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Sprouts Farmers Market, Inc. - Quarter Report: 2018 April (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 1, 2018

Commission File Number: 001-36029

 

Sprouts Farmers Market, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

32-0331600

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

5455 East High Street, Suite 111

Phoenix, Arizona 85054

(Address of principal executive offices and zip code)

(480) 814-8016

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes    No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes    No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

  (Do not check if a smaller reporting company)

Smaller reporting company

 

 

 

 

Emerging growth company

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes    No

As of May 1, 2018, the registrant had 131,846,682 shares of common stock, $0.001 par value per share, outstanding.

 

 

 


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED APRIL 1, 2018

TABLE OF CONTENTS

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements.

1

 

 

 

 

Consolidated Balance Sheets as of April 1, 2018 and December 31, 2017 (unaudited)

1

 

 

 

 

Consolidated Statements of Income for the thirteen weeks ended April 1, 2018 and April 2, 2017 (unaudited)

2

 

 

 

 

Consolidated Statements of Comprehensive Income for the thirteen weeks ended April 1, 2018 and April 2, 2017 (unaudited)

3

 

 

 

 

Consolidated Statements of Stockholders’ Equity for the thirteen weeks ended April 1, 2018 and the year ended December 31, 2017 (unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the thirteen weeks ended April 1, 2018 and April 2, 2017 (unaudited)

5

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

6

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

20

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

29

 

 

Item 4. Controls and Procedures.

29

 

 

PART II - OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings.

31

 

 

Item 1A. Risk Factors.

31

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

32

 

 

Item 6. Exhibits.

32

 

 

Signatures

33

 

 


Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve substantial risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (referred to as the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (referred to as the “Exchange Act”), including, but not limited to, statements regarding our expectations, beliefs, intentions, strategies, future operations, future financial position, future revenue, projected expenses, and plans and objectives of management. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “predict,” “potential,” “continue,” “objective,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and involve known risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievement to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors” included in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and our other filings with the Securities and Exchange Commission. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires, references to the “Company,” “Sprouts,” ”Sprouts Farmers Market,” “we,” “us” and “our” refer to Sprouts Farmers Market, Inc. and, where appropriate, its subsidiaries.

 

 

 


PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

 

 

 

April 1,

2018

 

 

December 31,

2017

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

21,356

 

 

$

19,479

 

Accounts receivable, net

 

 

26,746

 

 

 

25,893

 

Inventories

 

 

239,611

 

 

 

229,542

 

Prepaid expenses and other current assets

 

 

27,301

 

 

 

24,593

 

Total current assets

 

 

315,014

 

 

 

299,507

 

Property and equipment, net of accumulated depreciation

 

 

738,656

 

 

 

713,031

 

Intangible assets, net of accumulated amortization

 

 

195,855

 

 

 

196,205

 

Goodwill

 

 

368,078

 

 

 

368,078

 

Other assets

 

 

9,541

 

 

 

4,782

 

Total assets

 

$

1,627,144

 

 

$

1,581,603

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and other accrued liabilities

 

$

270,385

 

 

$

244,853

 

Accrued salaries and benefits

 

 

33,569

 

 

 

45,623

 

Current portion of capital and financing lease obligations

 

 

11,964

 

 

 

9,238

 

Total current liabilities

 

 

315,918

 

 

 

299,714

 

Long-term capital and financing lease obligations

 

 

122,833

 

 

 

125,489

 

Long-term debt

 

 

368,000

 

 

 

348,000

 

Other long-term liabilities

 

 

134,215

 

 

 

130,640

 

Deferred income tax liability

 

 

37,695

 

 

 

27,066

 

Total liabilities

 

 

978,661

 

 

 

930,909

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Undesignated preferred stock; $0.001 par value; 10,000,000 shares authorized, no shares issued and outstanding

 

 

 

 

 

 

Common stock, $0.001 par value; 200,000,000 shares authorized,

   131,860,411 shares issued and outstanding, April 1, 2018;

   132,823,981 shares issued and outstanding, December 31, 2017

 

 

131

 

 

 

132

 

Additional paid-in capital

 

 

631,631

 

 

 

620,788

 

Accumulated other comprehensive income (loss)

 

 

2,536

 

 

 

(784

)

Retained earnings

 

 

14,185

 

 

 

30,558

 

Total stockholders’ equity

 

 

648,483

 

 

 

650,694

 

Total liabilities and stockholders’ equity

 

$

1,627,144

 

 

$

1,581,603

 

The accompanying notes are an integral part of these consolidated financial statements.  

 

 

 

1


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Net sales

 

$

1,287,196

 

 

$

1,130,645

 

Cost of sales, buying and occupancy

 

 

900,144

 

 

 

793,359

 

Gross profit

 

 

387,052

 

 

 

337,286

 

Direct store expenses

 

 

262,595

 

 

 

229,058

 

Selling, general and administrative expenses

 

 

41,447

 

 

 

32,168

 

Store pre-opening costs

 

 

3,320

 

 

 

3,458

 

Store closure and other costs

 

 

10

 

 

 

91

 

Income from operations

 

 

79,680

 

 

 

72,511

 

Interest expense

 

 

(6,065

)

 

 

(4,738

)

Other income

 

 

208

 

 

 

95

 

Income before income taxes

 

 

73,823

 

 

 

67,868

 

Income tax provision

 

 

(7,199

)

 

 

(21,581

)

Net income

 

$

66,624

 

 

$

46,287

 

Net income per share:

 

 

 

 

 

 

 

 

Basic

 

$

0.50

 

 

$

0.34

 

Diluted

 

$

0.50

 

 

$

0.33

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

Basic

 

 

132,423

 

 

 

137,069

 

Diluted

 

 

133,752

 

 

 

140,147

 

The accompanying notes are an integral part of these consolidated financial statements.


2


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(UNAUDITED)

(IN THOUSANDS)

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Net income

 

$

66,624

 

 

$

46,287

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

Unrealized gain on cash flow hedging activities, net of

    income tax of $1,148 and $0

 

 

3,320

 

 

 

 

Total other comprehensive income

 

$

3,320

 

 

$

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

69,944

 

 

$

46,287

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

3


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

 

 

 

Shares

 

 

Common

Stock

 

 

Additional

Paid In

Capital

 

 

Retained

Earnings

 

 

Accumulated Other Comprehensive Income (Loss)

 

 

Total

Stockholders’

Equity

 

Balances at January 1, 2017

 

 

140,002,242

 

 

$

140

 

 

$

597,269

 

 

$

75,500

 

 

$

 

 

$

672,909

 

Net income

 

 

 

 

 

 

 

 

 

 

 

158,440

 

 

 

 

 

 

158,440

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(784

)

 

 

(784

)

Issuance of shares under stock plans

 

 

2,144,669

 

 

 

2

 

 

 

9,298

 

 

 

 

 

 

 

 

 

9,300

 

Repurchase and retirement of common stock

 

 

(9,696,819

)

 

 

(10

)

 

 

 

 

 

(203,382

)

 

 

 

 

 

(203,392

)

Equity-based compensation

 

 

 

 

 

 

 

 

14,221

 

 

 

 

 

 

 

 

 

14,221

 

Balances at December 31, 2017

 

 

132,450,092

 

 

$

132

 

 

$

620,788

 

 

$

30,558

 

 

$

(784

)

 

$

650,694

 

Net income

 

 

 

 

 

 

 

 

 

 

 

66,624

 

 

 

 

 

 

66,624

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,320

 

 

 

3,320

 

Issuance of shares under stock plans

 

 

2,292,511

 

 

 

2

 

 

 

6,875

 

 

 

 

 

 

 

 

 

6,877

 

Repurchase and retirement of common stock

 

 

(3,329,409

)

 

 

(3

)

 

 

 

 

 

(82,997

)

 

 

 

 

 

(83,000

)

Equity-based compensation

 

 

 

 

 

 

 

 

3,968

 

 

 

 

 

 

 

 

 

3,968

 

Balances at April 1, 2018

 

 

131,413,194

 

 

$

131

 

 

$

631,631

 

 

$

14,185

 

 

$

2,536

 

 

$

648,483

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income

 

$

66,624

 

 

$

46,287

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

26,810

 

 

 

22,622

 

Accretion of asset retirement obligation and closed store reserve

 

 

79

 

 

 

19

 

Amortization of financing fees and debt issuance costs

 

 

376

 

 

 

116

 

Loss on disposal of property and equipment

 

 

79

 

 

 

45

 

Equity-based compensation

 

 

3,968

 

 

 

2,446

 

Deferred income taxes

 

 

10,629

 

 

 

8,878

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(1,957

)

 

 

213

 

Inventories

 

 

(10,069

)

 

 

196

 

Prepaid expenses and other current assets

 

 

(2,135

)

 

 

(1,350

)

Other assets

 

 

(1,070

)

 

 

(27

)

Accounts payable and other accrued liabilities

 

 

18,637

 

 

 

31,547

 

Accrued salaries and benefits

 

 

(11,995

)

 

 

(1,642

)

Other long-term liabilities

 

 

4,511

 

 

 

5,187

 

Cash flows from operating activities

 

 

104,487

 

 

 

114,537

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(44,158

)

 

 

(57,205

)

Proceeds from sale of property and equipment

 

 

 

 

 

30

 

Cash flows used in investing activities

 

 

(44,158

)

 

 

(57,175

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from revolving credit facilities

