Sprouts Farmers Market, Inc. — Q3 2013 Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended September 29, 2013. Dollar figures below are in millions unless stated otherwise. Sprouts operates a specialty grocery business focused on natural and organic foods; it reported 167 stores in eight states at quarter-end.
Financial performance and position
| Metric | 13 weeks ended Sep. 29, 2013 | Comparable 2012 period | 39 weeks ended Sep. 29, 2013 | Comparable 2012 period |
|---|---|---|---|---|
| Net sales | $633.6 | $510.1 | $1,829.7 | $1,315.9 reported; $1,512.0 pro forma |
| Gross profit / margin | $190.1 / 30.0% | $146.4 / 28.7% | $551.1 / 30.1% | $393.9 / 29.9% reported; $451.4 / 29.9% pro forma |
| Operating income | $36.7 | $13.3 | $116.8 | $55.2 reported; $69.5 pro forma |
| Net income | $11.5 | $1.3 | $42.0 | $16.2 reported; $21.1 pro forma |
| Diluted EPS | $0.08 | $0.01 | $0.31 | $0.14 |
| Comparable-store sales growth | 10.2% | 10.0% | 9.7% | 10.1% |
- Quarterly sales increased 24%; year-to-date reported sales rose 39%. Against 2012 pro forma sales including Sunflower for the full period, year-to-date sales grew 21%. Sunflower’s partial inclusion in reported 2012 results makes the reported comparison less comparable.
- Quarterly gross margin rose 1.3 percentage points, attributed mainly to promotional and merchandise-alignment effects and occupancy leverage; tighter supply reduced produce margins. Year-to-date margin increased 0.2 percentage points, with occupancy leverage partly offset by produce inflation and lower margins in vitamins, supplements and body care.
- Cash from operations was $142.7 for the 39 weeks, versus $82.5 a year earlier. Investing used $74.6, including $74.8 of property and equipment purchases; financing used $43.6. Ending cash was $91.7, up from $67.2 at December 30, 2012.
- At September 29, current assets were $239.3 and current liabilities $172.9, implying working capital of $66.3. Total assets were $1,181.8 and total liabilities $696.2.
- Debt was $351.8, net of issue discount, under the term loan; $5.7 was current. The $60.0 revolving facility had no borrowings and $52.0 available after letters of credit. Capital and financing lease obligations totaled $120.3.
Material changes and significant transactions
- The August IPO raised $344.1 net for the company. Sprouts used $340.0 to repay term debt; selling stockholders received no IPO proceeds. The IPO and related transactions increased shares outstanding.
- In April, Sprouts refinanced its prior facilities with a $700.0 term loan and $60.0 revolver, and distributed $282.0 to equity holders. It also paid $13.9 to vested option holders and repaid $35.0 of subordinated notes in May.
- Debt extinguishment losses were $9.5 in the quarter and $17.7 year to date, principally from write-offs of financing costs and discounts associated with the refinancing and IPO repayment. Year-to-date interest expense was $30.3 versus $25.4 reported in 2012; the pro forma 2012 comparison was $30.4.
- Year-to-date net sales growth reflected Sunflower, new stores and comparable-store gains. Sprouts opened 19 stores during the 39-week period, compared with nine in reported 2012, which also included the acquisition of 37 Sunflower stores.
Outlook, risks and unusual items
- Management intends to grow the store base by at least 12% annually for at least five years, pursue comparable-store growth and improve margins through scale, cost discipline and merchandise initiatives. No specific revenue or earnings forecast was provided.
- Fiscal 2013 capital expenditures were expected to be $70–$75 million, net of an estimated $11 million in landlord allowances. Management said cash on hand and anticipated operating cash flow should cover expected needs for at least 12 months.
- The term loan matures in April 2020 and bears variable interest. The filing estimates that, once LIBOR exceeds its 1% floor, each 1 percentage-point increase in LIBOR would raise annual interest expense by $3.6 million on the stated $360.0 million principal balance. Management estimated annual cash interest would fall by about $17.1 million after the IPO repayment and interest-margin reduction, using September 29 rates and debt balances.
- Contractual obligations totaled $1,540.0, including $905.0 of operating lease commitments and $154.0 of capital and financing lease obligations. These are future contractual payments, not recorded debt alone.
- Management identified ordinary-course litigation and insurance/self-insurance estimation as contingencies; it did not expect pending proceedings to materially affect results, while noting litigation outcomes are inherently unpredictable. Closed-store reserves were $4.9, primarily future rent net of expected sublease income.
- Disclosure controls were deemed ineffective because a material weakness in internal controls over inventory costing remained. Management said it was addressing the issue.
- A separate Section 13(r) disclosure described transactions by CEVA and subsidiaries involving Iran. Sprouts stated the transactions did not involve the company or its management and had not been independently verified by Sprouts.
Important facts for investors to verify
- Whether the inventory-costing material weakness has been remediated and whether it affects reported inventory or cost of sales.
- Comparable-store sales trends, produce availability and margins, and the contribution and returns of new stores.
- Variable-rate debt exposure, actual cash interest after the IPO paydown, and compliance with credit-facility covenants.
- Capital spending and lease commitments relative to operating cash flow and planned store expansion.
- How much of reported earnings growth reflects underlying operations versus acquisition comparability, integration savings and debt-extinguishment costs.