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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-192165

17,000,000 Shares

 

Common Stock

 

 

The selling stockholders of Sprouts Farmers Market, Inc. identified in this prospectus are offering shares of our common stock. We are not selling any shares in this offering and will not receive any of the proceeds. We will bear all of the offering expenses other than the underwriting discounts and commissions.

Our common stock is listed on the NASDAQ Global Select Market under the symbol “SFM.” On November 25, 2013, the last reported sale price of our common stock was $37.52 per share.

 

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 15 for a discussion of factors you should consider before buying shares of our common stock.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

		Per Share				Total
Public offering price		$	37.00000			$	629,000,000
Underwriting discount(1)		$	1.20250			$	20,442,500
Proceeds to the selling stockholders		$	35.79750			$	608,557,500

 

(1)	We have agreed to reimburse the underwriters for certain FINRA-related expenses. See “Underwriting.”

The underwriters have the option to purchase up to an additional 2,550,000 shares from the selling stockholders at the public offering price less the underwriting discount. They may exercise that option for 30 days.

 

 

The underwriters expect to deliver the shares of common stock against payment in New York, New York on or about December 2, 2013.

 

Goldman, Sachs & Co.		Credit Suisse

BofA Merrill Lynch

 

Apollo Global Securities		Barclays		Deutsche Bank Securities		UBS Investment Bank
Guggenheim Securities				Wolfe Research Securities

 

 

Prospectus dated November 25, 2013

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		Page
Prospectus Summary			1
Risk Factors			15
Special Note Regarding Forward-Looking Statements			36
Use of Proceeds			38
Market Price Range of Common Stock			38
Dividend Policy			38
Capitalization			39
Selected Consolidated Historical and Pro Forma Financial and Other Data			40
Unaudited Pro Forma Condensed Consolidated Financial Information			46
Management’s Discussion and Analysis of Financial Condition and Results of Operations			55
Business			92
Management			111
Executive Compensation			120
Certain Relationships and Related Party Transactions			139
Principal and Selling Stockholders			142
Description of Capital Stock			168
Shares Eligible for Future Sale			172
Material U.S. Federal Income Tax Considerations for Non-U.S. Holders of Common Stock			175
Underwriting			180
Conflicts of Interest			185
Legal Matters			186
Experts			186
Where You Can Find Additional Information			186
Index to Financial Statements			F-1

 

 

Neither we, the selling stockholders, nor the underwriters have authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. We and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares of common stock offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

Persons who come into possession of this prospectus and any such free writing prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus and any such free writing prospectus applicable to that jurisdiction.

BASIS OF PRESENTATION

We report our results of operations on a 52- or 53-week fiscal year ending on the Sunday closest to December 31, with each fiscal quarter generally divided into three periods consisting of two four-week periods and one five-week period. Our last three completed fiscal years ended on January 2, 2011, January 1, 2012 and December 30, 2012. For ease of reference, we identify our fiscal years in this prospectus by reference to the calendar year ending closest to the last day of such fiscal year. For example, we refer to our fiscal years ended January 2, 2011, January 1, 2012 and December 30, 2012 as “fiscal 2010,” “fiscal 2011” and “fiscal 2012,” respectively.

 

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TRADEMARKS AND TRADE NAMES

This prospectus includes our trademarks and service marks, SPROUTS FARMERS MARKET^®, SPROUTS^® and HEALTHY LIVING FOR LESS!^®, which are protected under applicable intellectual property laws and are the property of Sprouts. This prospectus also contains trademarks, service marks, trade names and copyrights of other companies, which are the property of their respective owners. Solely for convenience, trademarks and trade names referred to in this prospectus may appear without the ^® or ^TM symbols. We do not intend our use or display of other parties’ trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.

MARKET, INDUSTRY AND OTHER DATA

Unless otherwise indicated, information contained in this prospectus concerning our industry and the markets in which we operate is based on information from independent industry and research organizations, such as Buxton Company, and other third-party sources (including the Nutrition Business Journal, the Progressive Grocer’s 80th Annual Report of the Grocery Industry (referred to as “Progressive Grocer”), and other industry publications, surveys and forecasts), and management estimates. Management estimates are derived from publicly available information released by independent industry analysts and third-party sources, as well as data from our internal research, and are based on assumptions made by us upon reviewing such data and our knowledge of our industry and markets, which we believe to be reasonable. In addition, projections, assumptions and estimates of the future performance of our industry and our future performance are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors.” These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

RECENT TRANSACTIONS

In 2002, Sprouts Farmers Markets, LLC, an Arizona limited liability company (referred to as “Sprouts Arizona”) opened the first Sprouts Farmers Market store in Chandler, Arizona. In 2011, we were formed when Sprouts Arizona combined with Henry’s Holdings, LLC (referred to as “Henry’s”), which operated 35 Henry’s Farmers Markets stores and eight Sun Harvest Market stores (referred to as the “Henry’s Transaction”). The Henry’s Transaction was led by investment funds affiliated with, and co-investment vehicles managed by, Apollo Management VI, L.P. (referred to as the “Apollo Funds”). The Apollo Funds are affiliates of Apollo Global Management, LLC (together with its subsidiaries, referred to as “Apollo”). In May 2012, we acquired Sunflower Farmers Market, Inc., which operated 37 Sunflower Farmers Market stores (referred to as “Sunflower”). We refer to this as the “Sunflower Transaction.” The Henry’s Transaction and the Sunflower Transaction are collectively referred to as the “Transactions.”

CORPORATE CONVERSION

On July 29, 2013, Sprouts Farmers Markets, LLC, a Delaware limited liability company, converted into Sprouts Farmers Market, Inc., a Delaware corporation and the issuer of the shares of common stock offered by this prospectus, pursuant to a statutory conversion (referred to as the “corporate conversion”). As used in this prospectus, unless the context otherwise requires, references to the “Company,” “Sprouts,” “we,” “us” and “our” refer to Sprouts Farmers Markets, LLC and after the corporate conversion to Sprouts Farmers Market, Inc. and, where appropriate, its subsidiaries. In the

 

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corporate conversion, each unit of Sprouts Farmers Markets, LLC was converted into 11 shares of common stock of Sprouts Farmers Market, Inc., and each option to purchase units of Sprouts Farmers Markets, LLC was converted into an option to purchase 11 shares of common stock of Sprouts Farmers Market, Inc. For the convenience of the reader, except as the context otherwise requires, all information included in this prospectus is presented giving effect to the corporate conversion.

COMPARABLE STORE SALES

As used in this prospectus, the term “comparable store sales growth” refers to the percentage change in our comparable store sales as compared to the prior comparable period. Our practice is to include sales from a store in comparable store sales beginning on the first day of the 61st week following the store’s opening and to exclude sales from a closed store from comparable store sales beginning on the day of closure. We include sales from an acquired store in comparable store sales on the later of (i) the day of acquisition or (ii) the first day of the 61st week following the store’s opening. This practice may differ from the methods that other retailers use to calculate comparable store sales.

In this prospectus we discuss our “pro forma comparable store sales growth” for fiscal 2008 through fiscal 2012 and for the thirty-nine weeks ended September 30, 2012 and September 29, 2013. We compute pro forma comparable store sales growth giving effect to (i) the 2011 combination of Sprouts Arizona with Henry’s in the Henry’s Transaction, and (ii) our 2012 acquisition of Sunflower in the Sunflower Transaction, in each case as if such Transactions occurred on the first day of fiscal 2007. Stores acquired in these transactions have been rebranded as Sprouts Farmers Market stores. See “Selected Consolidated Historical and Pro Forma Financial and Other Data” for a reconciliation of historical sales to pro forma net sales and a presentation of pro forma comparable store sales growth for fiscal 2008 through fiscal 2012 and for the thirty-nine weeks ended September 30, 2012 and September 29, 2013.

In addition, in this prospectus we refer to pro forma comparable store sales growth on a “two-year stacked basis,” which is computed by adding the pro forma comparable store sales growth of the period referenced and the pro forma comparable store sales growth of the same fiscal period ended twelve months prior.

We believe pro forma comparable store sales growth provides investors with helpful information with respect to our operating performance.

PRO FORMA INFORMATION

This prospectus contains unaudited pro forma financial information prepared in accordance with Article 11 of Regulation S-X. The unaudited pro forma condensed consolidated statement of operations for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013 gives pro forma effect to:

 

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the Sunflower Transaction and the related financing (in the case of fiscal 2012 and the thirty-nine weeks ended September 30, 2012 only);

 

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the April 2013 refinancing, as defined and described in “Prospectus Summary—April 2013 Refinancing”; and

 

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the issuance of 18,888,889 shares of common stock in our IPO (as defined below) (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and

 

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general corporate expenses) and the application of $340.0 million of the proceeds to us from the sale of such shares by us to repay certain indebtedness (referred to collectively as the “Pro Forma Offering”);

in each case as if such transactions had been consummated on January 2, 2012, the first day of fiscal 2012. See “Unaudited Pro Forma Condensed Consolidated Financial Information.”

In addition, this prospectus also contains an unaudited supplemental pro forma condensed consolidated statement of operations for fiscal 2011 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Unaudited Supplemental Fiscal 2011 Pro Forma Information.” This supplemental pro forma information gives effect to the Transactions as if they were consummated on the first day of fiscal 2011.

NON-GAAP FINANCIAL MEASURES

To supplement our financial information presented in accordance with U.S. generally accepted accounting principles (referred to as “GAAP”), we use the following additional measures to clarify and enhance an understanding of past performance:

 

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Adjusted EBITDA, which is defined as earnings (net income or loss) before interest, taxes, depreciation, amortization and accretion, further adjusted to eliminate the effects of items management does not consider in assessing our ongoing performance;

 

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Adjusted EBIT, which is defined as earnings (net income or loss) before interest and taxes, further adjusted to eliminate the effects of items management does not consider in assessing ongoing performance;

 

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Adjusted net income, which is defined as net income (loss) adjusted to eliminate the effects of items management does not consider in assessing ongoing performance; and

 

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Adjusted net income per share-diluted, which is defined as adjusted net income (defined above) divided by weighted average shares outstanding-diluted.

This prospectus contains pro forma information for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013 under the caption “Unaudited Pro Forma Condensed Consolidated Financial Information,” as described under “Pro Forma Information” above. For fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013, we present the foregoing non-GAAP measures on a pro forma basis derived from such pro forma information for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013. See “Prospectus Summary—Summary Consolidated Historical and Pro Forma Financial and Other Data” and “Selected Consolidated Historical and Pro Forma Financial and Other Data” for further discussion and a reconciliation of pro forma adjusted EBITDA, pro forma adjusted EBIT and pro forma adjusted net income to pro forma net income.

Pro forma adjusted EBITDA, pro forma adjusted EBIT, pro forma adjusted net income and pro forma adjusted net income per share are performance measures that provide supplemental information we believe is useful to analysts and investors to evaluate our ongoing results of operations, when considered alongside other GAAP measures such as net income, net income per share, operating income and gross profit. These non-GAAP measures exclude the financial impact of items management does not consider in assessing our ongoing operating performance, and thereby facilitate review of our operating performance on a period-to-period basis. Other companies may have different capital structures or different lease terms, and comparability to our results of operations may be impacted by the effects of acquisition accounting on our depreciation and amortization. As a result of the effects of these factors and factors specific to other companies, we believe pro forma adjusted

 

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EBITDA, pro forma adjusted EBIT and pro forma adjusted net income provide helpful information to analysts and investors to facilitate a comparison of our operating performance to that of other companies. We also use pro forma adjusted EBITDA, as further adjusted for additional items defined in our Credit Facility (as defined below), for board of director and bank compliance reporting.