 

 

40,000

 

 

 

60,000

 

Payments on revolving credit facilities

 

 

(20,000

)

 

 

(30,000

)

Payments on capital and financing lease obligations

 

 

(1,039

)

 

 

(1,093

)

Payments of deferred financing costs

 

 

(2,131

)

 

 

 

Cash from landlords related to financing lease obligations

 

 

900

 

 

 

300

 

Repurchase of common stock

 

 

(83,000

)

 

 

(80,000

)

Proceeds from exercise of stock options

 

 

6,877

 

 

 

2,292

 

Other

 

 

(59

)

 

 

 

Cash flows used in financing activities

 

 

(58,452

)

 

 

(48,501

)

Increase in cash and cash equivalents

 

 

1,877

 

 

 

8,861

 

Cash and cash equivalents at beginning of the period

 

 

19,479

 

 

 

12,465

 

Cash and cash equivalents at the end of the period

 

$

21,356

 

 

$

21,326

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

6,080

 

 

$

4,435

 

Cash refunded for income taxes

 

 

 

 

 

(48

)

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities

 

 

 

 

 

 

 

 

Property and equipment in accounts payable

 

$

25,068

 

 

$

36,038

 

Property acquired through capital and financing lease obligations

 

 

5,019

 

 

 

3,167

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

1. Basis of Presentation

Sprouts Farmers Market, Inc., a Delaware corporation, through its subsidiaries, operates as a healthy grocery store that offers fresh, natural and organic food through a complete shopping experience that includes fresh produce, bulk foods, vitamins and supplements, packaged groceries, meat and seafood, deli, baked goods, dairy products, frozen foods, beer and wine, natural body care and household items catering to consumers’ growing interest in health and wellness. The “Company” is used to refer collectively to Sprouts Farmers Market, Inc. and unless the context otherwise requires, its subsidiaries.

The accompanying unaudited consolidated financial statements include the accounts of the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial statements and are in the form prescribed by the Securities and Exchange Commission in instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair statement of the Company's financial position, results of operations and cash flows for the periods indicated.  All material intercompany accounts and transactions have been eliminated in consolidation. Interim results are not necessarily indicative of results for any other interim period or for a full fiscal year. The information included in these consolidated financial statements and notes thereto should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto for the fiscal year ended December 31, 2017 (“fiscal year 2017”) included in the Company’s Annual Report on Form 10-K, filed on February 22, 2018.

The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

The Company reports its results of operations on a 52- or 53-week fiscal calendar ending on the Sunday closest to December 31. The fiscal year ending December 30, 2018 (“fiscal year 2018”) and fiscal year 2017 are 52-week years. The Company reports its results of operations on a 13-week quarter, except for 53-week fiscal years.

Certain reclassifications of amounts reported in prior periods have been made to conform with the current period presentation.

All dollar amounts are in thousands, unless otherwise noted. 

 

 

2. Summary of Significant Accounting Policies

The Company has adopted Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers” in the first quarter of fiscal year 2018, with a date of initial application of January 1, 2018, using the modified retrospective approach. Comparative information presented has not been adjusted and continues to be reported under ASC 605.

The Company applied ASC 606 to all of its contracts with customers. As a result of the adoption, there is no impact to any financial statement line item, and the Company has recorded no impact to opening retained earnings as of January 1, 2018.

The Company does not have any material contract assets or receivables from contracts with customers, any revenue recognized in the current period from performance obligations satisfied in previous periods, any contract performance obligations, or any material costs to obtain or fulfill a contract as of April 1, 2018. The Company had a net gift card liability balance of $8.9 million as of April 1, 2018 and $13.1 million as of December 31, 2017. During the thirteen weeks ended April 1, 2018, the Company recognized $7.1 million in sales related to gift cards redeemed by customers.

6


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Revenue is recognized at the point of sale. The Company’s performance obligations are satisfied upon the transfer of goods to the customer, at the point of sale, and payment from customers is also due at the time of sale. Proceeds from the sale of gift cards are recorded as a liability at the time of sale, and recognized as sales when they are redeemed by the customer and the performance obligation is satisfied by the Company.

The nature of goods the Company transfers to customers at the point of sale are inventories, consisting of merchandise purchased for resale.

Recently Adopted Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers.” ASU No. 2014-09 provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance.  These may include identifying performance obligations in the contract, and estimating the amount of variable consideration to include in the transaction price attributable to each separate performance obligation. Subsequent to the initial standards, the FASB has also issued several ASUs to clarify specific revenue recognition topics. The Company adopted ASC 606 effective January 1, 2018 using the modified retrospective approach. As noted above, there is no impact to any financial statement line item as a result of the adoption, and the Company has recorded no impact to opening retained earnings as of January 1, 2018. The Company has added additional disclosures of disaggregated revenue by type in Note 13, “Segments.”

In March 2016, the FASB issued ASU No. 2016-04, “Liabilities-Extinguishments of Liabilities (Subtopic 405-20): Recognition of breakage for certain prepaid stored-value products.” ASU No. 2016-04 provides a narrow scope exception to the guidance in Subtopic 405-20 to require that stored-value breakage be accounted for consistently with the breakage guidance in Topic 606. The amendments in this update contain specific guidance for derecognition of prepaid stored-value product liabilities, thereby eliminating the current and potential future diversity. The guidance was effective for the Company for its fiscal year 2018. The Company adopted this guidance using the modified retrospective approach. As noted above, there is no impact to any financial statement line item as a result of the adoption, and the Company has recorded no impact to opening retained earnings as of January 1, 2018.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” This update provides clarifications on the cash flow classification for eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. Adoption of this guidance took place during the first quarter of fiscal year 2018, using the retrospective transition method, and the adoption had no impact on the Company’s consolidated financial statements or disclosures.

In May 2017, the FASB issued ASU No. 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” The amendments in this update provide guidance about which changes to the terms or conditions of a share-based award require an entity to apply modification accounting in Topic 718. Adoption of this guidance took place prospectively in fiscal year 2018, and the adoption did not have an impact on the Company’s consolidated financial statements or disclosures.

7


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Recently Issued Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU No. 2016-02, “Leases (ASC 842).” ASU No. 2016-02 requires lessees to recognize a right-of-use asset and corresponding lease liability for all leases with terms greater than twelve months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. The new guidance also requires certain additional quantitative and qualitative disclosures. This guidance will be effective for the Company for its fiscal year 2019, with early adoption permitted, and the Company is currently evaluating the potential impact of this guidance. The adoption of this ASU is expected to result in a material increase to the Company’s consolidated balance sheets for right-of-use assets and lease liabilities.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The amendments in this update eliminate the second step of the goodwill impairment test and provide that an entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. The guidance will be effective for the Company for its fiscal year 2020, with early adoption permitted. The Company does not expect this ASU to materially impact the Company’s consolidated financial statements.

No other new accounting pronouncements issued or effective during the thirteen weeks ended April 1, 2018 had, or are expected to have, a material impact on the Company’s consolidated financial statements.

 

3. Fair Value Measurements

The Company records its financial assets and liabilities in accordance with the framework for measuring fair value in accordance with GAAP. This framework establishes a fair value hierarchy that prioritizes the inputs used to measure fair value:

Level 1: Quoted prices for identical instruments in active markets.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Fair value measurements of nonfinancial assets and nonfinancial liabilities are primarily used in the impairment analysis of goodwill, indefinite-lived intangible assets and long-lived assets, and in the valuation of store closure and exit costs.

The following tables present our fair value hierarchy for our financial assets and liabilities measured at fair value on a recurring basis as of April 1, 2018 and December 31, 2017:

 

April 1, 2018

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Long-term debt

 

$

 

 

$

368,000

 

 

$

 

 

$

368,000

 

Total liabilities

 

$

 

 

$

368,000

 

 

$

 

 

$

368,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap asset

 

$

 

 

$

3,415

 

 

$

 

 

$

3,415

 

Closed store reserves

 

 

 

 

 

 

 

 

764

 

 

 

764

 

Total assets

 

$

 

 

$

3,415

 

 

$

764

 

 

$

4,179

 

8


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

December 31, 2017

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Long-term debt

 

$

 

 

$

348,000

 

 

$

 

 

$

348,000

 

Interest rate swap liability

 

 

 

 

 

1,064

 

 

 

 

 

 

1,064

 

Total liabilities

 

$

 

 

$

349,064

 

 

$

 

 

$

349,064

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Closed store reserves

 

$

 

 

$

 

 

$

811

 

 

$

811

 

Total assets

 

$

 

 

$

 

 

$

811

 

 

$

811

 

The Company’s interest rate swaps are considered Level 2 in the hierarchy and are valued using an income approach. Expected future cash flows are converted to a present value amount based on market expectations of the yield curve on floating interest rates, which is readily available on public markets.

The determination of fair values of certain tangible and intangible assets for purposes of the Company’s goodwill impairment evaluation as described above is based upon Level 3 inputs. Closed store reserves are recorded at net present value to approximate fair value which is classified as Level 3 in the hierarchy. The estimated fair value of the closed store reserve is calculated based on the present value of the remaining lease payments and other charges using a weighted average cost of capital, reduced by estimated sublease rentals. The weighted average cost of capital is estimated using information from comparable companies and management’s judgment related to the risk associated with the operations of the stores.

Cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and other accrued liabilities and, accrued salaries and benefits approximate fair value because of the short maturity of those instruments. Based on comparable open market transactions, the fair value of the long-term debt approximated carrying value as of April 1, 2018 and December 31, 2017.

