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 October 1, 2017September 30, 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 October 31, 2017,29, 2018, the registrant had 133,070,570127,603,836 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 OCTOBER 1, 2017SEPTEMBER 30, 2018

TABLE OF CONTENTS

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements.

1

 

 

 

 

Consolidated Balance Sheets as of October 1, 2017September 30, 2018 (unaudited) and January 1,December 31, 2017

1

 

 

 

 

Consolidated Statements of OperationsIncome for the thirteen and thirty-nine weeks ended September 30, 2018 and October 1, 2017 and October 2, 2016 (unaudited)

2

Consolidated Statements of Comprehensive Income for the thirteen and thirty-nine weeks ended September 30, 2018 and October 1, 2017 (unaudited)

3

 

 

 

 

Consolidated Statements of Stockholders’ Equity for the thirty-nine weeks ended October 1, 2017September 30, 2018 (unaudited) and the year ended January 1,December 31, 2017

34

 

 

 

 

Consolidated Statements of Cash Flows for the thirty-nine weeks ended September 30, 2018 and October 1, 2017 and October 2, 2016 (unaudited)

45

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

56

 

 

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

1721

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

3034

 

 

Item 4. Controls and Procedures.

3034

 

 

PART II - OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings.

3136

 

 

Item 1A. Risk Factors.

3137

 

 

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

3237

 

 

Item 6. Exhibits.

3238

 

 

Signatures

3339

 

 


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 January 1,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“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)

 

 

October 1, 2017

 

 

January 1, 2017

 

 

(Unaudited)

 

 

 

 

 

 

September 30,

2018

 

 

December 31,

2017

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

18,892

 

 

$

12,465

 

 

$

17,175

 

 

$

19,479

 

Accounts receivable, net

 

 

23,231

 

 

 

25,228

 

 

 

34,631

 

 

 

25,893

 

Inventories

 

 

222,216

 

 

 

204,464

 

 

 

253,045

 

 

 

229,542

 

Prepaid expenses and other current assets

 

 

25,594

 

 

 

21,869

 

 

 

37,523

 

 

 

24,593

 

Total current assets

 

 

289,933

 

 

 

264,026

 

 

 

342,374

 

 

 

299,507

 

Property and equipment, net of accumulated depreciation

 

 

690,763

 

 

 

604,660

 

 

 

773,348

 

 

 

713,031

 

Intangible assets, net of accumulated amortization

 

 

196,556

 

 

 

197,608

 

 

 

195,154

 

 

 

196,205

 

Goodwill

 

 

368,078

 

 

 

368,078

 

 

 

368,078

 

 

 

368,078

 

Other assets

 

 

5,886

 

 

 

5,521

 

 

 

16,010

 

 

 

4,782

 

Total assets

 

$

1,551,216

 

 

$

1,439,893

 

 

$

1,694,964

 

 

$

1,581,603

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

179,482

 

 

$

157,550

 

Accounts payable and other accrued liabilities

 

$

245,928

 

 

$

244,853

 

Accrued salaries and benefits

 

 

41,219

 

 

 

32,859

 

 

 

43,433

 

 

 

45,623

 

Other accrued liabilities

 

 

60,683

 

 

 

56,376

 

Current portion of capital and financing lease obligations

 

 

8,776

 

 

 

12,370

 

 

 

7,398

 

 

 

9,238

 

Total current liabilities

 

 

290,160

 

 

 

259,155

 

 

 

296,759

 

 

 

299,714

 

Long-term capital and financing lease obligations

 

 

126,806

 

 

 

117,366

 

 

 

120,670

 

 

 

125,489

 

Long-term debt

 

 

349,000

 

 

 

255,000

 

 

 

435,000

 

 

 

348,000

 

Other long-term liabilities

 

 

126,127

 

 

 

116,200

 

 

 

144,401

 

 

 

130,640

 

Deferred income tax liability

 

 

42,508

 

 

 

19,263

 

 

 

56,839

 

 

 

27,066

 

Total liabilities

 

 

934,601

 

 

 

766,984

 

 

 

1,053,669

 

 

 

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,

133,070,570 and 140,256,313 shares issued and outstanding,

October 1, 2017 and January 1, 2017, respectively

 

 

133

 

 

 

140

 

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

127,603,836 shares issued and outstanding, September 30, 2018;

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

 

 

127

 

 

 

132

 

Additional paid-in capital

 

 

614,232

 

 

 

597,269

 

 

 

653,509

 

 

 

620,788

 

Retained earnings

 

 

2,250

 

 

 

75,500

 

Accumulated other comprehensive income (loss)

 

 

4,567

 

 

 

(784

)

(Accumulated deficit) retained earnings

 

 

(16,908

)

 

 

30,558

 

Total stockholders’ equity

 

 

616,615

 

 

 

672,909

 

 

 

641,295

 

 

 

650,694

 

Total liabilities and stockholders’ equity

 

$

1,551,216

 

 

$

1,439,893

 

 

$

1,694,964

 

 

$

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 OPERATIONSINCOME

(UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

October 1,

2017

 

 

October 2,

2016

 

 

October 1,

2017

 

 

October 2,

2016

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Net sales

 

$

1,206,059

 

 

$

1,035,801

 

 

$

3,520,679

 

 

$

3,060,685

 

 

$

1,329,109

 

 

$

1,206,059

 

 

$

3,937,998

 

 

$

3,520,679

 

Cost of sales, buying and occupancy

 

 

859,650

 

 

 

744,288

 

 

 

2,494,998

 

 

 

2,156,857

 

 

 

946,734

 

 

 

859,650

 

 

 

2,788,159

 

 

 

2,494,998

 

Gross profit

 

 

346,409

 

 

 

291,513

 

 

 

1,025,681

 

 

 

903,828

 

 

 

382,375

 

 

 

346,409

 

 

 

1,149,839

 

 

 

1,025,681

 

Direct store expenses

 

 

250,191

 

 

 

216,932

 

 

 

715,336

 

 

 

617,817

 

 

 

281,365

 

 

 

250,191

 

 

 

816,933

 

 

 

715,336

 

Selling, general and administrative expenses

 

 

39,955

 

 

 

29,664

 

 

 

110,312

 

 

 

91,482

 

 

 

43,944

 

 

 

39,955

 

 

 

128,828

 

 

 

110,312

 

Store pre-opening costs

 

 

2,456

 

 

 

3,446

 

 

 

10,055

 

 

 

11,625

 

 

 

3,819

 

 

 

2,456

 

 

 

9,414

 

 

 

10,055

 

Store closure and other costs

 

 

803

 

 

 

24

 

 

 

992

 

 

 

159

 

 

 

461

 

 

 

803

 

 

 

497

 

 

 

992

 

Income from operations

 

 

53,004

 

 

 

41,447

 

 

 

188,986

 

 

 

182,745

 

 

 

52,786

 

 

 

53,004

 

 

 

194,167

 

 

 

188,986

 

Interest expense

 

 

(5,609

)

 

 

(3,723

)

 

 

(15,447

)

 

 

(10,985

)

 

 

(7,419

)

 

 

(5,609

)

 

 

(20,028

)

 

 

(15,447

)

Other income

 

 

162

 

 

 

135

 

 

 

388

 

 

 

326

 

 

 

 

 

 

162

 

 

 

325

 

 

 

388

 

Income before income taxes

 

 

47,557

 

 

 

37,859

 

 

 

173,927

 

 

 

172,086

 

 

 

45,367

 

 

 

47,557

 

 

 

174,464

 

 

 

173,927

 

Income tax provision

 

 

(16,071

)

 

 

(13,974

)

 

 

(55,186

)

 

 

(64,785

)

 

 

(7,867

)

 

 

(16,071

)

 

 

(28,631

)

 

 

(55,186

)

Net income

 

$

31,486

 

 

$

23,885

 

 

$

118,741

 

 

$

107,301

 

 

$

37,500

 

 

$

31,486

 

 

$

145,833

 

 

$

118,741

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.23

 

 

$

0.16

 

 

$

0.87

 

 

$

0.72

 

 

$

0.30

 

 

$

0.23

 

 

$

1.13

 

 

$

0.87

 

Diluted

 

$

0.23

 

 

$

0.16

 

 

$

0.86

 

 

$

0.71

 

 

$

0.29

 

 

$

0.23

 

 

$

1.12

 

 

$

0.86

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

134,320

 

 

 

147,743

 

 

 

136,063

 

 

 

149,202

 

 

 

126,855

 

 

 

134,320

 

 

 

129,572

 

 

 

136,063

 

Diluted

 

 

136,770

 

 

 

150,024

 

 

 

138,860

 

 

 

151,568

 

 

 

127,627

 

 

 

136,770

 

 

 

130,537

 

 

 

138,860

 

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



SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(IN THOUSANDS)

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Net income

 

$

37,500

 

 

$

31,486

 

 

$

145,833

 

 

$

118,741

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on cash flow hedging

   activities, net of income tax of $299, $0,

   $1,851 and $0

 

 

865

 

 

 

 

 

 

5,351

 

 

 

 

Total other comprehensive income

 

$

865

 

 

$

 

 

$

5,351

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

38,365

 

 

$

31,486

 

 

$

151,184

 

 

$

118,741

 

 

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

 

2



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

 

 

Total

Stockholders’

Equity

 

Balances at January 3, 2016

 

 

152,577,884

 

 

$

153

 

 

$

577,393

 

 

$

245,446

 

 

$

822,992

 

Net income

 

 

 

 

 

 

 

 

 

 

 

124,306

 

 

 

124,306

 

Issuance of shares under stock plans

 

 

666,841

 

 

 

 

 

 

2,740

 

 

 

 

 

 

2,740

 

Repurchase and retirement of common

   stock

 

 

(13,242,483

)

 

 

(13

)

 

 

 

 

 

(294,252

)

 

 

(294,265

)

Excess tax benefit for exercise of options

 

 

 

 

 

 

 

 

3,737

 

 

 

 

 

 

3,737

 

Equity-based compensation

 

 

 

 

 

 

 

 

13,399

 

 

 

 

 

 

13,399

 

Balances at January 1, 2017

 

 

140,002,242

 

 

$

140

 

 

$

597,269

 

 

$

75,500

 

 

$

672,909

 

Net income

 

 

 

 

 

 

 

 

 

 

 

118,741

 

 

 

118,741

 

Issuance of shares under stock plans

 

 

1,800,157

 

 

 

2

 

 

 

6,638

 

 

 

 

 

 

6,640

 

Repurchase and retirement of common

   stock

 

 

(9,136,468

)

 

 

(9

)

 

 

 

 

 

(191,991

)

 

 

(192,000

)

Equity-based compensation

 

 

 

 

 

 

 

 

10,325

 

 

 

 

 

 

10,325

 

Balances at October 1, 2017

 

 

132,665,931

 

 

$

133

 

 

$

614,232

 

 

$

2,250

 

 

$

616,615

 

 

 

Shares

 

 

Common

Stock

 

 

Additional

Paid In

Capital

 

 

(Accumulated

deficit)

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

 

 

 

 

 

 

 

 

 

 

 

145,833

 

 

 

 

 

 

145,833

 

Other comprehensive income

   (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,351

 

 

 

5,351

 

Issuance of shares under stock

   plans

 

 

3,170,818

 

 

 

3

 

 

 

21,048

 

 

 

 

 

 

 

 

 

21,051

 

Repurchase and retirement of

   common stock

 

 

(8,411,575

)

 

 

(8

)

 

 

 

 

 

(193,299

)

 

 

 

 

 

(193,307

)

Equity-based compensation

 

 

 

 

 

 

 

 

11,673

 

 

 

 

 

 

 

 

 

11,673

 

Balances at September 30, 2018

 

 

127,209,335

 

 

$

127

 

 

$

653,509

 

 

$

(16,908

)

 

$

4,567

 

 

 

641,295

 

 

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

 

3



SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

 

 

Thirty-nine Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

October 1,

2017

 

 

October 2,

2016

 

 

September 30,

2018

 

 

October 1,

2017

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

118,741

 

 

$

107,301

 

 

$

145,833

 

 

$

118,741

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

70,875

 

 

 

59,997

 

 

 

81,959

 

 

 

70,875

 

Accretion of asset retirement obligation and closed store reserve

 

 

168

 

 

 

237

 

 

 

219

 

 

 

168

 

Amortization of financing fees and debt issuance costs

 

 

347

 

 

 

347

 

 

 

658

 

 

 

347

 

Loss on disposal of property and equipment

 

 

820

 

 

 

226

 

 

 

404

 

 

 

820

 

Equity-based compensation

 

 

10,325

 

 

 

10,322

 

 

 

11,673

 

