United Natural Foods, Inc. (NYSE:UNFI) Q4 2023 Earnings Call Transcript

United Natural Foods, Inc. (NYSE:UNFI) Q4 2023 Earnings Call Transcript September 26, 2023

United Natural Foods, Inc. beats earnings expectations. Reported EPS is $0.25, expectations were $-0.47.

Operator: Good morning. My name is Rob and I’ll be your conference operator today. At this time, I would like to welcome everyone to the UNFI Fourth Quarter Fiscal 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Steve Bloomquist, Vice President of Investor Relations, you may begin your conference.

Steve Bloomquist: Good morning, everyone, and thank you for joining us on UNFI’s fourth quarter fiscal 2023 earnings conference call. By now you should have received a copy of the earnings release issued earlier this morning. The press release and earnings presentation, which management will speak to, are available under the Investors section of the company’s website. We’ve also included a supplemental disclosure file in Microsoft Excel with key financial information. Joining me for today’s call are Sandy Douglas, our Chief Executive Officer; and John Howard, our Chief Financial Officer. Sandy and John will provide a strategy and business update, after which we will take your questions. Before we begin, I’d like to remind everyone that comments made by management during today’s call may contain forward-looking statements.

These forward-looking statements include plans, expectations, estimates, and projections that might involve significant risks and uncertainties. These risks are discussed in the company’s earnings release and SEC filings. Actual results may differ materially from the results discussed in these forward-looking statements. And lastly, I’d like to point out that during today’s call, management will refer to certain non-GAAP financial measures. Definitions and reconciliations to the most comparable GAAP financial measures are included in our press release and the end of our earnings presentation. I’d like to now ask you to turn to Slide 6 of our presentation, as I turn the call over to Sandy.

Sandy Douglas: Thanks, Steve. We appreciate everyone joining us for our fourth quarter call. In my remarks this morning, I’ll provide a brief overview of our results, the operating environment, and then provide an update on the actions that we’re taking to continue to reset and restore our profitability and improve the value we create for our customers, suppliers and in parallel, our shareholders. As you saw in our release, our fourth quarter results for sales and capital expenditures were in line with the updated outlook we provided in June, while adjusted EPS and adjusted EBITDA finished towards the high end of their respective ranges. UNFI has not been immune to the post-COVID post-inflation challenges that the entire food industry is facing.

Despite these challenges, we remain confident in our multi-year value-creation opportunity and our plan to create and capture it. We are seeking to build upon our strengthening foundation and market leadership position by investing in the necessary capabilities to create a differentiated technology-enabled food retail services company that generates sustainable growth, profitability, and shareholder value. To this end, this morning, we also announced a refreshment of our Board, adding three new members with deep food industry, business transformation, and investment stewardship experience, who we believe will be highly valuable in guiding our customer and supplier-focused multi-year transformation plan in a disciplined manner that generates compelling shareholder returns.

UNFI has a strong industry leadership position with an expansive supply chain as the largest wholesale grocery distribution and value-added food retail services provider in North America with nearly 11,000 suppliers and manufacturers serving over 30,000 retail outlets, and the long-term growth opportunity in pipeline we see it in our core business remains significant within a $140 billion total addressable market for our core wholesale business. However, considerable progress remains to be made, modernizing and unifying our technology and network platforms as previous plans have taken longer than expected as the company faced the onset of the COVID pandemic, unprecedented inflation, and supply chain disruptions over the past few years. These events and their enduring consequences have brought cost increases across our total customer service system as we serve our large, diverse, and growing customer base.

In previous quarters, we’ve outlined a four-part plan to transform and realize the full value of our platform, including details on how we plan to strengthen our supply chain for our retailers and suppliers through distribution network automation and optimization, introducing smarter technology systems, and investing in operational excellence and efficiency. We believe that we will further differentiate UNFI from our peers by complementing our profitable growth strategy with our operational transformation, and specifically, we expect to execute our transformation in a manner that restores and grows our profitability to sustainably improve shareholder value-creation. We see significant sales and profit growth opportunities. So significant, that we are unwilling to be incremental in our approach, as we drive change and investment.

Our transformation agenda is challenging and it will take time. In the meantime, our management team is focused on working through the near-term environmental challenges, resetting the business, and taking action to turn profitability around, while simultaneously investing in the business to sustain and significantly accelerate profitable growth over time. While we lay the groundwork for our transformation, the management team is also taking decisive action to revamp and lower our sustaining cost structure in the near term. The benefits from these more easily executable profitability drivers that I outlined on our last call will largely go towards offsetting higher operating costs that include additional labor and supply chain costs, and the acceleration of work on our transformation initiatives.

