Business context and reporting period
Sprouts Farmers Market, Inc. operates specialty grocery stores focused on fresh, natural and organic food. This unaudited Form 10-Q covers the 13 weeks ended April 3, 2016; comparisons are to the 13 weeks ended March 29, 2015. The company had 228 stores in 13 states at quarter-end, versus 200 a year earlier.
Financial and operating performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $993.2 million | $857.5 million | +16% |
| Comparable-store sales growth | 4.8% | 4.8% | Unchanged |
| Gross profit / margin | $306.5 million / 30.9% | $257.8 million / 30.1% | Margin +0.8 percentage points |
| Operating income | $77.8 million | $66.6 million | +17% |
| Net income / diluted EPS | $46.2 million / $0.30 | $37.5 million / $0.24 | Net income +23% |
| Operating cash flow | $97.9 million | $68.1 million | +$29.9 million |
Direct store expenses rose 19% and increased from 19.0% to 19.5% of sales, reflecting planned wage increases and higher training costs. SG&A rose 29%, including greater advertising, equity compensation, corporate payroll and consulting costs. Lower interest expense ($3.6 million versus $5.9 million) and improved gross margin supported earnings growth. The effective tax rate was 37.8%, compared with 38.3%.
Financial position, liquidity and capital allocation
At April 3, 2016, cash was $145.7 million and current assets were $351.9 million, against current liabilities of $245.2 million. Long-term debt was $160.0 million, unchanged from January 3; capital and financing lease obligations totaled $121.0 million on the balance sheet. The $450 million revolving facility matures in April 2020; $1.7 million of letters of credit had been issued. The company reported compliance with its debt covenants.
Operating activities provided $97.9 million; investing activities used $33.5 million, primarily for property and equipment; financing activities used $54.9 million, including $59.3 million for share repurchases. Cash increased $9.6 million during the quarter. Fiscal 2016 capital expenditure expectations were $145–$155 million, net of estimated landlord allowances. The company stated existing cash and anticipated operating cash flow should cover expected needs for at least 12 months.
Contractual lease payments were $1.49 billion in total, including $1.35 billion of operating lease obligations, shown gross of subtenant receipts. The company had $65 million remaining under its $150 million repurchase authorization at quarter-end. Each 100-basis-point change in LIBOR was estimated to change annual interest expense by $1.6 million, based on outstanding debt.
Outlook, commentary and risks
Management planned 36 store openings in fiscal 2016, with 14 open as of the report date, and targeted annual new-store growth of 14% for at least five years. No specific revenue or earnings guidance was provided. Management cited new-store growth, comparable-store sales, product offerings, marketing and customer experience as growth strategies. Comparable-store sales growth remained 4.8%; management attributed improved gross margin partly to deflation in certain categories and more normalized promotions.
Risks and contingencies include food-price inflation or deflation and competition, execution of rapid store expansion, wage and operating-cost pressure, interest-rate exposure, and substantial lease commitments. A shareholder class action alleged inadequate disclosure of produce price deflation in the March 2015 offering; the claimed damages were unspecified and the company said the outcome could not be reasonably estimated. Two April 2016 purported class actions concerned inadvertent disclosure of team members’ personal information in a phishing scam; outcomes and potential liabilities likewise could not be estimated. The company also identified self-insurance claims and ordinary-course litigation as contingencies.
Important facts for investors to verify
- Whether comparable-store growth and the reported gross-margin improvement persist as pricing, produce deflation and promotions change.
- Progress on the 36 planned store openings, the 14% growth target and the $145–$155 million capital-spending plan.
- Cash generation after capital spending and repurchases, and remaining capacity under the credit facility and buyback authorization.
- Developments and potential financial effects of the securities and phishing-related litigation, which were not estimable in the filing.
- Exposure from long-term leases, self-insurance estimates and floating-rate debt.