 

 

10,325

 

Deferred income taxes

 

 

23,245

 

 

 

20,119

 

 

 

29,773

 

 

 

23,245

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

1,660

 

 

 

(1,336

)

 

 

(10,299

)

 

 

1,660

 

Inventories

 

 

(17,752

)

 

 

(29,784

)

 

 

(23,503

)

 

 

(17,752

)

Prepaid expenses and other current assets

 

 

(3,734

)

 

 

(1,212

)

 

 

(13,758

)

 

 

(3,734

)

Other assets

 

 

(702

)

 

 

(1,480

)

 

 

(3,945

)

 

 

(702

)

Accounts payable

 

 

31,669

 

 

 

24,050

 

Accounts payable and other accrued liabilities

 

 

3,240

 

 

 

35,957

 

Accrued salaries and benefits

 

 

8,360

 

 

 

(4,959

)

 

 

(2,130

)

 

 

8,360

 

Other accrued liabilities and income taxes payable

 

 

4,288

 

 

 

(2,762

)

Other long-term liabilities

 

 

10,659

 

 

 

14,971

 

 

 

15,342

 

 

 

10,659

 

Cash flows from operating activities

 

 

258,969

 

 

 

196,037

 

 

 

235,466

 

 

 

258,969

 

Cash flows used in investing activities

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(158,459

)

 

 

(142,571

)

 

 

(148,433

)

 

 

(158,459

)

Proceeds from sale of property and equipment

 

 

30

 

 

 

662

 

 

 

1

 

 

 

30

 

Purchase of leasehold interests

 

 

 

 

 

(491

)

Cash flows used in investing activities

 

 

(158,429

)

 

 

(142,400

)

 

 

(148,432

)

 

 

(158,429

)

Cash flows used in financing activities

 

 

 

 

 

 

 

 

Proceeds from revolving credit facility

 

 

134,000

 

 

 

45,000

 

Payments on revolving credit facility

 

 

(40,000

)

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from revolving credit facilities

 

 

180,000

 

 

 

134,000

 

Payments on revolving credit facilities

 

 

(93,000

)

 

 

(40,000

)

Payments on capital and financing lease obligations

 

 

(3,053

)

 

 

(3,144

)

 

 

(3,349

)

 

 

(3,053

)

Cash from landlords related to financing lease obligations

 

 

300

 

 

 

 

Payments of deferred financing costs

 

 

(2,131

)

 

 

-

 

Cash from landlords related to capital and financing lease obligations

 

 

2,113

 

 

 

300

 

Repurchase of common stock

 

 

(192,000

)

 

 

(187,836

)

 

 

(193,307

)

 

 

(192,000

)

Proceeds from exercise of stock options

 

 

6,640

 

 

 

2,616

 

 

 

21,051

 

 

 

6,640

 

Excess tax benefit for exercise of stock options

 

 

 

 

 

3,948

 

Other

 

 

(59

)

 

 

 

Cash flows used in financing activities

 

 

(94,113

)

 

 

(139,416

)

 

 

(88,682

)

 

 

(94,113

)

Increase / (Decrease) in cash and cash equivalents

 

 

6,427

 

 

 

(85,779

)

Cash and cash equivalents at beginning of the period

 

 

12,465

 

 

 

136,069

 

Cash and cash equivalents at the end of the period

 

$

18,892

 

 

$

50,290

 

(Decrease) increase in cash, cash equivalents, and restricted cash

 

 

(1,648

)

 

 

6,427

 

Cash, cash equivalents, and restricted cash at beginning of the period

 

 

19,479

 

 

 

12,465

 

Cash, cash equivalents, and restricted cash at the end of the period

 

$

17,831

 

 

$

18,892

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

15,052

 

 

$

10,942

 

 

$

19,784

 

 

$

15,052

 

Cash paid for income taxes

 

 

25,710

 

 

 

38,142

 

 

 

15,177

 

 

 

25,710

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and equipment in accounts payable

 

$

13,476

 

 

$

19,919

 

 

$

15,435

 

 

$

13,476

 

Property acquired through capital and financing lease obligations

 

 

5,512

 

 

 

8,324

 

 

 

8,911

 

 

 

5,512

 

 

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

 

4



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 January 1,December 31, 2017 (“fiscal year 2016”2017”) included in the Company’s Annual Report on Form 10-K, filed on February 23, 2017.22, 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 31, 201730, 2018 (“fiscal year 2017”2018”) is a 52-week year, and fiscal year 2016 was a2017 are 52-week year.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.

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

All dollar amounts are in thousands, unless otherwise noted.

 

 

56


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

2. Recently IssuedSummary of Significant Accounting PronouncementsPolicies

Revenue Recognition

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 September 30, 2018. The Company had a net gift card liability balance of $6.8 million as of September 30, 2018 and $13.1 million as of December 31, 2017. During the thirty-nine weeks ended September 30, 2018, the Company recognized $16.1 million in sales related to gift cards redeemed by customers.

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.

Restricted Cash

Restricted cash relates to defined benefit plan forfeitures of approximately $0.7 million and is included in prepaid expenses and other current assets in the consolidated balance sheets.

Recently Adopted Accounting Pronouncements

In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.” ASU No. 2015-11 changes the measurement principle for inventory from the lower of cost or market to lower of cost and net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business; less reasonably predictable costs of completion, disposal and transportation. This guidance is effective for the Company for its fiscal year 2017. Adoption of the guidance took place prospectively during 2017, and the adoption did not have a material effect on the Company’s consolidated financial statements or disclosures.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718).” This update involves several aspects of the accounting for share-based transactions, including the income tax consequences, classification of awards as either equity or liabilities, how to account for forfeitures, and classification on the statement of cash flows. The amendments in this update are effective for the Company for its fiscal year 2017. As a result of the adoption, the Company recognized excess tax benefits related to the exercise of options in its income tax provision during the thirty-nine weeks ended October 1, 2017 (see Note 6). Prior to the adoption, these items were recorded in Additional Paid-in Capital. The Company has elected to prospectively apply the amendments related to classifying cash flows related to excess tax benefits as an operating activity. During 2017, excess tax benefits were classified as an operating activity on the consolidated statement of cash flows, along with other income tax cash flows. The Company has made a policy election to account for forfeitures as they occur. This election was adopted using a modified retrospective approach resulting in no cumulative effect on retained earnings at the beginning of the period. Prior to the adoption, forfeitures were accounted for using an estimated forfeiture rate.

Recently Issued Accounting Pronouncements Not Yet Adopted

In May 2014, the FASBFinancial Accounting Standards Board (“FASB”) issued ASUAccounting 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. This guidance will be effective for the Company for its fiscal year 2018, with early adoption permitted. The Company adopted ASC 606 effective January 1, 2018 using the modified retrospective approach. As noted above, there is currently evaluating the potentialno impact of this guidance and does not expect this ASU to materially impact the Company’s consolidatedany financial statements.

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 classificationstatement line item as a finance or operating lease. The new guidance also requires certain additional quantitative and qualitative disclosures. This guidance will be effective forresult of the Company for its fiscal year 2019, with early adoption, permitted, and the Company is currently evaluating the potentialhas recorded no impact to opening retained earnings as of this guidance.January 1, 2018. The adoptionCompany has added additional disclosures of this ASU is expected to resultdisaggregated revenue by type in a material increase to the Company’s consolidated balance sheets for right-of-use assets and lease liabilities.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. ThisThe guidance will bewas effective for the Company for its fiscal year 2018, with early adoption permitted.2018. The Company does not expectadopted this ASUguidance using the modified retrospective approach. As noted above, there is no impact to materiallyany financial statement line item as a result of the adoption, and the Company recorded no impact the Company’s consolidated financial statements.to opening retained earnings as of January 1, 2018.

67


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

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 November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The amendments in this update require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Adoption of this guidance took place prospectively during the first quarter of 2018, and the adoption did not have a material 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 during the first quarter 2018, and the adoption did not have an impact on the Company’s consolidated financial statements or disclosures.

In August 2018, the FASB issued ASU No. 2018-15, “Intangibles —Goodwill and Other —Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include internal-use software license). The amendments require an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which service contract implementation costs to capitalize as an asset and which costs to expense. The amendments also require the entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangements, which includes reasonably certain renewals. The Company adopted this guidance during the third quarter 2018 using the prospective transition approach. Adoption of the guidance did not have a material impact to the Company's financial statements and resulted in capitalization of implementation costs associated with various technology initiatives which are included in other assets in the consolidated balance sheet as of September 30, 2018.

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 financing or operating lease. Certain additional quantitative and qualitative disclosures will also be required. This ASU will be effective for the Company forbeginning with its 2019 fiscal year 2018, with early adoption permitted.year. While the Company is still evaluating the impact of this ASU, the Company expects it will result in material increases in assets and liabilities in its consolidated balance sheet and enhanced disclosures. In addition, the Company anticipates that the transition of its financing leases to operating leases under the new standard will result in an increase in rent expense, partially offset by reductions to depreciation and interest expense. The Company does not expect thisthat the adoption of the ASU to materiallywill have an impact on the Company’s consolidated financial statements.cash flows.

8


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 is currently evaluatingdoes not expect this ASU to materially impact the potential impact of this guidance.Company’s consolidated financial statements.

In May 2017,August 2018, the FASB issued ASU No. 2017-09,2018-14, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.—Retirement Benefits —Defined Benefit Plans —General (Subtopic 715-20) —Disclosure Framework —Changes to the Disclosure Requirements for Defined Benefit Plans.” The amendments in this update provide guidance about which changes toremove disclosures that no longer are considered cost-beneficial, clarify the terms or conditionsspecific requirements of a share-based award require an entity to apply modification accounting in Topic 718. disclosures, and add disclosure requirements identified as relevant. The guidance will be effective for the Company for its fiscal year 2018,2020, with early adoption permitted.  The Company does not expect this ASU to materially impact the Company’s consolidated financial statements.disclosures.

No other new accounting pronouncements issued or effective during the thirty-nine weeks ended October 1, 2017September 30, 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.

The following tables present the fair value hierarchy for the Company’s financial assets and in the valuation of store closure and exit costs.

The determination of fair values of certain tangible and intangible assets for purposes of the Company’s goodwill impairment evaluation as described above was based upon a step zero assessment. Closed facility reserves are recordedliabilities measured at net present value to approximate fair value which is classifiedon a recurring basis as Level 3 in the hierarchy. The estimated fair value of the closed facility reserve is calculated based on the present value of the remaining lease paymentsSeptember 30, 2018 and other charges using a weighted average cost ofDecember 31, 2017:

7

September 30, 2018

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Long-term debt

 

$

 

 

$

435,000

 

 

$

 

 

$

435,000

 

Total liabilities

 

$

 

 

$

435,000

 

 

$

 

 

$

435,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap asset

 

$

 

 

$

6,159

 

 

$

 

 

$

6,159

 

Total assets

 

$

 

 

$

6,159

 

 

$

 

 

$

6,159

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

9


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

capital, reduced by estimated sublease rentals. The weighted average cost of capital was estimatedCompany’s interest rate swaps are considered Level 2 in the hierarchy and are valued using information from comparable companies and management’s judgment relatedan income approach. Expected future cash flows are converted to the risk associated with the operationsa present value amount based on market expectations of the stores.yield curve on floating interest rates, which is readily available on public markets.

Cash, and cash equivalents, and restricted cash, accounts receivable, prepaid expenses and other current assets, accounts payable and other accrued liabilities and, accrued salaries and benefits and other accrued liabilities approximate fair value because of the short maturity of those instruments. Based on comparable open market transactions, comparable to the Credit Facility (as defined in Note 4, “Long-Term Debt”), the fair value of the long-term debt approximatesapproximated carrying value as of October 1, 2017September 30, 2018 and January 1,December 31, 2017. The Company’s estimates of the fair value of long-term debt were classified as Level 2 in the fair value hierarchy.

 

4. Long-Term Debt

A summary of long-term debt is as follows:

 

 

 

 

 

 

As of

 

 

 

 

 

 

As of

 

Facility

 

Maturity

 

Interest Rate

 

October 1,

2017

 

 

January 1,

2017

 

 

Maturity

 

Interest Rate

 

September 30,

2018

 

 

December 31,

2017

 

Senior secured debt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$450.0 million Credit Facility

 

April 17, 2020

 

Variable

 

$

349,000

 

 

$

255,000

 

$700.0 million Credit Agreement

 

March 27, 2023

 

Variable

 

$

435,000

 

 

$

 

Former Credit Facility

 

April 17, 2020

 

Variable

 

 

 

 

 

348,000

 

Total debt

 

 

 

 

 

 

349,000

 

 

 

255,000

 

 

 

 

 

 

 

435,000

 

 

 

348,000

 

Long-term debt

 

 

 

 

 

$

349,000

 

 

$

255,000

 

 

 

 

 

 

$

435,000

 

 

$

348,000

 

 

Senior Secured Revolving Credit Facility

March 2018 Refinancing

On April 17, 2015,March 27, 2018, the Company’s subsidiary, Sprouts Farmers Markets Holdings, LLC (“Intermediate Holdings”), as borrower, entered into aan amended and restated credit agreement that(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 (the “Credit Facility”),from 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 Facility. TheAgreement.