These non-GAAP measures are intended to provide additional information only and do not have any standard meanings prescribed by GAAP. Use of these terms may differ from similar measures reported by other companies. Because of their limitations, none of these non-GAAP measures should be considered as a measure of discretionary cash available to use to reinvest in growth of our business, or as a measure of cash that will be available to meet our obligations. Each of these non-GAAP measures has its limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP.

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this prospectus, including our consolidated financial statements and related notes, before deciding whether to purchase shares of our common stock. Any of the following 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.

Risks Related to Our Business and Industry

Competition in our industry is intense, and our failure to compete successfully may adversely affect our revenues and profitability.

We operate in the highly competitive retail food industry. Our competitors include supermarkets, natural food stores, mass or discount retailers, warehouse membership clubs, online retailers, and specialty stores. These retailers compete with us for products, customers and locations. We compete on a combination of factors, primarily product selection and quality, customer service, store format, location and price. Our success depends on our ability to offer products that appeal to our customers’ preferences, and our failure to offer such products could lead to a decrease in our sales. To the extent that our competitors lower prices, our ability to maintain profit margins and sales levels may be negatively impacted. In addition, some competitors are aggressively expanding their number of stores or their product offerings or increasing the space allocated to perishable and specialty foods, including natural and organic foods. Some of these competitors may have been in business longer or may have greater financial or marketing resources than we do and may be able to devote greater resources to sourcing, promoting and selling their products. As competition in certain areas intensifies or competitors open stores within close proximity to our stores, our results of operations may be negatively impacted through a loss of sales, decrease in market share, reduction in margin from competitive price changes or greater operating costs.

Our continued growth depends on new store openings, and our failure to successfully open new stores could negatively impact our business and stock price.

Our continued growth depends, in large part, on our ability to open new stores and to operate those stores successfully. Successful implementation of this strategy depends upon a number of factors, including our ability to effectively achieve a level of cash flow or obtain necessary financing to support our expansion; find suitable sites for new store locations; negotiate and execute leases on acceptable terms; secure and manage the inventory necessary for the launch and operation of our new stores; hire, train and retain skilled store personnel; promote and market new stores; and address competitive merchandising, distribution and other challenges encountered in connection with expansion into new geographic areas and markets. Although we plan to expand our store base primarily through new store openings, we may grow through strategic acquisitions. Our ability to grow through strategic acquisitions will depend upon our ability to identify suitable targets and negotiate acceptable terms and conditions for their acquisition, as well as our ability to obtain financing for such acquisitions, integrate the acquired stores into our existing store base and retain the customers of such stores. If we are ineffective in performing these activities, then our efforts to open and operate new stores may be unsuccessful or unprofitable, and we may be unable to execute our growth strategy.

Although we believe, based on research conducted for us by a third-party research firm, that the U.S. market can support approximately 1,200 Sprouts Farmers Market stores operating under our current format, we anticipate that it will take years to grow our store count to that number. We cannot assure you that we will grow our store count to approximately 1,200 stores. We opened 19 stores in 2013, and we intend to achieve 12% or more annual new store growth over at least the next five years.

 

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However, we cannot assure you that we will achieve this expected level of new store growth. We may not have the level of cash flow or financing necessary to support our growth strategy. Additionally, our proposed expansion will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our existing business less effectively, which in turn could cause deterioration in the financial performance of our existing stores. Further, new store openings in markets where we have existing stores may result in reduced sales volumes at our existing stores in those markets. If we experience a decline in performance, we may slow or discontinue store openings, or we may decide to close stores that we are unable to operate in a profitable manner. If we fail to successfully implement our growth strategy, including by opening new stores, our financial condition and operating results may be adversely affected.

On many of our projects, including build-to-suit and existing repurposed locations, we have received landlord contributions for leasehold improvements and other build-out costs. We cannot guarantee that we will be able to continue to receive landlord contributions at the same levels or at all. Any reductions of landlord contributions could have an adverse impact on our new store cash-on-cash returns and our operating results.

We may be unable to maintain or increase comparable store sales, which could negatively impact our business and stock price.

We may not be able to maintain or improve the levels of comparable store sales that we have experienced in the past. Our comparable store sales growth could be lower than our historical average for many reasons, including:

 

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general economic conditions;

 

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slowing in the natural and organic retail sector;

 

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the impact of new and acquired stores entering into the comparable store base;

 

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the opening of new stores that cannibalize store sales in existing areas;

 

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increased competitive activity;

 

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price changes in response to competitive factors;

 

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possible supply shortages;

 

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consumer preferences, buying trends and spending levels;

 

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product price inflation and deflation;

 

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the number and dollar amount of customer transactions in our stores;

 

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cycling against any year of above-average sales results;

 

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our ability to provide product offerings that generate new and repeat visits to our stores; and

 

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the level of customer service that we provide in our stores.

These factors may cause our comparable store sales results to be materially lower than in recent periods, which could harm our business and result in a decline in the price of our common stock.

Our newly opened stores may negatively impact our financial results in the short-term, and may not achieve sales and operating levels consistent with our more mature stores on a timely basis or at all.

We have actively pursued new store growth and plan to continue doing so in the future. We cannot assure you that our new store openings will be successful or reach the sales and profitability

 

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levels of our existing stores. New store openings may negatively impact our financial results in the short-term due to the effect of store opening costs and lower sales and contribution to overall profitability during the initial period following opening. New stores build their sales volume and their customer base over time and, as a result, generally have lower margins and higher operating expenses, as a percentage of net sales, than our more mature stores. New stores may not achieve sustained sales and operating levels consistent with our more mature store base on a timely basis or at all. This may have an adverse effect on our financial condition and operating results.

In addition, we may not be able to successfully integrate new stores into our existing store base and those new stores may not be as profitable as our existing stores. Further, we have experienced in the past, and expect to experience in the future, some sales volume transfer from our existing stores to our new stores as some of our existing customers switch to new, closer locations. If our new stores are less profitable than our existing stores, or if we experience sales volume transfer from our existing stores, our financial condition and operating results may be adversely affected.

We may be unable to maintain or improve our operating margins, which could adversely affect our financial condition and ability to grow.

If we are unable to successfully manage the potential difficulties associated with store growth, we may not be able to capture the efficiencies of scale that we expect from expansion. If we are not able to continue to capture efficiencies of scale, improve our systems, continue our cost discipline, and maintain appropriate store labor levels and disciplined product selection, our operating margins may stagnate or decline, which could have a material adverse effect on our business, financial condition and results of operations and adversely affect the price of our common stock.

We rely heavily on sales of fresh produce, and product supply disruptions may have an adverse effect on our profitability and operating results.

We have a significant focus on perishable products, including fresh produce. Sales of produce accounted for approximately 25% of our pro forma net sales in fiscal 2012 and 26% of our net sales in the thirty-nine weeks ended September 29, 2013. Although we have not experienced difficulty in maintaining the supply of our produce to date, there is no assurance that quality fresh produce will be available to meet our needs in the future. Produce is vulnerable to adverse weather conditions and natural disasters, such as floods, droughts, frosts, earthquakes, hurricanes and pestilences. Adverse weather conditions and natural disasters can lower crop yields and reduce crop size and quality, which in turn could reduce the available supply of, or increase the price of, fresh produce. In addition, we could suffer significant produce inventory losses in the event of disruption of our distribution network or extended power outages in our distribution centers. If we are unable to maintain produce inventory levels suitable for our business needs, it would materially adversely affect our financial condition and results of operations.

If we are unable to successfully identify market trends and react to changing consumer preferences in a timely manner, our sales may decrease.

We believe our success depends, in substantial part, on our ability to:

 

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anticipate, identify and react to natural and organic grocery and dietary supplement trends and changing consumer preferences in a timely manner;

 

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translate market trends into appropriate, saleable product and service offerings in our stores before our competitors; and

 

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develop and maintain vendor relationships that provide us access to the newest merchandise on reasonable terms.

 

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Consumer preferences often change rapidly and without warning, moving from one trend to another among many product or retail concepts. Our performance is impacted by trends regarding healthy lifestyles, dietary preferences, natural and organic products, and vitamins and supplements. Consumer preferences towards supplements or natural and organic food products might shift as a result of, among other things, economic conditions, food safety perceptions and the cost of these products. Our store offerings currently include natural and organic products and dietary supplements. A change in consumer preferences away from our offerings would have a material adverse effect on our business. Additionally, negative publicity over the safety of any such items may adversely affect demand for our products, and could result in lower customer traffic, sales and results of operations.

If we are unable to anticipate and satisfy consumer preferences in the regions where we operate, our sales may decrease, which could have a material adverse effect on our business, financial condition and results of operations.

Real or perceived quality or food safety concerns could have an adverse effect on our sales and reputation.

We could be materially adversely affected if consumers lose confidence in the safety and quality of products we sell. We are a fresh, natural and organic retailer, and we believe that many customers choose to shop our stores because of their interest in health, nutrition and food safety. As a result, we believe that our customers hold us to a high food safety standard. Concerns regarding the safety of our food products or the safety and quality of our food supply chain could cause shoppers to avoid shopping with us, even if the basis for the concern is outside of our control. In addition, adverse publicity about these concerns, whether or not ultimately based on fact, and whether or not involving products sold at our stores, could discourage consumers from buying products we sell and have an adverse effect on our sales. Any lost confidence on the part of our customers would be difficult and costly to reestablish. Any such adverse effect could be exacerbated by our position in the market as a natural and organic food retailer, and could significantly reduce our brand value. Issues regarding the quality or safety of any food items sold by us, regardless of the cause, could have a substantial and adverse effect on our sales and operating results.

Products we sell could cause unexpected side effects, illness, injury or death that could result in their discontinuance or expose us to lawsuits, either of which could result in unexpected costs and damage to our reputation.

There is increasing governmental scrutiny of and public awareness regarding food safety. Unexpected side effects, illness, injury, or death caused by products we sell could result in the discontinuance of sales of these products or prevent us from achieving market acceptance of the affected products. Such side effects, illnesses, injuries and death could also expose us to product liability or negligence lawsuits. Any claims brought against us may exceed our existing or future insurance policy coverage or limits. Any judgment against us that is in excess of our policy limits would have to be paid from our cash reserves, which would reduce our capital resources. Further, we may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets. The real or perceived sale of contaminated or harmful products would cause negative publicity regarding our company, brand, or products, which could in turn harm our reputation and net sales, and could have a material adverse effect on our business, results of operations or financial condition.

If we fail to maintain our reputation and the value of our brand, our sales may decline.

We believe our continued success depends on our ability to maintain and grow the value of the Sprouts brand. Maintaining, promoting and positioning our brand and reputation will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high-

 

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quality customer experience. Brand value is based in large part on perceptions of subjective qualities, and even isolated incidents can erode trust and confidence, particularly if they result in adverse publicity, governmental investigations or litigation. Our brand could be adversely affected if we fail to achieve these objectives, or if our public image or reputation were to be tarnished by negative publicity. Our reputation could also suffer from real or perceived issues involving the labeling or marketing of products we sell as “natural.”

Although the Food and Drug Administration (referred to as the “FDA”) and the U.S. Department of Agriculture (referred to as the “USDA”) have each issued statements regarding the appropriate use of the word “natural,” there is no single, U.S. government-regulated definition of the term “natural” for use in the food industry. The resulting uncertainty has led to consumer confusion, distrust and legal challenges. Plaintiffs have commenced legal actions against a number of food companies that market “natural” products, asserting false, misleading and deceptive advertising and labeling claims, including claims related to genetically modified ingredients. In limited circumstances, the FDA has taken regulatory action against products labeled “natural” that nonetheless contain synthetic ingredients or components. Should we become subject to similar claims, consumers may avoid purchasing products from us or seek alternatives, even if the basis for the claim is unfounded. Adverse publicity about these matters may discourage consumers from buying our products. The cost of defending against any such claims could be significant. Any loss of confidence on the part of consumers in the truthfulness of our labeling or ingredient claims would be difficult and costly to overcome and may significantly reduce our brand value. Any of these events could adversely affect our reputation and brand and decrease our sales, which would have a material adverse effect on our business, financial condition and results of operations.