 

4. Long-Term Debt

A summary of long-term debt is as follows:

 

 

 

 

 

 

 

As of

 

Facility

 

Maturity

 

Interest Rate

 

April 1,

2018

 

 

December 31,

2017

 

Senior secured debt

 

 

 

 

 

 

 

 

 

 

 

 

$700.0 million Credit Agreement

 

March 27, 2023

 

Variable

 

$

368,000

 

 

$

 

Former Credit Facility

 

April 17, 2020

 

Variable

 

 

 

 

 

348,000

 

Total debt

 

 

 

 

 

 

368,000

 

 

 

348,000

 

Long-term debt

 

 

 

 

 

$

368,000

 

 

$

348,000

 

 

Senior Secured Revolving Credit Facility

March 2018 Refinancing

On March 27, 2018, the Company’s subsidiary, Sprouts Farmers Markets Holdings, LLC (“Intermediate Holdings”), as borrower, entered into an amended and restated credit agreement (the “Amended and Restated Credit Agreement”) to amend and restate the Company’s existing senior secured credit facility, dated April 17, 2015 (the “Former Credit Facility”). The Amended and Restated Credit Agreement provides for a revolving credit facility with an initial aggregate commitment of $700.0 million, an increase from $450.0 million under the Former Credit Facility, which may be increased from time to time pursuant to an expansion feature set forth in the Amended and Restated Credit Agreement.

9


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Concurrently with the closing of the Amended and Restated Credit Agreement, all commitments under the Former Credit Facility were terminated, resulting in a $0.3 million loss on early extinguishment of debt, recorded in interest expense. The loss was due to the write-off of a proportional amount of deferred financing costs associated with the Former Credit Facility as the result of certain banks exiting the Amended and Restated Credit Agreement in connection with the refinancing. No amounts are outstanding under the Former Credit Facility as of April 1, 2018.

The Company capitalized debt issuance costs of $2.1 million related to the refinancing which combined with the remaining $0.7 million debt issuance costs for the Former Credit Facility, are being amortized on a straight-line basis to interest expense over the five-year term of the Amended and Restated Credit Agreement.

The Amended and Restated Credit Agreement also provides for a letter of credit subfacility and a $15.0 million swingline facility. Letters of credit issued under the Amended and Restated Credit Agreement reduce its borrowing capacity. Letters of credit totaling $27.0 million have been issued as of April 1, 2018, primarily to support the Company’s insurance programs.

Guarantees

Obligations under the Amended and Restated Credit Agreement are guaranteed by the Company and all of its current and future wholly-owned material domestic subsidiaries (other than the borrower), and are secured by first-priority security interests in substantially all of the assets of the Company and its subsidiary guarantors, including, without limitation, a pledge by the Company of its equity interest in Intermediate Holdings.

Interest and Fees    

Loans under the Amended and Restated Credit Agreement initially bear interest at LIBOR plus 1.50% per annum. The interest rate margins are subject to adjustment pursuant to a pricing grid based on the Company’s total net leverage ratio, as set forth in the Amended and Restated Credit Agreement. Under the terms of the Amended and Restated Credit Agreement, the Company is obligated to pay a commitment fee on the available unused amount of the commitments between 0.15% to 0.30% per annum, also pursuant to a pricing grid based on the Company’s total net leverage ratio.

The rate on approximately 70% of outstanding debt under the Amended and Restated Credit Agreement is fixed, due to certain floating to fixed swaps implemented in December 2017 (see Note 11, “Derivative Financial Instruments”).

Outstanding letters of credit under the Amended and Restated Credit Agreement are subject to a participation fee of 1.50% per annum and an issuance fee of 0.125% per annum.

Payments and Borrowings    

The Amended and Restated Credit Agreement is scheduled to mature, and the commitments thereunder will terminate on March 27, 2023, subject to extensions as set forth therein.

The Company may prepay loans and permanently reduce commitments under the Amended and Restated Credit Agreement at any time in agreed-upon minimum principal amounts, without premium or penalty (except LIBOR breakage costs, if applicable).

During fiscal year 2017, the Company borrowed $153.0 million under the Former Credit Facility to be used in connection with the Company’s $250.0 million share repurchase program (see Note 9, “Stockholders’ Equity”) and made a total of $60.0 million of principal payments; resulting in total outstanding debt under the Former Credit Facility of $348.0 million at December 31, 2017. During the thirteen weeks ended April 1, 2018, the Company borrowed an additional $40.0 million and made a total of $20.0 million of principal payments; resulting in total outstanding debt under the Amended and Restated Credit Agreement of $368.0 million as of April 1, 2018.

10


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Covenants    

The Amended and Restated Credit Agreement contains financial, affirmative and negative covenants.  The negative covenants include, among other things, limitations on the Company’s ability to:

 

incur additional indebtedness;

 

grant additional liens;  

 

enter into sale-leaseback transactions;

 

make loans or investments;

 

merge, consolidate or enter into acquisitions;

 

pay dividends or distributions;

 

enter into transactions with affiliates;

 

enter into new lines of business;

 

modify the terms of debt or other material agreements; and

 

change its fiscal year.

Each of these covenants is subject to customary and other agreed-upon exceptions.

In addition, the Amended and Restated Credit Agreement requires that the Company and its subsidiaries maintain a maximum total net leverage ratio not to exceed 3.25 to 1.00 and minimum interest coverage ratio not to be less than 1.75 to 1.00. Each of these covenants is tested on the last day of each fiscal quarter, starting with the fiscal quarter ended April 1, 2018.

The Company was in compliance with all applicable covenants under the Amended and Restated Credit Agreement as of April 1, 2018.

 

Former Credit Facility

On April 17, 2015, Intermediate Holdings, as borrower, entered into the Former Credit Facility that provided for a revolving credit facility with an initial aggregate commitment of $450.0 million, subject to an expansion feature set forth therein. The Former Credit Facility also provided for a letter of credit subfacility and a $15.0 million swingline facility. 

The Former Credit Facility was scheduled to mature, and the commitments thereunder were scheduled to terminate, on April 17, 2020.

Loans under the Former Credit Facility bore interest, at the Company’s option, either at adjusted LIBOR plus 1.50% per annum, or a base rate plus 0.50% per annum. The interest rate margins were subject to adjustment pursuant to a pricing grid based on the Company’s total gross leverage ratio, as defined in the Former Credit Facility. Under the terms of the Former Credit Facility, the Company was obligated to pay a commitment fee on the available unused amount of the commitments equal to 0.20% per annum.

 

 

11


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

5. Closed Store Reserves

The following is a summary of closed store reserve activity during the thirteen weeks ended April 1, 2018 and fiscal year 2017:

 

 

 

Thirteen

Weeks Ended

 

 

Fiscal

Year Ended

 

 

 

April 1,

2018

 

 

December 31,

2017

 

Beginning balance

 

$

811

 

 

$

1,083

 

Additions

 

 

 

 

 

 

Usage

 

 

(107

)

 

 

(492

)

Adjustments

 

 

60

 

 

 

220

 

Ending balance

 

$

764

 

 

$

811

 

 

Usage relates to lease payments made during the periods for closed stores.

 

6. Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was enacted into law, which changes various corporate income tax provisions within the existing Internal Revenue Code.

The most significant changes that impact the Company are the reduction in the corporate federal income tax rate from 35% to 21% and 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023.

Under the guidance set forth in the SEC's Staff Accounting Bulletin No. 118 (“SAB 118”), the Company may record provisional amounts for the impact of the Tax Act. In 2017, the Company had substantially completed the measurement and made a provisional and reasonable estimate of the effects of the Tax Act on its existing deferred tax balances. The final impact of the Tax Act may differ due to changes in interpretations and assumptions the Company has made and guidance that may be issued. In accordance with SAB 118, future adjustments to the provisional numbers will be recorded as discrete adjustments to income tax expense in the period in which those adjustments become estimable and finalized. As of April 1, 2018 the Company has not made any changes to the provisional and estimated amounts.

The Company’s effective tax rate decreased to 9.8% for the thirteen weeks ended April 1, 2018 from 31.8% for the thirteen weeks ended April 2, 2017 primarily due to the enactment of the Tax Act as disclosed above and the recognition of excess tax benefits related to the exercise of stock options in the income tax provision.

Excess tax benefits associated with share-based payment awards are recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur. The income tax benefits resulting from excess tax benefits of share-based payment awards were $11.1 million and $3.8 million for the thirteen weeks ended April 1, 2018 and April 2, 2017, respectively.

 

7. Related-Party Transactions

A member of the Company’s board of directors is an investor in a company that is a supplier of coffee to the Company for resale. During the thirteen weeks ended April 1, 2018 and April 2, 2017, purchases from this supplier were $2.3 million and $2.9 million, respectively. As of April 1, 2018 and December 31, 2017, the Company had recorded accounts payable due to this vendor of $0.4 million and $0.7 million, respectively.

12


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

The Company’s former Executive Chairman of the Board, who retired from this position in February 2017, has been the chief executive officer, an equity investor, and lender to a technology supplier to the Company. During the thirteen weeks ended April 1, 2018 and April 2, 2017, purchases from this supplier and its predecessors were $1.2 million and $1.5 million, respectively. As of April 1, 2018 and December 31, 2017, the Company had recorded accounts payable due to the supplier of $0.4 million and $0.1 million, respectively.