Concurrently with the closing of the Amended and Restated Credit Agreement, all commitments under the Former Credit Facility replacedwere terminated, resulting in a $0.3 million loss on early extinguishment of debt, recorded in interest expense during the Company’s existing senior secured credit facility, dated April 23, 2013.first quarter of fiscal year 2018. 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 were outstanding under the Former Credit Facility as of September 30, 2018.

The Company capitalized debt issuance costs of $2.3$2.1 million related to the refinancing which combined with the remaining $0.7 million debt issuance costs for the Former Credit Facility, which are being amortized on a straight-line basis to interest expense over the five-year term of the Amended and Restated Credit Facility.Agreement.

The Amended and Restated Credit FacilityAgreement 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 FacilityAgreement reduce theits borrowing capacity of the Credit Facility.capacity. Letters of credit totaling $24.8$27.0 million have been issued as of October 1, 2017,September 30, 2018, primarily to support the Company’s insurance programs.

10


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Guarantees

Obligations under the Amended and Restated Credit FacilityAgreement 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 FacilityAgreement initially bear 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 are subject to adjustment pursuant to a pricing grid based on the Company’s total grossnet leverage ratio, as definedset forth in the Amended and Restated Credit Facility.Agreement. Under the terms of the Amended and Restated Credit Facility,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 interest rate on approximately 57% of outstanding debt under the Amended and Restated Credit Facility commitments equalAgreement is fixed, reflecting the effects of floating to 0.20% per annum.fixed interest rate swaps (see Note 11, “Derivative Financial Instruments”).

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

8


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Payments and Borrowings    

The Amended and Restated Credit FacilityAgreement is scheduled to mature, and the commitments thereunder will terminate on April 17, 2020,March 27, 2023, subject to extensions as set forth in the Credit Facility.therein.

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

During fiscal year 2016,2017, the Company borrowed $105.0$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 $10.0$60.0 million of principal payments; resulting in total outstanding debt under the Former Credit Facility of $255.0$348.0 million at January 1,December 31, 2017. During the thirteenthirty-nine weeks ended October 1, 2017,September 30, 2018, the Company borrowed $49.0an additional $180.0 million primarily for share repurchases and made a total of $10.0 million of principal payments. During the thirty-nine weeks ended October 1, 2017, the Company borrowed $134.0 million and made a total of $40.0$93.0 million of principal payments; resulting in total outstanding debt under the Amended and Restated Credit FacilityAgreement of $349.0$435.0 million as of October 1, 2017.  The Company has used borrowings under the Credit Facility to assist with its share repurchase programs (see Note 9).September 30, 2018.

Covenants    

The Amended and Restated Credit FacilityAgreement 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;

11


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

enter into new lines of business;

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 FacilityAgreement requires that the Company and its subsidiaries maintain a maximum total net leverage ratio not to exceed 3.003.25 to 1.00 and minimum interest coverage ratio not to be less than 1.75 to 1.00. Each of these covenants is tested as ofon the last day of each fiscal quarter.quarter, starting with the fiscal quarter ended September 30, 2018.

The Company was in compliance with all applicable covenants under the Amended and Restated Credit Agreement as of September 30, 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 October 1, 2017.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.

 

95. Closed Store Reserves

The following is a summary of closed store reserve activity during the thirty-nine weeks ended September 30, 2018 and fiscal year 2017:

 

 

Thirty-nine

Weeks Ended

 

 

Fiscal

Year Ended

 

 

 

September 30,

2018

 

 

December 31,

2017

 

Beginning balance

 

$

811

 

 

$

1,083

 

Additions

 

 

 

 

 

 

Usage

 

 

(320

)

 

 

(492

)

Adjustments

 

 

85

 

 

 

220

 

Ending balance

 

$

576

 

 

$

811

 

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

6. Income Taxes

On December 22, 2017, the legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law, which changed various corporate income tax provisions within the existing Internal Revenue Code. The most significant changes that impacted the Company were 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.

12


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

5. Closed Store and Other Costs

The following is a summary of closed store reserve activity duringUnder the thirty-nine weeks ended October 1, 2017 and fiscal year 2016:

 

 

Thirty-nine

Weeks Ended

 

 

Fiscal

Year Ended

 

 

 

October 1, 2017

 

 

January 1, 2017

 

Beginning balance

 

$

1,083

 

 

$

2,017

 

Additions

 

 

 

 

 

 

Usage

 

 

(387

)

 

 

(998

)

Adjustments

 

 

205

 

 

 

64

 

Ending balance

 

$

901

 

 

$

1,083

 

The Closed Store Reserve is included in Other accrued liabilities and Other long-term liabilitiesguidance set forth in the consolidated balance sheets.  Usage relates to lease payments made duringSEC's Staff Accounting Bulletin No. 118 (“SAB 118”), the periodCompany may record provisional amounts for closed stores.  

During August and September 2017, 14 of our stores in Texas, Florida and Georgia were affected by Hurricanes Harvey and Irma.  While physical damage was minimal, these stores experienced, to varying degrees, loss of perishable inventory, additional expenses to clean up and power stores, and a loss of business while closed. Actual costs incurred, not including the impact of lost sales, are estimatedthe Tax Act. As of September 30, 2018, the Company has finalized its 2017 federal income tax return and as such completed the accounting for the income tax effects of the 2017 Tax Act. In accordance with SAB 118, any future adjustments required due to changes in interpretation and guidance that may be $1.0 million, with an estimated insurance recovery of $0.3 million for these costs.  We are pursuing additional recovery under our business interruptionissued will be recorded as discrete adjustments to income tax expense in the period in which those adjustments become estimable and other insurance policy provisions; however, any additional recoveries are not expected to be material.finalized.

 

6. Income Taxes

The Company’s effective tax rate decreased to 17.3% for the thirteen weeks ended September 30, 2018 from 33.8% for the thirteen weeks ended October 1, 2017 and October 2, 2016primarily due to the enactment of the Tax Act as disclosed above, as well as the impact of a tax calculation method change. During the quarter ended September 30, 2018 the Company adopted tax calculation method changes that resulted in the accelerated deduction or deferral of certain items. The method changes were included in the Company’s 2017 tax return that was 33.8% and 36.9%, respectively. The decreasefinalized during the fiscal quarter. As a result, the Company recorded a $2.6 million discrete tax benefit in the third quarter of 2018, which decreased the effective tax rate is primarily due to tax return to provision adjustments for the 2016 income tax return.by 5.7%.

The Company’s effective tax rate decreased to 16.4% for the thirty-nine weeks ended September 30, 2018 from 31.7% for the thirty-nine weeks ended October 1, 2017 and October 2, 2016 was 31.7% and 37.7%, respectively. The decrease inprimarily due to the effective tax rate is primarily related toenactment of the Tax Act disclosed above, as well as the recognition of excess tax benefits related to the exercise or vesting of equity-based awardsstock options recognized in the income tax provision. See ASU 2016-09, Compensation – “Stock Compensation (Topic 718)” under Recently Adopted Accounting Pronouncements (Note 2).The tax calculation method change resulted in a discrete rate benefit of 1.5% for the thirty-nine weeks ended September 30, 2018.

Excess tax benefits associated with share-based payment awards are recognized as income tax expense or benefit in the income statement.statements of income. 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 equity-basedexcess tax benefits of share-based payment awards were $1.0 million and $0.2 million for the thirteen weeks ended September 30, 2018 and October 1, 2017.2017, respectively. The income tax benefits resulting from the equity-based awards for the thirteen weeks ended October 2, 2016 were $0.2 million and recorded in Additional Paid-in Capital.

The incomeexcess tax benefits resulting from equity-basedof share-based payment awards were $12.4 million and $8.4 million for the thirty-nine weeks ended September 30, 2018 and October 1, 2017. The income tax benefits resulting from equity-based awards for the thirty-nine weeks ended October 2, 2016 were $3.9 million and recorded in Additional Paid-in Capital.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 September 30, 2018, there were no purchases from this supplier and $2.7 million of purchases during the thirteen weeks ended October 1, 2017. During the thirty-nine weeks ended September 30, 2018 and October 1, 2017, and October 2, 2016, purchases from this supplier were $2.7$2.6 million and $2.1$8.1 million, respectively. DuringAs of September 30, 2018, the thirty-nine weeks ended October 1, 2017 and October 2, 2016, purchases from this supplier were $8.1 million and $7.3

10


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

million, respectively. The Company had recordedno accounts payable due to this vendor and as of December 31, 2017, the Company had recorded accounts payable of $0.7 million, as of both October 1, 2017 and October 2, 2016, respectively.million.

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 September 30, 2018 and October 1, 2017, and October 2, 2016, purchases from this supplier and its predecessors were $1.6$1.8 million and $2.2$1.6 million, respectively. During the thirty-nine weeks ended September 30, 2018 and October 1, 2017, and October 2, 2016, purchases from this supplier and its predecessors were $5.2$4.4 million and $6.0$5.2 million, respectively. As of October 1,September 30, 2018, and December 31, 2017, and October 2, 2016, the Company had recorded accounts payable due to the supplier of $0.2 million and $0.5$0.1 million, respectively.

 

13


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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.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 plaintiffsplaintiff sought remand, which the court granted in March 2017.  The Company has appealed the order granting remand to the Ninth Circuit Court of Appeals. 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.  On August 15, 2018, the Company reached an agreement in principle to settle these claims.  The Companyparties’ settlement agreement will continuebe presented to defend this case vigorously, but it is not possible at this time to reasonably estimate the outcome of, or any potential liabilitycourt for approval.  If approved by the court, the settlement will be funded from the case.Company’s directors and officers liability insurance policy and will not have a material impact on the Company’s consolidated financial statements.  

 

9. Stockholders’ Equity

Share Repurchases

On November 4, 2015, the Company’s board of directors authorized a $150 million common stock share repurchase program, which was completed during the second quarter of 2016. On September 6, 2016, the Company’s board of directors authorized a $250 million common stock share repurchase program, which was completed during the first quarter of 2017. On February 20, 2017, the Company’s board of directors authorized a new $250 million common stock share repurchase program. The following table outlines the common stock share repurchase programs authorized by the Board,Company’s board of directors from time to time, and the related repurchase activity and available authorization as of October 1, 2017 (in thousands):September 30, 2018.

 

Effective date

 

Expiration date

 

Amount

authorized

 

 

Cost of

repurchases

 

 

Authorization

available

 

 

Expiration date

 

Amount

authorized

 

 

Cost of

repurchases

 

 

Authorization

available

 

November 4, 2015

 

November 4, 2017

 

$

150,000

 

 

$

150,000

 

 

$

 

 

November 4, 2017

 

$

150,000

 

 

$

150,000

 

 

$

 

September 6, 2016

 

December 31, 2017

 

$

250,000

 

 

$

250,000

 

 

$

 

 

December 31, 2017

 

$

250,000

 

 

$

250,000

 

 

$

 

February 20, 2017

 

December 31, 2018

 

$

250,000

 

 

$

112,000

 

 

$

138,000

 

 

December 31, 2018

 

$

250,000

 

 

$

250,000

 

 

$

 

February 20, 2018

 

December 31, 2019

 

$

350,000

 

 

$

66,707

 

 

$

283,293

 

14


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

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

11


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 authorized on September 6, 2016 and February 20, 2017 (see Note 4)4, “Long-Term Debt”).