The current geographic concentration of our stores creates an exposure to local or regional downturns or catastrophic occurrences.

As of September 29, 2013, we operated 73 stores in California, making California our largest market representing 44% of our total stores and 46% of our net sales in the thirty-nine weeks ended September 29, 2013. We also have store concentration in Arizona, Colorado and Texas, operating 26, 24 and 29 stores in those states, respectively, and representing 45% in the aggregate of our net sales in the thirty-nine weeks ended September 29, 2013. In addition, we source a large portion of our produce from California, ranging from approximately 40% to approximately 70% depending on the time of year. As a result, our business is currently more susceptible to regional conditions than the operations of more geographically diversified competitors, and we are vulnerable to economic downturns in those regions. Any unforeseen events or circumstances that negatively affect these areas in which we have stores or from which we obtain products could materially adversely affect our revenues and profitability. These factors include, among other things, changes in demographics, population and employee bases, wage increases, changes in economic conditions, severe weather conditions and other catastrophic occurrences. Such conditions may result in reduced customer traffic and spending in our stores, physical damage to our stores, loss of inventory, closure of one or more of our stores, inadequate work force in our markets, temporary disruption in the supply of products, delays in the delivery of goods to our stores and a reduction in the availability of products in our stores. Any of these factors may disrupt our business and materially adversely affect our financial condition and results of operations.

Disruption of significant supplier relationships could negatively affect our business.

Nature’s Best, Inc. (referred to as “NB”) is our primary supplier of dry grocery and frozen food products, accounting for approximately 17% and 23% of our total purchases in fiscal 2012 and the thirty-nine weeks ended September 29, 2013, respectively. We also have commitments in place with NB to order certain amounts of our distribution-sourced organic and natural produce from NB, and to

 

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maintain certain minimum average annual store purchase volumes, including for any new stores we open. Our current contractual relationship with NB continues through April 2018. Due to this concentration of purchases from a single third-party supplier, the cancellation of our distribution arrangement or the disruption, delay or inability of NB to deliver product to our stores may materially and adversely affect our operating results while we establish alternative distribution channels. Another 4% of our total purchases for both fiscal 2012 and the thirty-nine weeks ended September 29, 2013 were made through our secondary supplier, United Natural Foods Inc. (referred to as “UNFI”). Our current contractual relationship with UNFI continues through December 2, 2014 (subject to automatic renewal for successive one-year periods unless either we or UNFI elect not to renew). There is no assurance UNFI or other distributors will be able to fulfill our needs on favorable terms or at all. In addition, if NB, UNFI or any of our other suppliers fail to comply with food safety or other laws and regulations, or face allegations of non-compliance, their operations may be disrupted. We cannot assure you that we would be able to find replacement suppliers on commercially reasonable terms, which would have a material adverse effect on our financial condition and results of operations.

Any significant interruption in the operations of our distribution centers could disrupt our ability to deliver our produce in a timely manner.

We self-distribute our produce through our two distribution centers located in Arizona and Texas and a third-party distribution center in California. Any significant interruption in the operation of our distribution center infrastructure, such as disruptions due to fire, severe weather or other catastrophic events, power outages, labor disagreements, or shipping problems, could adversely impact our ability to distribute produce to our stores. Such interruptions could result in lost sales and a loss of customer loyalty to our brand. While we maintain business interruption and property insurance, if the operation of our distribution centers were interrupted for any reason causing delays in shipment of produce to our stores, our insurance may not be sufficient to cover losses we experience, which could have a material adverse effect on our business, financial condition and results of operations.

We, as well as our vendors, are subject to numerous laws and regulations and our compliance with these laws and regulations, as they currently exist or as modified in the future, may increase our costs, limit or eliminate our ability to sell certain products, raise regulatory enforcement risks not present in the past, or otherwise adversely affect our business, results of operations and financial condition.

As a retailer of food, vitamins and supplements and a seller of many of our private label products, we are subject to numerous health and safety laws and regulations. Our suppliers and contract manufacturers are also subject to such laws and regulations. These laws and regulations apply to many aspects of our business, including the manufacturing, packaging, labeling, distribution, advertising, sale, quality and safety of products we sell, as well as the health and safety of our team members and the protection of the environment. We are subject to regulation by various government agencies, including the FDA, the USDA, the Federal Trade Commission (referred to as the “FTC”), the Occupational Safety and Health Administration, the Consumer Product Safety Commission and the Environmental Protection Agency, as well as various state and local agencies.

We are also subject to the USDA’s Organic Rule, which facilitates interstate commerce and the marketing of organically produced food, and provides assurance to our customers that such products meet consistent, uniform standards. Compliance with the USDA’s Organic Rule also places a significant burden on some of our suppliers, which may cause a disruption in some of our product offerings. In addition, the USDA’s Food Safety Inspection Service (referred to as “FSIS”) conducts regular, mandatory on-site inspections of processing and manufacturing facilities. When violations occur, the agency has broad discretion to withhold FSIS inspection services, shut down processing facilities and take civil or criminal actions against violators of applicable statutes and regulations.

 

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As a retailer of supplements, our sales of vitamins and supplements are regulated under the Dietary Supplement Health and Education Act of 1994 (referred to as “DSHEA”), a statute which is administered by the FDA as part of its responsibilities under the federal Food, Drug and Cosmetic Act (referred to as “FDCA”). DSHEA expressly permits vitamins and supplements to bear statements describing how a product affects the structure, function and/or general well-being of the body. However, no statement may expressly or implicitly represent that a supplement will diagnose, cure, mitigate, treat or prevent a disease.

New or revised government laws and regulations, such as the FDA Food Safety Modernization Act (referred to as “FSMA”), passed in January 2011, which grants the FDA greater authority over the safety of the national food supply, as well as increased enforcement by government agencies, could result in additional compliance costs and civil remedies. Specifically, the FSMA requires the FDA to issue regulations mandating that risk-based preventive controls be observed by the majority of food producers. This authority applies to all domestic food facilities and, by way of imported food supplier verification requirements, to all foreign facilities that supply food products. In addition, the FSMA requires the FDA to establish science-based minimum standards for the safe production and harvesting of produce, requires the FDA to identify “high risk” foods and “high risk” facilities and instructs the FDA to set goals for the frequency of FDA inspections of such high risk facilities as well as non-high risk facilities and foreign facilities from which food is imported into the United States.

With respect to both food and dietary supplements, the FSMA meaningfully augments the FDA’s ability to access a producer’s records and a supplier’s records. This increased access could permit the FDA to identify areas of concern it had not previously considered to be problematic either for us or for our suppliers. The FSMA is also likely to result in enhanced tracking and tracing of food requirements and, as a result, added recordkeeping burdens upon our suppliers. In addition, under the FSMA, the FDA has the authority to inspect certifications and therefore evaluate whether foods and ingredients from our suppliers are compliant with the FDA’s regulatory requirements. Such inspections may delay the supply of certain products or result in certain products being unavailable to us for sale in our stores.

DSHEA established that no notification to the FDA is required to market a dietary supplement if it contains only dietary ingredients that were present in the U.S. food supply prior to DSHEA’s enactment. However, for a dietary ingredient not present in the food supply prior to DSHEA’s enactment, the manufacturer is required to provide the FDA with information supporting the conclusion that the ingredient will reasonably be expected to be safe at least 75 days before introducing a new dietary ingredient into interstate commerce. As required by the FSMA, the FDA issued draft guidance in July 2011, which attempts to clarify when an ingredient will be considered a “new dietary ingredient,” the evidence needed to document the safety of a new dietary ingredient, and appropriate methods for establishing the identity of a new dietary ingredient. In particular, the guidance may cause dietary supplement products available in the market before DSHEA to now be classified to include a new dietary ingredient if the dietary supplement product was produced using manufacturing processes different from those used in 1994. Accordingly, the adoption of the draft FDA guidance or similar guidance could materially adversely affect the availability of dietary supplement products.

The FDA has broad authority to enforce the provisions of the FDCA applicable to the safety, labeling, manufacturing and promotion of foods and dietary supplements, including powers to issue a public warning letter to a company, publicize information about illegal products, institute an administrative detention of food, request or order a recall of illegal products from the market, and request the Department of Justice to initiate a seizure action, an injunction action or a criminal prosecution in the U.S. courts. Pursuant to the FSMA, the FDA also has the power to refuse the import of any food or dietary supplement from a foreign supplier that is not appropriately verified as in compliance with all FDA laws and regulations. Moreover, the FDA has the authority to administratively suspend the registration of any facility producing food, including supplements, deemed to present a reasonable probability of causing serious adverse health consequences.

 

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In connection with the marketing and advertisement of products we sell, we could be the target of claims relating to false or deceptive advertising, including under the auspices of the FTC and the consumer protection statutes of some states. Furthermore, in recent years, the FDA has been aggressive in enforcing its regulations with respect to nutrient content claims (e.g., “low fat,” “good source of,” “calorie free,” etc.), unauthorized “health claims” (claims that characterize the relationship between a food or food ingredient and a disease or health condition), and other claims that impermissibly suggest therapeutic benefits for certain foods or food components. These events could interrupt the marketing and sales of products in our stores, including our private label products, severely damage our brand reputation and public image, increase the cost of products in our stores, result in product recalls or litigation, and impede our ability to deliver merchandise in sufficient quantities or quality to our stores, which could result in a material adverse effect on our business, financial condition and results of operations.

We are also subject to laws and regulations more generally applicable to retailers, including labor and employment, taxation, zoning and land use, environmental protection, workplace safety, public health, community right-to-know and alcoholic beverage sales. Our stores are subject to unscheduled inspections on a regular basis, which, if violations are found, could result in the assessment of fines, suspension of one or more needed licenses and, in the case of repeated “critical” violations, closure of the store until a re-inspection demonstrates that we have remediated the problem. Further, our new store openings could be delayed or prevented or our existing stores could be impacted by difficulties or failures in our ability to obtain or maintain required approvals or licenses. In addition, we are subject to environmental laws pursuant to which we could be held responsible for all of the costs relating to any contamination at our or our predecessors’ past or present facilities and at third-party waste disposal sites, regardless of our knowledge of, or responsibility for, such contamination.

As is common in our industry, we rely on our suppliers and contract manufacturers to ensure that the products they manufacture and sell to us comply with all applicable regulatory and legislative requirements. In general, we seek certifications of compliance, representations and warranties, indemnification and/or insurance from our suppliers and contract manufacturers. However, even with adequate insurance and indemnification, any claims of non-compliance could significantly damage our reputation and consumer confidence in our products. In order to comply with applicable statutes and regulations, our suppliers and contract manufacturers have from time to time reformulated, eliminated or relabeled certain of their products and we have revised certain provisions of our sales and marketing program.

We cannot predict the nature of future laws, regulations, interpretations or applications, or determine what effect either additional government regulations or administrative orders, when and if promulgated, or disparate federal, state and local regulatory schemes would have on our business in the future. They could, however, increase our costs or require the reformulation of certain products to meet new standards, the recall or discontinuance of certain products not able to be reformulated, additional recordkeeping, expanded documentation of the properties of certain products, expanded or different labeling and/or scientific substantiation. Any or all of such requirements could have a material adverse effect on our business, financial condition and results of operations.

Our nutrition-oriented educational activities may be impacted by government regulation or our inability to secure adequate liability insurance.

