Sprouts Farmers Market, Inc. — FY2014 Form 10-K
Business context and reporting period. Sprouts operates specialty grocery stores focused on fresh, natural and organic products. The fiscal year ended December 28, 2014, comprised 52 weeks. The company had 191 stores in 10 states at year-end, up from 167 a year earlier; seven more stores had opened by February 26, 2015.
Financial performance
| Metric | FY2014 | FY2013 |
|---|---|---|
| Net sales | $2,967.4 million | $2,437.9 million |
| Gross profit / margin | $885.2 million / 29.8% | $725.3 million / 29.7% |
| Operating income / margin | $199.7 million / 6.7% | $139.5 million / 5.7% |
| Net income / diluted EPS | $107.7 million / $0.70 | $51.3 million / $0.37 |
| Cash from operations | $181.2 million | $160.6 million |
| Cash and equivalents at year-end | $130.5 million | $77.7 million |
| Term loan principal outstanding | $261.3 million | Not stated here on the same gross-principal basis |
Revenue rose 22%, driven by $343.0 million of growth from stores operating before 2014 and $186.5 million from 2014 openings. Pro forma comparable-store sales growth was 9.9%, versus 10.7% in 2013. Gross margin improved 10 basis points; direct-store expenses fell to 19.6% of sales from 20.4%, and SG&A fell to 3.2% from 3.4% of sales. Lower interest expense and a smaller debt-extinguishment loss also supported earnings growth.
Fourth quarter: In the 13 weeks ended December 28, 2014, sales were $734.6 million, gross profit $211.2 million, operating income $32.8 million and net income $17.7 million (diluted EPS $0.11). In the comparable 2013 quarter, these were $608.2 million, $174.2 million, $22.7 million and $9.3 million (diluted EPS $0.06). The filing notes sales are typically lowest in the fourth quarter.
Investing activities used $126.7 million, primarily for property and equipment; financing activities used $1.7 million. The company made a voluntary $50 million term-loan payment in August 2014 and had no revolving-credit borrowings at year-end; $52.6 million remained available under its revolving facility. The balance sheet reports $256.4 million of long-term debt net of discount, including current maturities. Current assets were $334.1 million and current liabilities $220.8 million.
Material changes, outlook and risks
- Management planned 27 store openings in fiscal 2015 and targeted 14% annual new-store growth for at least five years. Fiscal 2015 capital expenditures were estimated at $100–$110 million, net of approximately $18 million in landlord allowances. Management expects cash on hand and operating cash flow to cover anticipated needs for at least 12 months.
- Management expects scale, systems, cost discipline and merchandising improvements to support margins, while cautioning that new stores initially carry lower margins. No specific earnings or comparable-sales guidance was provided.
- Long-term operating lease commitments were $1.149 billion, undiscounted, in addition to capital and financing lease obligations. The company also disclosed $377.1 million of purchase commitments. These obligations are important alongside reported debt.
- Nature’s Best supplied approximately 23% of purchases in 2014; United Natural Foods supplied another 4%. Produce represented about 26% of sales and is exposed to weather, supply and regional sourcing risks. California accounted for 44% of sales and 41% of stores.
- Other key risks include intense competition and pricing pressure, execution of rapid expansion, customer demand and food safety, regulatory changes affecting food and supplements, labor and commodity costs, and interest-rate exposure. A 100-basis-point LIBOR increase above the loan’s 1% floor would increase annual interest expense by approximately $2.6 million, based on year-end debt.
- Unusual items included a $1.1 million debt-extinguishment loss on the 2014 principal payment. Fourth-quarter accounting corrections added $4.4 million of depreciation expense and reduced direct-store expense by $3.6 million for store-development costs; management said these errors were not material to prior periods. A $0.9 million closed-store reserve accretion correction was also recorded and was not material to prior periods.
- The 2013 material weakness in controls over non-perishable inventory costing was reported remediated in 2014. Management and the auditor concluded internal control over financial reporting was effective at year-end. The auditor issued an unqualified opinion on the financial statements.
Investor verification priorities
- Verify comparable-store sales trends and the contribution of new stores to reported growth, including the company’s pro forma calculation methodology.
- Assess store-opening returns against management’s targets, planned expansion pace and expected capital spending.
- Review cash generation, debt repayment capacity, variable-rate exposure, and the scale and timing of lease and purchase commitments.
- Evaluate supplier concentration, produce availability and geographic concentration, particularly reliance on California.
- Check the ongoing effectiveness of inventory-costing controls and the treatment of the 2014 accounting corrections.
- Monitor food-safety, labeling and regulatory developments, litigation and self-insurance claims; the filing says ordinary-course legal matters had not caused material losses to date but outcomes remain uncertain.