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

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

October 1,

2017

 

 

October 2,

2016

 

 

October 1,

2017

 

 

October 2,

2016

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Number of common shares acquired

 

 

3,249,204

 

 

 

3,189,818

 

 

 

9,136,468

 

 

 

8,169,510

 

 

 

719,004

 

 

 

3,249,204

 

 

 

8,411,575

 

 

 

9,136,468

 

Average price per common share acquired

 

$

22.16

 

 

$

19.93

 

 

$

21.01

 

 

$

22.99

 

 

$

21.29

 

 

$

22.16

 

 

$

22.98

 

 

$

21.01

 

Total cost of common shares acquired

 

$

72,000

 

 

$

63,572

 

 

$

192,000

 

 

$

187,836

 

 

$

15,307

 

 

$

72,000

 

 

$

193,307

 

 

$

192,000

 

 

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

 

 

Thirty-nine Weeks Ended

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

October 1,

2017

 

 

October 2,

2016

 

 

October 1,

2017

 

 

October 2,

2016

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Basic net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

31,486

 

 

$

23,885

 

 

$

118,741

 

 

$

107,301

 

 

$

37,500

 

 

$

31,486

 

 

$

145,833

 

 

$

118,741

 

Weighted average shares outstanding

 

 

134,320

 

 

 

147,743

 

 

 

136,063

 

 

 

149,202

 

 

 

126,855

 

 

 

134,320

 

 

 

129,572

 

 

 

136,063

 

Basic net income per share

 

$

0.23

 

 

$

0.16

 

 

$

0.87

 

 

$

0.72

 

 

$

0.30

 

 

$

0.23

 

 

$

1.13

 

 

$

0.87

 

Diluted net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

31,486

 

 

$

23,885

 

 

$

118,741

 

 

$

107,301

 

 

$

37,500

 

 

$

31,486

 

 

$

145,833

 

 

$

118,741

 

Weighted average shares outstanding - basic

 

 

134,320

 

 

 

147,743

 

 

 

136,063

 

 

 

149,202

 

 

 

126,855

 

 

 

134,320

 

 

 

129,572

 

 

 

136,063

 

Dilutive effect of equity-based awards:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assumed exercise of options to purchase shares

 

 

2,128

 

 

 

2,200

 

 

 

2,506

 

 

 

2,278

 

 

 

341

 

 

 

2,128

 

 

 

484

 

 

 

2,506

 

RSUs

 

 

122

 

 

 

28

 

 

 

124

 

 

 

49

 

 

 

175

 

 

 

122

 

 

 

193

 

 

 

124

 

RSAs

 

 

114

 

 

 

13

 

 

 

102

 

 

 

9

 

 

 

82

 

 

 

114

 

 

 

137

 

 

 

102

 

PSAs

 

 

86

 

 

 

40

 

 

 

65

 

 

 

30

 

 

 

174

 

 

 

86

 

 

 

151

 

 

 

65

 

Weighted average shares and equivalent

shares outstanding

 

 

136,770

 

 

 

150,024

 

 

 

138,860

 

 

 

151,568

 

 

 

127,627

 

 

 

136,770

 

 

 

130,537

 

 

 

138,860

 

Diluted net income per share

 

$

0.23

 

 

$

0.16

 

 

$

0.86

 

 

$

0.71

 

 

$

0.29

 

 

$

0.23

 

 

$

1.12

 

 

$

0.86

 

 

15


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

For the thirteen weeks ended September 30, 2018, the computation of diluted net income per share does not include 0.7 million options and 0.1 million PSAs as those awards would have been antidilutive or were performance awards with performance conditions net yet deemed met. For the thirteen weeks ended October 1, 2017, the computation of diluted net income per share does not include 1.9 million options and 0.1 million PSAs as those awards would have been antidilutive or were unvested performance awards.

For the thirteenthirty-nine weeks ended October 2, 2016,September 30, 2018, the computation of diluted net income per share does not include 2.21.1 million options 0.1 million RSUs, and 0.1 million PSAs as those awards would have been antidilutive or were unvested performance awards.

12


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

awards with performance conditions net yet deemed met. For the thirty-nine weeks ended October 1, 2017, the computation of diluted net income per share does not include 1.9 million options and 0.1 million PSAs as those awards would have been antidilutive or were unvested performance awards. For

11. Derivative Financial Instruments

The Company entered into an interest rate swap agreement in December 2017 to manage its 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, the Company needs 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 September 30, 2018 and December 31, 2017, respectively, under which the Company pays 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. The Company reviews the effectiveness of its hedging instruments on a quarterly basis.

The counterparties to these derivative financial instruments are major financial institutions. The Company evaluates the credit ratings of the financial institutions and believes that credit risk is at an acceptable level.

 

 

As of

September 30, 2018

 

 

As of

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

 

$

6,159

 

 

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 ncome.

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Consolidated Statements of

   Income Classification

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income (expense), net

 

$

176

 

 

$

 

 

$

115

 

 

$

 

16


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

12. Comprehensive Income

During the thirty-nine weeks ended October 2, 2016,1, 2017, the computationCompany did not record accumulated other comprehensive income. The following table presents the changes in accumulated other comprehensive income for the thirty-nine weeks ended September 30, 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 $1,851

 

 

5,351

 

Total other comprehensive income

 

 

5,351

 

Balance at September 30, 2018

 

$

4,567

 

Amounts reclassified from accumulated other comprehensive income (loss) are included within interest expense on the consolidated statements of diluted net income per share does not include 1.3 million options, 0.1 million RSUs and 0.1 million PSAs as those awards would have been antidilutive or were unvested performance awards.income.

 

13. Segments

11.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 and thirty-nine weeks ended September 30, 2018 and October 1, 2017.

 

 

Thirteen Weeks Ended

 

 

 

September 30, 2018

 

 

October 1, 2017

 

Perishables

 

$

777,413

 

 

 

58.5

%

 

$

710,250

 

 

 

58.9

%

Non-Perishables

 

 

551,696

 

 

 

41.5

%

 

 

495,809

 

 

 

41.1

%

Net Sales

 

$

1,329,109

 

 

 

100.0

%

 

$

1,206,059

 

 

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirty-nine Weeks Ended

 

 

 

September 30, 2018

 

 

October 1, 2017

 

Perishables

 

$

2,283,348

 

 

 

58.0

%

 

$

2,060,367

 

 

 

58.5

%

Non-Perishables

 

 

1,654,650

 

 

 

42.0

%

 

 

1,460,312

 

 

 

41.5

%

Net Sales

 

$

3,937,998

 

 

 

100.0

%

 

$

3,520,679

 

 

 

100.0

%

The Company categorizes the varieties of products it sells as perishable and non-perishable. Perishable product categories include produce, meat, seafood, deli, bakery, floral 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 equity-basedstock-based and cash-based incentive compensation programs for its directors, officers and other team members.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.

17


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 October 1, 2017,September 30, 2018, there were 3,686,043 3,025,033stock awards outstanding and 5,805,6745,205,689 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 October 1, 2017,September 30, 2018, there were 2,384,978130,643 options outstanding under the 2011 Option Plan.

Awards Granted

During the thirty-nine weeks ended October 1, 2017,September 30, 2018, the Company granted the following equity-basedstock-based compensation awards:

 

Grant Date

 

RSUs

 

 

PSAs

 

 

RSAs

 

 

RSUs

 

 

PSAs

 

March 2017

 

 

325,406

 

 

 

148,944

 

 

 

288,746

 

May 2017

 

 

21,820

 

 

 

 

 

 

 

August 2017

 

 

10,630

 

 

 

 

 

 

 

March 2018

 

 

451,951

 

 

 

126,098

 

May 2018

 

 

54,913

 

 

 

2,756

 

August 2018

 

 

8,732

 

 

 

 

Total:

 

 

357,856

 

 

 

148,944

 

 

 

288,746

 

 

 

515,596

 

 

 

128,854

 

Weighted-average grant date fair value

 

$

18.66

 

 

$

18.11

 

 

$

18.11

 

 

$

24.80

 

 

$

25.10

 

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. No options have been granted subsequent to 2016.

13


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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. During the thirty-nine weeks ended October 2, 2016, theThe performance conditions with respect to 2015 earnings per share targets were deemed to have been met, and all PSAs have vested. During the PSAs will vest 50 percent at eachthirty-nine weeks ended September 30, 2018, 20,595 of the second2015 PSAs were vested, and third anniversary of the grant date. Duringduring the thirty-nine weeks ended October 1, 2017, 21,050 of the 2015 PSAs were vested.  No PSAs vested during the thirty-nine weeks ended October 2, 2016.

18


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 fair value of these PSAs is based on the closing price of the Company’s common stock on the grant date. The EBIT target resets annually 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 independentmeasured independently of the previous and next tranche.tranche. Cumulative performance is based on the aggregate annual performance targets.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. Ifgranted, depending upon goal achievement. Although deemed unlikely to be met, if the performance conditions are met, PSAsthe applicable number of performance shares is subject to cliff vestvesting on the third anniversary of the grant date. date (March 2019). The Company’s board of directors determined that the performance targets for the fiscal yearconditions with respect to 2016 trancheand 2017 EBIT were not met and 30,981 performance shares were not earned.met.

PSAs granted in fiscal yearMarch 2017 are restricted shares that arewere subject to the Company achieving certain earnings per share performance targets as well as additional time-vesting conditions.during 2017. The fair value of PSAscriteria is based on the closing pricea range of the Company’s common stock on the grant date. Payout of the performance shares will either be 0% or range fromtargets in which grantees may earn between 10% toand 150% of the targetbase number of sharesawards granted. If theThe performance conditions arewith respect to 2017 earnings per share were deemed to have been met, and the PSAs will vest 50 percent at each50% on the second anniversary of the secondgrant date (2019) and 50% on the third anniversary of the grant date.date (2020).

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. RSAs granted prior to January 1, 2017 will vest either ratably over a seven quarter period, beginning on December 31, 2016 or cliff vest on June 30, 2018.  RSAs granted in fiscal year 2017 willOutstanding RSA grants vest annually over a period of three years from the grant date.years.

Equity Award Restructuring

In connection with the appointments of the Company’s Chief Executive Officer and President & Chief Operating Officer in August 2015, theEquity-based Compensation Committee of the Company’s Board of Directors approved a grant of stock options to purchase 1,200,000 and 500,000 shares of the Company’s common stock at an exercise price of $20.98 per share to these officers, respectively (the “August 2015 Options”) pursuant to the 2013 Incentive Plan. The August 2015 Options, taken together with other options granted under the 2013 Incentive Plan to such officers during 2015, exceeded the limit of 500,000 shares which may be granted pursuant to stock options and stock appreciation rights per calendar year to each participant under the 2013 Incentive Plan by 733,439 sharesExpense

Equity-based compensation expense was reflected in the caseconsolidated statements of the Company’s Chief Executive Officer and 33,439 shares in the case of the Company’s President & Chief Operating Officer (the “Excess Options”).  Accordingly, the Company has determined, and these officers have acknowledged, that the grants of the Excess Options were null and void.  income as follows:

In order to satisfy the original intent with respect to these individuals’ compensation, on May 23, 2016, the Compensation Committee granted to the Company’s Chief Executive Officer and President & Chief Operating Officer under the 2013 Incentive Plan options to purchase 386,496 and 33,439 shares of

14

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Cost of sales, buying and occupancy

 

$

251

 

 

$

265

 

 

$

827

 

 

$

777

 

Direct store expenses

 

 

339

 

 

 

349

 

 

 

1,063

 

 

 

1,098

 

Selling, general and administrative expenses

 

 

2,453

 

 

 

3,471

 

 

 

9,783

 

 

 

8,450

 

Equity-based compensation expense before

   income taxes

 

 

3,043

 

 

 

4,085

 

 

 

11,673

 

 

 

10,325

 

Income tax benefit

 

 

(782

)

 

 

(1,528

)

 

 

(3,000

)

 

 

(3,863

)

Net equity-based compensation expense

 

$

2,261

 

 

$

2,557

 

 

$

8,673

 

 

$

6,462

 

19


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

the Company’s common stock at an exercise price of $24.48 per share, respectively, and 215,251 and 2,601 RSAs, respectively. The Company recognized compensation expense of $0.9 million during the thirteen week period and $2.9 million during the thirty-nine week period ended October 1, 2017 related to the options and RSAs granted.  The Company recognized compensation expense of $1.0 million during the thirteen week period and $1.4 million during the thirty-nine week period ended October 2, 2016 related to the options and RSAs granted.

