Sprouts Farmers Market, Inc. — Q1 2014 Form 10-Q
Reporting period: Thirteen weeks ended March 30, 2014; compared with the thirteen weeks ended March 31, 2013. Unless otherwise noted, dollar figures below are in millions. Sprouts operated 171 stores in nine states at quarter-end.
Financial and operating performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $722.6 | $573.7 | +26% |
| Comparable-store sales growth | 12.8% | 8.0% | +4.8 percentage points |
| Gross profit / gross margin | $223.9 / 31.0% | $173.9 / 30.3% | Margin +0.7 percentage points |
| Operating income | $61.7 | $40.0 | +54% |
| Net income / diluted EPS | $33.7 / $0.22 | $18.1 / $0.14 | Net income +86% |
| Operating cash flow | $76.3 | $63.4 | +$12.8 |
| Capital expenditures (cash purchases of property and equipment) | $18.2 | $27.4 | -$9.2 |
Gross margin improved mainly through occupancy, utility and buying-cost leverage, strong produce quality and availability, and vendor discounts; promotions partly offset the gains. Direct store expenses fell to 19.1% of sales from 20.0%, reflecting labor and depreciation leverage and lower medical-benefit utilization. SG&A rose to 3.1% of sales from 2.9%, partly due to $1.4 million of secondary-offering-related expense. Interest expense declined to $6.5 million from $10.2 million, reflecting lower debt and interest rates after refinancing and the IPO-related repayment.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $149.0 million at March 30, 2014, up from $77.7 million at December 29, 2013. Current assets were $303.7 million and current liabilities $210.3 million.
- Long-term debt, net of current maturities and issue discount, was $309.8 million, including $5.8 million current. The company also had $123.7 million of capital and financing lease obligations on the balance sheet.
- No borrowings were outstanding on the $60 million revolving facility; $52.6 million remained available after letters of credit. The company reported compliance with its credit-facility covenants.
- Operating cash flow was $76.3 million; investing cash use was $18.2 million; financing cash inflow was $13.3 million. Financing cash flow included a $14.8 million excess tax benefit from option exercises.
- Management said cash on hand and expected operating cash flow should meet anticipated needs for at least 12 months. Fiscal 2014 capital expenditures were projected at $110–$120 million, net of estimated landlord allowances.
Outlook, commentary and notable matters
- Management planned 23–24 store openings in fiscal 2014; five had opened by the report date. It stated an intention to achieve at least 12% annual new-store growth for at least five years.
- Growth priorities include new stores, comparable-store sales, operating-margin improvement and brand development. Management cited scale efficiencies, cost discipline, IT systems and merchandise improvements as potential margin supports.
- Sales increased by $148.9 million: $81.3 million was attributed to comparable-store growth and fiscal 2013 openings not yet in the comparable base; $67.6 million came from stores opened after March 31, 2013.
- Seasonality is modest; weekly sales are typically highest in the first half, when produce availability is generally greater. Produce represented 25% of Q1 2014 sales.
- The April 2, 2014 secondary offering was conducted by existing stockholders; the company sold no shares and received no proceeds. Separately, exercised-option proceeds of $3.4 million were received after quarter-end.
- Management disclosed a continuing material weakness in internal control over financial reporting related to costing non-perishable inventory. Disclosure controls and procedures were therefore deemed ineffective at March 30, 2014; the company was implementing and testing an automated weighted-average-cost system.
- Key exposures include variable-rate debt: the filing estimated that each 100-basis-point LIBOR increase above the 1.00% floor would raise annual interest expense by about $3.2 million, based on principal outstanding. Insurance and self-insurance claims require estimates; ordinary-course litigation was described as inherently unpredictable, with no expected material adverse effect stated.
- Future results may also be affected by food-price inflation or deflation, consumer demand and preferences, competition, new-store execution, and the ability to obtain financing if needed. The filing reported no material changes to the risk factors in the 2013 Form 10-K.
Important facts for investors to verify
- Whether comparable-store sales growth and new-store performance continue, and how much growth reflects new locations versus existing stores.
- Progress against the 23–24 store-opening plan, projected capital spending and the economics of new stores.
- Resolution and testing of the inventory-costing material weakness, including whether controls are later assessed as effective.
- Debt and lease obligations, revolver availability, covenant compliance and sensitivity to variable interest rates.
- Cash-flow quality, including the impact of working-capital changes and the nonrecurring $14.8 million option-related tax benefit in financing cash flow.
- Gross-margin durability and the effects of promotions, vendor allowances, produce availability, labor costs and public-company expenses.