 

8. Commitments and Contingencies

The Company is exposed to claims and litigation matters arising in the ordinary course of business and uses various methods to resolve these matters that are believed to best serve the interests of the Company’s stakeholders. The Company’s primary contingencies are associated with self-insurance obligations and litigation matters. Self-insurance liabilities require significant judgment and actual claim settlements and associated expenses may differ from the Company’s current provisions for loss.

Securities Action

On March 4, 2016, a complaint was filed in the Superior Court for the State of Arizona against the Company and certain of its directors and officers on behalf of a purported class of purchasers of shares of the Company’s common stock in the Company’s underwritten secondary public offering which closed on March 10, 2015 (the “March 2015 Offering”). The complaint purports to state claims under Sections 11, 12 and 15 of the Securities Act of 1933, as amended, based on an alleged failure by the Company to disclose adequate information about produce price deflation in the March 2015 Offering documents. The complaint seeks damages on behalf of the purported class in an unspecified amount, rescission, and an award of reasonable costs and attorneys’ fees. After removal to federal court, the plaintiff sought remand, which the court granted in March 2017.  On May 25, 2017, the Company filed a Motion to Dismiss in the Superior Court for the State of Arizona, which the court granted in part and denied in part by order entered August 30, 2017.  The Company answered the complaint on September 28, 2017.  The parties are engaged in discovery at this time. The Company will continue to defend this case vigorously, but it is not possible at this time to reasonably estimate the outcome of, or any potential liability from, the case.

 

9. Stockholders’ Equity

Share Repurchases

The following table outlines the common stock share repurchase programs authorized by the Company’s board of directors from time to time, and the related repurchase activity and available authorization as of April 1, 2018.

 

Effective date

 

Expiration date

 

Amount

authorized

 

 

Cost of

repurchases

 

 

Authorization

available

 

November 4, 2015

 

November 4, 2017

 

$

150,000

 

 

$

150,000

 

 

$

 

September 6, 2016

 

December 31, 2017

 

$

250,000

 

 

$

250,000

 

 

$

 

February 20, 2017

 

December 31, 2018

 

$

250,000

 

 

$

206,400

 

 

$

43,600

 

February 20, 2018

 

December 31, 2019

 

$

350,000

 

 

$

 

 

$

350,000

 

 

The shares under the Company’s repurchase programs may be purchased on a discretionary basis from time to time prior to the applicable expiration date, subject to general business and market conditions and other investment opportunities, through open market purchases, privately negotiated transactions, or other means, including through Rule 10b5-1 trading plans. The board’s authorization of the share repurchase programs does not obligate the Company to acquire any particular amount of common stock, and the repurchase programs may be commenced, suspended, or discontinued at any time. The Company has used borrowings under its Former Credit Facility and Amended and Restated Credit Agreement to assist with the repurchase programs (see Note 4, “Long-Term Debt”).

13


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Share repurchase activity under the Company’s repurchase programs for the periods indicated was as follows (total cost in thousands):

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Number of common shares acquired

 

 

3,329,409

 

 

 

4,099,936

 

Average price per common share acquired

 

$

24.93

 

 

$

19.51

 

Total cost of common shares acquired

 

$

83,000

 

 

$

80,000

 

 

Shares purchased under the Company’s repurchase programs were subsequently retired.

 

10. Net Income Per Share

The computation of net income per share is based on the number of weighted average shares outstanding during the period. The computation of diluted net income per share includes the dilutive effect of share equivalents consisting of incremental shares deemed outstanding from the assumed exercise of options, assumed vesting of restricted stock units (“RSUs”), assumed vesting of performance stock awards (“PSAs”), and assumed vesting of restricted stock awards (“RSAs”).

A reconciliation of the numerators and denominators of the basic and diluted net income per share calculations is as follows (in thousands, except per share amounts):

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Basic net income per share:

 

 

 

 

 

 

 

 

Net income

 

$

66,624

 

 

$

46,287

 

Weighted average shares outstanding

 

 

132,423

 

 

 

137,069

 

Basic net income per share

 

$

0.50

 

 

$

0.34

 

Diluted net income per share:

 

 

 

 

 

 

 

 

Net income

 

$

66,624

 

 

$

46,287

 

Weighted average shares outstanding - basic

 

 

132,423

 

 

 

137,069

 

Dilutive effect of equity-based awards:

 

 

 

 

 

 

 

 

Assumed exercise of options to purchase shares

 

 

807

 

 

 

2,962

 

RSUs

 

 

221

 

 

 

62

 

RSAs

 

 

160

 

 

 

19

 

PSAs

 

 

141

 

 

 

35

 

Weighted average shares and equivalent

   shares outstanding

 

 

133,752

 

 

 

140,147

 

Diluted net income per share

 

$

0.50

 

 

$

0.33

 

 

For the thirteen weeks ended April 1, 2018, the computation of diluted net income per share does not include 1.1 million options and 0.1 million PSAs as those awards would have been antidilutive or were performance awards with performance conditions not yet deemed met. For the thirteen weeks ended April 2, 2017, the computation of diluted net income per share does not include 2.6 million options and 0.1 million PSAs as those awards would have been antidilutive or were unvested performance awards.  

 

14


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

11. Derivative Financial Instruments

We entered into an interest rate swap agreement in December 2017 to manage our cash flow associated with variable interest rates. This forward contract has been designated and qualifies as a cash flow hedge, and its change in fair value is recorded as a component of other comprehensive income and reclassified into earnings in the same period or periods in which the forecasted transaction occurs. The forward contract consists of five cash flow hedges. To qualify as a hedge, we need to formally document, designate and assess the effectiveness of the transactions that receive hedge accounting.

 

The notional dollar amount of the five outstanding swaps was $250.0 million at April 1, 2018 and December 31, 2017, respectively, under which we pay a fixed rate and received a variable rate of interest (cash flow swap). The cash flow swaps hedge the change in interest rates on debt related to fluctuations in interest rates and each have a length of one year and mature annually from 2018 to 2022. These interest rate swaps have been designated and qualify as cash flow hedges and have met the requirements to assume zero ineffectiveness. We review the effectiveness of our hedging instruments on a quarterly basis.

 

The counterparties to our derivative financial instruments are major financial institutions. We evaluate the credit ratings of the financial institutions and believe that credit risk is at an acceptable level.

 

 

 

Thirteen Weeks Ended

April 1, 2018

 

 

Fiscal Year Ended

December 31, 2017

 

 

 

Balance Sheet Location

 

Fair Value

 

 

Balance Sheet Location

 

Fair Value

 

Derivatives designated as hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other Current Assets and Other Assets

 

$

3,415

 

 

Other Accrued Liabilities and Long-term Liabilities

 

$

1,064

 

 

 

The gain or loss on these derivative instruments is recognized in other comprehensive income, net of tax, with the portion related to current period interest payments reclassified to interest expense on the Consolidated Statements of Income.

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Consolidated Statements of Income

Classification

 

 

 

 

 

 

 

 

Interest expense

 

$

132

 

 

$

 

 

 

12. Comprehensive Income

During the thirteen weeks ended April 2, 2017, the Company did not record accumulated other comprehensive income. The following table presents the changes in accumulated other comprehensive income for the thirteen weeks ended April 1, 2018.

 

 

 

Cash Flow

Hedges

 

Balance at December 31, 2017

 

 

(784

)

Other comprehensive income, net of tax

 

 

 

 

Unrealized gain on cash flow hedging activities, net of

    income tax of $1,148

 

 

3,320

 

Total other comprehensive income

 

 

3,320

 

Balance at April 1, 2018

 

 

2,536

 

 

15


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Amounts reclassified from accumulated other comprehensive income (loss) are included within interest expense on the Consolidated Statements of Income.

 

13. Segments

The Company has one reportable and one operating segment, healthy grocery stores.

In accordance with ASC 606, the following table represents a disaggregation of revenue for the thirteen weeks ended April 1, 2018 and April 2, 2017.

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Perishables

 

$

732,602

 

 

 

56.9

%

 

$

649,434

 

 

 

57.4

%

Non-Perishables

 

 

554,594

 

 

 

43.1

%

 

 

481,211

 

 

 

42.6

%

Net Sales

 

$

1,287,196

 

 

 

100.0

%

 

$

1,130,645

 

 

 

100.0

%

We categorize the varieties of products we sell as perishable and non-perishable. Perishable product categories include produce, meat, seafood, deli, bakery, and dairy and dairy alternatives. Non-perishable product categories include grocery, vitamins and supplements, bulk items, frozen foods, beer and wine, and natural health and body care.

 

14. Equity-Based Compensation

2013 Incentive Plan

The Company’s board of directors adopted, and its equity holders approved, the Sprouts Farmers Market, Inc. 2013 Incentive Plan (the “2013 Incentive Plan”). The 2013 Incentive Plan became effective July 31, 2013 in connection with the Company’s initial public offering and replaced the 2011 Option Plan (as defined below) (except with respect to outstanding options under the 2011 Option Plan). The 2013 Incentive Plan serves as the umbrella plan for the Company’s stock-based and cash-based incentive compensation programs for its directors, officers and other team members, including RSUs, PSAs, and RSAs. On May 1, 2015, the Company’s stockholders approved the material terms of the performance goals under the 2013 Incentive Plan for purposes of Section 162(m) of the Internal Revenue Code.