Equity-based Compensation Expense

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

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

 

October 1,

2017

 

 

October 2,

2016

 

 

October 1,

2017

 

 

October 2,

2016

 

Cost of sales, buying and occupancy

 

$

265

 

 

$

244

 

 

$

777

 

 

$

726

 

Direct store expenses

 

 

349

 

 

 

339

 

 

 

1,098

 

 

 

1,015

 

Selling, general and administrative expenses

 

 

3,471

 

 

 

3,414

 

 

 

8,450

 

 

 

8,581

 

Equity-based compensation expense before

   income taxes

 

 

4,085

 

 

 

3,997

 

 

 

10,325

 

 

 

10,322

 

Income tax benefit

 

 

(1,528

)

 

 

(1,519

)

 

 

(3,863

)

 

 

(3,922

)

Net equity-based compensation expense

 

$

2,557

 

 

$

2,478

 

 

$

6,462

 

 

$

6,400

 

The following equity-based awards were outstanding as of October 1, 2017September 30, 2018 and January 1,December 31, 2017:

 

 

As of

 

 

As of

 

 

October 1, 2017

 

 

January 1, 2017

 

 

September 30,

2018

 

 

December 31,

2017

 

 

(in thousands)

 

 

(in thousands)

 

Options

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested

 

 

4,394

 

 

 

5,552

 

 

 

1,816

 

 

 

4,226

 

Unvested

 

 

609

 

 

 

1,205

 

 

 

98

 

 

 

464

 

RSUs

 

 

453

 

 

 

274

 

 

 

694

 

 

 

449

 

PSAs

 

 

231

 

 

 

159

 

 

 

366

 

 

 

231

 

RSAs

 

 

384

 

 

 

187

 

 

 

182

 

 

 

353

 

 

As of October 1, 2017,September 30, 2018, total unrecognized compensation expense related to outstanding equity-based awards was as follows:

 

 

As of

 

 

 

October 1, 2017

 

Options

 

$

3,629

 

RSUs

 

 

6,803

 

PSAs

 

 

3,171

 

RSAs

 

 

6,106

 

Total unrecognized compensation expense

 

$

19,709

 

As of October 1, 2017, the totaland remaining weighted average recognition period related to outstanding equity-based awards was as follows:

 

As of

October 1, 2017

Options

1.0

RSUs

1.7

PSAs

1.7

RSAs

2.0

 

 

Unrecognized

compensation

expense

 

 

Remaining

weighted

average

recognition

period

 

Options

 

$

360

 

 

 

0.4

 

RSUs

 

 

11,895

 

 

 

1.8

 

PSAs

 

 

3,834

 

 

 

1.4

 

RSAs

 

 

2,343

 

 

 

1.4

 

Total unrecognized compensation expense

   at September 30, 2018

 

$

18,432

 

 

 

 

 

15


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

During the thirty-nine weeks ended September 30, 2018 and October 1, 2017, and October 2, 2016, the Company received $6.6$21.1 million and $2.6$6.6 million, respectively, in cash proceeds from the exercise of options.

 

 


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 23, 201722, 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 offersspecializes 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 bulk foods,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 packaged groceries, meatdepartment and seafood, deli, baked goods, dairy products, frozen foods, body care and natural household items catering to consumers’ growing interest in health and wellness.more. Since our founding in 2002, we have grown rapidly, significantly increasing our sales, store count and profitability. With 282313 stores in 1519 states as of October 1, 2017,September 30, 2018, we are one of the largest specialty retailers of fresh, natural and organic food in the United States. As of November 1, 2017,October 29, 2018, we have grown to 285315 stores in 1519 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 October 1, 2017,September 30, 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 (referred to as the “Transactions”).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 32 new stores in 2017, of which all 32 have opened through November 1, 2017, and approximately 30 new stores per year for the near term.term, and in 2018, we have opened 30 new stores through October 29, 2018.

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.

 


Results of Operations for Thirteen Weeks Ended September 30, 2018 and October 1, 2017 and October 2, 2016

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

 

 

Thirteen weeks ended

 

 

October 1, 2017

 

 

October 2, 2016

 

 

September 30, 2018

 

 

October 1, 2017

 

Unaudited Consolidated Statement of Operations Data:

 

 

 

 

 

 

 

 

Unaudited Quarterly Consolidated Statement of Income Data:

 

 

 

 

 

 

 

 

Net sales

 

$

1,206,059

 

 

$

1,035,801

 

 

$

1,329,109

 

 

$

1,206,059

 

Cost of sales, buying and occupancy

 

 

859,650

 

 

 

744,288

 

 

 

946,734

 

 

 

859,650

 

Gross profit

 

 

346,409

 

 

 

291,513

 

 

 

382,375

 

 

 

346,409

 

Direct store expenses

 

 

250,191

 

 

 

216,932

 

 

 

281,365

 

 

 

250,191

 

Selling, general and administrative expenses

 

 

39,955

 

 

 

29,664

 

 

 

43,944

 

 

 

39,955

 

Store pre-opening costs

 

 

2,456

 

 

 

3,446

 

 

 

3,819

 

 

 

2,456

 

Store closure and other costs

 

 

803

 

 

 

24

 

 

 

461

 

 

 

803

 

Income from operations

 

 

53,004

 

 

 

41,447

 

 

 

52,786

 

 

 

53,004

 

Interest expense

 

 

(5,609

)

 

 

(3,723

)

 

 

(7,419

)

 

 

(5,609

)

Other income

 

 

162

 

 

 

135

 

 

 

 

 

 

162

 

Income before income taxes

 

 

47,557

 

 

 

37,859

 

 

 

45,367

 

 

 

47,557

 

Income tax provision

 

 

(16,071

)

 

 

(13,974

)

 

 

(7,867

)

 

 

(16,071

)

Net income

 

$

31,486

 

 

$

23,885

 

 

$

37,500

 

 

$

31,486

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

134,320

 

 

 

147,743

 

 

 

126,855

 

 

 

134,320

 

Dilutive effect of equity-based awards

 

 

2,450

 

 

 

2,281

 

Diluted effect of equity-based awards

 

 

772

 

 

 

2,450

 

Weighted average shares and equivalent shares outstanding

 

 

136,770

 

 

 

150,024

 

 

 

127,627

 

 

 

136,770

 

Diluted net income per share

 

$

0.23

 

 

$

0.16

 

 

$

0.29

 

 

$

0.23

 

 

 

Thirteen weeks ended

 

 

Thirteen weeks ended

 

 

October 1, 2017

 

 

October 2, 2016

 

 

September 30, 2018

 

 

October 1, 2017

 

Other Operating Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comparable store sales growth

 

 

4.6

%

 

 

1.3

%

 

 

1.5

%

 

 

4.6

%

Stores at beginning of period

 

 

274

 

 

 

240

 

 

 

301

 

 

 

274

 

Closed

 

 

 

 

 

 

Opened

 

 

8

 

 

 

10

 

 

 

12

 

 

 

8

 

Stores at end of period

 

 

282

 

 

 

250

 

 

 

313

 

 

 

282

 


Comparison of Thirteen Weeks Ended October 1, 2017September 30, 2018 to Thirteen Weeks Ended

October 2, 20161, 2017

Net sales

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Net sales

 

$

1,206,059

 

 

$

1,035,801

 

 

$

170,258

 

 

 

16

%

 

$

1,329,109

 

 

$

1,206,059

 

 

$

123,050

 

 

 

10

%

Comparable store sales growth

 

 

4.6

%

 

 

1.3

%

 

 

 

 

 

 

 

 

 

 

1.5

%

 

 

4.6

%

 

 

 

 

 

 

 

 

 

Net sales during the thirteen weeks ended October 1, 2017September 30, 2018 totaled $1.2$1.3 billion, increasing 16%10% over the same period of the prior fiscal year. Sales growth was primarily driven by solidstrong performance in new stores opened.opened and a 1.5% increase in comparable store sales. Comparable stores contributed approximately 87%90% of nettotal sales for each of the thirteen weeks ended October 1, 2017September 30, 2018 and October 2, 2016, respectively.approximately 87% for the same period of the prior fiscal year.

 

Cost of sales, buying and occupancy and gross profit

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Net sales

 

$

1,206,059

 

 

$

1,035,801

 

 

$

170,258

 

 

 

16

%

 

$

1,329,109

 

 

$

1,206,059

 

 

$

123,050

 

 

 

10

%

Cost of sales, buying and occupancy

 

 

859,650

 

 

 

744,288

 

 

 

115,362

 

 

 

15

%

 

 

946,734

 

 

 

859,650

 

 

 

87,084

 

 

 

10

%

Gross profit

 

 

346,409

 

 

 

291,513

 

 

 

54,896

 

 

 

19

%

 

 

382,375

 

 

 

346,409

 

 

 

35,966

 

 

 

10

%

Gross margin

 

 

28.7

%

 

 

28.1

%

 

 

0.6

%

 

 

 

 

 

 

28.77

%

 

 

28.72

%

 

 

0.05

%

 

 

 

 

 

Gross profit increased during the thirteen weeks ended October 1, 2017September 30, 2018 compared to the thirteen weeks ended October 2, 20161, 2017 by $54.9$36.0 million, of which $47.4$35.4 million was as a result of increased sales volume and $7.5$0.6 million related to increased margin rate. This improvement was primarily driven by cycling a heightened promotional environmenthigher margin rates for new stores opened in the third quarter of 2016 in addition to leverage from increased comparable sales.current period partially offset by higher occupancy costs.

 

Direct store expenses

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Direct store expenses

 

$

250,191

 

 

$

216,932

 

 

$

33,259

 

 

 

15

%

 

$

281,365

 

 

$

250,191

 

 

$

31,174

 

 

 

12

%

Percentage of net sales

 

 

20.7

%

 

 

20.9

%

 

 

-0.2

%

 

 

 

 

 

 

21.2

%

 

 

20.7

%

 

 

0.5

%

 

 

 

 

 

Direct store expenses for the thirteen weeks ended October 1, 2017September 30, 2018 increased $33.3$31.2 million, including $26.5$24.5 million related to stores opened after October 2, 2016,1, 2017, and $6.8$6.7 million related to stores operatedoperating prior to the same period in 2016.2017. Direct store expenses, as a percentage of net sales, decreased 20increased 50 basis points. This leveragedeleverage is primarily driven by improved comparable sales,planned wage investments funded by the savings from the legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) as well as operating efficiencies, partially offset byincreased healthcare costs and higher benefit costs.depreciation expense associated with new store and strategic initiatives.

 

 

Selling, general and administrative expenses

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Selling, general and administrative

expenses

 

$

39,955

 

 

$

29,664

 

 

$

10,291

 

 

 

35

%

 

$

43,944

 

 

$

39,955

 

 

$

3,989

 

 

 

10

%

Percentage of net sales

 

 

3.3

%

 

 

2.9

%

 

 

0.4

%

 

 

 

 

 

 

3.3

%

 

 

3.3

%

 

 

 

 

 

 

 

 


Selling, general and administrative expenses, as a percentage of sales, remained consistent during the thirteen weeks ended September 30, 2018 as compared to the thirteen weeks ended October 1, 2017. The $4.0 million increase in selling, general and administrative expenses primarily reflects a $7.1 million increaserelates to increases in bonusadvertising, consulting and compensation expenses, $1.5 million increaseexpense in advertising expenses, and $1.7 million of increases in other corporate expenses, commensurateline with store growth and improved company performance.  the Company’s strategic initiatives, partially offset by lower bonus and stock-based compensation expense.

Store pre-opening costs

 


 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Attributable to 2017 store openings

 

 

 

 

 

2,055

 

 

 

(2,055

)

 

 

 

 

Attributable to planned 2018 store openings

 

 

3,505

 

 

 

139

 

 

 

3,366

 

 

 

 

 

Attributable to planned 2019 store openings

 

 

314

 

 

 

262

 

 

 

52

 

 

 

 

 

Total store pre-opening costs

 

$

3,819

 

 

$

2,456

 

 

$

1,363

 

 

 

55

%

Percentage of net sales

 

 

0.3

%

 

 

0.2

%

 

 

0.1

%

 

 

 

 

Store pre-opening costs

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

Attributable to 2016 store openings

 

 

 

 

 

3,109

 

 

 

(3,109

)

 

 

 

 

Attributable to 2017 store openings

 

 

2,046

 

 

 

337

 

 

 

1,709

 

 

 

 

 

Attributable to future store openings

 

 

410

 

 

 

 

 

 

410

 

 

 

 

 

Total store pre-opening costs

 

$

2,456

 

 

$

3,446

 

 

$

(990

)

 

 

(29

)%

Percentage of net sales

 

 

0.2

%

 

 

0.3

%

 

 

(0.1

)%

 

 

 

 

in the thirteen weeks ended September 30, 2018 included $3.5 million primarily related to 12 stores opening during the period and two additional stores planned to be open in 2018 and $0.3 million associated with stores expected to open in 2019. Store pre-opening costs in the thirteen weeks ended October 1, 2017 included $1.9$2.1 million related to opening 811 stores during the thirteen weeks ended October 1,third and fourth quarter 2017 and $0.6 million associated with stores expected to open subsequent to October 1, 2017. Store pre-opening costs in the thirteen weeks ended October 2, 2016 included $2.6 million related to opening 10 stores during that period and $0.8$0.4 million associated with stores opened subsequent to quarter end.2017.