We provide nutrition-oriented education to our customers, and these activities may be subject to state and federal regulation, and oversight by professional organizations. In the past, the FDA has expressed concerns regarding summarized health and nutrition-related information that (i) does not, in the FDA’s view, accurately present such information, (ii) diverts a consumer’s attention and focus from FDA-required nutrition labeling and information or (iii) impermissibly promotes drug-type disease-related benefits. If our team members or third parties we engage to provide this information do not act

 

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in accordance with regulatory requirements, we may become subject to penalties that could have a material adverse effect on our business. We believe we are currently in compliance with relevant regulatory requirements, and we maintain professional liability insurance in order to mitigate risks associated with this nutrition-oriented education. However, we cannot predict the nature of future government regulation and oversight, including the potential impact of any such regulation on this activity. Furthermore, the availability of professional liability insurance or the scope of such coverage may change, or our insurance coverage may prove inadequate, which may adversely impact the ability of our customer educators to provide some information to our customers. The occurrence of any such developments could negatively impact the perception of our brand, our sales and our ability to attract new customers.

General economic conditions that impact consumer spending could adversely affect our business.

The retail food business is sensitive to changes in general economic conditions. Recessionary economic cycles, increases in interest rates, higher prices for commodities, fuel and other energy, inflation, high levels of unemployment and consumer debt, depressed home values, high tax rates and other economic factors that affect consumer spending and confidence or buying habits may materially adversely affect the demand for products we sell in our stores. In recent years, the U.S. economy has experienced volatility due to uncertainties related to energy prices, credit availability, difficulties in the banking and financial services sectors, decreases in home values and retirement accounts, high unemployment and falling consumer confidence. As a result, consumers are more cautious and could shift their spending to lower-priced competition, such as warehouse membership clubs, dollar stores or extreme value formats, which could have a material and adverse effect on our operating results and financial condition.

In addition, inflation or deflation can impact our business. Food deflation could reduce sales growth and earnings, while food inflation, combined with reduced consumer spending, could reduce gross profit margins. As a result, our operating results and financial condition could be materially adversely affected.

A widespread health epidemic could materially impact our business.

Our business could be severely impacted by a widespread regional, national or global health epidemic. A widespread health epidemic may cause customers to avoid public gathering places such as our stores or otherwise change their shopping behaviors. Additionally, a widespread health epidemic could also adversely impact our business by disrupting production and delivery of products to our stores and by impacting our ability to appropriately staff our stores.

Increased commodity prices and availability may impact profitability.

Many products we sell include ingredients such as wheat, corn, oils, milk, sugar, cocoa and other commodities. Commodity prices worldwide have been increasing. Any increase in commodity prices may cause our vendors to seek price increases from us. We cannot assure you that we will be able to mitigate vendor efforts to increase our costs, either in whole or in part. In the event we are unable to continue mitigating potential vendor price increases, we may in turn consider raising our prices, and our customers may be deterred by any such price increases. Our profitability may be impacted through increased costs to us which may impact gross margins, or through reduced revenue as a result of a decline in the number and average size of customer transactions.

 

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Energy costs are an increasingly significant component of our operating expenses and increasing energy costs, unless offset by more efficient usage or other operational responses, may impact our profitability.

We utilize natural gas, water, sewer and electricity in our stores and use gasoline and diesel in trucks that deliver products to our stores. We may also be required to pay certain adjustments or other amounts pursuant to our supply and delivery contracts in connection with increases in fuel prices. Increases in energy costs, whether driven by increased demand, decreased or disrupted supply or an anticipation of any such events will increase the costs of operating our stores. Our shipping costs have also increased recently due to rising fuel and freight prices, and these costs may continue to increase. We may not be able to recover these rising costs through increased prices charged to our customers, and any increased prices may exacerbate the risk of customers choosing lower-cost alternatives. In addition, if we are unsuccessful in attempts to protect against these increases in energy costs through long-term energy contracts, improved energy procurement, improved efficiency and other operational improvements, the overall costs of operating our stores will increase, which would impact our profitability, financial condition and results of operations.

Increases in certain costs affecting our marketing, advertising and promotions may adversely impact our ability to advertise effectively and reduce our profitability.

Postal rate increases, and increasing paper and printing costs affect the cost of our promotional mailings. In response to any future increase in mailing costs, we may consider reducing the number and size of certain promotional pieces. In addition, we rely on discounts from the basic postal rate structure, such as discounts for bulk mailings and sorting by zip code and carrier routes. We are not party to any long-term contracts for the supply of paper. Future increases in costs affecting our marketing, advertising and promotions could adversely impact our ability to advertise effectively and our profitability.

Disruptions to, or security breaches involving, our information technology systems could harm our ability to run our business.

We rely extensively on information technology systems for point of sale processing in our stores, supply chain, financial reporting, human resources and various other processes and transactions. Our information technology systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches, including breaches of our transaction processing or other systems that could result in the compromise of confidential customer data, catastrophic events, and usage errors by our team members. In January 2013, we discovered sophisticated malware installed on certain credit card “pin pads” in a limited number of our stores designed to illegally access our customers’ credit card information. We discovered the malware shortly after it was planted and promptly shut down its access to our systems, but it is possible that our customers’ credit card information was compromised. In connection with the January 2013 breach, in addition to replacing the affected card terminals for a total cost of approximately $170,000, we engaged a nationally recognized cybersecurity firm to investigate the incident. The costs associated with the investigation, and any penalties assessed by our credit card vendors, are covered by our insurance policy, subject to our insurance deductible of $100,000. We have implemented numerous additional security protocols since the attack in order to further tighten security, but there can be no assurance similar breaches will not occur in the future. Our information technology systems may also fail to perform as we anticipate, and we may encounter difficulties in adapting these systems to changing technologies or expanding them to meet the future needs of our business. If our systems are breached, damaged or cease to function properly, we may have to make significant investments to fix or replace them, suffer interruptions in our operations, incur liability to our customers and others, face costly litigation, and our reputation with our customers may be harmed. Various third parties, such as our suppliers and payment processors, also rely heavily on information technology systems, and any

 

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failure of these systems could also cause significant interruptions to our business. Any material interruption in the information technology systems we rely on may have a material adverse effect on our operating results and financial condition.

We may be unable to adequately protect our intellectual property rights, which could harm our business.

We rely on a combination of trademark, trade secret, copyright and domain name law and internal procedures and nondisclosure agreements to protect our intellectual property. In particular, we believe our trademarks, including SPROUTS FARMERS MARKET^®, SPROUTS^® and HEALTHY LIVING FOR LESS!^®, and our domain names, including sprouts.com, are valuable assets. However, there can be no assurance that our intellectual property rights will be sufficient to distinguish our products and services from those of our competitors and to provide us with a competitive advantage. From time to time, third parties may use names and logos similar to ours, may apply to register trademarks or domain names similar to ours, and may infringe or otherwise violate our intellectual property rights. There can be no assurance that our intellectual property rights can be successfully asserted against such third parties or will not be invalidated, circumvented or challenged. Asserting or defending our intellectual property rights could be time consuming and costly and could distract management’s attention and resources. If we are unable to prevent our competitors from using names, logos and domain names similar to ours, consumer confusion could result, the perception of our brand and products could be negatively affected, and our sales and profitability could suffer as a result. We also license the SPROUTS FARMERS MARKETS trademark to a third party for use in operating two grocery stores. If the licensee fails to maintain the quality of the goods and services used in connection with this trademark, our rights to, and the value of, this and similar trademarks could potentially be harmed. Negative publicity relating to the licensee could also be incorrectly associated with us, which could harm the business. Failure to protect our proprietary information could also have a material adverse effect on our business.

We may also be subject to claims that our activities or the products we sell infringe, misappropriate or otherwise violate the intellectual property rights of others. Any such claims can be time consuming and costly to defend and may distract management’s attention and resources, even if the claims are without merit. Such claims may also require us to enter into costly settlement or license agreements (which could, for example, prevent us from using our trademarks in certain geographies or in connection with certain products and services), pay costly damage awards, and face a temporary or permanent injunction prohibiting us from marketing or providing the affected products and services, any of which could have a material adverse effect on our business.

Changes in accounting standards may materially impact reporting of our financial condition and results of operations.

Accounting principles generally accepted in the United States and related accounting pronouncements, implementation guidelines, and interpretations for many aspects of our business, such as accounting for inventories, goodwill and intangible assets, store closures, leases, insurance, income taxes, stock-based compensation and accounting for mergers and acquisitions, are complex and involve subjective judgments. Changes in these rules or their interpretation may significantly change or add significant volatility to our reported earnings without a comparable underlying change in cash flow from operations. As a result, changes in accounting standards may materially impact our reported financial condition and results of operations.

Specifically, proposed changes to financial accounting standards could require such leases to be recognized on our balance sheet. In addition to our indebtedness, we have significant obligations relating to our current operating leases. All of our existing stores are subject to leases, which have average remaining terms of nine years and, as of September 29, 2013, we had undiscounted operating

 

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lease commitments of approximately $905.0 million, scheduled through 2032, related primarily to our stores, including stores that are not yet open. These commitments represent the minimum lease payments due under our operating leases, excluding common area maintenance, insurance and taxes related to our operating lease obligations, and do not reflect fair market value rent reset provisions in the leases. These leases are classified as operating leases and disclosed in Note 20 to our consolidated financial statements included elsewhere in this prospectus, but are not reflected as liabilities on our consolidated balance sheets. During fiscal 2012, our rent expense charged under operating leases was approximately $54.2 million.

The Financial Accounting Standards Board (referred to as “FASB”) is currently working on amendments to existing accounting standards governing a number of areas including, but not limited to, accounting for leases. In May 2013, the FASB issued a new exposure draft, Leases (referred to as the “Exposure Draft”), which would replace the existing guidance in Accounting Standards Codification 840 (referred to as “ASC 840”), Leases (formerly Statement of Financial Accounting Standards 13, Accounting for Leases). Under the Exposure Draft, among other changes in practice, a lessee’s rights and obligations under most leases, including existing and new arrangements, would be recognized as assets and liabilities, respectively, on the balance sheet. Other significant provisions of the Exposure Draft include (i) defining the “lease term” to include the noncancellable period together with periods for which there is a significant economic incentive for the lessee to extend or not terminate the lease; (ii) defining the initial lease liability to be recorded on the balance sheet to contemplate only those variable lease payments that depend on an index or that are in substance “fixed;” and (iii) a dual approach for determining whether lease expense is recognized on a straight-line or accelerated basis, depending on whether the lessee is expected to consume more than an insignificant portion of the leased asset’s economic benefits. The comment period for the Exposure Draft ended on September 13, 2013. If and when effective, this Exposure Draft will likely have a significant impact on our consolidated financial statements, as a majority of our store leases have been classified as operating leases, which results in rental payments being charged to expense over the terms of the related leases. Additionally, operating leases are not reflected in our consolidated balance sheets, which means that neither a leased asset nor an obligation for future lease payments is reflected in our consolidated balance sheets. The proposed changes to ASC 840 would require that substantially all operating leases be recognized as assets and liabilities on our balance sheet. The right to use the leased property would be capitalized as an asset and the present value of future lease payments would be accounted for as a liability. However, as the standard-setting process is still ongoing, we are unable to determine the impact this proposed change in accounting standards will have on our consolidated financial statements.

Legal proceedings could materially impact our business, financial condition and results of operations.

Our operations, which are characterized by a high volume of customer traffic and by transactions involving a wide variety of product selections, carry a higher exposure to consumer litigation risk when compared to the operations of companies operating in some other industries. Consequently, we may be a party to individual personal injury, product liability, intellectual property, employment-related and other legal actions in the ordinary course of our business, including litigation arising from food-related illness. The outcome of litigation, particularly class action lawsuits, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. While we maintain insurance, insurance coverage may not be adequate, and the cost to defend against future litigation may be significant. There may also be adverse publicity associated with litigation that may decrease consumer confidence in our business, regardless of whether the allegations are valid or whether we are ultimately found liable. As a result, litigation may materially adversely affect our business, financial condition, and results of operations.