The aggregate number of shares of common stock that may be issued to team members and directors under the 2013 Incentive Plan may not exceed 10,089,072. Shares subject to awards granted under the 2013 Incentive Plan which are subsequently forfeited, expire unexercised or are otherwise not issued will not be treated as having been issued for purposes of the share limitation. As of April 1, 2018, there were 3,720,726 stock awards outstanding and 5,205,419 shares remaining available for issuance under the 2013 Incentive Plan.

2011 Option Plan

In May 2011, the Company adopted the Sprouts Farmers Markets, LLC Option Plan (the “2011 Option Plan”) to provide team members or directors of the Company with options to acquire shares of the Company. The Company had authorized 12,100,000 shares for issuance under the 2011 Option Plan. Options may no longer be issued under the 2011 Option Plan. As of April 1, 2018, there were 315,836 options outstanding under the 2011 Option Plan.

16


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Awards Granted

During the thirteen weeks ended April 1, 2018, the Company granted the following stock-based compensation awards:

 

Grant Date

 

RSUs

 

 

PSAs

 

March 5, 2018

 

 

447,594

 

 

 

126,098

 

March 12, 2018

 

 

4,357

 

 

 

 

Total:

 

 

451,951

 

 

 

126,098

 

Weighted-average grant date fair value

 

$

25.18

 

 

$

25.18

 

Weighted-average exercise price

 

 

 

 

 

 

Stock Options

The Company uses the Black-Scholes option pricing model to estimate the fair value of options at grant date. Options vest in accordance with the terms set forth in the grant letter and vary depending on if they are time-based or performance-based.

Time-based options granted prior to fiscal year 2016 generally vest ratably over a period of 12 quarters (three years), and time-based options granted in fiscal year 2016 vest annually over a period of three years.

RSUs

The fair value of RSUs is based on the closing price of the Company’s common stock on the grant date. RSUs generally vest annually over a period of two or three years from the grant date.

PSAs

PSAs granted in fiscal year 2015 are restricted shares that were subject to the Company achieving certain earnings per share performance targets, as well as additional time-vesting conditions. The fair value of PSAs is based on the closing price of the Company’s common stock on the grant date. The performance conditions with respect to 2015 earnings per share targets were deemed to have been met, and all PSAs have vested. During the thirteen weeks ended April 1, 2018, 20,595 of the 2015 PSAs were vested, and during the thirteen weeks ended April 2, 2017, 21,050 of the 2015 PSAs were vested.  

PSAs granted in fiscal year 2016 are restricted shares that are subject to the Company achieving certain earnings before interest and taxes (“EBIT”) performance targets on an annual and cumulative basis over a three-year performance period, as well as additional time-vesting conditions. The EBIT target for each of the three years during the performance period is based on a percentage increase over the previous year’s actual EBIT, with each annual performance tranche measured independently of the previous and next tranche. Cumulative performance is based on the aggregate annual performance and is measured against a cumulative performance target. Payout of the performance shares will either be 0% or range from 50% to 150% of the target number of shares granted, depending upon goal achievement. If the performance conditions are met, the applicable number of performance shares is subject to cliff vesting on the third anniversary of the grant date (March 2019). The performance conditions with respect to 2016 and 2017 EBIT were not met.

PSAs granted in March 2017 were subject to the Company achieving certain earnings per share performance targets during 2017. The criteria is based on a range of performance targets in which grantees may earn between 10% and 150% of the base number of awards granted. During the thirteen weeks ended April 1, 2018, the performance conditions with respect to 2017 earnings per share were deemed to have been met, and the PSAs will vest 50% on the second anniversary of the grant date (2019) and 50% on the third anniversary of the grant date (2020).

17


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

PSAs granted in March 2018 are subject to the Company achieving certain EBIT performance targets for the 2020 fiscal year. The criteria is based on a range of performance targets in which grantees may earn 0% to 200% of the base number of awards granted. If performance conditions are met, the applicable number of performance shares will vest on the third anniversary of the grant date (2021).

RSAs

The fair value of RSAs is based on the closing price of the Company’s common stock on the grant date. Outstanding RSA grants have varying vest schedules. Such grants will vest either a) ratably over a seven quarter period, b) cliff vest on June 30, 2018 or c) vest annually over three years.

 

Equity-based Compensation Expense

Equity-based compensation expense was reflected in the consolidated statements of operations as follows:

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Cost of sales, buying and occupancy

 

$

269

 

 

$

246

 

Direct store expenses

 

 

328

 

 

 

361

 

Selling, general and administrative expenses

 

 

3,371

 

 

 

1,839

 

Equity-based compensation expense before income taxes

 

 

3,968

 

 

 

2,446

 

Income tax benefit

 

 

(1,020

)

 

 

(915

)

Net equity-based compensation expense

 

$

2,948

 

 

$

1,531

 

 

The following equity-based awards were outstanding as of April 1, 2018 and December 31, 2017:

 

 

 

As of

 

 

 

April 1,

2018

 

 

December 31,

2017

 

 

 

(in thousands)

 

Options

 

 

 

 

 

 

 

 

Vested

 

 

2,505

 

 

 

4,226

 

Unvested

 

 

233

 

 

 

464

 

RSUs

 

 

692

 

 

 

449

 

PSAs

 

 

380

 

 

 

231

 

RSAs

 

 

226

 

 

 

353

 

 

As of April 1, 2018, total unrecognized compensation expense and remaining weighted average recognition period related to outstanding equity-based awards was as follows:

 

 

 

Unrecognized compensation expense

 

 

Remaining weighted average recognition period

 

Options

 

$

1,548

 

 

 

0.6

 

RSUs

 

 

15,138

 

 

 

2.2

 

PSAs

 

 

5,324

 

 

 

1.9

 

RSAs

 

 

3,974

 

 

 

1.7

 

Total unrecognized compensation expense

   at April 1, 2018

 

$

25,984

 

 

 

 

 

 

During the thirteen weeks ended April 1, 2018 and April 2, 2017, the Company received $6.9 million and $2.3 million, respectively, in cash proceeds from the exercise of options.

18


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

 

15. Subsequent Events

 

Subsequent to April 1, 2018, and through April 30, 2018, the Company repurchased an additional 44,000 shares of common stock for $1.0 million.

 

 

 

 

19


 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K filed for the 2017 fiscal year, February 22, 2018 with the Securities and Exchange Commission. All dollar amounts included below are in thousands, unless otherwise noted.

Business Overview

Sprouts Farmers Market operates as a healthy grocery store that specializes in fresh, natural and organic products at prices that appeal to everyday grocery shoppers. Based on the belief that healthy food should be affordable, Sprouts’ welcoming environment and knowledgeable team members continue to drive its growth. Sprouts offers a complete shopping experience that includes an array of fresh produce in the heart of the store, a deli with prepared entrees and side dishes, The Butcher Shop, The Fish Market, an expansive vitamins and supplements department and more. Since our founding in 2002, we have grown rapidly, significantly increasing our sales, store count and profitability. With 294 stores in 16 states as of April 1, 2018, we are one of the largest specialty retailers of fresh, natural and organic food in the United States. As of April 30, 2018, we have grown to 297 stores in 16 states.

At Sprouts, we believe healthy living is a journey and every meal is a choice. The cornerstones of our business are fresh, natural and organic products at compelling prices (which we refer to as “Healthy Living for Less”), an attractive and differentiated shopping experience featuring a broad selection of innovative healthy products, and knowledgeable team members who we believe provide best-in-class customer engagement and product education.

Our Heritage

In 2002, we opened the first Sprouts Farmers Market store in Chandler, Arizona. From our founding in 2002 through April 1, 2018, we continued to open new stores while successfully rebranding 43 Henry’s Farmers Market and 39 Sunflower Farmers Market stores added in 2011 and 2012, respectively, through acquisitions to the Sprouts banner. These three businesses all trace their lineage back to Henry’s Farmers Market and were built with similar store formats and operations including a strong emphasis on value, produce and service in smaller, convenient locations. The consistency of these formats and operations was an important factor that allowed us to rapidly and successfully rebrand and integrate each of these businesses under the Sprouts banner and on a common platform.

Outlook

We are pursuing a number of strategies designed to continue our growth, including expansion of our store base, continuing positive comparable store sales and growing the Sprouts brand. We intend to continue expanding our store base by pursuing new store openings in our existing markets, expanding into adjacent markets and penetrating new markets. Although we plan to expand our store base primarily through new store openings, we may grow through strategic acquisitions if we identify suitable targets and are able to negotiate acceptable terms and conditions for acquisition. We intend to open approximately 30 new stores in 2018, of which 12 have opened through April 30, 2018, and approximately 30 new stores per year for the near term.

We also believe we can continue to deliver positive comparable store sales growth by enhancing our core value proposition and distinctive customer-oriented shopping experience, as well as through expanding and refining our fresh, natural and organic product offerings, our targeted and personalized marketing efforts and our in-store education. We are committed to growing the Sprouts brand by supporting our stores, product offerings and corporate partnerships, including the expansion of innovative marketing and promotional strategies through print, digital and social media platforms.

 

20


 

Results of Operations for Thirteen Weeks Ended April 1, 2018 and April 2, 2017

The following tables set forth our unaudited results of operations and other operating data for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. All dollar amounts are in thousands, unless otherwise noted.