 

Store closure and other costs

Store closure costs for the thirteen weeks ended September 30, 2018 and October 1, 2017 and October 2, 2016 are related to adjustments to the closed store facility reserve primarily related to refinement of estimated subtenant income and other actual occupancy costs from original estimates.

During the third quarter 2018, we incurred $0.4 million in costs, net of estimated insurance recovery, primarily associated with Hurricane Florence which affected 24 stores in three states. Although physical damage was minimal, the stores incurred costs for hurricane preparation work, temporary closures and inventory loss.

During the third quarter of 2017, 14 of our stores were affected by hurricanes in three states.  Although physical damage was minimal, the stores experienced loss of business due to temporary closures, inventory loss and additional expenses to clean up and power the stores.  These costs, net of estimated insurance recovery, approximate $0.7 million in the thirteen weeks ended October 1, 2017.

Interest expense

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Long-term debt

 

$

4,312

 

 

$

2,305

 

 

$

2,007

 

 

 

87

%

Capital and financing leases

 

$

3,033

 

 

$

2,708

 

 

$

325

 

 

 

12

%

 

 

3,023

 

 

 

3,033

 

 

 

(10

)

 

 

(0

)%

Long-term debt

 

 

2,305

 

 

 

786

 

 

 

1,519

 

 

 

193

%

Deferred financing costs / Original issuance

discount

 

 

116

 

 

 

116

 

 

 

 

 

 

0

%

Other

 

 

155

 

 

 

113

 

 

 

42

 

 

 

37

%

Deferred financing costs

 

 

141

 

 

 

116

 

 

 

25

 

 

 

22

%

Interest rate hedge and other

 

 

(57

)

 

 

155

 

 

 

(212

)

 

 

(137

)%

Total Interest Expense

 

$

5,609

 

 

$

3,723

 

 

$

1,886

 

 

 

51

%

 

$

7,419

 

 

$

5,609

 

 

$

1,810

 

 

 

32

%

 

The increase in interest expense is primarily due to the higher principal balance on the Credit Facility for borrowing to support our share repurchase program,long-term debt combined with the slightly higher interest rate on our Credit Facilityrates for the thirteen weeks ended October 1, 2017.September 30, 2018.


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

 

 

 

September 30,

2018

 

 

October 1,

2017

 

Federal statutory rate

 

 

21.0

%

 

 

35.0

%

Increase (decrease) in income taxes resulting from:

 

 

 

 

 

 

 

 

State income taxes, net of federal benefit

 

 

4.9

%

 

 

3.7

%

Excess tax benefits from share based payments

 

 

(2.1

)%

 

 

(0.5

)%

Tax calculation method change

 

 

(5.7

)%

 

 

 

Other, net

 

 

(0.8

)%

 

 

(4.4

)%

Effective tax rate

 

 

17.3

%

 

 

33.8

%

 

Income tax provision

Income tax provision increased decreased to $7.9 million for the thirteen weeks ended September 30, 2018 from $16.1 million for the thirteen weeks ended October 1, 2017 from $14.0 million for the thirteen weeks ended October 2, 2016, primarily related to an increase in income before taxes.2017. Our effective income tax rate decreased to 17.3% in the thirteen weeks ended September 30, 2018 from 33.8% in the thirteen weeks ended October 1, 2017 primarily related to the effects of the Tax Act, a discrete rate benefit resulting from 36.9%a tax calculation method change made in connection with finalizing the thirteen weeks ended October 2, 2016.  The decrease in the effective tax rate was primarily due to2017 income tax return and the recognition of excess tax benefits related to provision adjustments for the 2016 income tax return.

exercise of stock options.

Net income

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Net income

 

$

31,486

 

 

$

23,885

 

 

$

7,601

 

 

 

32

%

 

$

37,500

 

 

$

31,486

 

 

$

6,014

 

 

 

19

%

Percentage of net sales

 

 

2.6

%

 

 

2.3

%

 

 

0.3

%

 

 

 

 

 

 

2.8

%

 

 

2.6

%

 

 

0.2

%

 

 

 

 

 

Net income increased $6.0 million as a percentageresult of netincreased sales, increased primarily due to higher salesstrong new store performance and margins combined with a lower effective tax rate due to the Tax Act and tax accounting method change, partially offset in part by higher interest expense associated withcompensation expenses due to planned wage investments funded by the drawdown on our Credit Facility in connection withsavings from the stock buyback program.Tax Act.

 

Diluted earnings per share

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Diluted earnings per share

 

$

0.23

 

 

$

0.16

 

 

$

0.07

 

 

 

44

%

 

$

0.29

 

 

$

0.23

 

 

$

0.06

 

 

 

26

%

Diluted weighted average shares

outstanding

 

 

136,770

 

 

 

150,024

 

 

 

(13,254

)

 

 

 

 

 

 

127,627

 

 

 

136,770

 

 

 

(9,143

)

 

 

 

 

 

The increase in diluted earnings per share of $0.07$0.06 was driven by the increase inhigher net income as well asand fewer diluted shares outstanding compared to the prior year, due primarily to the share repurchase program.


Results of Operations for Thirty-nine Weeks Ended September 30, 2018 and October 1, 2017 and October 2, 2016

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.

 

 

Thirty-nine Weeks Ended

 

 

Thirty-nine weeks ended

 

 

October 1, 2017

 

 

October 2, 2016

 

 

September 30, 2018

 

 

October 1, 2017

 

Unaudited Consolidated Statement of Operations Data:

 

 

 

 

 

 

 

 

Unaudited Quarterly Consolidated Statement of Income Data:

 

 

 

 

 

 

 

 

Net sales

 

$

3,520,679

 

 

$

3,060,685

 

 

$

3,937,998

 

 

$

3,520,679

 

Cost of sales, buying and occupancy

 

 

2,494,998

 

 

 

2,156,857

 

 

 

2,788,159

 

 

 

2,494,998

 

Gross profit

 

 

1,025,681

 

 

 

903,828

 

 

 

1,149,839

 

 

 

1,025,681

 

Direct store expenses

 

 

715,336

 

 

 

617,817

 

 

 

816,933

 

 

 

715,336

 

Selling, general and administrative expenses

 

 

110,312

 

 

 

91,482

 

 

 

128,828

 

 

 

110,312

 

Store pre-opening costs

 

 

10,055

 

 

 

11,625

 

 

 

9,414

 

 

 

10,055

 

Store closure and other costs

 

 

992

 

 

 

159

 

 

 

497

 

 

 

992

 

Income from operations

 

 

188,986

 

 

 

182,745

 

 

 

194,167

 

 

 

188,986

 

Interest expense

 

 

(15,447

)

 

 

(10,985

)

 

 

(20,028

)

 

 

(15,447

)

Other income

 

 

388

 

 

 

326

 

 

 

325

 

 

 

388

 

Income before income taxes

 

 

173,927

 

 

 

172,086

 

 

 

174,464

 

 

 

173,927

 

Income tax provision

 

 

(55,186

)

 

 

(64,785

)

 

 

(28,631

)

 

 

(55,186

)

Net income

 

$

118,741

 

 

$

107,301

 

 

$

145,833

 

 

$

118,741

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

136,063

 

 

 

149,202

 

 

 

129,572

 

 

 

136,063

 

Dilutive effect of equity-based awards

 

 

2,797

 

 

 

2,366

 

Diluted effect of equity-based awards

 

 

965

 

 

 

2,797

 

Weighted average shares and equivalent shares outstanding

 

 

138,860

 

 

 

151,568

 

 

 

130,537

 

 

 

138,860

 

Diluted net income per share

 

$

0.86

 

 

$

0.71

 

 

$

1.12

 

 

$

0.86

 

 

 

Thirty-nine Weeks Ended

 

 

Thirty-nine weeks ended

 

 

October 1, 2017

 

 

October 2, 2016

 

 

September 30, 2018

 

 

October 1, 2017

 

Other Operating Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comparable store sales growth

 

 

2.4

%

 

 

3.4

%

 

 

2.0

%

 

 

2.4

%

 

 

 

 

 

 

 

 

Stores at beginning of period

 

 

253

 

 

 

217

 

 

 

285

 

 

 

253

 

Closed

 

 

 

 

 

 

Opened

 

 

29

 

 

 

33

 

 

 

28

 

 

 

29

 

Stores at end of period

 

 

282

 

 

 

250

 

 

 

313

 

 

282

 


Comparison of Thirty-nine Weeks Ended October 1, 2017September 30, 2018 to Thirty-nine Weeks Ended

October 2, 20161, 2017

Net sales

 

 

Thirty-nine Weeks Ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Net sales

 

$

3,520,679

 

 

$

3,060,685

 

 

$

459,994

 

 

 

15

%

 

$

3,937,998

 

 

$

3,520,679

 

 

$

417,319

 

 

 

12

%

Comparable store sales growth

 

 

2.4

%

 

 

3.4

%

 

 

 

 

 

 

 

 

 

 

2.0

%

 

 

2.4

%

 

 

 

 

 

 

 

 

 

Net sales during the thirty-nine weeks ended October 1, 2017September 30, 2018 totaled $3.5$3.9 billion, increasing 15%12% over the same period of the prior fiscal year. year. Sales growth was primarily driven by solidstrong performance in new stores opened.opened and a 2.0% increase in comparable store sales. Comparable stores contributed approximately 87%89% of net sales for the thirty-nine weeks ended October 1, 2017September 30, 2018 and approximately 88%87% for the same period of the prior fiscal year.

 

Cost of sales, buying and occupancy and gross profit

 

 

Thirty-nine Weeks Ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Net sales

 

$

3,520,679

 

 

$

3,060,685

 

 

$

459,994

 

 

 

15

%

 

$

3,937,998

 

 

$

3,520,679

 

 

$

417,319

 

 

 

12

%

Cost of sales, buying and occupancy

 

 

2,494,998

 

 

 

2,156,857

 

 

 

338,141

 

 

 

16

%

 

 

2,788,159

 

 

 

2,494,998

 

 

 

293,161

 

 

 

12

%

Gross profit

 

 

1,025,681

 

 

 

903,828

 

 

 

121,853

 

 

 

13

%

 

 

1,149,839

 

 

 

1,025,681

 

 

 

124,158

 

 

 

12

%

Gross margin

 

 

29.1

%

 

 

29.5

%

 

 

(0.4

)%

 

 

 

 

 

 

29.20

%

 

 

29.13

%

 

 

0.07

%

 

 

 

 

 

Gross profit increased during the thirty-nine weeks ended October 1, 2017September 30, 2018 compared to the thirty-nine weeks ended October 2, 20161, 2017 by $121.9$124.2 million, primarily as a result of increased sales volume. Gross margin decreasedvolume due in part to the competitive environment, primarily in the first halfopening of 2017, as well as higher occupancy costs.28 new stores and increased margin rate.

 

Direct store expenses

 

 

Thirty-nine Weeks Ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Direct store expenses

 

$

715,336

 

 

$

617,817

 

 

$

97,519

 

 

 

16

%

 

$

816,933

 

 

$

715,336

 

 

$

101,597

 

 

 

14

%

Percentage of net sales

 

 

20.3

%

 

 

20.2

%

 

 

0.1

%

 

 

 

 

 

 

20.7

%

 

 

20.3

%

 

 

0.4

%

 

 

 

 

 

Direct store expenses for the thirty-nine weeks ended October 1, 2017September 30, 2018 increased $97.5$101.6 million. Direct store expenses, as a percentage of net sales, increased 1040 basis points. This deleverage is primarily reflects higher payrolldriven by planned wage investments funded by the savings from the Tax Act as well as increased healthcare costs and benefit costs, in part due to deleverage of fixed costsdepreciation expense associated with lower comparablenew store sales growth, partially offset by other operating efficiencies.

and strategic initiatives.

 

Selling, general and administrative expenses

 

 

Thirty-nine Weeks Ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Selling, general and administrative

expenses

 

$

110,312

 

 

$

91,482

 

 

$

18,830

 

 

 

21

%

 

$

128,828

 

 

$

110,312

 

 

$

18,516

 

 

 

17

%

Percentage of net sales

 

 

3.1

%

 

 

3.0

%

 

 

0.1

%

 

 

 

 

 

 

3.3

%

 

 

3.1

%

 

 

0.2

%

 

 

 

 

 

The increase in selling, general and administrative expenses primarily reflects an $8.1 million increaseincreases in compensation expense, a $3.7 million increase in regional expenses, a $3.5 million increase in advertising to support growth and $3.5 million of increases in other corporate expenses,consulting costs, commensurate with store growth and improved company performance.

strategic initiatives.