We also believe this transformation, including our planned investments to modernize and optimize our infrastructure will help us to create a more nimble, streamlined, and responsive company. Let me briefly report on the near-term actions I previously outlined. Since our third quarter call, we’ve captured nearly $100 million of benefits on a run-rate basis from work around our organizational structure, SG&A spending, and wholesale efficiency initiatives. Having completed a deeper dive, we now believe a greater opportunity exists than we previously thought to continue to improve and become more efficient. As such, we are increasing the near-term value-creation benefit from $100 million, called out in June to nearly $150 million. These amounts do not include the potential opportunity from improving our shrink rate which as I mentioned on our last call is meaningfully higher than the pre-pandemic run rate and which we expect to improve over the course of the year as we operationalize process improvements.

These value-creation initiatives are expected to benefit fiscal 2024 which will be an important year for UNFI as we take action to reset and begin to accelerate and expand our transformation program, including critical investments to our supply chain and technology infrastructure. Let me provide some more details on our transformation program progress and our plan going forward. Let me point you to Slide 6, which includes a summary of our transformation plan to truly leverage the power of our competitive advantages through what we’re calling One UNFI. We’re working to modernize and unify our technologies, infrastructure, and processes to drive better service for our customers and suppliers, as well as improve our internal analytical capabilities to guide the company and help us be as dynamic and responsive as possible.

Slide 7 shows a broad roadmap of the key work streams we’re pursuing over the next few years under the four transformation pillars that we previously identified. First is the work we’re doing around our supply chain, what we’ve called network automation and optimization. We formally announced that Centralia, Washington will be the first location where Symbotic’s automation technology will be installed. On our last call, we also stated that we’d begun the design phases for the next two installs and expect to be running up to four of these projects simultaneously as we further expand the automation levels in our distribution system. We will take learnings from Centralia to fine-tune the implementation of ensuing projects prior to completion and expect to accelerate the pace of installs as we gain confidence in our processes and the intricacies of the system.

Collectively, when we complete, these projects are designed to increase our capacity, improve our service levels, enhance the customer experience, make for a safer workplace and importantly, create meaningful operating efficiencies. We’re also continuing our evaluation of fast and slow moving facilities and regional DCs and how best to migrate our network in a way that will further enhance our capacity, lower our cost structure and optimize DC footprints and working capital levels. Next is our work around commercial value creation, which aims to enable us to generate more profitable and scalable growth for UNFI, and a more streamlined experience for our customers and suppliers. We see significant potential to increase the visibility of profitable growth opportunities and data-driven real-time insights across our ecosystem.

Said simply, our suppliers want to see our customers and their shoppers better so they can make productive investments in sales, merchandising, and marketing opportunities across the 30,000 plus retail locations that make up our customer base. Our customers want them to do so and UNFI’s opportunity is to build the capabilities necessary for this to happen seamlessly. We’re also focused on building-related capabilities and streamlining legacy processes to help customers and suppliers grow faster and more profitably together and to ensure that UNFI is rewarded appropriately for the value created. Over time, our goal is to evolve our go-to-market programs to reduce complexity, and drive accelerated supplier brand growth with and for UNFI customers.

The third area of our transformation focus is enhancing our digital offering, which is another way that we can more effectively connect our customers and suppliers to grow their businesses collectively and profitably. Digital transformation is the key enabler to fully activate the commercial opportunities in our ecosystem, opportunities that many of the large retail chains are activating now. While we will be providing more specifics as we progress in digital, let me give you a quick example of early progress in this area to help illustrate how important elements of this plan are coming to life. Our newest value-added supplier program UNFI Insights, powered by Crisp, provides suppliers with a granular understanding of sell-through data across natural and conventional channels directly through the myunfi.com supplier portal.

The UNFI Insights team is dedicated to uncovering the latest data into actionable intelligence, so suppliers and customers can see each other and their shoppers and drive mutual benefits. We have seen solid early adoption and positive initial feedback from suppliers of this early stage program. And finally, our fourth transformation program is the work of technology infrastructure unification and modernization, where we plan to reduce the number of systems used to run the business across areas such as finance, warehouse management, procurement, promotions, and data management. We’re planning for our first go-live implementation of a common warehouse management system, accompanied by what we are calling hyper support to ensure success, which will serve as the pilot for the continued rollout of a single solution.

