Sprouts Farmers Market, Inc. — Q3 2019 Form 10-Q
Reporting period: Thirteen weeks ended September 29, 2019; year-to-date figures cover the thirty-nine weeks ended that date. Comparisons are with the corresponding 2018 periods. Sprouts operated 335 stores in 21 states at quarter-end and reported 339 stores in 22 states as of October 30, 2019.
Financial performance
| Metric | Q3 2019 | Q3 2018 | 39 weeks 2019 | 39 weeks 2018 |
|---|---|---|---|---|
| Net sales | $1,440.2 million | $1,329.1 million | $4,269.8 million | $3,938.0 million |
| Comparable-store sales growth | 1.5% | 1.5% | 1.0% | 2.0% |
| Gross profit | $476.7 million | $443.4 million | $1,425.9 million | $1,326.5 million |
| Gross margin | 33.1% | 33.4% | 33.4% | 33.7% |
| Operating income | $39.6 million | $52.8 million | $170.4 million | $194.2 million |
| Net income | $26.3 million | $37.5 million | $118.0 million | $145.8 million |
| Diluted EPS | $0.22 | $0.29 | $0.98 | $1.12 |
- Quarterly sales rose 8%, driven chiefly by recent store openings and 1.5% comparable-store growth. Gross margin fell 0.3 percentage points, which management attributed mainly to increased promotions and slightly higher distribution and transportation costs.
- Quarterly SG&A increased 12% to $404.3 million and rose to 28.1% of sales from 27.3%. Management cited new-store costs, lease-related occupancy costs, home-delivery expansion and higher healthcare costs. Quarterly store-closure and other costs were $2.1 million, primarily executive severance and hurricane preparedness.
- Net income declined 30% in Q3 and 19% year to date. Management cited higher expenses, including lease-related occupancy costs; the year-to-date comparison also reflects a higher effective tax rate in 2019 (23.6% versus 16.4%), as 2018 benefited from exercises of expiring pre-IPO options.
- Interest expense declined year to date to $16.0 million from $20.0 million, largely because adoption of the lease standard moved certain costs from interest expense to operating lease expense. Higher average revolver borrowings partly offset the decline.
Cash flow, liquidity and obligations
- For the first 39 weeks, operating cash flow was $323.3 million, versus $235.5 million in 2018; capital spending was $146.5 million, versus $148.4 million. Cash used in financing was $97.7 million. Cash, cash equivalents and restricted cash ended at $81.4 million, versus $17.8 million a year earlier.
- Management attributed the operating cash-flow increase primarily to working capital, including elevated accounts payable and accrued-liability balances. The working-capital contribution was $101.9 million in 2019, compared with a $46.5 million use in 2018.
- Revolver debt was $515.0 million at September 29, 2019, up $62.0 million from December 30, 2018; the $700 million facility matures March 27, 2023. Letters of credit outstanding were $26.9 million. The company reported compliance with its financial covenants, including maximum net leverage of 3.25-to-1.00 and minimum interest coverage of 1.75-to-1.00.
- Operating and finance lease liabilities totaled $1,204.6 million. The company adopted ASC 842 at the start of fiscal 2019, recognizing roughly $1.0 billion of operating lease assets and $1.1 billion of operating lease liabilities at transition. Management said adoption did not affect liquidity or cash flows.
- The company said existing cash and expected operating cash generation should meet anticipated needs for at least 12 months. Fiscal 2019 capital expenditures were expected to be $150–$160 million, net of estimated landlord allowances.
Capital allocation and outlook
- Sprouts repurchased $163.3 million of shares in the first 39 weeks of 2019; no repurchases occurred in Q3. At quarter-end, $55.0 million remained under the authorization expiring December 31, 2019. Management said it may use credit-facility borrowings to support repurchases.
- Management’s stated growth strategy includes new-store openings, positive comparable sales and brand development. The company had opened 27 stores during 2019 through October 30. The filing does not provide a specific earnings or comparable-sales forecast.
- Management noted that food-price deflation or inflation, competitive pricing and promotional responses could affect sales, margins and comparable-store growth. It did not expect these price effects to materially impair its long-term strategy.
Risks, contingencies and unusual items
- A Proposition 65 lawsuit concerning acrylamide warnings for coffee remained unresolved. The company could not reasonably estimate potential loss; possible outcomes include dismissal or further proceedings involving penalties or warning requirements.
- Phishing-related claims were largely subject to an agreement in principle to settle, with primary funding expected from cyber insurance. Fewer than 15 individual claimants were pursuing arbitration; the company could not estimate potential liability from those claims.
- A securities class action was settled and dismissed in May 2019; directors’ and officers’ insurance funded the settlement, which had no material financial-statement impact. The company also cited ordinary-course litigation and judgment-sensitive self-insurance liabilities.
- Interest-rate exposure remains: management estimated that a 100-basis-point LIBOR change would affect annual interest expense by about $2.7 million after swaps, versus $5.2 million without them. Swaps covered $250 million of debt; approximately 49% of outstanding debt was fixed after swaps.
- ASC 842 substantially increased reported lease assets and liabilities. Separately, the company’s voluntary expense-classification change, applied retrospectively, moved occupancy and buying costs into SG&A and did not affect operating income, net income or EPS.
Important facts for investors to verify
- Whether comparable-store sales and gross margin stabilize, given year-to-date comparable growth slowed to 1.0% and gross margin declined 0.3 percentage points.
- How much operating cash flow reflects sustainable operations versus working-capital timing, particularly elevated payables and accrued liabilities.
- Debt and capital-allocation plans, including share repurchases, covenant headroom and the effect of lease commitments on the company’s obligations.
- Progress and potential costs of the Proposition 65 and phishing-related matters, which remain uncertain in part.
- Share-count figures: the filing’s balance-sheet cover reports 118,138,870 shares outstanding at September 29, while the stockholders’ equity statement reports 118,048,120 shares at that date; investors may wish to confirm the discrepancy.