Store pre-opening costs

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Attributable to 2016 store openings

 

 

 

 

 

11,186

 

 

 

(11,186

)

 

 

 

 

Attributable to 2017 store openings

 

 

9,210

 

 

 

439

 

 

 

8,771

 

 

 

 

 

 

 

 

 

 

9,272

 

 

 

(9,272

)

 

 

 

 

Attributable to future store openings

 

 

845

 

 

 

 

 

 

845

 

 

 

 

 

Attributable to planned 2018 store openings

 

 

8,416

 

 

 

254

 

 

 

8,162

 

 

 

 

 

Attributable to planned 2019 store openings

 

 

998

 

 

 

529

 

 

 

469

 

 

 

 

 

Total store pre-opening costs

 

$

10,055

 

 

$

11,625

 

 

$

(1,570

)

 

 

(14

)%

 

$

9,414

 

 

$

10,055

 

 

$

(641

)

 

 

(6

)%

Percentage of net sales

 

 

0.3

%

 

 

0.4

%

 

 

(0.1

)%

 

 

 

 

 

 

0.2

%

 

 

0.3

%

 

 

(0.1

)%

 

 

 

 

 

Store pre-opening costs in the thirty-nine weeks ended September 30, 2018 included $8.4 million primarily related to 28 stores opening during the period and two additional stores planned to be open in 2018 and $1.0 million associated with stores expected to open in 2019. Store pre-opening costs in the thirty-nine weeks ended October 1, 2017 included $9.0$9.3 million related to opening 2932 stores during the thirty-nine weeks ended October 1, 2017year and $1.0 million associated with stores expected to open subsequent to October 1, 2017. Store pre-opening costs in the thirty-nine weeks ended October 2, 2016 included $10.6 million related to opening 33 stores during that period and $1.0$0.8 million associated with stores opened subsequent to quarter end.

2017.

 

Store closure and other costs

Store closure costs for the thirty-nine weeks ended September 30, 2018 and October 1, 2017 and October 2, 2016 are related to adjustments to the closed facility reserve primarily related to refinement of estimated subtenant income and other actual occupancy costs from original estimates.

During the third quarter 2018, we incurred $0.4 million in costs, net of estimated insurance recovery, primarily associated with Hurricane Florence which affected 24 stores in three states. Although physical damage was minimal, the stores incurred costs for hurricane preparation work, temporary closures and inventory loss.

During the third quarter of 2017, 14 of our stores were affected by hurricanes in three states.  Although physical damage was minimal, the stores experienced loss of business due to temporary closures, inventory loss and additional expenses to clean up and power the stores.  These costs, net of estimated insurance recovery, approximate $0.7 million in the thirty-nine weeks ended October 1, 2017.

Interest expense

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Long-term debt

 

$

10,495

 

 

$

5,919

 

 

$

4,576

 

 

 

77

%

Capital and financing leases

 

$

8,715

 

 

$

8,048

 

 

$

667

 

 

 

8

%

 

 

8,748

 

 

 

8,715

 

 

 

33

 

 

 

0

%

Long-term debt

 

 

5,919

 

 

 

2,247

 

 

 

3,672

 

 

 

163

%

Deferred financing costs / Original issuance

discount

 

 

347

 

 

 

347

 

 

 

 

 

 

0

%

Other

 

 

466

 

 

 

343

 

 

 

123

 

 

 

36

%

Deferred financing costs

 

 

658

 

 

 

347

 

 

 

311

 

 

 

90

%

Interest rate hedge and other

 

 

127

 

 

 

466

 

 

 

(339

)

 

 

(73

)%

Total Interest Expense

 

$

15,447

 

 

$

10,985

 

 

$

4,462

 

 

 

41

%

 

$

20,028

 

 

$

15,447

 

 

$

4,581

 

 

 

30

%

 

The increase in interest expense is primarily due to the higher principal balance on the Credit Facility for borrowing to support our share repurchase programof long-term debt combined with the slightly higher interest raterates on our Former Credit Facility for the thirty-nine weeks ended October 1, 2017.September 30, 2018.

 


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:

 

 

Thirty-nine weeks ended

 

 

 

September 30, 2018

 

 

October 1, 2017

 

Federal statutory rate

 

 

21.0

%

 

 

35.0

%

Decrease in income taxes resulting from:

 

 

 

 

 

 

 

 

State income taxes, net of federal benefit

 

 

4.9

%

 

 

3.7

%

Excess tax benefits from share based payments

 

 

(7.1

)%

 

 

(4.9

)%

Tax calculation method change

 

 

(1.5

)%

 

 

 

Other, net

 

 

(0.9

)%

 

 

(2.1

)%

Effective tax rate

 

 

16.4

%

 

 

31.7

%

Income tax provision decreased to $28.6 million for the thirty-nine weeks ended September 30, 2018 from $55.2 million for the thirty-nine weeks ended October 1, 20172017. Our effective income tax rate decreased to 16.4% in the thirty-nine weeks ended September 30, 2018 from $64.8 million for31.7% in the thirty-nine weeks ended October 2, 2016,1, 2017 primarily related to the effects of the Tax Act, the recognition of excess tax benefits related to the exercise or vesting of equity-based awardsstock options and a discrete rate benefit resulting from a tax calculation method change made in connection with finalizing the 2017 income tax provision. Our effectivereturn.

Net income tax rate decreased to 31.7% in the thirty-nine weeks ended October 1, 2017 from 37.7% in the thirty-nine weeks ended October 2, 2016 primarily related to recognition of excess tax benefits related to the exercise or vesting of equity-based awards in the income tax provision. See ASU 2016-09, Compensation – “Stock Compensation (Topic 718)” under Recently Adopted Accounting Pronouncements (Note 2).

 


Net income

 

Thirty-nine Weeks Ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Net income

 

$

118,741

 

 

$

107,301

 

 

$

11,440

 

 

 

11

%

 

$

145,833

 

 

$

118,741

 

 

$

27,092

 

 

 

23

%

Percentage of net sales

 

 

3.4

%

 

 

3.5

%

 

 

(0.1

)%

 

 

 

 

 

 

3.7

%

 

 

3.4

%

 

 

0.3

%

 

 

 

 

 

Net income increased $11.4$27.1 million as a result of increased sales, but decreased slightly as a percentage of net sales due to strong new store performance and lower gross margin and higher payroll expensestax rate due primarily to the Tax Act, partially offset higher compensation expenses due to planned wage investments funded by a lower effective tax rate.the savings from the Tax Act.

 

Diluted earnings per share

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

Thirty-nine weeks ended

 

 

 

 

 

 

 

 

 

 

October 1, 2017

 

 

October 2, 2016

 

 

Change

 

 

% Change

 

 

September 30, 2018

 

 

October 1, 2017

 

 

Change

 

 

% Change

 

Diluted earnings per share

 

$

0.86

 

 

$

0.71

 

 

$

0.15

 

 

 

21

%

 

$

1.12

 

 

$

0.86

 

 

$

0.26

 

 

 

30

%

Diluted weighted average shares

outstanding

 

 

138,860

 

 

 

151,568

 

 

 

(12,708

)

 

 

 

 

 

 

130,537

 

 

 

138,860

 

 

 

(8,323

)

 

 

 

 

 

The increase in diluted earnings per share of $0.15$0.26 was driven by the increase in net income as well as 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.


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

 

 

Rolling Four Quarters Ended

 

 

October 1, 2017

 

 

October 2, 2016 (4)

 

 

September 30,

2018

 

 

October 1,

2017

 

 

(dollars in thousands)

 

 

(dollars in thousands)

 

Net income (1)

 

$

135,745

 

 

$

135,518

 

 

$

185,531

 

 

$

135,745

 

Interest expense, net of tax (2)

 

 

11,770

 

 

 

9,580

 

Income Tax Adjustment for Tax Act (2)

 

 

(21,266

)

 

 

 

Interest expense, net of tax (3)

 

 

20,534

 

 

 

11,770

 

Net operating profit after tax (NOPAT)

 

$

147,515

 

 

$

145,098

 

 

$

184,799

 

 

$

147,515

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total rent expense, net of tax (2)

 

 

78,113

 

 

 

63,983

 

Estimated depreciation on capitalized operating leases, net of tax (2)

 

 

(34,370

)

 

 

(28,153

)

Estimated interest on capitalized operating leases, net of tax (2) (3)

 

 

43,743

 

 

 

35,830

 

Total rent expense, net of tax (3)

 

 

104,958

 

 

 

78,113

 

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

 

 

(46,182

)

 

 

(34,370

)

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

 

 

58,776

 

 

 

43,743

 

NOPAT, including effect of capitalized operating leases

 

$

191,258

 

 

$

180,928

 

 

$

243,575

 

 

$

191,258

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average working capital

 

 

15,093

 

 

 

103,321

 

 

 

21,536

 

 

 

15,093

 

Average property and equipment

 

 

641,451

 

 

 

522,183

 

 

 

738,424

 

 

 

641,451

 

Average other assets

 

 

574,281

 

 

 

586,777

 

 

 

573,946

 

 

 

574,281

 

Average other liabilities

 

 

(149,039

)

 

 

(115,077

)

 

 

(192,287

)

 

 

(149,039

)

Average invested capital

 

$

1,081,786

 

 

$

1,097,204

 

 

$

1,141,619

 

 

$

1,081,786

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average estimated asset base of capitalized operating leases

 

 

930,645

 

 

 

814,532

 

 

 

1,053,271

 

 

 

930,645

 

Average invested capital, including the effect of capitalized

operating leases

 

$

2,012,431

 

 

$

1,911,736

 

 

$

2,194,890

 

 

$

2,012,431

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ROIC

 

 

13.6

%

 

 

13.2

%

 

 

16.2

%

 

 

13.6

%

ROIC, including the effect of capitalized operating leases

 

 

9.5

%

 

 

9.5

%

 

 

11.1

%

 

 

9.5

%

 

(1)

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

(2)

$18.7 million income tax benefit related to the Tax Act enacted in December 2017 and $2.6 million income tax benefit related to tax calculation method changes recognized in the third quarter of 2018, see Note 6, “Income Taxes.”

(3)

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

(3)(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.

(4)

Inclusive of $4.1 million net income benefit of 53rd week in 2015.


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 and restricted cash at the end of each period (in thousands):

 

 

Thirty-nine weeks ended

 

 

Thirty-nine weeks ended

 

 

October 1, 2017

 

 

October 2, 2016

 

 

September 30, 2018

 

 

October 1, 2017

 

Cash and cash equivalents at end of period

 

$

18,892

 

 

$

50,290

 

Cash, cash equivalents and restricted cash at end of period

 

$

17,831

 

 

$

18,892

 

Cash flows from operating activities

 

$

258,969

 

 

$

196,037

 

 

$

235,466

 

 

$

258,969

 

Cash flows used in investing activities

 

$

(158,429

)

 

$

(142,400

)

 

$

(148,432

)

 

$

(158,429

)

Cash flows used in financing activities

 

$

(94,113

)

 

$

(139,416

)

 

$

(88,682

)

 

$

(94,113

)

 

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 restricted cash, 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 FacilityAgreement as discussed in Note 4, “Long-Term Debt” 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, cash equivalents and restricted 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 increased $63.0decreased $23.5 million to $235.5 million for the thirty-nine weeks ended September 30, 2018 compared to $259.0 million for the thirty-nine weeks ended October 1, 2017 compared to $196.0 million for the thirty-nine weeks ended October 2, 2016.2017. The decrease in cash flows from operating activities came from net income adjustedis primarily for non-cash expensesa result of depreciation and amortization, deferred income taxes, equity-based compensation and changes in working capital.capital, partially offset higher noncash depreciation and amortization.

Cash flows provided byby/(used in) operating activities from changes in working capital was $34.4($46.5) million in the thirty-nine weeks ended September 30, 2018, compared to $24.5 million in the thirty-nine weeks ended October 1, 2017, compared to $2.5 million use of cash in the thirty-nine weeks ended October 2, 2016. The increase in cash flows from operating activities for changes in working capital in the thirty-nine weeks ended October 1, 2017, compared to the thirty-nine weeks ended October 2, 2016, was primarily due to higher net income combined with working capital improvements as a result of operating efficiencies achieved through our strategic initiatives, and higher payroll and bonus accruals in line with improved performance and company growth.  2017.

Investing Activities

Cash flows used in investing activities were $158.4 million, and $142.4 million for the thirty-nine weeks ended October 1, 2017 and the thirty-nine weeks ended October 2, 2016, respectively. The increase in cash flows used in investing activities is primarily due to additional purchases of property and equipment, due to the addition of 32 stores in the last twelve months. 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 $148.4 million, and $158.4 million, for the thirty-nine weeks ended September 30, 2018 and October 1, 2017, respectively.

We expect capital expenditures to be approximately $170in the range of $160 - $165 million in fiscal 2017,2018, 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 Facility.Agreement.

