Sprouts Farmers Market, Inc. — Q3 2014 Form 10-Q
Business context and period. The filing covers the 13 weeks ended September 28, 2014, and year-to-date results for the 39 weeks ended that date, compared with the corresponding 2013 periods. Sprouts operates specialty grocery stores focused on fresh, natural and organic products. It had 191 stores in 10 states at quarter-end.
Financial performance and liquidity
Dollar amounts below are in millions except per-share figures. Financial statements are unaudited.
| Metric | Q3 2014 | Q3 2013 | 39 weeks 2014 | 39 weeks 2013 |
|---|---|---|---|---|
| Net sales | $766.4 | $633.6 | $2,232.8 | $1,829.7 |
| Comparable-store sales growth | 9.0% | 10.2% | 10.4% | 9.7% |
| Gross profit / margin | $226.0 / 29.5% | $190.1 / 30.0% | $674.0 / 30.2% | $551.1 / 30.1% |
| Income from operations | $49.7 | $36.7 | $166.9 | $116.8 |
| Net income | $26.1 | $11.5 | $89.9 | $42.0 |
| Diluted earnings per share | $0.17 | $0.08 | $0.58 | $0.31 |
- Q3 sales increased 21% year over year; net income rose 127%. Year-to-date sales increased 22% and net income rose 114%.
- Q3 gross margin declined 0.5 percentage points, which management attributed to price investments and inflation in certain categories, partly offset by lower occupancy, utilities and buying costs. Year-to-date gross margin increased 0.1 percentage points.
- Direct store expenses fell as a share of sales: 19.4% versus 20.4% in Q3 and 19.3% versus 20.1% year to date. SG&A was 3.1% of sales in Q3 versus 3.6%, and 3.1% year to date versus 3.3%.
- Cash from operations was $151.3 million for the 39 weeks, versus $138.3 million. Investing used $95.9 million, mainly for capital expenditures, versus $74.6 million. Operating cash flow less purchases of property and equipment was approximately $55.2 million, compared with $63.5 million.
- Cash was $118.4 million at September 28, 2014, up from $77.7 million at December 29, 2013. Current assets were $287.8 million and current liabilities $197.2 million.
- Long-term debt, including current maturities, was $257.9 million, down from $311.2 million at year-end; the company made a voluntary $50 million term-loan payment during the quarter. The $60 million revolver had no borrowings, with $52.6 million available after letters of credit. The company reported covenant compliance.
- Balance-sheet capital and financing lease obligations totaled approximately $126.6 million. Separately, disclosed future lease payments totaled $1,257.8 million, including $1,101.4 million of operating leases, before subtenant rentals.
Material changes and notable items
- Store count increased from 167 at the beginning of the year to 191 at quarter-end; 24 stores opened and one was relocated year to date. New stores opened after September 29, 2013 contributed $68.1 million of Q3 sales growth and $110.8 million of year-to-date growth.
- Q3 comparable-store sales growth eased to 9.0% from 10.2% a year earlier, while the year-to-date rate improved to 10.4% from 9.7%.
- Interest expense fell to $6.2 million in Q3 from $8.8 million and to $19.1 million year to date from $30.3 million, reflecting lower debt and borrowing rates. The current-period $1.1 million debt-extinguishment loss related to the voluntary loan repayment; the prior-year periods included larger refinancing and IPO-related write-offs.
- Secondary offerings in April and August were sales by existing stockholders; Sprouts did not sell shares in either offering or receive their proceeds. The company issued 3.0 million shares through option plans year to date.
Outlook, risks and contingencies
- Management stated it intends to achieve 14% annual new-store growth for at least five years, while pursuing comparable-store growth, margin improvement and brand development. It opened 24 stores and relocated one during 2014 through quarter-end.
- Management expected fiscal 2014 capital expenditures of approximately $110 million, net of estimated landlord tenant-improvement allowances, and said cash on hand and anticipated operating cash flow should cover expected needs for at least 12 months.
- Key operating sensitivities include competition, consumer demand, pricing and food inflation or deflation, product mix, inventory shrinkage and the execution and costs of expansion. The business has modest seasonality, with sales typically highest in the first half of the fiscal year.
- The variable-rate term loan exposes the company to interest-rate changes; management estimated that each 100-basis-point LIBOR change above the 1% floor would change annual interest expense by approximately $2.6 million, based on outstanding principal at quarter-end.
- The company reported a material weakness in internal control over financial reporting related to costing non-perishable inventory. Disclosure controls were deemed ineffective as of quarter-end; a new automated inventory-costing system was being tested, and remediation was not yet complete.
- Ordinary-course litigation had not resulted in material losses to date, but outcomes are inherently uncertain. Self-insurance reserves involve judgment and actual claims may differ from estimates.
- A $0.9 million correcting entry adjusted closed-store liabilities for prior-period accretion and occupancy costs; management said its effect was not material to any period. A favorable landlord settlement adjustment also reduced the reserve. The filing reports commitments and contingencies but does not identify a material pending claim.
Important facts for investors to verify
- Whether comparable-store sales and new-store performance remain strong, and how the Q3 slowdown compares with subsequent results.
- Whether price investments and inflation continue to pressure gross margin, and whether operating-expense leverage is sustainable.
- Progress in opening stores toward the stated growth objective, including capital requirements and returns from newer locations.
- Remediation and testing of the inventory-costing material weakness, and any resulting financial-reporting adjustments.
- Debt repayment capacity, variable-rate exposure, lease commitments and compliance with credit-facility covenants.