Sprouts Farmers Market, Inc. — Q3 2016 Form 10-Q
Reporting period: Thirteen weeks ended October 2, 2016; year-to-date (YTD) covers the thirty-nine weeks ended that date. Comparisons are with the thirteen and thirty-nine weeks ended September 27, 2015. Dollar amounts are in millions unless stated otherwise.
Business context
Sprouts operates specialty grocery stores focused on fresh, natural and organic foods. It had 250 stores in 13 states at quarter-end, up from 216 a year earlier. The company opened 10 stores during the quarter and 33 YTD.
Financial performance
| Metric | Q3 2016 | Q3 2015 | YTD 2016 | YTD 2015 |
|---|---|---|---|---|
| Net sales | $1,035.8 | $903.1 | $3,060.7 | $2,662.7 |
| Gross profit | $291.5 | $261.5 | $903.8 | $782.9 |
| Gross margin | 28.1% | 28.9% | 29.5% | 29.4% |
| Operating income | $41.4 | $54.4 | $182.7 | $181.0 |
| Net income | $23.9 | $32.0 | $107.3 | $100.8 |
| Diluted earnings per share | $0.16 | $0.21 | $0.71 | $0.65 |
- Quarterly sales grew 15%, while comparable-store sales growth slowed to 1.3% from 5.8%. YTD sales also rose 15%; comparable-store sales growth was 3.4%, down from 5.2%.
- Q3 net income fell 25%, despite higher sales. Management attributed the decline to lower gross margin, price investments amid deflation and competition, and higher store payroll and SG&A costs. YTD net income rose 6%, partly because the prior year included a $5.5 million debt-extinguishment loss.
- Quarterly gross margin declined 0.8 percentage points. Management cited 60 basis points of price investments and slightly higher shrink, plus 20 basis points of occupancy deleverage. YTD gross margin increased 0.1 percentage points.
Cash, debt and liquidity
- YTD operating cash flow was $196.0 million, versus $179.1 million. Investing cash outflow was $142.4 million, including $142.6 million of property and equipment purchases; financing cash outflow was $139.4 million.
- Cash and cash equivalents were $50.3 million at October 2, down from $136.1 million at January 3, 2016. The company said cash, together with anticipated operating cash flow, should meet expected needs for at least 12 months.
- Credit Facility debt was $205.0 million, up from $160.0 million at January 3; the $450 million revolving facility matures in April 2020. The company was in compliance with its financial covenants. A 100-basis-point change in LIBOR would change annual interest expense by approximately $2.1 million, based on quarter-end debt.
- Capital and financing lease obligations totaled approximately $124.8 million on the balance sheet. Contractual operating lease payments were approximately $1.4 billion, before subtenant rentals.
Outlook, risks and other notable items
- Management planned 36 store openings for fiscal 2016; 35 had opened as of the report date. It aims for 14% annual new-store growth for at least five years. Expected fiscal 2016 capital expenditures were $160–$165 million.
- The board authorized a new $250 million share-repurchase program in September. The company repurchased 3.2 million shares for $63.6 million during Q3 and 8.2 million shares for $187.8 million YTD. After quarter-end through October 31, it repurchased another 2.9 million shares for $60.9 million and borrowed an additional $60 million, bringing facility debt to $265 million.
- Management identified food-price deflation, competitive pricing and promotions, consumer demand, store execution and expansion, and labor and operating costs as factors affecting results. Produce represented about 25% of YTD sales; the business is modestly seasonal.
- The company disclosed securities litigation alleging inadequate disclosure of produce-price deflation in its March 2015 offering, and class actions concerning employee personal information exposed in a phishing incident. It said outcomes and potential liabilities could not be reasonably estimated. Self-insurance claims are another significant contingency.
- Management reported effective disclosure controls as of October 2, 2016, with no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether comparable-store sales and margins stabilize after the quarter’s slowdown and pricing investments.
- How continued store expansion affects labor costs, operating margins, capital spending and returns on new stores.
- The pace and financing of further repurchases, particularly given lower cash and increased revolving debt after quarter-end.
- Available borrowing capacity, covenant headroom, and exposure to variable interest rates.
- Developments in the securities and phishing-related litigation and any changes to estimated self-insurance or other liabilities.
- Execution against the 36-store fiscal 2016 plan, the $160–$165 million capital expenditure outlook, and the longer-term store-growth target.