Financing Activities

Cash flows used in financing activities were $88.7 million for the thirty-nine weeks ended September 30, 2018 compared to $94.1 million for the thirty-nine weeks ended October 1, 2017 compared to $139.4 million for2017. During the thirty-nine weeks ended October 2, 2016. September 30, 2018, cash flows used in financing activities primarily consisted of $193.3 million for stock repurchases, partially offset by $87.0 million of net borrowings on our credit facilities, and $21.1 million in proceeds from the exercise of stock options.


During the thirty-nine weeks ended October 1, 2017, cash flows used in financing activities primarily consisted of $192.0 million for stock repurchases, $40.0 million in payments on our Credit Facility, $3.0 million cash paid for capital and financing lease obligations, partially offset by $134.0$94.0 million of net borrowings on the Former Credit Facility, and $6.6 million in proceeds from the exercise of stock options and $0.3 million of cash received from landlords related to financing lease obligations.

During the thirty-nine weeks ended October 2, 2016, cash flows used in financing activities consisted of $187.8 million for stock repurchases and $3.1 million cash paid for capital and financing lease obligations, partially offset by $45.0 million of borrowings on the Credit Facility $3.9 million of excess tax benefits from the exercise of stock options and $2.6 million in proceeds from the exercise of stock options.

Long-Term Debt and Credit Facilities

Long-term debt increased $144.0$87.0 million to $349.0$435.0 million as of October 1, 2017,September 30, 2018, compared to October 2, 2016December 31, 2017. The increase is due to net borrowings under our credit facilities primarily related to borrowings to fundused 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 Facility.Agreement and our Former Credit Facility (each as defined therein).


Share Repurchase Program

On November 4, 2015, ourOur board of directors authorized a $150 million common stockfrom time to time authorizes share repurchase program, which was completed during the second quarter of 2016. On September 6, 2016, our board of directors authorized a $250 million share repurchase program for our common stock, which was completed during the first quarter of 2017. On February 20, 2017, our board of directors authorized a new $250 million share repurchase programprograms for our common stock. The following table outlines the share repurchase programs authorized by the Board,our board, and the related repurchase activity and available authorization as of October 1, 2017.September 30, 2018.

 

Effective date

 

Expiration date

 

Amount

authorized

 

 

Cost of

repurchases

 

 

Authorization

available

 

 

Expiration date

 

Amount

authorized

 

 

Cost of

repurchases

 

 

Authorization

available

 

November 4, 2015

 

November 4, 2017

 

$

150,000

 

 

$

150,000

 

 

$

 

 

November 4, 2017

 

$

150,000

 

 

$

150,000

 

 

$

 

September 6, 2016

 

December 31, 2017

 

$

250,000

 

 

$

250,000

 

 

$

 

 

December 31, 2017

 

$

250,000

 

 

$

250,000

 

 

$

 

February 20, 2017

 

December 31, 2018

 

$

250,000

 

 

$

112,000

 

 

$

138,000

 

 

December 31, 2018

 

$

250,000

 

 

$

250,000

 

 

$

 

February 20, 2018

 

December 31, 2019

 

$

350,000

 

 

$

66,707

 

 

$

283,293

 

The shares under theour 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. TheOur board’s authorization of the share repurchase programs does not obligate usour 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 Facilitycredit facilities to assist with the repurchase program authorized on September 6, 2016 and February 20, 2017.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:follows (total cost in thousands):

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

October 1,

2017

 

 

October 2,

2016

 

 

October 1,

2017

 

 

October 2,

2016

 

 

September 30,

2018

 

 

October 1,

2017

 

 

September 30,

2018

 

 

October 1,

2017

 

Number of common shares acquired

 

 

3,249,204

 

 

 

3,189,818

 

 

 

9,136,468

 

 

 

8,169,510

 

 

 

719,004

 

 

 

3,249,204

 

 

 

8,411,575

 

 

 

9,136,468

 

Average price per common share acquired

 

$

22.16

 

 

$

19.93

 

 

$

21.01

 

 

$

22.99

 

 

$

21.29

 

 

$

22.16

 

 

$

22.98

 

 

$

21.01

 

Total cost of common shares acquired

 

$

72,000

 

 

$

63,572

 

 

$

192,000

 

 

$

187,836

 

 

$

15,307

 

 

$

72,000

 

 

$

193,307

 

 

$

192,000

 

 

Shares purchased under our repurchase programs were subsequently retired.

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 2035.2034.


The following table summarizes our leasecontractual obligations as of October 1, 2017,September 30, 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)

 

Capital and financing lease obligations (1)

 

$

142,221

 

 

$

17,018

 

 

$

33,472

 

 

$

31,175

 

 

$

60,556

 

Operating lease obligations (1)

 

 

1,590,493

 

 

 

138,329

 

 

 

302,886

 

 

 

287,356

 

 

 

861,922

 

Totals

 

$

1,732,714

 

 

$

155,347

 

 

$

336,358

 

 

$

318,531

 

 

$

922,478

 

 

 

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)

 

$

435,000

 

 

 

 

 

 

 

 

$

435,000

 

 

 

 

Interest payments on $700.0 million Credit

   Agreement (2)

 

 

69,831

 

 

 

16,063

 

 

 

33,305

 

 

 

20,463

 

 

 

 

Capital and financing lease obligations(3)

 

 

123,421

 

 

 

16,444

 

 

 

31,692

 

 

 

26,810

 

 

 

48,475

 

Operating lease obligations(3)

 

 

1,690,376

 

 

 

155,489

 

 

 

334,592

 

 

 

310,553

 

 

 

889,742

 

Totals

 

$

2,318,628

 

 

$

187,996

 

 

$

399,589

 

 

$

792,826

 

 

$

938,217

 

 

(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” to our unaudited consolidated financial statements located elsewhere in this Quarterly Report on Form 10-Q.

(2)

Represents estimated interest payments through the March 27, 2023 maturity date of our Amended and Restated Credit Agreement based on the outstanding amounts as of September 30, 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 October 1, 2017.September 30, 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, $2.4$2.7 million for years one to three, $1.7$2.1 million for years four to five, and $1.7$2.2 million for the period beyond five years.


We have other contractual purchase commitments and debt, which were presented under Contractual Obligations in our Annual Report on Form 10-K for the fiscal year ended January 1, 2017.  ThereDecember 31, 2017, and for which there have not been material changes to our contractual purchase commitments since that filing through October 1, 2017. As of October 1, 2017, the outstanding balance on the Credit Facility was $349.0 million, as discussed in Note 4 to the unaudited consolidated financial statements.

We periodically make other commitments and become subject to other contractual obligations that we believe to be routine in nature and incidental to the operation of the business. Management believes that such routine commitments and contractual obligations do not have a material impact on our business, financial condition or results of operations.September 30, 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, including among other things weather conditions, product supply and geopolitical conditions (including tariffs), 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.


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 thirty-nine weeks ended October 1, 2017.September 30, 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 January 1,December 31, 2017.

Recently Issued Accounting Pronouncements

See Note 2, “Recently Issued“Summary of Significant Accounting Pronouncements”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 QualitativeQualitative 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 aan Amended and Restated Credit FacilityAgreement that bears interest at a rate based in part on LIBOR. Accordingly, we are exposed to fluctuations in interest rates. Based on the $349.0$435.0 million principal outstanding under our Amended and Restated Credit FacilityAgreement as of October 1, 2017,September 30, 2018, each hundred basis point change in LIBOR would result in a change in interest expense by $3.5$4.4 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 and September 30, 2018 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 $435.0 million principal outstanding under our Amended and Restated Credit Agreement as of September 30, 2018, each hundred basis point change in LIBOR would result in a change in interest expense by $1.9 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 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 October 1, 2017,September 30, 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 October 1, 2017,September 30, 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.

 

 


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 plaintiffsplaintiff sought remand, which the court granted in March 2017.  We have appealed the order granting remand to the Ninth Circuit Court of Appeals.  On May 25, 2017, weour 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.  We answeredOn August 15, 2018, we reached an agreement in principle to settle these claims.  The parties’ settlement agreement will be presented to the complaintcourt for approval.  If approved by the court, the settlement will be funded from our directors and officers liability insurance policy and will not have a material impact on September 28, 2017.  We 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.our consolidated financial statements.

“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 like those signed by each of the named plaintiffs are enforceable; oral argumentenforceable. On May 21, 2018, the Supreme Court issued its opinion in Epic Systems Corp. v. Lewis and upheld enforceability of arbitration agreements containing class action waivers, like the ones the named plaintiffs signed in this case was heard bymatter. Subsequent to 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. stay, it remains to be seen what strategy plaintiffs will pursue following Epic Systems.  We will continueintend 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.

Proposition 65 Coffee Action

On April 13, 2010, an organization named Council for Education and Research on Toxics (“CERT”) filed a lawsuit in the Superior Court of the State of California, County of Los Angeles, against nearly 80 defendants who manufacture, package, distribute or sell brewed coffee, including Sprouts. CERT alleges that the defendants failed to provide warnings for their coffee products of exposure to the chemical acrylamide as required under California Health and Safety Code section 25249.5, the California Safe Drinking Water and Toxic Enforcement Act of 1986, better known as Proposition 65. CERT seeks equitable relief, including providing warnings to consumers of coffee products, as well as civil penalties.


Our company, as part of a joint defense group, asserted multiple defenses against the lawsuit. On May 7, 2018, the trial court issued a ruling adverse to defendants on these defenses to liability. On June 15, 2018, before the court tried damages, remedies and attorneys' fees, California’s Office of Environmental Health Hazard Assessment (“OEHHA”) published a proposal to amend Proposition 65’s implementing regulations by adding a stand-alone sentence that reads as follows: “Exposures to listed chemicals in coffee created by and inherent in the processes of roasting coffee beans or brewing coffee do not pose a significant risk of cancer.” OEHHA accepted public comments on the proposed regulation until August 30, 2018, and expects that the proposed regulation, if finalized, could be effective as early as January 2019. The joint defense group sought a stay of the lawsuit pending resolution of OEHHA’s rulemaking, and a temporary stay order was granted by the Court of Appeal of the State of California on October 12, 2018, until further order.

At this stage of the proceedings, prior to a trial on the remedies issues, Sprouts is unable to predict or reasonably estimate the potential loss or effect on our company or our operations. Accordingly, no loss contingency was recorded for this matter. If the proposed regulation is not adopted, or the court determines that it does not apply to this case, the trial court has discretion to impose zero penalties against our company or to impose significant statutory penalties. Significant labeling or warning requirements that could potentially be imposed by the trial court may increase our costs and adversely affect sales of our coffee products. Furthermore, a future appellate court decision could reverse the trial court rulings. The outcome and the financial impact of settlement or the trial or appellate court rulings of the case to our company, if any, cannot be predicted.

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 January 1,December 31, 2017.


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 thirteenthirty-nine weeks ended October 1, 2017.September 30, 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

 

July 3, 2017 - July 30, 2017

 

 

675,727

 

 

$

23.01

 

 

 

675,727

 

 

$

194,450,000

 

July 31, 2017 - August 27, 2017

 

 

1,017,618

 

 

$

24.03

 

 

 

1,017,618

 

 

$

170,000,000

 

August 28, 2017 - October 1, 2017

 

 

1,555,859

 

 

$

20.57

 

 

 

1,555,859

 

 

$

138,000,000

 

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

 

July 2, 2018 - July 29, 2018

 

 

215,795

 

 

$

21.25

 

 

 

215,795

 

 

$

294,023,000

 

July 30, 2018 - August 26, 2018

 

 

503,209

 

 

$

21.31

 

 

 

503,209

 

 

$

283,293,000

 

August 27, 2018 - September 30, 2018

 

 

 

 

 

 

 

 

 

 

$

283,293,000

 

 

(1)

Periodic information is presented by reference to our fiscal periods during the third quarter of fiscal year 2017.2018.


Item 6. Exhibits.Exhibits.

 

Exhibit

Number

 

Description

 

 

 

  10.1

Distribution Agreement, dated as of July 18, 2018, by and between SFM, LLC dba Sprouts Farmers Market and KeHE Distributors, LLC

31.1

 

Certification of Chief Executive OfficeOfficer 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

 

 

 

 

Portions of this exhibit (indicated by asterisks) have been omitted pursuant to a confidential treatment request submitted separately to the SEC pursuant to Rule 406 under the Securities Act. 

 


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: November 2, 20171, 2018

By:

/s/ Bradley S. Lukow

 

Name:

Bradley S. Lukow

 

Title:

Chief Financial Officer

 

 

(Principal Financial Officer)

 

 

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