Sprouts Farmers Market, Inc. — Q2 2015 Form 10-Q
Business context and reporting period
Sprouts operates specialty grocery stores focused on fresh, natural and organic products. This unaudited filing covers the 13 weeks ended June 28, 2015, and year-to-date results for the 26 weeks ended that date; comparisons are with the corresponding periods ended June 29, 2014. The company had 208 stores in 13 states at quarter-end, versus 177 a year earlier. Fiscal 2015 is a 53-week year.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net sales | $902.2 million | $743.8 million | $1,759.7 million | $1,466.4 million |
| Comparable-store sales growth | 5.1% | 9.5% | 4.9% | 11.1% |
| Gross margin | 29.2% | 30.1% | 29.6% | 30.5% |
| Operating income | $60.0 million | $55.6 million | $126.6 million | $117.2 million |
| Net income | $31.3 million | $30.2 million | $68.8 million | $63.9 million |
| Diluted EPS | $0.20 | $0.20 | $0.44 | $0.42 |
Quarterly sales rose 21%; first-half sales rose 20%. New stores opened after June 29, 2014 accounted for 69% of the Q2 sales increase and 63% of the first-half increase. Gross profit grew, but gross margin fell 0.9 percentage point in both comparisons, primarily from price investments, partly offset by buying-cost leverage. Direct store expenses rose to 19.7% of Q2 sales from 19.2%, reflecting the larger share of newer stores and higher medical-benefit utilization. Net income grew 4% in Q2 and 8% year to date; results included a debt-extinguishment charge.
First-half operating cash flow was $120.9 million, down from $137.9 million. Investing cash outflow was $74.5 million, mainly reflecting capital spending; financing cash outflow was $79.7 million, primarily from net debt repayment. Cash and equivalents were $97.3 million at June 28, down from $130.5 million at December 28, 2014. Current assets were $318.1 million and current liabilities $208.8 million.
At quarter-end, debt was $160.0 million and capital and financing lease obligations totaled $128.7 million on the balance sheet. The company also disclosed $1.37 billion of estimated gross capital, financing and operating lease payments, before subtenant receipts. Its $450 million revolving credit facility had $160 million drawn and $2.5 million of letters of credit outstanding. The company reported compliance with its financial covenants.
Material changes and unusual items
- In April 2015, the company refinanced its former term loan and revolving facility with a new $450 million revolving credit facility maturing in April 2020. It initially borrowed $260 million, repaid $100 million of principal, and reported $160 million outstanding at quarter-end. The refinancing reduced interest expense, but generated a $5.5 million noncash loss from writing off deferred financing costs and original issue discount.
- Q2 included $0.8 million of gift-card breakage income recognized in net sales after the company obtained sufficient redemption history to estimate breakage.
- Q2 comparable-store growth slowed to 5.1% from 9.5%; first-half growth slowed to 4.9% from 11.1%. Store count increased to 208 from 177 year over year.
- First-half store pre-opening costs were $5.3 million, versus $3.4 million, and store closure and exit costs were $1.5 million, versus $0.3 million. The 2015 closure and exit costs included support-office relocation costs and reserve adjustments.
- First-half cash flow included $19.1 million of income-tax payments. Excess tax benefits from option exercises contributed $19.3 million to financing cash flow and stockholders’ equity.
Outlook, commentary and risks
Management planned 27 store openings in fiscal 2015, of which 22 had opened by the filing date, and stated an objective of 14% annual new-store growth for at least five years. Fiscal 2015 capital expenditures were expected to be approximately $110 million, net of estimated landlord tenant-improvement allowances. Management said cash on hand and anticipated operating cash flows should cover expected needs for at least 12 months; it may use the credit facility if required.
Management identified pricing, product mix, shrink, labor and operating costs, competition, consumer demand, food-price inflation or deflation, and new-store execution as factors that can affect sales and margins. The floating-rate credit facility exposes the company to interest-rate movements: management estimated that a 100-basis-point LIBOR change would alter annual interest expense by $1.6 million at the quarter-end debt balance. Self-insurance estimates and litigation outcomes are uncertain; management did not expect ordinary-course proceedings to materially affect results, but noted litigation is inherently unpredictable. No material changes to the risk factors in the 2014 Form 10-K were reported. The company stated its disclosure controls were effective and reported no material change in internal controls over financial reporting.
Important facts for investors to verify
- Whether comparable-store sales growth stabilizes or continues to decelerate, and how much future sales growth depends on new stores.
- Whether price investments and newer-store costs continue to pressure gross and operating margins.
- Actual capital spending, operating cash conversion, and the cash demands of the company’s substantial lease commitments.
- Debt repayment, borrowing availability, covenant headroom and sensitivity to variable interest rates.
- The sustainability and accounting impact of gift-card breakage estimates, self-insurance reserves and other management estimates.
- Related-party supplier transactions and the terms and enforceability of the executive confidentiality and restrictive-covenant agreements disclosed after quarter-end.