 

 

Thirteen weeks ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Unaudited Quarterly Consolidated Statement of Income Data:

 

 

 

 

 

 

 

 

Net sales

 

$

1,287,196

 

 

$

1,130,645

 

Cost of sales, buying and occupancy

 

 

900,144

 

 

 

793,359

 

Gross profit

 

 

387,052

 

 

 

337,286

 

Direct store expenses

 

 

262,595

 

 

 

229,058

 

Selling, general and administrative expenses

 

 

41,447

 

 

 

32,168

 

Store pre-opening costs

 

 

3,320

 

 

 

3,458

 

Store closure and other costs

 

 

10

 

 

 

91

 

Income from operations

 

 

79,680

 

 

 

72,511

 

Interest expense

 

 

(6,065

)

 

 

(4,738

)

Other income

 

 

208

 

 

 

95

 

Income before income taxes

 

 

73,823

 

 

 

67,868

 

Income tax provision

 

 

(7,199

)

 

 

(21,581

)

Net income

 

$

66,624

 

 

$

46,287

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

132,423

 

 

 

137,069

 

Diluted effect of equity-based awards

 

 

1,329

 

 

 

3,078

 

Weighted average shares and equivalent shares outstanding

 

 

133,752

 

 

 

140,147

 

Diluted net income per share

 

$

0.50

 

 

$

0.33

 

 

 

 

Thirteen weeks ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Other Operating Data:

 

 

 

 

 

 

 

 

Comparable store sales growth

 

 

2.7

%

 

 

1.1

%

Stores at beginning of period

 

 

285

 

 

 

253

 

Closed

 

 

 

 

 

 

Opened

 

 

9

 

 

 

8

 

Stores at end of period

 

 

294

 

 

 

261

 

 


21


 

Comparison of Thirteen Weeks Ended April 1, 2018 to Thirteen Weeks Ended

April 2, 2017

Net sales

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Net sales

 

$

1,287,196

 

 

$

1,130,645

 

 

$

156,551

 

 

 

14

%

Comparable store sales growth

 

 

2.7

%

 

 

1.1

%

 

 

 

 

 

 

 

 

 

Net sales during the thirteen weeks ended April 1, 2018 totaled $1.3 billion, increasing 14% over the same period of the prior fiscal year. Sales growth was primarily driven by solid performance in new stores opened. Comparable stores contributed approximately 89% of total sales for the thirteen weeks ended April 1, 2018 and approximately 86% for the same period of the prior fiscal year.

 

Cost of sales, buying and occupancy and gross profit

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Net sales

 

$

1,287,196

 

 

$

1,130,645

 

 

$

156,551

 

 

 

14

%

Cost of sales, buying and occupancy

 

 

900,144

 

 

 

793,359

 

 

 

106,785

 

 

 

13

%

Gross profit

 

 

387,052

 

 

 

337,286

 

 

 

49,766

 

 

 

15

%

Gross margin

 

 

30.1

%

 

 

29.8

%

 

 

0.3

%

 

 

 

 

 

Gross profit increased during the thirteen weeks ended April 1, 2018 compared to the thirteen weeks ended April 2, 2017 by $49.8 million, of which $46.3 million was as a result of increased sales volume, in addition to $3.5 million related to improved margin rate, primarily reflecting stronger merchandise margins.

 

Direct store expenses

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Direct store expenses

 

$

262,595

 

 

$

229,058

 

 

$

33,537

 

 

 

15

%

Percentage of net sales

 

 

20.4

%

 

 

20.3

%

 

 

0.1

%

 

 

 

 

 

Direct store expenses for the thirteen weeks ended April 1, 2018 increased $33.5 million, including $25.8 million related to stores opened after April 2, 2017, and $7.7 million related to stores operating prior to the same period in 2017. Direct store expenses, as a percentage of net sales, increased 10 basis points. This deleverage is primarily driven by higher holiday pay related to calendar shift in New Years as well as increased benefit costs and depreciation.  This was partially offset by improvement in labor productivity and other operating efficiencies.

 

 

Selling, general and administrative expenses

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Selling, general and administrative

   expenses

 

$

41,447

 

 

$

32,168

 

 

$

9,279

 

 

 

29

%

Percentage of net sales

 

 

3.2

%

 

 

2.8

%

 

 

0.4

%

 

 

 

 

 

22


 

The increase in selling, general and administrative expenses included $4.6 million of compensation expense (including stock-based compensation and bonus expense), $2.2 million to support our strategic technology investments, $1.7 million for advertising, and $0.8 million for other corporate expenses, commensurate with store growth and improved company performance.

 

Store pre-opening costs

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Attributable to 2017 store openings

 

 

 

 

 

3,458

 

 

 

(3,458

)

 

 

 

 

Attributable to 2018 store openings

 

 

2,516

 

 

 

 

 

 

2,516

 

 

 

 

 

Attributable to planned 2018 store

   openings

 

 

804

 

 

 

 

 

 

804

 

 

 

 

 

Total store pre-opening costs

 

$

3,320

 

 

$

3,458

 

 

$

(138

)

 

 

(4

)%

Percentage of net sales

 

 

0.3

%

 

 

0.3

%

 

 

 

 

 

 

 

 

Store pre-opening costs in the thirteen weeks ended April 1, 2018 included $2.5 million related to opening 9 stores during the thirteen weeks ended April 1, 2018 and $0.8 million associated with stores expected to open subsequent to April 1, 2018. Store pre-opening costs in the thirteen weeks ended April 2, 2017 included $2.2 million related to opening 8 stores during that period and $1.2 million associated with stores opened subsequent to quarter end.

 

Store closure and other costs

Store closure and other costs were insignificant in the thirteen weeks ended April 1, 2018 and April 2, 2017.

Interest expense

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Capital and financing leases

 

$

3,040

 

 

$

2,810

 

 

$

230

 

 

 

8

%

Long-term debt

 

 

2,712

 

 

 

1,665

 

 

 

1,047

 

 

 

63

%

Deferred financing costs

 

 

376

 

 

 

116

 

 

 

260

 

 

 

224

%

Other

 

 

(63

)

 

 

147

 

 

 

(210

)

 

 

(143

)%

Total Interest Expense

 

$

6,065

 

 

$

4,738

 

 

$

1,327

 

 

 

28

%

 

The increase in interest expense is due to the higher principal balance on the Amended and Restated Credit Agreement combined with the slightly higher interest rate on our Former Credit Facility for the thirteen weeks ended April 1, 2018.

 

23


 

Income tax provision

Income tax provision differed from the amounts computed by applying the U.S. federal income tax rate to pretax income as a result of the following:

 

 

 

Thirteen weeks ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Federal statutory rate

 

 

21.00

%

 

 

35.00

%

Decrease in income taxes resulting from:

 

 

 

 

 

 

 

 

State income taxes, net of federal benefit

 

 

4.50

 

 

 

3.90

 

Excess tax benefits from share based payments

 

 

(15.10

)

 

 

(5.60

)

Other, net

 

 

(0.60

)

 

 

(1.50

)

Effective tax rate

 

 

9.80

%

 

 

31.80

%

 

Income tax provision decreased to $7.2 million for the thirteen weeks ended April 1, 2018 from $21.6 million for the thirteen weeks ended April 2, 2017. Our effective income tax rate decreased to 9.8% in the thirteen weeks ended April 1, 2018 from 31.8% in the thirteen weeks ended April 2, 2017 primarily related to the effects of the Tax Act and higher excess tax benefits related to the exercise of options in the income tax provision.

 

Net income

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Net income

 

$

66,624

 

 

$

46,287

 

 

$

20,337

 

 

 

44

%

Percentage of net sales

 

 

5.2

%

 

 

4.1

%

 

 

1.1

%

 

 

 

 

 

Net income as a percentage of net sales increased, driven by a lower effective tax rate due to the Tax Act and the exercise of expiring pre-IPO options, as well as higher sales and margins.

 

Diluted earnings per share

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

Change

 

 

% Change

 

Diluted earnings per share

 

$

0.50

 

 

$

0.33

 

 

$

0.17

 

 

 

52

%

Diluted weighted average shares

   outstanding

 

 

133,752

 

 

 

140,147

 

 

 

(6,395

)

 

 

 

 

 

The increase in diluted earnings per share of $0.17 was driven by higher net income and fewer diluted shares outstanding compared to the prior year, due primarily to the share repurchase program.

 

Return on Invested Capital

In addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, we provide information regarding Return on Invested Capital (referred to as “ROIC”) as additional information about our operating results. ROIC is a non-GAAP financial measure and should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP. ROIC is an important measure used by management to evaluate our investment returns on capital and provides a meaningful measure of the effectiveness of our capital allocation over time.

24


 

We define ROIC as net operating profit after tax (referred to as “NOPAT”), including the effect of capitalized operating leases, divided by average invested capital. Operating leases are capitalized as part of the ROIC calculation to control for differences in capital structure between us and our competitors.  Capitalized operating lease interest represents this adjustment to NOPAT and is calculated by the hypothetical capitalization of our operating leases, using eight times our trailing twelve months rent expense and an interest rate factor of seven percent.  Operating leases are determined as the trailing twelve months’ rent expense times a factor of eight.  Invested capital reflects a trailing twelve-month average.

As numerous methods exist for calculating ROIC, our method may differ from methods used by other companies to calculate their ROIC.  It is important to understand the methods and the differences in those methods used by other companies to calculate their ROIC before comparing our ROIC to that of other companies.

