United Natural Foods, Inc. (NYSE:UNFI) is a leading distributor of natural, organic, specialty, produce, and conventional grocery and non-food products, as well as a provider of support services to retailers in the United States and Canada. The company has a diversified customer base of over 30,000 customer locations, ranging from some of the largest grocers in the country to smaller independents.

Business Overview

UNFI's business is classified into two reportable segments: Wholesale and Retail. The company operates 55 distribution centers and warehouses, representing approximately 31 million square feet of warehouse space, making it a coast-to-coast distributor with customers in all 50 states and all ten provinces in Canada.

Financials

For fiscal 2024 year-to-date, UNFI reported net sales of $22.825 billion. The company's Wholesale segment net sales were $22.004 billion, while the Retail segment net sales were $1.808 billion. The decrease in net sales was primarily driven by a decline in unit volumes, which was offset by inflation and new business with existing customers.

For the third quarter of fiscal 2024, UNFI reported net sales of $7.498 billion, compared to $7.507 billion in the prior-year period, a decrease of 0.1%. The company's Wholesale segment net sales were $7.236 billion, while the Retail segment net sales were $571 million. The decrease in net sales was primarily driven by a decline in unit volumes, which was offset by inflation and new business with existing customers.

Gross profit for the third quarter of fiscal 2024 was $1.020 billion, compared to $1.000 billion in the prior-year period, an increase of 2.0%. The company's gross profit as a percentage of net sales increased to 13.6% from 13.3% in the prior-year period. Excluding the non-cash LIFO charge, the gross profit rate was 13.7% and 13.8% for the third quarter of fiscal 2024 and 2023, respectively.

Operating expenses increased $25 million, or 2.6%, to $992 million, or 13.2% of net sales, for the third quarter of fiscal 2024, compared to $967 million, or 12.9% of net sales, for the prior-year period. The increase in operating expenses as a percentage of net sales was primarily driven by a $33 million increase in incentive compensation.

Reflecting the factors described above, operating income decreased $27 million to $6 million for the third quarter of fiscal 2024, compared to $33 million for the prior-year period. The decrease in operating income was primarily driven by an increase in operating expenses and restructuring, acquisition, and integration-related expenses, partially offset by an increase in gross profit.

Gross profit for fiscal 2024 year-to-date was $3.085 billion, compared to $3.165 billion in the prior-year period, a decrease of 2.5%. The company's gross profit as a percentage of net sales decreased to 13.5% from 13.8% in the prior-year period. Excluding the non-cash LIFO charge, the gross profit rate was 13.6% and 14.2% for fiscal 2024 and fiscal 2023 year-to-date, respectively.

Operating expenses increased $56 million, or 1.9%, to $3.025 billion, or 13.3% of net sales, for fiscal 2024 year-to-date, compared to $2.969 billion, or 13.0% of net sales, for the prior-year period. The increase in operating expenses as a percentage of net sales was primarily driven by approximately $40 million higher incentive compensation expense and incremental transformation costs.

Reflecting the factors described above, operating income decreased $189 million to $6 million for fiscal 2024 year-to-date, compared to operating income of $195 million for the prior-year period. The decrease in operating income was primarily driven by a decrease in gross profit, an increase in operating expenses, a loss on sale of assets and other asset charges, and higher restructuring, acquisition, and integration-related expenses.

Liquidity

UNFI's balance sheet remains strong, with total liquidity of $1.264 billion as of April 27, 2024, consisting of $1.225 billion of unused credit under its $2.600 billion asset-based revolving credit facility and $39 million of cash and cash equivalents. The company's total debt increased to $2.151 billion as of April 27, 2024, from $1.963 billion as of July 29, 2023, primarily due to additional net borrowings under the asset-based revolving credit facility.

In the third quarter of fiscal 2024, UNFI generated $49 million of free cash flow, enabling the company to reduce its net debt by $30 million during the quarter. The company has also taken strategic actions to strengthen its long-term capital structure, including amending and extending its secured term loan by 5.5 years to 2031.

Outlook

Looking ahead, UNFI is focused on closing out fiscal 2024 with improving operational and financial performance. The company has maintained its outlook for sales, slightly raised the midpoint of its adjusted EBITDA and adjusted EPS ranges, and reduced its outlook for capital and cloud investments from approximately $400 million to around $370 million.

More importantly, UNFI is embarking on a comprehensive transformation journey, focusing on several strategic initiatives to improve margins, enhance cash flow generation, and strengthen its balance sheet. The company is intensifying and expanding its network optimization efforts, reducing annual capital spending, optimizing its cost structure, and materially reducing its net working capital position.

UNFI sees a meaningful opportunity to streamline its supply chain footprint and drive capital efficiencies beyond what it has already achieved. The company plans to spend approximately $300 million in fiscal 2025, a $70 million reduction compared to its updated outlook of $370 million for fiscal 2024. This reduced level of capital spend will help UNFI reallocate resources, strengthen its broader business and balance sheet, and enhance its ability to strategically invest in higher-margin parts of the business, such as services.

Additionally, UNFI is working to better understand the full operating potential of its business and the long-term expense efficiencies it can realize. The company expects to build on the initial work it has done over the last year to improve its expense structure and believes it has an opportunity to recognize additional efficiencies over the next few years, approaching a similar magnitude to the $150 million it has already removed.

UNFI is also focused on improving its working capital management, as it believes there is a sizable opportunity to drive stronger free cash flow by improving metrics that have been pressured in recent years. The company is taking actions to drive benefits from these opportunities, including reductions in transportation costs and shrink, which is about 30 basis points lower as a percent of sales than the rate at which it exited fiscal 2023.

As a result of these initiatives, UNFI expects to generate free cash flow approaching $100 million in fiscal 2025 and plans to use these funds to reduce net debt. Over the next several years, the company expects to generate stable and dependable profit and cash flow growth, improve returns on capital, and reduce net leverage to 2.5 turns or less by fiscal year-end 2027.

UNFI's leadership team is highly motivated and directly accountable for rapidly improving profitability, free cash flow, net leverage, and financial and shareholder returns. The company's new multiyear strategic plan, which will begin in fiscal 2025, is expected to focus on optimizing controllable variables across network optimization, cost management, and working capital efficiency, as well as the reallocation of resources to enhance value for its stakeholders.

Conclusion

Overall, UNFI is well-positioned to navigate the evolving dynamics in the food distribution market and support its diverse customer base. The company's comprehensive transformation efforts, coupled with its industry-leading position and innovative service offerings, suggest a promising outlook for its future performance and shareholder value creation.