Sprouts Farmers Market, Inc. — Q1 2020 Form 10-Q
Business context and period. Sprouts operates healthy-grocery stores. The filing covers the 13 weeks ended March 29, 2020, compared with the 13 weeks ended March 31, 2019. Sprouts had 344 stores in 23 states at quarter-end and 347 as of May 5, 2020. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $1,646.5 | $1,413.9 | +16% |
| Comparable-store sales growth | 10.6% | 1.4% | +9.2 percentage points |
| Gross profit / gross margin | $593.8 / 36.1% | $484.3 / 34.3% | +23% / +1.8 points |
| Operating income | $127.6 | $79.6 | +60% |
| Net income / net margin | $91.8 / 5.6% | $56.4 / 4.0% | +63% / +1.6 points |
| Diluted EPS | $0.78 | $0.46 | +70% |
| Operating cash flow | $277.1 | $112.6 | +$164.5 |
| Capital expenditures | $28.0 | $30.1 | -$2.1 |
Sales growth reflected recent store openings and sharply higher comparable sales, primarily from increased customer traffic and grocery stockpiling during the COVID-19 outbreak. Management attributed gross-margin expansion to more balanced promotions in the first two months, plus March product mix and shrink benefits. SG&A rose 16% to $436.3 million, including new-store costs, COVID-related store bonuses and e-commerce fees, and strategic-initiative professional fees; it remained 26.5% of sales.
Financial position and liquidity
- Cash and cash equivalents were $247.1 million at March 29, 2020, versus $85.3 million at December 29, 2019. Cash, cash equivalents and restricted cash totaled $248.7 million.
- Current assets were $530.8 million and current liabilities were $547.4 million; the current ratio was approximately 0.97.
- Outstanding credit-facility debt was $451.0 million, down $87.0 million from year-end. The company also reported $11.2 million of finance lease liabilities. Approximately 55% of outstanding debt was fixed through interest-rate swaps. Sprouts reported compliance with its credit covenants.
- Operating cash flow increased substantially, mainly because of working-capital movements, including higher accounts payable and inventory-related cash effects. Financing cash outflow of $87.2 million primarily reflected debt repayment. No shares were repurchased in the quarter.
- Management said cash on hand and anticipated operating cash generation should cover expected needs for at least 12 months. Total contractual obligations were $2.31 billion, including $1.80 billion of operating lease obligations.
Material changes, outlook and risks
- COVID-19: The quarter benefited from elevated demand, but Sprouts incurred added compensation, benefits and protective-equipment costs. Management could not predict the pandemic’s duration or its effect on future performance and withdrew certainty from near-term planning; the filing provides no earnings guidance.
- Growth plans: Sprouts expected to open approximately 20 stores in 2020; seven had opened by May 5. The company cautioned that pandemic-related construction delays could affect openings and longer-term expansion. It expected fiscal 2020 capital expenditures of 2.5%–3.5% of net sales, net of estimated landlord allowances.
- Key risks: Store closures or reduced traffic, supply-chain and staffing disruption, inability to source or stock products, added health and safety costs, construction delays, and economic hardship or shifts to lower-priced options could weaken future sales and cash flows. Remote work also increases cybersecurity and data-protection risks.
- Interest-rate exposure: With $451 million of debt outstanding, a 100-basis-point LIBOR change was estimated to affect annual interest expense by $4.5 million before swaps and $2.0 million after swaps.
- Contingencies: Three individual claimants were expected to continue arbitration related to a 2016 phishing incident; potential liability was not reasonably estimable. A California Proposition 65 coffee case remained pending, and the company recorded no loss contingency because the potential outcome could not be estimated. The 2017 federal tax return was under IRS examination.
- Other items: Store closure costs and other credits were a net credit of $1.1 million, principally a gain on assignment of a closed-store lease. The effective tax rate rose to 25.2% from 24.4%, mainly due to share-based award tax detriments versus prior-year benefits.
Investor verification points
- Assess how much of the 10.6% comparable-sales increase was temporary COVID-related stockpiling and whether later-quarter demand and margins normalized.
- Review cash-flow quality: operating cash flow benefited substantially from working-capital changes, particularly accounts payable.
- Confirm debt repayment, available revolver capacity, interest-rate swap effects and ongoing compliance with leverage and interest-coverage covenants.
- Track store openings, capital spending and any pandemic-related delays against management’s 2020 plans.
- Monitor pandemic-related litigation, supply-chain, staffing and store-operation developments, as well as the unresolved legal and tax matters.