Business context and reporting period
Sprouts Farmers Market, Inc. operates specialty grocery stores focused on fresh, natural and organic products. This unaudited Form 10-Q covers the 13 weeks ended April 4, 2021; comparisons are with the 13 weeks ended March 29, 2020. Sprouts operated 362 stores in 23 states at quarter-end, versus 344 stores a year earlier.
Financial performance and liquidity
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Net sales | $1,575.4 | $1,646.5 | (4)% |
| Gross profit / margin | $586.2 / 37.2% | $593.8 / 36.1% | Profit (1)%; margin +1.1 pts |
| Operating income | $113.2 | $127.6 | (11)% |
| Net income | $83.0 | $91.8 | (10)% |
| Diluted EPS | $0.70 | $0.78 | (10)% |
| Operating cash flow | $105.4 | $277.1 | Down $171.6 |
| Capital expenditures | $16.6 | $28.0 | Down $11.4 |
- Comparable-store sales fell 9.4%, compared with growth of 10.6% a year earlier. Management attributed the decline primarily to cycling the initial pandemic-related sales surge in 2020.
- Gross margin improved through changes to promotional activity and efforts to reduce shrink. SG&A rose 1% to $439.7 million and increased to 27.9% of sales from 26.5%, reflecting ecommerce costs, new stores and sales deleverage, partly offset by lower bonus expense.
- Cash, cash equivalents and restricted cash totaled $257.8 million at quarter-end; balance-sheet cash and cash equivalents were $256.0 million. Operating cash flow was lower mainly because working-capital movements benefited the prior-year period, including elevated accounts payable and accruals. Operating cash flow less capital expenditures was approximately $88.8 million.
- Debt under the revolving credit agreement was $250.0 million, unchanged from January 3, 2021. Long-term debt and finance lease liabilities totaled $260.3 million. Operating lease liabilities were $1,208.7 million in total. The company was in compliance with its credit covenants.
- The effective tax rate was 24.7%, down from 25.2%. The company reported total assets of $2,896.7 million and stockholders’ equity of $966.9 million at April 4, 2021.
Material changes and unusual items
- Sales declined despite a larger store base, as comparable-store performance reversed from the pandemic-driven comparison-period increase. Perishables represented 57.8% of sales, up from 55.4%; non-perishables were 42.2%, down from 44.6%.
- Store closure and other costs were $2.0 million, versus a $1.1 million credit in Q1 2020. Current-quarter costs included inventory losses and expenses from winter storms and a store fire; the prior-year credit primarily reflected a gain on assignment of a closed-store lease.
- Interest expense, net declined to $3.0 million from $4.8 million, primarily due to a lower average debt balance, partly offset by interest expense associated with an unfavorable swap. Interest-rate swaps covered the full $250 million debt balance; management stated that a 100-basis-point LIBOR move would have no annual interest expense impact after swaps.
- The board authorized a new $300 million repurchase program in March 2021. During the quarter, Sprouts repurchased 129,968 shares for $3.2 million, leaving $296.8 million authorized; it repurchased another 75,000 shares for $1.9 million through May 6, 2021.
Outlook, commentary and risks
- No specific near-term revenue or earnings guidance is provided. Sprouts expects fiscal 2021 capital expenditures of $140 million to $160 million, net of estimated landlord allowances.
- Management’s long-term strategy emphasizes target customers, ecommerce, smaller updated stores in selected markets, improved fresh-supply-chain capabilities and brand positioning. The company cited a runway for at least 10% annual unit growth beginning in 2022.
- Management believes existing cash and cash expected from operations will meet anticipated needs for at least the next 12 months. Future capital needs depend on pandemic impacts, store openings, remodels and other investments.
- COVID-19-related uncertainty remains, including the effects of reopening, changing consumer behavior, elevated frontline compensation and safety costs, and ecommerce fees. Management said the pandemic’s future duration and impact are difficult to predict.
- Food-price deflation or inflation and competitor pricing responses may affect sales, margins and comparable-store sales. Other noted exposures include self-insurance estimates, litigation and interest-rate risk. The company reported no material changes to the risk factors in its 2020 Form 10-K.
- A California Proposition 65 coffee lawsuit was dismissed, but the plaintiff appealed; Sprouts said it could not estimate a potential loss and recorded no contingency. Ordinary-course claims and litigation are also disclosed.
Important facts for investors to verify
- Whether sales and comparable-store trends stabilize as the unusually strong pandemic comparison period passes.
- Whether gross-margin gains from lower shrink and promotional changes can offset SG&A deleverage and ecommerce costs.
- Cash-flow conversion and working-capital trends, especially compared with the unusually favorable prior-year working-capital contribution.
- Execution of the $140 million to $160 million capital plan and the stated store-growth strategy, including the timing and economics of new stores.
- Debt maturity in March 2023, covenant compliance, lease commitments and continued effectiveness of interest-rate hedges.
- Potential developments in the Proposition 65 appeal and changes in COVID-19, food-price, self-insurance or other litigation exposures.