Our calculation of ROIC for the fiscal periods indicated was as follows:

 

 

 

Rolling Four Quarters Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

 

 

(dollars in thousands)

 

Net income (1)

 

$

178,776

 

 

$

124,386

 

Q4 Income Tax Adjustment for Tax Act (2)

 

 

(18,693

)

 

 

 

Interest expense, net of tax (3)

 

 

17,035

 

 

 

9,587

 

Net operating profit after tax (NOPAT)

 

$

177,118

 

 

$

133,973

 

 

 

 

 

 

 

 

 

 

Total rent expense, net of tax (3)

 

 

95,151

 

 

 

70,655

 

Estimated depreciation on capitalized operating leases, net of tax (3)

 

 

(41,866

)

 

 

(31,088

)

Estimated interest on capitalized operating leases, net of tax (3) (4)

 

 

53,285

 

 

 

39,567

 

NOPAT, including effect of capitalized operating leases

 

$

230,403

 

 

$

173,540

 

 

 

 

 

 

 

 

 

 

Average working capital

 

 

4,416

 

 

 

48,121

 

Average property and equipment

 

 

695,375

 

 

 

578,511

 

Average other assets

 

 

571,313

 

 

 

581,683

 

Average other liabilities

 

 

(169,221

)

 

 

(132,077

)

Average invested capital

 

$

1,101,883

 

 

$

1,076,238

 

 

 

 

 

 

 

 

 

 

Average estimated asset base of capitalized operating leases

 

 

1,005,567

 

 

 

877,789

 

Average invested capital, including the effect of capitalized

   operating leases

 

$

2,107,450

 

 

$

1,954,027

 

 

 

 

 

 

 

 

 

 

ROIC

 

 

16.1

%

 

 

12.4

%

ROIC, including the effect of capitalized operating leases

 

 

10.9

%

 

 

8.9

%

(1)

Net income amounts represent total net income for past four trailing quarters.

(2)

$18.7 million income tax credit related to the Tax Act enacted in December 2017, see Note 6, “Income Taxes.”

(3)

Net of tax amounts are calculated using the effective tax rate for the periods presented.

(4)

Interest on capitalized leases is calculated as the trailing four quarters’ rent expense multiplied by eight and by a seven percent interest rate factor.

 

25


 

Liquidity and Capital Resources

The following table sets forth the major sources and uses of cash for each of the periods set forth below, as well as our cash and cash equivalents at the end of each period (in thousands):

 

 

 

Thirteen weeks ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Cash and cash equivalents at end of period

 

$

21,356

 

 

$

21,326

 

Cash flows from operating activities

 

$

104,487

 

 

$

114,537

 

Cash flows used in investing activities

 

$

(44,158

)

 

$

(57,175

)

Cash flows used in financing activities

 

$

(58,452

)

 

$

(48,501

)

 

We have generally financed our operations principally through cash generated from operations and borrowings under our credit facilities. Our primary uses of cash are for purchases of inventory, operating expenses, capital expenditures primarily for opening new stores, remodels and maintenance, repurchases of our common stock and debt service. We believe that our existing cash and cash equivalents, and cash anticipated to be generated from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months, and we may continue to use borrowings under our Amended and Restated Credit Agreement to fund our share repurchase programs. Our future capital requirements will depend on many factors, including new store openings, remodel and maintenance capital expenditures at existing stores, store initiatives and other corporate capital expenditures and activities. Our cash and cash equivalents position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within days from the related sale.

Operating Activities

Cash flows from operating activities decreased $10.1 million to $104.5 million for the thirteen weeks ended April 1, 2018 compared to $114.5 million for the thirteen weeks ended April 2, 2017. The decrease in cash flows from operating activities is a result of changes in working capital including a decrease in income tax liability as a result of the Tax Act, partially offset by higher net sales and pretax income reflecting higher gross profit due to store and sales growth and higher noncash depreciation and amortization.

Cash flows provided by/(used in) operating activities from changes in working capital was ($7.6) million in the thirteen weeks ended April 1, 2018, compared to $29.0 million in the thirteen weeks ended April 2, 2017. The decrease in cash flows from operating activities for changes in working capital in the thirteen weeks ended April 1, 2018, compared to the thirteen weeks ended April 2, 2017, was primarily due to increased spend for inventory, annual incentive compensation and other payables in line with improved performance and store growth used for accounts payable and inventory.  

Investing Activities

Cash flows used in investing activities consist primarily of capital expenditures in new stores, including leasehold improvements and store equipment, capital expenditures to maintain the appearance of our stores, sales enhancing initiatives and other corporate investments.  Cash flows used in investing activities were $44.2 million, and $57.2 million, for the thirteen weeks ended April 1, 2018 and April 2, 2017, respectively. The increase in cash flows used in investing activities in each of these periods is primarily due to capital investments in new stores combined with store remodels and other store-level capital projects.

We expect capital expenditures to be in the range of $165 - $170 million in fiscal 2018, including expenditures incurred to date, net of estimated landlord tenant improvement allowances, primarily to fund investments in new stores, remodels, maintenance capital expenditures and corporate capital expenditures. We expect to fund our capital expenditures with cash on hand, cash generated from operating activities and, if required, borrowings under our Amended and Restated Credit Agreement.

26


 

Financing Activities

Cash flows used in financing activities were $58.5 million for the thirteen weeks ended April 1, 2018 compared to $48.5 million for the thirteen weeks ended April 2, 2017. During the thirteen weeks ended April 1, 2018, cash flows used in financing activities primarily consisted of $83.0 million for stock repurchases, partially offset by $20.0 million of net borrowings on our credit facilities, and $6.9 million in proceeds from the exercise of stock options.

During the thirteen weeks ended April 2, 2017, cash flows used in financing activities primarily consisted of $80.0 million for stock repurchases, partially offset by $30.0 million of net borrowings on the Former Credit Facility, and $2.3 million in proceeds from the exercise of stock options.

Long-Term Debt and Credit Facilities

Long-term debt increased $20.0 million to $368.0 million as of April 1, 2018, compared to December 31, 2017. The increase resulted primarily from $20.0 million of net borrowings under our credit facilities primarily used for our share repurchase programs.

See Note 4, “Long-Term Debt” of our unaudited consolidated financial statements for a description of our Amended and Restated Credit Agreement and our Former Credit Facility (each as defined therein).

Share Repurchase Program

Our board of directors from time to time authorizes share repurchase programs for our common stock. The following table outlines the share repurchase programs authorized by our board, and the related repurchase activity and available authorization as of April 1, 2018.

 

Effective date

 

Expiration date

 

Amount

authorized

 

 

Cost of

repurchases

 

 

Authorization

available

 

November 4, 2015

 

November 4, 2017

 

$

150,000

 

 

$

150,000

 

 

$

 

September 6, 2016

 

December 31, 2017

 

$

250,000

 

 

$

250,000

 

 

$

 

February 20, 2017

 

December 31, 2018

 

$

250,000

 

 

$

206,400

 

 

$

43,600

 

February 20, 2018

 

December 31, 2019

 

$

350,000

 

 

$

 

 

$

350,000

 

 

The shares under our repurchase programs may be purchased on a discretionary basis from time to time prior to the applicable expiration date, subject to general business and market conditions and other investment opportunities, through open market purchases, privately negotiated transactions, or other means, including through Rule 10b5-1 trading plans. Our board’s authorization of the share repurchase programs does not obligate our Company to acquire any particular amount of common stock, and the repurchase programs may be commenced, suspended, or discontinued at any time. We have used borrowings under our credit facilities to assist with the repurchase programs (see Note 4, “Long-Term Debt” of our unaudited consolidated financial statements).

Share repurchase activity under our repurchase programs for the periods indicated was as follows (total cost in thousands):

 

 

 

Thirteen Weeks Ended

 

 

 

April 1,

2018

 

 

April 2,

2017

 

Number of common shares acquired

 

 

3,329,409

 

 

 

4,099,936

 

Average price per common share acquired

 

$

24.93

 

 

$

19.51

 

Total cost of common shares acquired

 

$

83,000

 

 

$

80,000

 

 

Shares purchased under our repurchase programs were subsequently retired.

Subsequent to April 1, 2018 and through April 30, 2018, we repurchased an additional 44,000 shares of common stock for $1.0 million.

 

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Contractual Obligations

We are committed under certain capital leases for the rental of certain land and buildings and certain operating leases for rental of facilities and equipment. These leases expire or become subject to renewal clauses at various dates through 2034.

The following table summarizes our lease obligations as of April 1, 2018, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

 

 

 

Payments Due by Period

 

 

 

Total

 

 

Less Than

1 Year

 

 

1-3 Years

 

 

4-5 Years

 

 

More Than

5 Years

 

 

 

(in thousands)

 

$700.0 million Credit Agreement (1)

 

$

368,000

 

 

 

 

 

 

 

 

$

368,000

 

 

 

 

Interest payments on $700 million Credit Agreement (2)

 

 

60,166

 

 

 

13,792

 

 

 

28,719

 

 

 

17,655

 

 

 

 

Capital and financing lease obligations(3)

 

 

131,863

 

 

 

16,855

 

 

 

31,984

 

 

 

28,356

 

 

 

54,668

 

Operating lease obligations(3)

 

 

1,624,760

 

 

 

146,256

 

 

 

317,211

 

 

 

298,009

 

 

 

863,284

 

Totals

 

$

2,184,789

 

 

$

176,903

 

 

$

377,914

 

 

$

712,020

 

 

$

917,952

 

 

 

(1)

The Amended and Restated Credit Agreement is scheduled to mature and the commitments thereunder will terminate on March 27 2023, subject to extensions as set forth therein. These borrowings are reflected in the “4-5 Years” column and discussed in the financing activities section above. See Note 4, “Long-Term Debt”.

