Sprouts Farmers Market, Inc. — Q1 2017 Form 10-Q
Business context and period. Sprouts operates healthy grocery stores focused on fresh, natural and organic products. This unaudited report covers the 13 weeks ended April 2, 2017; comparisons are with the 13 weeks ended April 3, 2016 unless noted. The company had 261 stores in 15 states at quarter-end and 268 stores as of May 3, 2017.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $1,130.6 million | $993.2 million | +14% |
| Comparable-store sales growth | 1.1% | 4.8% | Down 3.7 percentage points |
| Gross profit / margin | $337.3 million / 29.8% | $306.5 million / 30.9% | Margin down 1.1 points |
| Operating income | $72.5 million | $77.8 million | Down 7% |
| Net income / margin | $46.3 million / 4.1% | $46.2 million / 4.7% | Net income essentially flat |
| Diluted EPS | $0.33 | $0.30 | +10% |
| Cash from operations | $114.5 million | $97.9 million | Up $16.6 million |
| Capital expenditures | $57.2 million | $34.0 million | Up $23.2 million |
Margins and earnings drivers. Cost of sales, buying and occupancy rose 16%, faster than sales. Management attributed lower gross margin primarily to cycling a prior-year benefit from deflation without a corresponding promotional environment and to higher occupancy costs. Direct store expenses rose 18% and increased from 19.5% to 20.3% of sales, reflecting payroll and benefit costs, fixed-cost deleverage on slower comparable sales growth, and higher depreciation. Lower gross margin and higher payroll weighed on net margin; the lower tax rate partly offset these effects. Diluted EPS growth was driven by fewer diluted shares following repurchases.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $21.3 million at April 2, 2017, versus $12.5 million at January 1, 2017. Operating cash flow was $114.5 million; investing and financing used $57.2 million and $48.5 million, respectively.
- Long-term debt was $285.0 million, up from $255.0 million at January 1, 2017. The $450 million revolving credit facility matures in April 2020; $24.8 million of letters of credit were outstanding. The company was in compliance with its covenants.
- Current assets were $273.5 million and current liabilities $300.1 million at quarter-end. Lease obligations include $132.2 million of capital and financing lease payments and $1,523.9 million of operating lease payments, presented gross of subtenant rentals.
- The company repurchased 4.1 million shares for $80.0 million during the quarter, completing its September 2016 $250 million program. A new $250 million authorization was approved in February 2017 and remained unused at quarter-end. The filing says repurchases may be funded in part with credit-facility borrowings.
- Management said existing cash and expected operating cash flow should meet anticipated needs for at least 12 months. Fiscal 2017 capital expenditures were expected to be $155–$165 million, net of estimated landlord allowances.
Outlook, risks and unusual items
- Management planned 32 store openings in 2017, with 15 opened through May 3, and approximately 30 openings annually in the near term. Its strategy includes expansion, positive comparable sales growth, product and marketing initiatives, and brand development. No numerical comparable-sales or earnings guidance was provided.
- Management identified food inflation or deflation, competitive pricing, and the ability to pass through cost changes as factors that can affect sales and margins. A 100-basis-point change in LIBOR would change annual interest expense by approximately $2.9 million, based on quarter-end facility borrowings.
- A securities class action alleges inadequate disclosure about produce-price deflation in 2015 offering documents; the company appealed the remand to state court. Four related class actions concern a 2016 phishing incident involving team members’ personal information. The company could not reasonably estimate potential liability in either matter.
- Self-insurance claims and settlements may differ from recorded estimates. Management reported no material changes to previously disclosed risk factors and said disclosure controls were effective.
- The effective tax rate fell to 31.8% from 37.8%, primarily reflecting recognition of stock-option tax benefits under newly adopted accounting guidance. The filing also reports ROIC, a non-GAAP measure, of 12.4% versus 13.4%; including capitalized operating leases, ROIC was 8.9% versus 9.8%.
Important facts for investors to verify
- Whether comparable-sales growth and gross margin stabilize after slowing and declining, respectively, year over year.
- How store expansion and planned capital spending affect returns, cash generation and operating expenses.
- Whether further repurchases rely on additional borrowing, and the resulting debt, interest expense and covenant headroom.
- The outcomes and potential financial exposure from the securities and phishing-related litigation, which the company could not estimate.
- The assumptions behind management’s 12-month liquidity outlook, including lease commitments, capital needs and variable-rate debt exposure.