Sprouts Farmers Market, Inc. — Q2 2018 Form 10-Q
Reporting period: The 13-week quarter ended July 1, 2018; year-to-date results cover 26 weeks. Comparisons are against the periods ended July 2, 2017. Sprouts operated 301 stores in 17 states at quarter-end and 305 stores as of August 1, 2018.
Financial and operating results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $1,321.7M | $1,184.0M | $2,608.9M | $2,314.6M |
| Comparable-store sales growth | 2.0% | 1.4% | 2.3% | 1.2% |
| Gross profit / margin | $380.4M / 28.8% | $342.0M / 28.9% | $767.5M / 29.4% | $679.3M / 29.3% |
| Operating income | $61.7M | $63.5M | $141.4M | $136.0M |
| Net income | $41.7M | $41.0M | $108.3M | $87.3M |
| Diluted EPS | $0.32 | $0.29 | $0.82 | $0.62 |
| Cash from operations | — | — | $171.1M | $179.9M |
| Capital expenditures | — | — | $103.9M | $117.8M |
Quarterly sales rose 12%, driven by new stores and comparable-store growth. Quarterly gross margin slipped 0.1 percentage point; management cited slightly lower merchandise margins. Direct-store expenses increased 16% and rose to 20.7% of sales from 19.9%, reflecting planned wage investments, higher healthcare costs and depreciation associated with growth. SG&A increased 14%, including higher compensation, advertising and technology costs. Operating income declined 3% in Q2, while first-half operating income increased 4%. First-half net income rose 24%, benefiting from sales growth and a lower tax rate.
Effective tax rates were 24.5% for Q2 and 16.1% for the first half, versus 30.0% and 31.0%, respectively, a year earlier. The reduction reflects the Tax Cuts and Jobs Act; first-half results also benefited from excess tax benefits on share-based awards. Diluted EPS growth also benefited from fewer shares following repurchases.
Balance sheet, cash flow and financing
- At July 1, 2018, cash was $23.2M; current assets were $330.0M and current liabilities $318.4M.
- Long-term debt was $458.0M, up $110.0M from year-end 2017. The company had $136.0M of total capital and financing lease obligations, including current amounts.
- First-half operating cash flow was $171.1M, down from $179.9M, primarily due to working-capital changes. Investing cash outflow was $103.9M. Cash used in financing was $63.5M, including $178.0M of repurchases, partly offset by $110.0M of net credit-facility borrowing.
- The March 2018 refinancing established a $700M revolving facility maturing in March 2023. $27.0M of letters of credit had been issued. Approximately 55% of outstanding debt was fixed through interest-rate swaps. The company reported compliance with its financial covenants at quarter-end.
- Operating lease obligations totaled $1.628B in undiscounted scheduled payments. The company expected adoption of the new lease standard in fiscal 2019 to materially increase reported assets and liabilities.
Outlook, risks and notable items
- Management planned approximately 30 new stores in 2018 and approximately 30 annually in the near term; 20 had opened by August 1. It expects fiscal 2018 capital expenditures of $165M–$170M, net of estimated landlord allowances.
- Management stated that cash, expected operating cash flow and available credit were expected to meet anticipated needs for at least 12 months. Repurchases may continue using credit-facility borrowings.
- The $458M revolving debt balance is exposed to LIBOR: management estimated each 100-basis-point LIBOR change would alter annual interest expense by $4.6M before swaps and $2.1M after swaps.
- Quarterly repurchases totaled $95.0M; first-half repurchases totaled $178.0M. The company repurchased a further 0.6M shares for $13.5M through August 1. The filing notes repurchase plans are discretionary and may be suspended or discontinued.
- A securities class action concerning alleged disclosures about produce-price deflation in a 2015 offering remained in discovery; the company said potential liability could not be reasonably estimated. Related phishing-scam class actions also remained unresolved, with outcomes and potential liability not estimable.
- Food-price inflation or deflation, competitive pricing, wages, healthcare costs, store execution and interest rates may affect performance. Management reported no material changes to previously disclosed risk factors. The company reported effective disclosure controls and no material changes to internal control over financial reporting.
Investor facts to verify
- Whether comparable-store sales and merchandise margins sustain or improve as store growth continues.
- How wage, healthcare, advertising and technology investments affect operating expense leverage and profitability.
- Debt levels, covenant headroom, interest-rate exposure and the extent to which repurchases are funded by borrowing.
- Execution of the 2018 store-opening and capital-spending plans, alongside cash generation and lease commitments.
- Any developments in the securities and phishing litigation, and the financial impact, if any.