Photo by WGB StaffBooming demand for the better-for-you products it distributes—particularly from its largest customer, Whole Foods Market—continued to boost sales for United Natural Foods in the third quarter.
The higher sales volume, however, came amid ongoing challenges of warehouse capacity and freight costs, low inflation, a tighter margin mix, and higher supplier out-of-stocks, said executives of the Providence, R.I.-based natural products supplier. The distributor also got into a debate with analysts over visibility into the effects of a change in how it accounts for inventories, with the confusion evidently resulting in a sharp drop in its stock price early Thursday.
Sales for the quarter, which ended April 28, jumped by 11.8% to $2.7 billion, led by a whopping 24.3% increase in sales to what UNFI calls the “supernatural” channel, or Whole Foods Market. That figure marked UNFI’s highest quarterly sales gain in that channel in more than seven years but isn’t necessarily reflective of retail sales gains at Whole Foods. While the retailer is undoubtedly seeing soaring sales under its new corporate parent Amazon, UNFI’s reported gain also reflects an increase in the breadth of product the retailer is acquiring from UNFI, executives said.

“Supernatural growth is driven by the growth of our supernatural customer, and the success of our build-out-the-store strategy, which is driving growth in new categories, most notably, health, beauty and supplements,” CFO Michael Zechmeister said in a conference call with analysts late Wednesday.
UNFI’s build-out-the-store strategy, which also focuses on distributing more fresh and specialty foods, also helped to drive sales to independent natural food stores (up 6.1% in the quarter) and to conventional supermarkets (up 3.7%). Food service net sales improved by 4.3% and e-commerce sales jumped by 23%.

Gross margins increased by 5 basis points to 15.4% of sales but were boosted in the quarter by a change in how UNFI accounted for inventory estimates—a topic that became a point of debate between UNFI officials and analysts reviewing results. Warehouse capacity challenges associated with the fast ramp in sales, along with a rise in inbound out-of-stocks and a lower margin sales mix continue to pressure margins, officials said.
“Higher demand is pressuring our supply chain as we continue to see degradation in supplier inbound fill rates,” CEO Steven Spinner said. “Supplier out-of-stocks in the third quarter of fiscal 2018 were approximately 150 basis points unfavorable versus the same quarter in the prior year. We continue to be dedicated to working with our suppliers and to enhance alignment on demand signals.”
Officials said the accounting change related to how it estimated inventory purchases resulting from higher than expected growth and the centralization of its shared services. Analysts however were puzzled trying to square the positive impact—a 27-cent boost to quarterly earnings per share—with updated guidance calling for a full-year EPS increase of just 11 cents.
Chris Mandeville, a Jefferies analyst covering UNFI, said in a note to clients that the conflict did “more harm than good to investor confidence,” reflected in a stock price decline of more than 9% in early trading Thursday.