Business context and reporting period
Sprouts Farmers Market, Inc. operates healthy grocery stores focused on fresh, natural and organic products. This unaudited Form 10-Q covers the 13 weeks ended April 1, 2018; comparisons are with the 13 weeks ended April 2, 2017. The company had 294 stores in 16 states at quarter-end and 297 stores as of April 30, 2018. Amounts below are in millions unless stated otherwise.
Financial and operating performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $1,287.2 | $1,130.6 | +14% |
| Comparable-store sales growth | 2.7% | 1.1% | +1.6 percentage points |
| Gross profit / margin | $387.1 / 30.1% | $337.3 / 29.8% | Margin +0.3 points |
| Operating income | $79.7 | $72.5 | +10% |
| Net income / net margin | $66.6 / 5.2% | $46.3 / 4.1% | +44% |
| Diluted EPS | $0.50 | $0.33 | +52% |
| Operating cash flow | $104.5 | $114.5 | Down $10.1 |
- Sales growth was primarily driven by new stores; comparable stores contributed approximately 89% of sales, versus 86% a year earlier. Management attributed gross-margin improvement mainly to stronger merchandise margins.
- Direct store expenses rose 15% and were 20.4% of sales, up 0.1 percentage point. SG&A rose 29% and was 3.2% of sales, up 0.4 point; increases included compensation, technology investment and advertising.
- Net income benefited from the lower effective tax rate and higher sales and margins. The effective tax rate fell to 9.8% from 31.8%, primarily reflecting the Tax Act and $11.1 million of excess tax benefits from stock-based awards (versus $3.8 million in the prior period). The filing cautions that tax measurements under the Tax Act remained provisional.
Financial position, cash flow and capital allocation
- At April 1, cash was $21.4; current assets were $315.0 and current liabilities $315.9. Long-term debt was $368.0, up $20.0 from year-end; cash less long-term debt was approximately $346.6. Capital and financing lease obligations totaled $134.8 on the balance sheet.
- Operating cash flow of $104.5 was below the prior-year $114.5, with working-capital changes a significant factor. Investing used $44.2, primarily for capital expenditures; financing used $58.5.
- The company repurchased 3.33 million shares for $83.0 during the quarter, at an average $24.93 per share. It reported $393.6 million of authorization remaining across active programs at quarter-end. Repurchases were funded in part by credit-facility borrowings.
- Operating lease commitments totaled $1,624.8; reported contractual obligations also included $131.9 of capital and financing lease payments and $368.0 of credit-agreement principal. These commitments are not all balance-sheet liabilities under the accounting rules then in effect.
Outlook, changes, risks and unusual items
- Management planned approximately 30 new stores in 2018 and about 30 annually in the near term; 12 had opened by April 30. Fiscal 2018 capital expenditures were expected to be $165–$170 million, net of estimated landlord allowances. The filing provides no specific earnings or comparable-sales numerical guidance.
- The March 2018 refinancing replaced the former facility with a $700 million revolving credit agreement maturing March 27, 2023. Quarter-end borrowings were $368 million and letters of credit totaled $27 million. Approximately 70% of outstanding debt was fixed through interest-rate swaps. The company was in compliance with its financial covenants at quarter-end.
- Management said existing cash and expected operating cash flow should meet anticipated needs for at least 12 months. A 100-basis-point LIBOR change was estimated to affect annual interest expense by $1.2 million after swaps, versus $3.7 million without them.
- Risks include food-price inflation or deflation and competition, lease and self-insurance estimate uncertainty, and litigation. The securities class action concerning alleged disclosure of produce-price deflation remained in discovery; potential liability could not be reasonably estimated. Phishing-related privacy cases also remained unresolved, with outcomes not estimable. The company reported no material changes to its previously disclosed risk factors.
- Adoption of ASC 606 had no reported financial-statement or opening-retained-earnings impact. The company expected adoption of the new lease standard in fiscal 2019 to materially increase balance-sheet assets and liabilities.
Important facts for investors to verify
- How much of the 44% net-income growth and 52% diluted-EPS growth reflects recurring operating improvement versus lower taxes and share repurchases.
- Whether comparable-sales growth and stronger merchandise margins continue, and how store-expansion costs affect operating leverage.
- Debt, covenant headroom, interest-rate exposure and the extent to which repurchases are funded with borrowings.
- Capital-expenditure delivery against the $165–$170 million outlook and the effect of long-term lease commitments, including adoption of the lease standard.
- Developments and potential exposure in the securities and phishing-related litigation; the filing does not provide a clear estimate of possible liabilities.