In a preview to grocery wholesale distributor United Natural Foods' (NYSE:UNFI) fiscal first-quarter 2020 earnings, I wrote that investors were likely to either embrace the report or flee from it. They ended up fleeing. The company's filing, issued before the markets opened on Wednesday, revealed a massive goodwill impairment charge, smaller additional charges against earnings, and an alarming cash burn. Shares of the consumer staples investment were off roughly 28% in midday trade. As we review what went wrong over the last three months, note that all comparable numbers refer to the prior-year quarter.

United Natural Foods: The headline numbers

Metric Q1 2020 Q1 2019 Change
Revenue $6.0 billion $2.9 billion 107%
Net income ($384.0 million) ($19.3 million) N/A
Diluted EPS ($7.21) ($0.38) N/A

Data source: United Natural Foods. EPS = earnings per share. N/A = not applicable; earnings not comparable due to outsize one-time charges discussed below.

Highlights from the quarter

  • After removing $3.1 billion in revenue contributed from the company's October 2018 acquisition of wholesale and retail grocer SUPERVALU, legacy revenue was essentially flat at $2.9 billion.
  • United Natural Foods recorded goodwill and intangible asset impairment charges of $425.4 million against its U.S. wholesale business and SUPERVALU acquisition. The total follows $293 million in net goodwill and asset impairments booked over the preceding three quarters related to the SUPERVALU purchase.
  • The company also recorded a $12.5 million write-off of customer receivables and incurred $14.3 million in restructuring, acquisition, and merger integration expenses.
  • United Natural Foods' gross margin fell by 157 basis points to 12.81, weighed down by the contribution of lower-margin SUPERVALU sales.
  • After excluding the goodwill and receivables charges, as well as the merger-related expenses outlined above, the company generated adjusted operating income of $13.6 million. The wholesaler's operating margin of just 0.23% illustrates how squeezed its margins have become as it struggles to profitably operate SUPERVALU and overcome initial distribution integration issues following the merger.
  • As expected, adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $121.7 million well exceeded the prior-year quarter's mark of $86.2 million due to addition of SUPERVALU's earnings.
  • The company recorded negative operating cash flow of nearly $135 million during the quarter. This was partially due to a ramp-up in inventory ahead of the holiday season. Management noted that United Natural Foods tapped into its revolving credit line to support this uptick, increasing total debt by $232 million to $3.1 billion. The company indicated that it expected to pay down the new borrowings following the holiday season.
A grocery shelf of organic produce.

Image source: Getty Images.

The outlook: Adjusted guidance remains unchanged

This quarter's massive impairment charge reduces United Natural Foods' total goodwill balance to just $19.8 million -- at least shareholders won't have to worry about future huge charges against this intangible asset! The company noted today that included in the current impairment is a finalization of charges against goodwill from the SUPERVALU acquisition. We can see from the current balance sheet that United Natural Foods overpaid for SUPERVALU by at least $345 million (the original goodwill added to its books at the time of purchase).

Yet intangible asset impairments form just part of shareholders' frustrations today. More at issue are the company's vulnerable gross and operating margins and its cash burn, which is exacerbated by high interest expense due to the leverage undertaken to fund the SUPERVALU acquisition. The organization incurred $49.5 million in interest expense in the current quarter -- that's roughly 3.5 times the amount of its operating income.

Management is sticking to its adjusted full-year earnings outlook for now, even though it's dramatically revised its GAAP estimates. The company still expects adjusted earnings per diluted share of $1.22 to $1.76 in fiscal 2020 and adjusted EBITDA of $560 million to $600 million. Management also left the company's projected net sales range of $23.5 million to $24.3 million intact.

On a GAAP basis, the company anticipates a loss of $324 million to $353 million and a net loss per diluted share of $6.06 to $6.60. The main differences between GAAP and adjusted outlook figures are the noncash asset impairment charges. Judging from today's overwhelming selling pressure on United Natural Foods' shares, a host of investors aren't sticking around to see if the company will hit either its GAAP or adjusted targets this year.

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