As we’ve talked about before, this is consistent with our goal to simplify the business model, to lower our cost structure, and improve the customer experience. Common platforms are expected to lead to enhanced efficiencies, more uniform datasets, and improved business management. Similar work streams are moving forward in other parts of the business guided by executive leaders and cross-functional teams. While we expect our transformation program to be a multi-year endeavor, we’re already making progress, adding incremental growth and profit accretive drivers to our business, while also making long-term structural improvements to our efficiency processes and cost base. So in summary, I want to make sure that I leave you with three things. First, fiscal 2024 is an important year as we emerge from three years of unprecedented volatility and look to reset our profitability in the near term while investing in critical foundational skills, infrastructure, and capabilities that we believe will accelerate growth in sales and profitability for UNFI, our customers, and our suppliers.

Second, there have been and continue to be challenges that impact the entire food industry. But we are taking decisive action to strengthen the business and drive improved performance. We run a complex business and know the path forward will take time, tenacity, and discipline, and that will need to be adaptable along the way. But we also know the way to fully realize our vision and maximize shareholder value-creation is through a proactive combination of near-term action and the multi-year transformation path that I’ve outlined. And finally, with the steps we are taking to continue to strengthen both our leadership team and our Board, we are positioning our company to capture the significant profitable growth opportunities that lie ahead. We look forward to updating you on our progress along the way.

And let me now turn the call over to John for his insights on our financials.

John Howard: Thank you, Sandy, and good morning, everyone. As Sandy noted, we finished the year toward the upper half of the outlook provided on our third quarter call, and our focus continues to be on driving improved capabilities, operational efficiencies, and near-term profitability. Today, I will provide commentary on fourth quarter results, our balance sheet and capital structure, and our outlook for fiscal 2024. With that, let’s review our Q4 results. Turning to Slide 9. Fourth quarter net sales grew by 2% and totaled more than $7.4 billion, primarily reflecting inflation and new business wins, which more than offset a decline in unit volume. Sales from our three primary wholesale channels grew by nearly 3%, including the impact of inflation of nearly 6% with supernatural growing the fastest at over 9%.

This includes incremental volume from new customers added over the last year, additional categories and new-store openings in supernatural, and increased item and category penetration with existing customers. Unit volumes remained negative, but improved sequentially by about 100 basis points from Q3 and were slightly better than Nielsen’s total U.S. food volume changes which is representative of performance for the grocery industry as a whole. Retail sales declined 2% compared to last year’s fourth quarter, primarily driven by lower unit volumes, partly offset by higher average unit retail prices. We’ve continued to experience pressure across our retail footprint primarily located in the Minneapolis-Saint Paul market, due in large part to tightening consumer demand, reductions in government support programs, and more intense competition on price.

Flipping to Slide 10. Adjusted EBITDA for the fourth quarter totaled $93 million, which was at the top half of the implied range we provided in June. This compares to $213 million in the year ago fourth quarter. As we indicated would be the case with our updated outlook, the biggest driver for the decline in Q4 year-over-year profitability was lower levels of procurement gain opportunities resulting from decelerating inflation. This resulted in a reduction in our gross profit rate prior to the LIFO charge in both years of approximately 175 basis points or more than $100 million. We also experienced higher levels of shrink compared to last year’s fourth quarter, which we are actively addressing. Our fourth quarter operating costs as a percent of sales were flat to last year.

However, last year included approximately $14 million in higher performance based incentive compensation expense compared to this year. Excluding this performance based incentive compensation expense, our operating expense rate increased by about 25 basis points. A good portion of this came from higher health benefit costs driven by a higher level of claims, representing a more normalized run rate as associates returned to more pre-pandemic medical visits. Within our retail segment, adjusted EBITDA decreased to $4 million, primarily due to margin investments intended to drive traffic and basket size improvements, as well as higher-than-normal costs associated with recently opened stores. During the quarter, we opened one new store, bringing total stores opened during fiscal 2023 to six stores.

Our GAAP EPS for Q4 was a loss of $1.15, which included $0.90 in after-tax costs and expenses composed primarily of LIFO, restructuring, and business transformation. Our adjusted EPS totaled a loss of $0.25 compared to $1.27 of income in last year’s fourth quarter. This decline is primarily attributable to the lower adjusted EBITDA compared to last year as well as lower non-cash pension income and higher D&A, which was driven by elevated levels of investment, which is expected to continue. Moving to Slide 11, we finished the quarter with total outstanding net debt of just under $1.95 billion, a $70 million decrease compared to last quarter. This is our lowest net debt balance since the October 2018 closing of our Supervalu acquisition, reflecting our strong efforts to prioritize debt reduction over the past several years.

