otherwise, and future acquisitions, particularly in periods immediately following the consummation of such acquisition transactions, while the operations of the acquired businesses are being integrated into our operations. 17
Due to the foregoing factors, we believe that period-to-period comparisons of our operating results may not necessarily be meaningful, and that such comparisons cannot be relied upon as indicators of future performance. We are subject to significant governmental regulation Our business is highly regulated at the federal, state and local levels and our products and distribution operations require various licenses, permits and approvals. In particular: our products are subject to inspection by the U.S. Food and Drug Administration, our warehouse and distribution facilities are subject to inspection by the U.S. Department of Agriculture and state health authorities, and The U.S. Department of Transportation and the U.S. Federal Highway Administration regulate our trucking operations. The loss or revocation of any existing licenses, permits or approvals or the failure to obtain any additional licenses, permits or approvals in new jurisdictions where we intend to do business could have a material adverse effect on our business, financial condition or results of operations. Union-organizing activities could cause labor relations difficulties As of October 31, 2002, approximately 381 employees, representing approximately 13% of our approximately 2,950 employees, were union members. We have in the past been the focus of union organizing efforts. As we increase our employee base and broaden our distribution operations to new geographic markets, our increased visibility could result in increased or expanded union organizing efforts. Although we have not experienced a work stoppage to date, if additional employees were to unionize, we could be subject to work stoppages and increases in labor costs, either of which could materially adversely affect our business, financial condition or results of operations. Item 3. Quantitative and Qualitative Disclosure About Market Risk We do not believe that there is any material market risk exposure with respect to derivative or other financial instruments that would require disclosure under this item. Item 4. Controls and Procedures Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely reporting material information required to be included in our periodic reports filed with the Securities and Exchange Commission. In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those internal controls subsequent to the date we carried out our last evaluation. 18
PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K Exhibits - ----------------------------------------------------------------------- Exhibit No. Description Page - ----------------------------------------------------------------------- 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - CEO - ----------------------------------------------------------------------- 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - CFO - ----------------------------------------------------------------------- 99.3 Third Amendment to Loan and Security with Fleet Capital Corporation dated October 17, 2002. - ----------------------------------------------------------------------- 99.4 Fourth Amendment to Loan and Security with Fleet Capital Corporation dated October 23, 2002. - ----------------------------------------------------------------------- 99.5 Employment Agreement between Steven H. Townsend and United Natural Foods, Inc. - ----------------------------------------------------------------------- Reports on Form 8-K Current Report on Form 8-K, filed with the Commission on August 7, 2002. 19
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/ Todd Weintraub ----------------------------- Todd Weintraub Chief Financial Officer (Principal Financial and Accounting Officer) Dated: December 13, 2002 20
CERTIFICATION Each of the undersigned, in his capacity as the Chief Executive Officer and Chief Financial Officer of United Natural Foods, Inc., as the case may be, provides the following certifications required by 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Executive Officer I, Michael S. Funk, hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of United Natural Foods, Inc., a Delaware corporation (the "Company"). 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report. 4. The Company's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended) for the Company and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of the Company's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls. 21
6. The Company's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Michael S. Funk -------------------------- Michael S. Funk Chief Executive Officer December 13, 2002 22
Certification of Chief Financial Officer I, Todd Weintraub, hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of United Natural Foods, Inc., a Delaware corporation (the "Company"). 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report. 4. The Company's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended) for the Company and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of the Company's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls. 6. The Company's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Todd Weintraub ----------------------- Todd Weintraub Chief Financial Officer December 13, 2002 23