 

(2)

Represents estimated interest payments through maturity date of March 27, 2023 on our Amended and Restated Credit Agreement based on the outstanding amounts as of April 1, 2018 and based on LIBOR rates in effect at the time of this report, net of interest rate swaps.

 

(3)

Represents estimated payments for capital and financing and operating lease obligations as of April 1, 2018. Capital and financing lease obligations and operating lease obligations are presented gross without offset for subtenant rentals. We have subtenant agreements under which we will receive $1.5 million for the period of less than one year, $2.8 million for years one to three, $2.1 million for years four to five, and $2.9 million for the period beyond five years.

 

We have other contractual commitments which were presented under Contractual Obligations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and for which there have not been material changes since that filing through April 1, 2018.

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet financing activities, nor do we have any interest in entities referred to as variable interest entities.

Impact of Inflation and Deflation

Inflation and deflation in the prices of food and other products we sell may periodically affect our sales, gross profit and gross margin. The short-term impact of inflation and deflation is largely dependent on whether or not the effects are passed through to our customers, which is subject to competitive market conditions.

Food inflation and deflation is affected by a variety of factors and our determination of whether to pass on the effects of inflation or deflation to our customers is made in conjunction with our overall pricing and marketing strategies, as well as our competitors’ responses. Although we may experience periodic effects on sales, gross profit, gross margins and cash flows as a result of changing prices, we do not expect the effect of inflation or deflation to have a material impact on our ability to execute our long-term business strategy.

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Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, cash flow and related disclosure of contingent assets and liabilities. Our estimates include, but are not limited to, those related to inventory, lease assumptions, self-insurance reserves, sublease assumptions for closed stores, goodwill and intangible assets, impairment of long-lived assets, fair values of equity-based awards and derivatives, and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

There have been no substantial changes to these estimates or the policies related to them during the thirteen weeks ended April 1, 2018. For a full discussion of these estimates and policies, see “Critical Accounting Estimates” in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Recently Issued Accounting Pronouncements

See Note 2, “Summary of Significant Accounting Policies” to our accompanying unaudited consolidated financial statements contained in this Quarterly Report on Form 10-Q.

We have determined that all other recently issued accounting standards will not have a material impact on our financial statements, or do not apply to our operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

As described in Note 4, “Long-Term Debt” to our unaudited consolidated financial statements located elsewhere in this Quarterly Report on Form 10-Q, we have an Amended and Restated Credit Agreement that bears interest at a rate based in part on LIBOR. Accordingly, we are exposed to fluctuations in interest rates. Based on the $368.0 million principal outstanding under our Amended and Restated Credit Agreement as of April 1, 2018, each hundred basis point change in LIBOR would result in a change in interest expense by $3.7 million annually.   We have entered into an interest rate swap agreement in December 2017 to manage our cash flow associated with variable interest rates. The notional dollar amount of the five outstanding swaps at December 31, 2017 was $250.0 million under which we pay a fixed rate and received a variable rate of interest (cash flow swap). Taking into account the interest rate swaps, based on the $368.0 million principal outstanding under our Amended and Restated Credit Agreement as of April 1, 2018, each hundred basis point change in LIBOR would result in a change in interest expense by $1.2 million annually.

This sensitivity analysis assumes our mix of financial instruments and all other variables will remain constant in future periods. These assumptions are made in order to facilitate the analysis and are not necessarily indicative of our future intentions.

We do not enter into derivative financial instruments for trading purposes (see Note 11, “Derivative Financial Instruments” of our unaudited consolidated financial statements).

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) designed to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission, and is accumulated and communicated to our management, including our Chief Executive

29


 

Officer (our principal executive officer) and our Chief Financial Officer (our principal financial officer), as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures under the Exchange Act as of April 1, 2018, the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

During the quarterly period ended April 1, 2018, there were no changes in our internal controls over financial reporting that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

 

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time we are a party to legal proceedings, including matters involving personnel and employment issues, product liability, personal injury, intellectual property and other proceedings arising in the ordinary course of business, which have not resulted in any material losses to date. Although management does not expect that the outcome in these proceedings will have a material adverse effect on our financial condition or results of operations, litigation is inherently unpredictable. Therefore, we could incur judgments or enter into settlements of claims that could materially impact our results.

Securities Action

On March 4, 2016, a complaint was filed in the Superior Court for the State of Arizona against our company and certain of our directors and officers on behalf of a purported class of purchasers of shares of our common stock in our underwritten secondary public offering which closed on March 10, 2015 (the “March 2015 Offering”). The complaint purports to state claims under Sections 11, 12 and 15 of the Securities Act of 1933, as amended, based on an alleged failure by our company to disclose adequate information about produce price deflation in the March 2015 Offering documents. The complaint seeks damages on behalf of the purported class in an unspecified amount, rescission, and an award of reasonable costs and attorneys’ fees. After removal to federal court, the plaintiff sought remand, which the court granted in March 2017.  On May 25, 2017, our company filed a Motion to Dismiss in the Superior Court for the State of Arizona, which the court granted in part and denied in part by order entered August 30, 2017.  Our company answered the complaint on September 28, 2017. The parties are engaged in discovery at this time. We intend to defend this case vigorously, but it is not possible at this time to reasonably estimate the outcome of, or any potential liability from, the case.

“Phishing” Scam Actions

In April 2016, four complaints were filed, two in the federal courts of California, one in the Superior Court of California and one in the federal court in the District of Colorado, each on behalf of a purported class of our current and former team members whose personally identifiable information (referred to as “PII”) was inadvertently disclosed to an unauthorized third party that perpetrated an email “phishing” scam against one of our team members. The complaints allege we failed to properly safeguard the PII in accordance with applicable law.  The complaints seek damages on behalf of the purported class in unspecified amounts, attorneys’ fees and litigation expenses. In June 2016, a motion was filed before the Judicial Panel on Multidistrict Litigation (referred to as “JPML”) to transfer and consolidate all four of the cases to the federal court in the District of Arizona. The JPML granted the motion on October 6, 2016.  On May 24, 2017, the JPML granted our motion to stay proceedings in the case pending a U.S. Supreme Court ruling which is likely to be dispositive on the question of whether the arbitration agreements signed by each of the named plaintiffs are enforceable; oral argument in this case was heard by the U.S. Supreme Court on October 2, 2017, and we do not expect a decision from the U.S. Supreme Court until Spring 2018.  We intend to defend these cases vigorously, but it is not possible at this time to reasonably estimate the outcome of, or any potential liability from, the cases.

Item 1A. Risk Factors.

Certain factors may have a material adverse effect on our business, financial condition and results of operations.  You should carefully consider the risks and uncertainties referenced below, together with all of the other information in this Quarterly Report on Form 10-Q, including our consolidated financial statements and related notes. Any of those risks could materially and adversely affect our business, operating results, financial condition, or prospects and cause the value of our common stock to decline, which could cause you to lose all or part of your investment.

There have been no material changes to the Risk Factors described under “Part I – Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Issuer Purchases of Equity Securities

The following table provides information about our share repurchase activity during the thirteen weeks ended April 1, 2018.

 

Period (1)

 

Total number

of shares

purchased

 

 

Average

price paid

per share

 

 

Total number of

shares purchased

as part of publicly

announced plans

or programs

 

 

Approximate dollar

value of shares

that may yet be

purchased under

the plans or

programs

 

January 1, 2018 - January 28, 2018

 

 

1,239,175

 

 

$

24.56

 

 

 

1,239,175

 

 

$

96,180,000

 

January 29, 2018 - February 25, 2018

 

 

 

 

 

 

 

 

 

 

 

96,180,000

 

February 26, 2018 - April 1, 2018

 

 

2,090,234

 

 

 

25.15

 

 

 

2,090,234

 

 

 

43,600,000

 

 

(1)

Periodic information is presented by reference to our fiscal periods during the first quarter of fiscal year 2018.

Item 6. Exhibits.

 

Exhibit

Number

 

Description

  10.1

 

2018 Form of Performance Share Award Agreement under Sprouts Farmers Market, Inc. 2013 Incentive Plan

 

 

 

  10.2

 

Amended and Restated Credit Agreement, dated as of March 27, 2018, among Sprouts Farmers Market, Inc., Sprouts Farmers Markets Holdings, LLC, the lenders party thereto, JPMorgan Chase Bank, N.A., as administrative agent, Bank of America, N.A., as Syndication Agent, and BMO Harris Bank N.A., Coöperatieve Centrale Raiffeisen – Boerenleenbank, B.A. “Rabobank Nederland,” New York Branch, Wells Fargo Bank, N.A., and SunTrust Bank, as Documentation Agents (1)

 

 

 

  31.1

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

  31.2

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

  32.1

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

  32.2

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

 

 

(1)

Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the SEC on March 27, 2018, and incorporated herein by reference.

 

32


 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

SPROUTS FARMERS MARKET, INC.

 

 

 

Date: May 3, 2018

By:

/s/ Bradley S. Lukow

 

Name:

Bradley S. Lukow

 

Title:

Chief Financial Officer

 

 

(Principal Financial Officer)

 

 

33