Our net debt to adjusted EBITDA leverage ratio finished fiscal 2023 at 3.0 times. Turning to Slide 12. Let’s move to our outlook for fiscal 2024, which will be a 53-week year. From a reporting perspective, our fourth quarter will have one additional week, making it a 14-week quarter. We expect fiscal 2024’s full-year net sales to grow approximately 3% or $900 million at the midpoint of the $30.9 billion to $31.5 billion range we have provided. This includes an approximate $600 million, or 2% benefit from the 53rd week. Our growth will include the addition of new business from customers added in fiscal 2023 we have yet to cycle, the continued growth of selling more products to existing customers, new customer wins, and anticipated strong growth within services.

We expect full-year inflation to continue to moderate and be in the low to mid-single digits, which is a decline compared to the over 9% reflected in our fiscal 2023 results. We’re also expecting ongoing near-term volume headwinds as consumers continue to adapt to higher costs across their household budgets. We expect fiscal 2024’s full year adjusted EBITDA to be in $450 million to $550 million range. This decline primarily reflects approximately $125 million in lower anticipated procurement gains, primarily in last year’s first and second quarters, resulting from the continued decline in the number of supplier price increases compared to the first half of fiscal 2023. It also includes normalized performance-based incentive compensation accrual of approximately $62 million.

This compares to fiscal 2023 when no material performance based incentive compensation was paid to eligible associates. Partly offsetting these items is the estimated contribution of $9 million from the 53rd week, as well as the near-term profitability drivers Sandy discussed earlier, with nearly half of the actions addressing profitability from cost savings, including our recent regional reorganization and other SG&A and operating expense rationalization, and the remainder being driven by SKU rationalization and contract review benefits. Additionally, as Sandy mentioned, we expect there could be some upside from shrink improvement as we operationalize and scale process improvements during fiscal 2024. From a cadence perspective, we would expect our first quarter to be the lowest of the year in absolute adjusted EBITDA dollar terms and likely to be similar to the adjusted EBITDA level we generated during Q4 2023.

Our first quarter is expected to have the largest percentage decline compared to last year, as we cycle last year’s elevated level of procurement gains and further build the benefits of our near-term profitability initiatives. Finally, we expect fiscal 2024’s full year adjusted EPS to be in the range of $0.88 loss to $0.38 of adjusted net income. This primarily reflects lower adjusted EBITDA, as well as lower non-cash pension income and higher D&A. It also includes about $21 million of higher net interest expense, primarily resulting from higher expected interest rates and ABL balances during the year and an additional week of interest expense. More than 65% of our debt is currently fixed rate, taking into account our approximately $800 million of hedges in place as well as our senior notes.

We expect to invest approximately $400 million in the business in fiscal 2024 with our primary driver of the increase compared to fiscal 2023 being investments in our transformation agenda, with the largest component going towards network optimization and automation. This also includes investments to improve critical infrastructure, as well as drive higher profitability and growth in the future. Turning to the summary on Slide 13. We expect fiscal 2024 will be a pivotal year for our transformation into a more modernized technology-enabled partner for our customers and suppliers. While we expect this will be a multi-year endeavor, we are committed to making progress as quickly as possible and look forward to updating our shareholders on this path.

We are confident we’re taking the appropriate actions to best position UNFI for improved efficiency and profitability, enhanced growth, and long-term success. We strongly believe that combining a more dynamic and nimble UNFI with our industry-leading position will enable us to drive meaningful and sustainable shareholder value-creation. With that operator, please open the lines for questions.

See also What are Golden Visas and 10 Countries that Hand Them Out? and 18 Highest Paying Countries for ESL Teachers.

Q&A Session

Operator: [Operator Instructions] And your first question today comes from the line of Mark Carden from UBS. Your line is open.

Mark Carden: Good morning. Thanks so much for taking our question. So looking to 2024, you’re lapping a few quarters of lower inventory gains beginning in 2Q, Your cost savings sound like that they’re falling nicely into place. Still, your guidance is assuming a meaningful step-down in profitability. So what’s changed the most relative to where your expectations may have been three months ago? How much of it is macro-driven? And to what extent are you building in some conservatism just given all the initiatives that you have in place?

