Sprouts Farmers Market, Inc. — Q2 2017 Form 10-Q
Business context and period. Sprouts operates specialty healthy-grocery stores. This unaudited report covers the 13 and 26 weeks ended July 2, 2017, compared with the corresponding periods ended July 3, 2016. The company had 274 stores in 15 states at quarter-end and 278 as of August 1, 2017.
Financial and operating performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $1,184 million | $1,032 million | $2,315 million | $2,025 million |
| Comparable-store sales growth | 1.4% | 4.1% | 1.2% | 4.4% |
| Gross margin | 28.9% | 29.6% | 29.3% | 30.2% |
| Operating income | $63.5 million | $63.5 million | $136.0 million | $141.3 million |
| Net income | $41.0 million | $37.2 million | $87.3 million | $83.4 million |
| Diluted EPS | $0.29 | $0.25 | $0.62 | $0.55 |
| Operating cash flow | — | $179.9 million | $147.9 million | |
| Capital expenditures | — | $117.8 million | $85.1 million |
Sales rose 15% in Q2 and 14% in the first half, with growth driven primarily by new stores. Comparable-store sales growth slowed materially year over year. Gross margin contracted 0.7 percentage points in Q2 and 0.9 points in the first half. Management attributed pressure to competition and higher occupancy costs; Q2 commentary also cited modest cost inflation. First-half direct store expenses increased as a share of sales, reflecting payroll and benefit costs and fixed-cost deleverage, partly offset by operating efficiencies.
Q2 operating income was essentially flat despite sales growth; first-half operating income declined about 4%. Net income rose 10% in Q2 and 5% in the first half, helped by lower effective tax rates. Tax rates were 30.0% and 31.0%, respectively, versus 37.9% in both 2016 comparison periods, primarily due to tax benefits from equity awards. Diluted EPS growth also benefited from fewer shares following repurchases.
Cash, debt and liquidity
- Cash and cash equivalents were $14.8 million at July 2, 2017, versus $12.5 million at January 1, 2017. Current assets were $276.4 million and current liabilities $281.8 million.
- First-half operating cash flow was $179.9 million; investing cash outflow was $117.7 million and financing cash outflow $59.8 million. Cash flow from operations increased $32.0 million year over year, with improved working-capital contribution.
- Credit-facility debt was $310 million, up from $255 million at January 1, 2017. The $450 million revolving facility matures in April 2020; $24.8 million of letters of credit were outstanding. The company was in compliance with its covenants at quarter-end.
- Capital and financing lease obligations totaled $139.6 million on the balance sheet; scheduled lease payments were $1.70 billion in total, including $1.55 billion of operating-lease payments. Amounts are gross of subtenant rentals.
- The company said cash on hand and expected operating cash flow would cover anticipated needs for at least 12 months. Each 100-basis-point LIBOR change was estimated to change annual interest expense by $3.1 million, based on quarter-end debt.
Outlook, material items and risks
- Management planned 32 new stores in 2017, with 25 opened by August 1, and approximately 30 openings annually in the near term. It also expects positive comparable-store sales growth, without providing a numerical target.
- Fiscal 2017 capital expenditures were expected to be $155–$165 million, net of estimated landlord tenant-improvement allowances.
- The board authorized a $250 million repurchase program in February 2017. By July 2, $40 million had been used, leaving $210 million authorized. First-half repurchases totaled $120 million; subsequent to quarter-end through August 2, another 0.7 million shares were repurchased for $15.5 million. Borrowings supported the repurchase activity.
- A securities class action alleges inadequate disclosure of produce-price deflation in 2015 offering documents; the company said the potential outcome or liability could not be reasonably estimated. Separate class actions concerning a 2016 phishing incident were stayed pending a court decision relevant to arbitration agreements; potential liability also could not be estimated.
- Other areas to monitor include competitive and food-price pressures, self-insurance claims, variable-rate borrowing costs, and substantial lease commitments. The company reported no material changes to its previously disclosed risk factors and said disclosure controls were effective.
Important facts for investors to verify
- Whether comparable-store sales stabilize or weaken further, and how new-store growth translates into profitability.
- Whether gross-margin pressure, payroll and benefit costs, and store-expansion spending affect future operating margins and cash generation.
- How debt-funded repurchases and the remaining authorization affect leverage, interest expense, and liquidity.
- Progress against the 2017 store-opening and capital-spending plans, and whether the company achieves its stated positive comparable-sales objective.
- Developments in the securities and phishing-related litigation, including any change in the company’s ability to estimate exposure.