 

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Claims under our insurance plans may differ from our estimates, which could materially impact our results of operations.

We use a combination of insurance and self-insurance plans to provide for the potential liabilities for workers’ compensation, general liability (including, in connection with legal proceedings described under “—Legal proceedings could materially impact our business, financial condition and results of operations” above), property insurance, director and officers’ liability insurance, vehicle liability and team member health-care benefits. Liabilities associated with the risks that are retained by us are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. Our results could be materially impacted by claims and other expenses related to such plans if future occurrences and claims differ from these assumptions and historical trends.

Our high level of fixed lease obligations could adversely affect our financial performance.

Our high level of fixed lease obligations will require us to use a significant portion of cash generated by our operations to satisfy these obligations, and could adversely impact our ability to obtain future financing to support our growth or other operational investments. We will require substantial cash flows from operations to make our payments under our operating leases, all of which provide for periodic increases in rent. If we are not able to make the required payments under the leases, the lenders or owners of the relevant stores, distribution centers or administrative offices may, among other things, repossess those assets, which could adversely affect our ability to conduct our operations. In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under agreements governing our indebtedness, which could cause the counterparties under those agreements to accelerate the obligations due thereunder.

Our lease obligations may require us to continue paying rent for store locations that we no longer operate.

We are subject to risks associated with our current and future store, distribution center and administrative office real estate leases. We generally cannot cancel our leases, so if we decide to close or relocate a location, we may nonetheless be committed to perform our obligations under the applicable lease, including paying the base rent for the remaining lease term. In addition, as our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or any terms at all, which could materially adversely affect our business, results of operations or financial condition.

The loss of key management could negatively affect our business.

We are dependent upon a number of key management and other team members. If we were to lose the services of a significant number of key team members within a short period of time, this could have a material adverse effect on our operations as we may not be able to find suitable individuals to replace them on a timely basis, if at all. In addition, any such departure could be viewed in a negative light by investors and analysts, which may cause our stock price to decline. We do not maintain key person insurance on any team member.

If we are unable to attract, train and retain team members, we may not be able to grow or successfully operate our business.

The food retail industry is labor intensive. Our continued success is dependent upon our ability to attract and retain qualified team members who understand and appreciate our culture and are able to represent our brand effectively and establish credibility with our business partners and consumers. We face intense competition for qualified team members, many of whom are subject to offers from competing employers. Our ability to meet our labor needs, while controlling wage and labor-related

 

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costs, is subject to numerous external factors, including the availability of a sufficient number of qualified persons in the work force in the markets in which we are located, unemployment levels within those markets, unionization of the available work force, prevailing wage rates, changing demographics, health and other insurance costs and changes in employment legislation. In the event of increasing wage rates, if we fail to increase our wages competitively, the quality of our workforce could decline, causing our customer service to suffer, while increasing our wages could cause our earnings to decrease. If we are unable to hire and retain team members capable of meeting our business needs and expectations, our business and brand image may be impaired. Any failure to meet our staffing needs or any material increase in turnover rates of our team members or team member wages may adversely affect our business, results of operations or financial condition.

Higher wage and benefit costs could adversely affect our business.

Changes in federal and state minimum wage laws and other laws relating to employee benefits, including the Patient Protection and Affordable Care Act, could cause us to incur additional wage and benefit costs. Increased labor costs would increase our expenses and have an adverse impact on our profitability.

Union attempts to organize our team members could negatively affect our business.

None of our team members are currently subject to a collective bargaining agreement. As we continue to grow and enter different regions, unions may attempt to organize all or part of our team member base at certain stores or within certain regions. Responding to such organization attempts may distract management and team members and may have a negative financial impact on individual stores, or on our business as a whole.

We may require additional capital to fund the expansion of our business, and our inability to obtain such capital could harm our business.

To support our expanding business, we must have sufficient capital to continue to make significant investments in our new and existing stores and advertising. We cannot assure you that cash generated by our operations will be sufficient to allow us to fund such expansion. If cash flows from operations are not sufficient, we may need additional equity or debt financing to provide the funds required to expand our business. If such financing is not available on satisfactory terms or at all, we may be unable to expand our business or to develop new business at the rate desired and our operating results may suffer. Debt financing increases expenses, may contain covenants that restrict the operation of our business, and must be repaid regardless of operating results. Equity financing, or debt financing that is convertible into equity, could result in additional dilution to our existing stockholders.

Our inability to obtain adequate capital resources, whether in the form of equity or debt, to fund our business and growth strategies may require us to delay, scale back or eliminate some or all of our operations or the expansion of our business, which may have a material adverse effect on our business, operating results, financial condition or prospects.

We may be unable to generate sufficient cash flow to satisfy our debt service obligations, which could adversely impact our business.

As of September 29, 2013, after giving effect to the application of $340.0 million of net proceeds from our IPO described herein, we had outstanding indebtedness of $360.0 million. We may incur additional indebtedness in the future, including borrowings under our Credit Facility. We continue to have significant debt service obligations following the completion of our IPO. Our indebtedness, or any

 

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additional indebtedness we may incur, could require us to divert funds identified for other purposes for debt service and impair our liquidity position. If we cannot generate sufficient cash flow from operations to service our debt, we may need to refinance our debt, dispose of assets or issue equity to obtain necessary funds. We do not know whether we will be able to take any of such actions on a timely basis, on terms satisfactory to us or at all.

The fact that a substantial portion of our cash flow from operations could be needed to make payments on this indebtedness could have important consequences, including the following:

 

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reducing our ability to execute our growth strategy, including new store development;

 

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impacting our ability to continue to execute our operational strategies in existing stores;

 

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increasing our vulnerability to general adverse economic and industry conditions;

 

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reducing the availability of our cash flow for other purposes;

 

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limiting our flexibility in planning for, or reacting to, changes in our business and the market in which we operate, which would place us at a competitive disadvantage compared to our competitors that may have less debt;

 

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limiting our ability to borrow additional funds; and

 

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failing to comply with the covenants in our debt agreements could result in all of our indebtedness becoming immediately due and payable.

Our ability to obtain necessary funds through borrowing will depend on our ability to generate cash flow from operations. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control. If our business does not generate sufficient cash flow from operations or if future borrowings are not available to us under our Credit Facility or otherwise in amounts sufficient to enable us to fund our liquidity needs, our operating results and financial condition may be adversely affected. Our inability to make scheduled payments on our debt obligations in the future would require us to refinance all or a portion of our indebtedness on or before maturity, sell assets, delay capital expenditures, or seek additional equity investment.

Covenants in our debt agreements restrict our operational flexibility.

The agreement governing our Credit Facility contains usual and customary restrictive covenants relating to our management and the operation of our business, including the following:

 

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incurring additional indebtedness;

 

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making certain investments;

 

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merging, dissolving, liquidating, consolidating, or disposing of all or substantially all of our assets;

 

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paying dividends, making distributions, or redeeming capital stock;

 

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entering into transactions with our affiliates; and

 

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granting liens on our assets.

Our Credit Facility also requires us to maintain a specified financial ratio at the end of any fiscal quarter at any time the Revolving Credit Facility is drawn. Our ability to meet this financial ratio, if applicable, could be affected by events beyond our control. Failure to comply with any of the covenants under our Credit Facility could result in a default under the facility, which could cause our lenders to accelerate the timing of payments and exercise their lien on substantially all of our assets, which would have a material adverse effect on our business, operating results, and financial condition.

 

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We incur substantial costs as a result of being a public company.

Following the completion of our IPO, we are subject to public company reporting obligations under the Securities Exchange Act of 1934, as amended (referred to as the “Exchange Act”), and the rules and regulations regarding corporate governance practices, including those under the Sarbanes-Oxley Act of 2002 (referred to as the “Sarbanes-Oxley Act”), the Dodd-Frank Act of 2010, and the listing requirements of NASDAQ Global Select Market. We incur significant legal, accounting, and other expenses as a public company, including costs resulting from our public company reporting obligations and maintenance of corporate governance practices. Our management and other personnel devote a substantial amount of time to ensure that we comply with all of these requirements. The reporting requirements, rules, and regulations require substantial legal and financial compliance costs and will make some activities more time-consuming and costly than when we were a private company. Any changes that we make to comply with these obligations may not be sufficient to allow us to satisfy our obligations as a public company on a timely basis, or at all.

Our management has limited experience managing a public company, and our current resources may not be sufficient to fulfill our public company obligations.

As a public company, we are subject to various regulatory requirements, including those of the Securities and Exchange Commission (referred to as the “SEC”) and the NASDAQ Global Select Market. These requirements include record keeping, financial reporting and corporate governance rules and regulations. Our management team has limited experience in managing a public company and, historically, has not had the resources typically found in a public company. Our internal infrastructure may not be adequate to support our increased reporting obligations, and we may be unable to hire, train or retain necessary staff and may initially be reliant on engaging outside consultants or professionals to overcome our lack of experience. Our business could be adversely affected if our internal infrastructure is inadequate, we are unable to engage outside consultants, or are otherwise unable to fulfill our public company obligations.

If we are unable to implement and maintain effective internal control over financial reporting in the future, we may fail to prevent or detect material misstatements in our financial statements, in which case investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock may decline.

As a public company, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal control. In addition, beginning with our 2014 annual report on Form 10-K to be filed in 2015, we will be required to file a report by management on the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We are in the process of designing, implementing, and testing the internal control over financial reporting required to comply with this obligation, which is a time-consuming, costly and complicated process. In addition, our independent registered public accounting firm will be required to attest to the effectiveness of our internal control over financial reporting beginning with our 2014 annual report on Form 10-K to be filed in 2015.

In connection with the audit of the financial statements for Sprouts Arizona for fiscal 2010 and our financial statements for fiscal 2011, material weaknesses were identified. We have taken steps to remediate these items by hiring additional finance and accounting personnel and by establishing and formalizing accounting policies and procedures.

In connection with the audit of our financial statements for fiscal 2012, a material weakness related to internal controls with respect to costing of inventories was identified. We previously valued our non-perishable products at the lower of cost or market with costs determined based on replacement costs before discounts. We later determined that replacement costs before discounts was

 

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not an acceptable method under GAAP. As a result, we restated our fiscal 2011 financial statements to correct for this error and we changed our inventory method for non-perishable products to the lower of cost or market using weighted-average costs. The correction of this error also resulted in an audit adjustment in fiscal 2012. As a result, it was determined that a material weakness in our internal control over financial reporting existed related to our failure to design and maintain effective controls with respect to the application of an appropriate GAAP method in determining inventory costs for non-perishable products. We are currently recording our inventory costs for non-perishable inventory using weighted-average costs that include statistical and other estimation methods which we believe provide a reasonable basis to value our non-perishable inventory. We are currently addressing this material weakness in the development of our internal control over financial reporting processes. However we cannot at this time estimate how long it will take to remediate this material weakness.

If we are unsuccessful in our efforts to remediate any material weakness in our internal control over financial reporting, if we identify any additional material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 in a timely manner or assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting when required, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected. In addition, we could become subject to investigations by NASDAQ Global Select Market, the SEC, or other regulatory authorities, which could require additional financial and management resources.

If our goodwill becomes impaired, we may be required to record a significant charge to earnings.

We have a significant amount of goodwill. As of September 29, 2013, we had goodwill of approximately $368.1 million, which represented 31% of our total assets as of such date. Goodwill is reviewed for impairment on an annual basis in the fourth fiscal quarter or whenever events occur or circumstances change that would more likely than not reduce the fair value of our reporting unit below its carrying amount. Fair value is determined based on the discounted cash flows and comparable market values of our single reporting unit. If the fair value of the reporting unit is less than its carrying value, the fair value of the implied goodwill is calculated as the difference between the fair value of our reporting unit and the fair value of the underlying assets and liabilities, excluding goodwill. In the event an impairment to goodwill is identified, an immediate charge to earnings in an amount equal to the excess of the carrying value over the implied fair value would be recorded, which would adversely affect our operating results. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Goodwill and Intangible Assets.”

