Sprouts Farmers Market, Inc. — Q3 2018 Form 10-Q
Reporting period: Thirteen weeks ended September 30, 2018; year-to-date figures cover the thirty-nine weeks ended that date. Comparisons are with the corresponding periods ended October 1, 2017. Sprouts operated 313 stores in 19 states at quarter-end and 315 stores as of October 29, 2018.
Financial and operating performance
| Metric | Q3 2018 | Q3 2017 | 39 weeks 2018 | 39 weeks 2017 |
|---|---|---|---|---|
| Net sales | $1,329.1 million | $1,206.1 million | $3,938.0 million | $3,520.7 million |
| Comparable-store sales growth | 1.5% | 4.6% | 2.0% | 2.4% |
| Gross profit | $382.4 million | $346.4 million | $1,149.8 million | $1,025.7 million |
| Gross margin | 28.77% | 28.72% | 29.20% | 29.13% |
| Income from operations | $52.8 million | $53.0 million | $194.2 million | $189.0 million |
| Net income | $37.5 million | $31.5 million | $145.8 million | $118.7 million |
| Diluted EPS | $0.29 | $0.23 | $1.12 | $0.86 |
- Q3 sales increased 10%, driven by new-store growth and positive comparable sales. Year-to-date sales increased 12%; Sprouts opened 28 stores in the first 39 weeks.
- Q3 operating income was essentially flat as higher direct-store and interest expenses offset sales growth. Direct-store expense rose to 21.2% of sales from 20.7%; management cited wage investments, healthcare costs, and depreciation related to new stores and initiatives.
- Net income rose 19% in Q3 and 23% year to date, benefiting materially from lower income taxes. Effective tax rates were 17.3% and 16.4%, respectively, versus 33.8% and 31.7% in the comparative periods. The change reflected the Tax Act, excess tax benefits from stock awards, and a tax-method change; Q3 included a $2.6 million discrete tax benefit.
Cash flow, debt, and liquidity
- For the first 39 weeks, operating cash flow was $235.5 million, down from $259.0 million. Investing cash outflow was $148.4 million, primarily capital expenditures; financing cash outflow was $88.7 million.
- Cash, cash equivalents, and restricted cash totaled $17.8 million at September 30, 2018. Management stated available cash and expected operating cash generation should cover anticipated needs for at least 12 months.
- Long-term debt was $435.0 million, up $87.0 million from year-end 2017, with net borrowings used primarily to support share repurchases. The amended $700 million revolving facility matures in 2023; $27.0 million of letters of credit were outstanding. About 57% of debt was fixed through interest-rate swaps. The company reported compliance with its credit covenants.
- Capital and financing lease obligations were $128.1 million on the balance sheet. Contractual operating lease obligations totaled $1.690 billion; these are future commitments, not balance-sheet debt in this filing. Fiscal 2018 capital expenditures were expected to be $160–$165 million, net of estimated landlord allowances.
- Share repurchases totaled $193.3 million year to date, covering 8.4 million shares. The company had $283.3 million of authorization remaining under its then-current program. Repurchases were partly funded by credit-facility borrowings.
Outlook, risks, and notable items
- Management intended to open approximately 30 stores annually for the near term and reported 30 openings through October 29, 2018. Its stated strategy also emphasized positive comparable sales and continued investment in the brand and customer experience; no specific comparable-sales or earnings guidance was provided in the filing.
- Interest-rate exposure remained: management estimated that a 100-basis-point LIBOR change would alter annual interest expense by $1.9 million after swaps, versus $4.4 million without them.
- The company reached an agreement in principle to settle a securities action; subject to court approval, insurance was expected to fund the settlement without a material financial-statement impact. A separate Proposition 65 coffee case remained unresolved, with potential penalties or warning requirements not estimable; proceedings were stayed pending regulatory developments. Phishing-scam class actions also remained pending, with potential liability not reasonably estimable.
- Hurricane Florence-related preparation, closures, and inventory costs were approximately $0.4 million in Q3, net of estimated insurance recovery. Management reported no material changes to the risk factors in its 2017 Form 10-K.
- The company expected adoption of the new lease standard in fiscal 2019 to materially increase reported assets and liabilities; it anticipated higher rent expense from lease reclassification, partly offset by lower depreciation and interest, and no cash-flow impact.
Important facts for investors to verify
- Whether comparable-store sales stabilize or improve, given Q3 growth slowed to 1.5% from 4.6% a year earlier.
- How much reported earnings growth reflects ongoing operations versus lower tax rates and discrete tax benefits.
- Returns and financing consequences of continued share repurchases, including the increase in debt to $435.0 million.
- Execution of the store-opening and capital-spending plans, alongside store-cost pressures and lease commitments.
- Resolution and financial implications of the securities, Proposition 65, and phishing-related litigation.