Sandy Douglas: Yeah, Mark. This is Sandy. Thanks for your question. I guess we’re looking at several factors. If you look at the fourth quarter and consider the momentum of the business, the addition back of performance incentives for executives, you get to a fairly low run rate. You add back then the actions that we’ve taken most of which we’ve already captured and you get sort of in the range of our mid-point. The external environment continues to be pretty soft. So I think we’re going to manage our way this year and we’re taking a number of initiatives to try to optimize the results. But the net of all of those factors gave us the range that we provided today.

Mark Carden: Got it. That’s helpful. And then what are you seeing from your independent grocer base? Would you expect the pace of customer migration to mask the pickup in 2024 and further pressure the channel? And if so, how does that typically impact demand for value-added services and private label?

Sandy Douglas: Yeah. I mean, you can’t really generalize about independence. There is some incredibly strong and vibrant ones, and then some they’re struggling. This community is the focus of our whole product service makeup. I mean, it’s our job to help them succeed. I think broadly compared to independents in syndicated data, our customers are outperforming the market by a small margin. But we’ve got a lot of programs and you mentioned two of them, brands and services that are designed to provide independents with a great owned brand program at multiple price points and then services that help them save money and compete better. In the end, their success is the most important priority we have.

Mark Carden: Great. Thanks so much. Good luck guys.

Sandy Douglas: Thanks.

Operator: Your next question comes from the line of John Heinbockel from Guggenheim Securities. Your line is open.

John Heinbockel: Hey, Sandy. Maybe talk to what procurement gains were pre-COVID in a normal environment, right? It looks like, I don’t know, maybe they got up to $250 million or $300 million at the peak, right? Was that all just gains on stuff that was in your inventory or was there a lot of forward buy, right, that went along with that? And when you think about that, does that then — what you had earned right over the past couple of years, right, sort of an EBITDA margin in the upper two’s, is that no longer attainable anytime, right, or over a very long period of time because those inventory gains are just going to — going to be very de-minimis the next couple of years.

Sandy Douglas: John, it’s Sandy. Let me come at this a couple of ways, and then I’ll ask John Howard to add to my comments. Definitely, we saw an out-of-pattern increase in procurement gains beginning in January of ’22 and that lasted (ph) for a year before the year-over-year disinflation started and that generated numbers in line with your estimates. And that was the out-of-pattern part. You’ve got really two things going on there. You’ve got actual price increase events both the frequency and depth, and then you have promotions. And we saw a decline in promotions while prices were going way up. What we expect to happen is that as price increase events decline, we expect promotions to come back, although they’ve done so very slowly.

But as we look forward and we see units continuing to be soft, the consumer to be stressed, and inflation now returning to lower levels, we definitely expect consumer products companies to start promoting more. They’ll need to in order to drive sales and so we’ll see a positive there. The out-of-pattern high number of price events have kind of returned back to more normal levels. We’re still cycling the higher ones as John mentioned in his comments. But net-net-net from a run rate perspective, we’d expect that to be slightly positive as promotions come back. John, do you want to add anything?

John Howard: No. I think that’s spot-on. The only thing just to put some numbers around that ’23 to ’24 impact, it’s going to be about $125 million that we’ve, of course, factored into our guidance. And most of that is going to be in the first two quarters of FY ’24 as we cycle those gains that were still happening in the first half of FY ’23.

John Heinbockel: Great. And then maybe second thing right, so leverage is going to go from 3 times to 4 times returns this year. You’d say that’s temporary. Yeah, I think there was some commentary with the — with the Board changes of strengthening the balance sheet. So do you feel a need to do that urgently? And then what do you do? I know you securitized receivables before. I don’t know if you want to do that. I don’t know if you want to sell retail at a low level. I don’t know what the options are, right, to strengthen the balance sheet short term.

Sandy Douglas: Hey, John. I’ll answer that strategically, and I’ll let John pick apart the pieces. The refreshment of our Board from our point of view is going to strengthen our offense. We have a transformation plan and the strategy that we’re investing in and that we are excited about and confident that it’s going to make a significant difference. Now, we’re in the investment phase. So it is obviously out there in the future that the benefits will come. But I think as a Board, new members and old members alike, we are aligned on the importance of that. With the financial review with the new Board and the new skill sets, it’s just going to help us make sure that we’re sweating every decision we make in the most detailed way to ensure that not only are we driving the transformation strategy, but we’re also maximizing returns to shareholders on a strong basis.

We have strong liquidity. We have the resources we need to invest in the plan, but we want to make sure that every stakeholder of ours, customers, suppliers, and shareholders are getting the best possible return. John?