Determining market values using a discounted cash flow method requires that we make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate market rates. Our judgments are based on historical experience, current market trends and other information. In estimating future cash flows, we rely on internally generated forecasts for operating profits and cash flows, including capital expenditures. Based on our annual impairment test during fiscal 2010, 2011 and 2012, no goodwill impairment charge was required to be recorded. Changes in estimates of future cash flows caused by items such as unforeseen events or changes in market conditions could negatively affect our reporting unit’s fair value and result in an impairment charge. Factors that could cause us to change our estimates of future cash flows include a prolonged economic crisis, successful efforts by our competitors to gain market share in our core markets, our inability to compete effectively with other retailers or our inability to maintain price competitiveness. An impairment of a significant portion of our goodwill could materially adversely affect our financial condition and results of operations.

 

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Risks Related to this Offering and Ownership of our Common Stock

Our stock price may be volatile, and you may not be able to resell your shares at or above the offering price or at all.

Prior to our IPO, there had been no public market for our common stock. An active public market for our common stock may not be sustained. If an active public market is not sustained, it may be difficult for you to sell your shares of our common stock at a price that is attractive to you, or at all. The price of our common stock in any such market may be higher or lower than the price that you pay in this offering. If you purchase shares of our common stock in this offering, you will pay a price that was not established in a competitive market. Rather, you will pay the price that the selling stockholders negotiated with the representatives of the underwriters, which may not be indicative of prices that will prevail in the trading market.

There is no guarantee that our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares. The trading price of our common stock may be volatile and subject to wide price fluctuations in response to various factors, many of which are beyond our control, including the following:

 

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actual or anticipated fluctuations in our quarterly or annual financial results;

 

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the financial guidance we may provide to the public, any changes in such guidance, or our failure to meet such guidance;

 

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failure of industry or securities analysts to maintain coverage of our company, changes in financial estimates by any industry or securities analysts that follow our company, or our failure to meet such estimates;

 

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various market factors or perceived market factors, including rumors, whether or not correct, involving us or our competitors;

 

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fluctuations in stock market prices and trading volumes of securities of similar companies;

 

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sales, or anticipated sales, of large blocks of our stock;

 

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short selling of our common stock by investors;

 

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additions or departures of key personnel;

 

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new store openings or entry into new markets by us or by our competitors;

 

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regulatory or political developments;

 

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changes in accounting principles or methodologies;

 

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litigation and governmental investigations;

 

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acquisitions by us or by our competitors; and

 

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general financial market conditions or events.

Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These and other factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the price or liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have sometimes instituted securities class action litigation against the company that issued the stock. If any of our stockholders were to bring a lawsuit against us, we could incur substantial costs defending the lawsuit or paying for settlements or damages. Such a lawsuit could also divert the time and attention of our management from our business.

 

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The large number of shares eligible for public sale could depress the market price of our common stock.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, and the perception that these sales could occur may depress the market price. We had 146,433,944 shares of common stock outstanding as of September 29, 2013. Of these shares, the 21,275,000 shares of common stock sold in our IPO are freely tradable, except for any shares purchased by our “affiliates” as defined in Rule 144 under the Securities Act of 1933, as amended (referred to as the “Securities Act”). The holders of substantially all of the remaining shares of common stock have agreed with the underwriters in our IPO, subject to certain exceptions, not to dispose of or hedge any of their common stock or securities convertible into or exchangeable for shares of common stock during the 180-day period beginning on July 31, 2013, except with the prior written consent of Goldman, Sachs & Co. and Credit Suisse Securities (USA) LLC (and this offering is being made pursuant to such a consent). This 180-day restricted period may be extended under a limited number of circumstances. We, our officers and directors and the selling stockholders will enter into new lock-up agreements in connection with this offering that will restrict transfers for a period of 90 days, subject to certain exceptions. This 90-day restricted period may be extended under a limited number of circumstances. See “Underwriting”.

In addition, the stockholders agreement by and among us and holders of all of the outstanding shares of our common stock prior to our IPO limits the ability of current equity holders (other than the Apollo Funds) to sell their shares, subject to various exceptions, until October 31, 2014 (subject to a potential extension of up to 90 days). However, the Apollo Funds will have the ability to require us to register shares of our common stock held by them for resale (subject to the restrictions during the 180-day restricted period referred to above), and our stockholders party to the stockholders agreement will also have the ability to participate in such registered offerings or to otherwise sell the same percentage of their shares of our common stock as the percentage of shares sold by the Apollo Funds in any such registered offering. We are registering the shares offered by the selling stockholders hereby pursuant to the exercise by the Apollo Funds of a demand registration right under the Stockholders Agreement. See “Certain Relationships and Related Party Transactions—Stockholders Agreement.” Subject to the foregoing, after the expiration of the restricted period, these shares may be sold in the public market, subject to prior registration or qualification for an exemption from registration, including, in the case of shares held by affiliates, compliance with the volume restrictions of Rule 144.

We have registered all shares of common stock that we may issue under our incentive plans. They can be freely sold in the public market upon issuance, subject to volume limitations applicable to affiliates and the lock-up arrangements described above.

Sales of common stock as restrictions end may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

In the future, we may also issue our securities in connection with a capital raise or acquisitions. The amount of shares of our common stock issued in connection with a capital raise or acquisition could constitute a material portion of our then-outstanding shares of our common stock, which would result in dilution.

Our principal stockholders have substantial control over us and are able to influence corporate matters.

Upon the closing of our IPO and as of the date of this prospectus, our directors, executive officers, and holders of more than 5% of our common stock, together with their affiliates, beneficially own, in the aggregate, approximately 63.6% of our outstanding common stock. In particular, as of the date of this prospectus, the Apollo Funds beneficially own, in the aggregate, approximately 44.5% of

 

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our outstanding common stock, and will own, in the aggregate, approximately 38.2% of our outstanding common stock upon the completion of this offering. These amounts compare to approximately 14.5% of our outstanding common stock represented by the shares sold in our IPO and 11.5% of our outstanding common stock sold in this offering. As a result, these stockholders, acting together, or the Apollo Funds acting alone, will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.

Certain underwriters are affiliates of our controlling stockholder and have interests in this offering beyond customary underwriting discounts and commissions.

Apollo Global Securities, LLC, an underwriter of this offering, is an affiliate of Apollo, our controlling stockholder. Since Apollo beneficially owns more than 10% of our outstanding common stock, a “conflict of interest” is deemed to exist under FINRA Rule 5121(f)(5)(B). In addition, a “conflict of interest” is also deemed to exist under Rule 5121(f)(5)(C) because affiliates of Apollo Global Securities, LLC will receive more than 5% of the net proceeds of this offering. Accordingly, we intend that this offering will be made in compliance with the applicable provisions of Rule 5121. In particular, pursuant to Rule 5121, the appointment of a qualified independent underwriter is not necessary because Apollo Global Securities, LLC is not primarily responsible for managing this offering, and the underwriters that are primarily responsible for managing this offering (Goldman, Sachs & Co. and Credit Suisse Securities (USA) LLC) satisfy the criteria required by Rule 5121(f)(12)(E) and do not have a conflict of interest with us. However, in accordance with Rule 5121, Apollo Global Securities, LLC will not sell our common stock to a discretionary account without receiving written approval from the account holder. See “Underwriting—Conflicts of Interest.”

Anti-takeover provisions could impair a takeover attempt and adversely affect existing stockholders.

Certain provisions of our certificate of incorporation and bylaws and applicable provisions of Delaware law may have the effect of rendering more difficult, delaying, or preventing an acquisition of our company, even when this would be in the best interest of our stockholders. Our corporate governance documents include the following provisions:

 

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creating a classified board of directors whose members serve staggered three-year terms;

 

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authorizing “blank check” preferred stock, which could be issued by our board of directors without stockholder approval and may contain voting, liquidation, dividend, and other rights superior to our common stock;

 

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limiting the liability of, and providing indemnification to, our directors and officers;

 

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prohibiting our stockholders from acting by written consent, thereby requiring stockholder action to be taken at an annual or special meeting of stockholders;

 

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prohibiting our stockholders from calling special meetings of stockholders, which may delay the ability of our stockholders to force consideration of a proposal or the ability of holders controlling a majority of our capital stock to take any action, including the removal of directors;

 

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requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;

 

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controlling the procedures for the conduct and scheduling of board and stockholder meetings;

 

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providing the board of directors with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings;

 

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permitting newly created directorships resulting from an increase in the authorized number of directors or vacancies on our board of directors to be filled only by a majority of our remaining directors, even if less than a quorum is then in office, or by a sole remaining director; and

 

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providing that our board of directors is expressly authorized to make, repeal, alter, or amend our bylaws.

In addition, Delaware law imposes conditions on the voting of “control shares” and on certain business combination transactions with “interested stockholders.”

These provisions, alone or together, could delay or prevent hostile takeovers and changes in control or changes in our management. Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

If securities or industry analysts cease publishing research or reports about us, our business, or our market, or if they adversely change their recommendations regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock is influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If we do not maintain adequate research coverage, or if any of the analysts who may cover us downgrade our stock or publish inaccurate or unfavorable research about our business or provide relatively more favorable recommendations about our competitors, our stock price could decline. If any analyst who may cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Since we do not expect to pay any cash dividends for the foreseeable future, investors in this offering may be forced to sell their stock in order to obtain a return on their investment.

We do not anticipate declaring or paying in the foreseeable future any cash dividends on our capital stock. Instead, we plan to retain any earnings to finance our operations and growth plans discussed elsewhere in this prospectus. In addition, our Credit Facility contains covenants that would restrict our ability to pay cash dividends. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any return on their investment. As a result, investors seeking cash dividends should not purchase our common stock.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus, including the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business,” contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future operating results and financial position, business strategy, and plans and objectives of management for future operations, are forward-looking statements. In many cases, you can identify forward-looking statements by terms such as “may,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other similar expressions.

The forward-looking statements contained in this prospectus reflect our views as of the date of this prospectus about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause our actual results, performance, or achievements to differ significantly from those expressed or implied in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, performance, or achievements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, without limitation, those factors described in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Some of the key factors that could cause actual results to differ from our expectations include the following:

 

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the competitive nature of the industry in which we conduct our business;

 

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our ability to open new stores;

 

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our ability to increase comparable store sales;

 

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the potential for our newly opened stores to negatively impact our financial results in the short or long term;

 

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our ability to maintain or improve operating margins;

 

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produce or supply chain disruptions;

 

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our ability to identify market trends and react to changing consumer preferences;

 

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the impact of quality or food safety concerns;

 

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our exposure to lawsuits relating to the products we sell;

 

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our ability to maintain our brand value and reputation;

 

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the geographic concentration of our stores;

 

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disruption of significant supplier relationships;

 

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significant interruptions in the operations of our distribution centers;

 

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the effects of government regulation;

 

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liabilities arising out of our nutrition-oriented educational activities;

 

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general economic conditions affecting consumer spending;

 

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the occurrence of a widespread health epidemic;

 

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increased commodity prices and lack of availability;

 

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increased energy costs;

 

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increases in the cost of our marketing, advertising, and promotional activities;

 

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the failure of our information technology systems;

 

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our inability to protect our intellectual property;

 

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changes in accounting standards;

 

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the outcome of litigation against us;

 

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our ability to accurately estimate claims under our insurance plans;

 

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our high level of fixed lease obligations;

 

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our ability to satisfy our lease obligations;

 

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the retention of key management;

 

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our ability to attract, train and retain store team members;

 

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the effect of increased labor costs;

 

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union organization activities;

 

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our ability to raise additional capital to finance the growth of our business;

 

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our ability to service our debt obligations;

 

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restrictions in our debt agreements;

 

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increased costs as the result of being a public company;

 

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the limited experience of our management in managing a public company;

 

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our ability to maintain effective internal control over financial reporting; and

 

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the potential for our goodwill to become impaired.

Readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on these forward-looking statements. All of the forward-looking statements we have included in this prospectus are based on information available to us on the date of this prospectus. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise, except as otherwise required by law.

 

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USE OF PROCEEDS

The selling stockholders will receive all of the net proceeds from the sale of the shares offered hereby. We will not receive any proceeds from this offering. Certain of the selling stockholders will exercise options to purchase all or a portion of the shares they are offering hereby. Any proceeds we receive from the exercise of such options will be used by us for general corporate purposes.

In connection with this offering, we will incur certain issuance costs, consisting of various registration, printing and professional services fees. We will expense these costs as incurred.

MARKET PRICE RANGE OF COMMON STOCK

Our common stock began trading on the NASDAQ Global Select Market under the symbol “SFM” on August 1, 2013. Prior to that date, there was no public market for our common stock. The price range per share of common stock presented below represents the highest and lowest closing prices for our common stock on the NASDAQ Global Select Market for each full quarterly period since our IPO.

 

		High				Low
2013
Third quarter		$	46.31			$	33.00
Fourth quarter (through November 25, 2013)		$	49.45			$	37.52

The closing price of our common stock as of November 25, 2013 was $37.52 per share, and the number of stockholders of record of our common stock as of November 25, 2013 was 523. This number excludes stockholders whose stock is held in nominee or street name by brokers.

DIVIDEND POLICY

We do not anticipate declaring or paying in the foreseeable future, any cash dividends on our capital stock. Any future determination as to the declaration and payment of dividends, if any, will be at the discretion of our board of directors and will depend on then existing conditions, including our operating results, financial condition, contractual restrictions, capital requirements, business prospects, and other factors our board of directors may deem relevant. Our Credit Facility contains covenants that would restrict our ability to pay cash dividends.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of September 29, 2013.

In connection with this offering we will incur certain issuance costs, consisting of various registration, printing and professional services fees. We will expense these costs as incurred.

You should read this table together with “Selected Consolidated Historical and Pro Forma Financial and Other Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

		As of September 29, 2013
		(in thousands, except share data)
Cash and cash equivalents		$	91,735
Capital and finance lease obligations, including current portion		$	120,308
Long-term debt, including current portion			351,778
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; 146,433,944 shares issued and outstanding			146
Additional paid-in capital			460,271
Retained earnings			25,217
Total stockholders’ equity			485,634
Total capitalization		$	957,720

The outstanding share information in the table above is based on 146,433,944 shares of our common stock outstanding as of September 29, 2013 and excludes the following:

 

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12,035,289 shares of common stock issuable upon the exercise of stock options outstanding as of September 29, 2013 under the 2011 Option Plan and the 2013 Incentive Compensation Plan at a weighted average exercise price of $3.54 per share; and

 

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9,681,960 shares of common stock reserved for future issuance under the 2013 Incentive Plan.

In connection with the closing of this offering, selling stockholders will exercise 1,036,601 stock options to acquire 1,036,601 newly-issued shares of common stock to be sold in this offering. If the underwriters’ option to acquire up to 2,550,000 additional shares is exercised in full, an additional 146,015 shares of common stock will be issued upon the exercise of stock options and sold in the offering.

 

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SELECTED CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL AND OTHER DATA

The following tables set forth our selected historical financial and other data, as well as certain pro forma information. You should read the selected historical and pro forma financial and other data in conjunction with the information included under the heading “Unaudited Pro Forma Condensed Consolidated Financial Information,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus. Our historical results set forth below are not necessarily indicative of results to be expected for any future period.

The historical balance sheet data as of January 1, 2012 and December 30, 2012 and the historical statements of operations data for fiscal 2010, fiscal 2011 and fiscal 2012 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Historical statements of operations data for the thirty-nine weeks ended September 30, 2012 and September 29, 2013 and historical balance sheet data as of September 29, 2013 have been derived from our unaudited consolidated financial statements which are included elsewhere in this prospectus. These statements, in the opinion of management, include all adjustments (inclusive of normal recurring adjustments) necessary for a fair statement. The historical balance sheet data as of January 3, 2010 and January 2, 2011 and the historical statement of operations data for fiscal 2009 have been derived from our audited consolidated financial statements, which are not included in this prospectus. The historical balance sheet data as of January 4, 2009 and the historical statement of operations data for fiscal 2008 have been derived from our unaudited consolidated financial statements, which are not included in this prospectus.

In 2002, Sprouts Arizona opened the first Sprouts Farmers Market store in Chandler, Arizona. In 2011, Sprouts Arizona combined with Henry’s, which operated 35 Henry’s Farmers Market stores and eight Sun Harvest Market stores, as a part of the Henry’s Transaction led by the Apollo Funds. Apollo held a controlling interest in Henry’s former parent prior to the Henry’s Transaction and continued to hold a controlling interest in the Company afterwards. Due to Apollo’s continued controlling interest, the Henry’s Transaction resulted in Henry’s financial statements becoming the financial statements of the Company, followed immediately by the acquisition by the Company of the Sprouts Farmers Market business. As a result, the Company was determined to be the accounting acquirer, effective April 18, 2011. Accordingly, our consolidated financial statements for fiscal 2008, fiscal 2009 and fiscal 2010 and for the period from January 3, 2011 through April 17, 2011 reflect only the historic results of Henry’s prior to the Henry’s Transaction. Commencing on April 18, 2011, our consolidated financial statements also include the financial position, results of operations and cash flows of Sprouts Arizona.

In May 2012, we acquired Sunflower in the Sunflower Transaction. Commencing on May 29, 2012, our consolidated financial statements also include the financial position, results of operations and cash flows of Sunflower.

The Sunflower Transaction, the April 2013 Refinancing and our IPO had a material impact on our results of operations. Accordingly, we have included pro forma information for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013, which gives effect to these transactions as more fully described in the notes below. See “Unaudited Pro Forma Condensed Consolidated Financial Information” for unaudited pro forma information for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013. In addition, see “Management’s Discussion and Analysis and Financial Condition and Results of Operations—Unaudited Supplemental Fiscal 2011 Pro Forma Information” for unaudited supplemental pro forma information for fiscal 2011 prepared to reflect the Transactions as if they had been consummated on the first day of fiscal 2011.

 

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																		Fiscal 2012
		Fiscal 2008(1)				Fiscal 2009(1)				Fiscal 2010(1)				Fiscal 2011(1)				Actual(2)				Pro Forma for Sunflower Transaction(3)				Pro Forma Sprouts Farmers Market, Inc.(4)
		(dollars in thousands, except per share data)
Statements of Operations Data:
Net sales		$	441,056			$	487,693			$	516,816			$	1,105,879			$	1,794,823			$	1,990,963			$	1,990,963
Cost of sales, buying and occupancy			315,527				346,310				366,947				794,905				1,264,514				1,403,158				1,403,158
Gross profit			125,529				141,383				149,869				310,974				530,309				587,805				587,805
Direct store expenses			92,207				106,373				114,463				238,245				368,323				403,731				403,731
Selling, general and administrative expenses			26,520				23,506				23,277				58,528				86,364				91,611				91,611
Amortization of Henry’s trade names and capitalized software			—				—				867				32,202				—				—				—
Store pre-opening costs			780				2,647				2,341				1,338				2,782				5,218				5,218
Store closure and exit costs			133				299				354				6,382				2,155				2,214				2,214
Income (loss) from operations			5,889				8,558				8,567				(25,721	)			70,685				85,031				85,031
Interest expense			(202	)			(582	)			(681	)			(19,813	)			(35,488	)			(40,250	)			(28,313	)
Other income			444				343				295				358				562				649				649
Loss on extinguishment of debt			—				—				—				—				(992	)			(992	)			(992	)
Income (loss) before income taxes			6,131				8,319				8,181				(45,176	)			34,767				44,438				56,375
Income tax (provision) benefit			(2,466	)			(3,346	)			(3,320	)			17,731				(15,267	)			(19,912	)			(24,568	)
Net income (loss)		$	3,665			$	4,973			$	4,861			$	(27,445	)		$	19,500			$	24,526			$	31,807
Per Share Data:
Net income (loss) per share—basic(5)		$	0.06			$	0.08			$	0.08			$	(0.28	)		$	0.16			$	0.20			$	0.22
Net income (loss) per share—diluted(5)		$	0.06			$	0.08			$	0.08			$	(0.28	)		$	0.16			$	0.19			$	0.22
Weighted average shares outstanding—basic(5)			64,350				64,350				64,350				96,954				119,427				125,510				144,399
Weighted average shares outstanding—diluted(5)			64,350				64,350				64,350				96,954				121,781				127,864				146,247
Pro Forma Financial Measures:
Pro forma adjusted EBITDA(6)																						$	147,340			$	147,340
Pro forma adjusted EBIT(6)																						$	106,967			$	106,967
Pro forma adjusted net income(6)																						$	39,996			$	47,277
Pro forma adjusted net income per share—diluted(6)																						$	0.31			$	0.32

 

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		Thirty-Nine weeks ended
		September 30, 2012												September 29, 2013
		Actual(2)				Pro Forma for Sunflower Transaction(3)				Pro Forma Sprouts Farmers Market, Inc.(4)				Actual				Pro Forma Sprouts Farmers Market, Inc.(4)
		(dollars in thousands, except per share data)
Statements of Operations Data:
Net sales		$	1,315,882			$	1,512,022			$	1,512,022			$	1,829,675			$	1,829,675
Cost of sales, buying and occupancy			921,955				1,060,573				1,060,573				1,278,623				1,278,623
Gross profit			393,927				451,449				451,449				551,052				551,052
Direct store expenses			268,279				303,726				303,726				367,064				367,064
Selling, general and administrative expenses			64,846				70,109				70,109				60,259				60,259
Store pre-opening costs			2,070				4,506				4,506				5,254				5,254
Store closure and exit costs			3,552				3,611				3,611				1,670				1,670
Income from operations			55,180				69,497				69,497				116,805				116,805
Interest expense			(25,414	)			(30,352	)			(21,386	)			(30,346	)			(21,156	)
Other income			201				288				288				447				447
Loss on extinguishment of debt			(992	)			(992	)			(992	)			(17,682	)			(474	)
Income before income taxes			28,975				38,441				47,407				69,224				95,622
Income tax provision			(12,816	)			(17,382	)			(20,880	)			(27,178	)			(37,473	)
Net income		$	16,159			$	21,059			$	26,527			$	42,046			$	58,149
Per Share Data:
Net income per share—basic(5)		$	0.14			$	0.17			$	0.18			$	0.32			$	0.40
Net income per share—diluted(5)		$	0.14			$	0.17			$	0.18			$	0.31			$	0.39
Weighted average shares outstanding—basic(5)			116,791				125,363				144,252				130,538				144,850
Weighted average shares outstanding—diluted(5)			118,441				127,013				145,443				134,529				149,334
Pro Forma Financial Measures:
Pro forma adjusted EBITDA(6)						$	118,610			$	118,610							$	157,424
Pro forma adjusted EBIT(6)						$	88,331			$	88,331							$	122,478
Pro forma adjusted net income(6)						$	34,748			$	40,218							$	61,479
Pro forma adjusted net income per share—diluted(6)						$	0.27			$	0.27							$	0.41

 

		Fiscal 2008(1)(7)				Fiscal 2009(1)				Fiscal 2010(1)				Fiscal 2011(1)				Fiscal 2012(2)				Thirty-Nine weeks ended
																						September 30, 2012(2)				September 30, 2013
Pro forma comparable store sales growth(8)			9.0	%			2.6	%			2.3	%			5.1	%			9.7	%			10.1	%			9.7	%
Pro forma stores at end of period			87				109				129				138				148				148				167
Other Operating Data:
Stores at beginning of period			36				36				40				43				103				103				148
Opened			—				4				3				7				9				9				19
Acquired(9)			—				—				—				56				37				37				—
Closed			—				—				—				(3	)			(1	)			(1	)			—
Stores at end of period			36				40				43				103				148				148				167
Gross square feet at end of period			837,630				949,627				1,035,841				2,721,430				4,064,888				4,064,888				4,582,743
Average store size at end of period (gross square feet)			23,268				23,741				24,089				26,422				27,465				27,465				27,442

 

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		As of
		January 4, 2009(1)				January 3, 2010(1)				January 2, 2011(1)				January 1, 2012				December 30, 2012				September 29, 2013
		(in thousands)
Balance Sheet Data
Cash and cash equivalents		$	3,921			$	6,232			$	4,918			$	14,542			$	67,211			$	91,735
Total assets			191,653				220,818				232,636				761,646				1,103,236				1,181,803
Total capital and finance lease obligations, including current portion			5,311				7,967				8,248				75,409				107,639				120,308
Total long-term debt, including current portion			—				—				—				294,764				426,544				351,778
Total stockholders’ equity			140,300				157,932				156,660				267,453				386,755				485,634

 

(1)

Fiscal 2008, fiscal 2009, fiscal 2010 and the period from January 3, 2011 through April 18, 2011 reflect the sales and expenses directly attributable to Henry’s operations and include allocations of expenses from Henry’s previous parent company. These expenses were allocated to Henry’s on the basis that was considered to reflect fairly or reasonably the utilization of the services provided to, or the benefit obtained by, Henry’s. Historical financial statements for Henry’s prior to April 18, 2011 do not reflect the interest expense or debt Henry’s might have incurred if it had been a stand-alone entity. Additionally, we would have expected to incur other expenses not reflected in our historical financial statements prior to April 18, 2011, if Henry’s had operated as a stand-alone entity. Commencing on April 18, 2011, our consolidated financial statements include the financial position, results of operations and cash flows of Sprouts Arizona.

(2)

For the period from April 18, 2011 to May 28, 2012 our consolidated financial statements include the financial position results of operations and cash flows of Henry’s and Sprouts Arizona. Commencing on May 29, 2012, our consolidated financial statements also include the financial position, results of operations and cash flows of Sunflower.

(3)

The Pro Forma for Sunflower Transaction information includes the pre-combination results of operations of Sunflower and pro forma adjustments for acquisition accounting and the related acquisition financing, as if the Sunflower Transaction and related financing had been consummated on the first day of fiscal 2012. See “Unaudited Pro Forma Condensed Consolidated Financial Information” for a presentation of such pro forma financial data for fiscal 2012 and the thirty-nine weeks ended September 30, 2012.

(4)

The Pro Forma information for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 includes the Pro Forma for Sunflower Transaction information described in note 3 above. Additionally, the Pro Forma information for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013 gives effect to pro forma adjustments to reflect the April 2013 Refinancing, the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses) and the application of $340.0 million of the proceeds to us from the sale of such shares by us to repay certain indebtedness under our Credit Facility as described herein as if these events had occurred on the first day of fiscal 2012. See “Unaudited Pro Forma Condensed Consolidated Financial Information” for a presentation of such pro forma financial data for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013.

(5)

Pro forma net income per share (basic and diluted) gives effect to the items described in notes 3 or 4 above, as applicable, as if they had occurred on the first day of fiscal 2012. See “Unaudited Pro Forma Condensed Consolidated Financial Information” for a presentation of such pro forma financial data for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013.

(6)

Pro forma adjusted EBITDA is a non-GAAP measure defined as pro forma earnings (pro forma net income (loss)) before interest, taxes, depreciation, amortization and accretion, further adjusted to eliminate the effects of items management does not consider in assessing our ongoing performance. Pro forma adjusted EBIT is a non-GAAP measure defined as pro forma earnings (pro forma net income (loss)) before interest and taxes, further adjusted to eliminate the effects of items management does not consider in assessing ongoing performance. Pro forma adjusted net income is a non-GAAP measure defined as pro forma net income adjusted to eliminate the effects of items management does not consider in assessing ongoing performance. Pro forma net income gives effect to the items described in notes 3 or 4 above, as applicable, as if they had occurred on the first day of fiscal 2012. Pro forma adjusted net income per share—diluted is calculated by dividing pro forma adjusted net income by pro forma diluted weighted average shares outstanding.

Pro forma adjusted EBITDA, pro forma adjusted EBIT, pro forma adjusted net income and pro forma adjusted net income per share—diluted are performance measures that provide supplemental information we believe is useful to analysts and investors to evaluate our ongoing results of operations, when considered alongside other GAAP measures such as net income, operating income and gross profit. These non-GAAP measures exclude the financial impact of items management does not consider in assessing our ongoing operating performance, and thereby facilitate review of our operating performance on a period-to-period basis. Other companies may have different capital structures or different lease terms and comparability to our results of operations may be impacted by the effects of acquisition accounting on our depreciation and amortization. As a result of the effects of these factors and factors specific to other companies, we believe pro forma adjusted EBITDA, pro forma adjusted EBIT and pro forma adjusted net income provide helpful information to analysts and investors to facilitate a comparison of our operating performance to that of other companies.

 

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We also use pro forma adjusted EBITDA, as further adjusted for additional items defined in our Credit Facility, for board of director and bank compliance reporting.

These non-GAAP measures are intended to provide additional information only and do not have any standard meanings prescribed by GAAP. Use of these terms may differ from similar measures reported by other companies. Because of their limitations, none of these non-GAAP measures should be considered as a measure of discretionary cash available to use to reinvest in growth of our business, or as a measure of cash that will be available to meet our obligations. Each of these non-GAAP measures has its limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP.

The following table shows a reconciliation of pro forma adjusted net income, pro forma adjusted EBIT and pro forma adjusted EBITDA to pro forma net income for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013:

 

		Fiscal 2012								Thirty-Nine Weeks Ended
										September 30, 2012								September 29, 2013
		Pro Forma for Sunflower Transaction				Pro Forma Sprouts Farmers Market, Inc.				Pro Forma for Sunflower Transaction				Pro Forma Sprouts Farmers Market, Inc.				Pro Forma Sprouts Farmers Market, Inc.
		(dollars in thousands)
Pro forma net income(a)		$	24,526			$	31,807			$	21,059			$	26,527			$	58,149
Add: Pro forma income tax provision			19,912				24,568				17,382				20,880				37,473
Pro forma net income before income taxes			44,438				56,375				38,441				47,407				95,622
Adjustments:
Costs associated with integration(b)			17,120				17,120				13,010				13,010				(15	)
IPO bonus(c)			—				—				—				—				3,183
Loss on extinguishment of debt(d)			992				992				992				992				474
Store closure and exit costs(e)			2,214				2,214				3,611				3,611				1,670
Loss on disposal of assets(f)			1,953				1,953				1,925				1,925				399
Pro forma adjusted income tax provision(g)			(26,721	)			(31,377	)			(23,231	)			(26,727	)			(39,854	)
Pro forma adjusted net income			39,996				47,277				34,748				40,218				61,479
Pro forma interest expense, net			40,250				28,313				30,352				21,386				21,145
Pro forma adjusted income tax provision(g)			26,721				31,377				23,231				26,727				39,854
Pro forma adjusted EBIT			106,967				106,967				88,331				88,331				122,478
Pro forma depreciation, amortization and accretion			40,373				40,373				30,279				30,279				34,946
Pro forma adjusted EBITDA		$	147,340			$	147,340			$	118,610			$	118,610			$	157,424

 

(a)

See “Unaudited Pro Forma Condensed Consolidated Financial Information” for a reconciliation of pro forma net income to net income for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013.

(b)

Costs associated with integration represent the costs to integrate the combined businesses resulting from the Transactions. These expenses include professional fees and severance, which we exclude from our pro forma adjusted EBITDA, pro forma adjusted EBIT and pro forma adjusted net income to provide period-to-period comparability of our operating results because management believes these costs do not directly reflect the ongoing performance of our store operations. We do not expect to incur material expenses associated with integration of the Transactions in fiscal 2013.

(c)

IPO bonus represents bonuses related to the IPO paid to our team members, which are included in selling, general and administrative expenses.

(d)

Loss on extinguishment of debt in fiscal 2012 represents the amount recorded as a result of the renegotiation of a store lease that was classified as a financing lease obligation. The loss on extinguishment of debt in fiscal 2013 includes $0.5 million related to the renegotiation of a store lease that was classified as a financing lease obligation. We exclude losses on extinguishment of debt from our pro forma adjusted EBITDA, pro forma adjusted EBIT and pro forma adjusted net income to provide period-to-period comparability of our operating results because management believes these costs do not directly reflect the ongoing performance of our store operations.

(e)

Store closure and exit costs have been excluded from our pro forma adjusted EBITDA, pro forma adjusted EBIT and pro forma adjusted net income. In fiscal 2012 these consisted of the costs to close one store and a Sunflower administrative facility following the Sunflower Transaction, as well as revised estimates for store closure costs recorded in fiscal 2011. Store closure and exit costs in the thirty-nine weeks ended September 29, 2013 primarily consisted of the costs to close the former Sunflower warehouse.

 

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(f)

Loss on disposal of assets in fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013 represents the loss recorded in connection with the disposal of property and equipment. We exclude gains and losses on disposals of assets from our pro forma adjusted EBITDA, pro forma adjusted EBIT and pro forma adjusted net income to provide period-to-period comparability of our operating results because management believes these costs do not directly reflect the ongoing performance of our store operations.

(g)

Pro forma adjusted income tax provision represents pro forma income tax provision plus the tax effect of the adjustments described in notes (b) through (f) above based on statutory tax rates for the period. This amount was further adjusted to reflect a $1.8 million reduction in pro forma income tax provision for the effects of certain items related to the Sunflower Transaction during fiscal 2012 and the thirty-nine weeks ended September 30, 2012. Of the adjustment, $2.2 million relates to the tax effect of $3.3 million and $2.9 million of non-deductible transaction costs incurred by us and Sunflower, respectively, based on statutory tax rates for the period. This adjustment was partially offset by a $0.4 million adjustment related to tax benefits from Sunflower stock option exercises. We have excluded these items from our pro forma adjusted income tax provision because management believes they do not directly reflect the ongoing performance of our store operations and are not reflective of our ongoing income tax provision.

 

(7)	In fiscal 2008, two stores in California were relocated in close proximity to the original store locations. These stores are not reflected as either opened or closed in the period.

(8)

Pro forma comparable store sales growth reflects comparable store sales growth calculated as if the Transactions had been consummated on the first day of fiscal 2007. Our practice is to include net sales from a store in comparable store sales beginning on the first day of the 61st week following the store’s opening and to exclude net sales from a closed store from comparable store sales on the day of closure. We include net sales from an acquired store in comparable store sales on the later of (i) the day of acquisition or (ii) the first day of the 61st week following the store’s opening. We use pro forma comparable store sales to calculate pro forma comparable store sales growth. A reconciliation of pro forma net sales to net sales and a presentation of pro forma comparable store sales growth are as follows for the periods indicated:

Supplemental Pro Forma Data—Net Sales

 

		Fiscal 2008				Fiscal 2009				Fiscal 2010				Fiscal 2011				Fiscal 2012				Thirty-Nine Weeks Ended
																						September 30, 2012				September 29, 2013
		(dollars in thousands)
Net sales—actual		$	441,056			$	487,693			$	516,816			$	1,105,879			$	1,794,823			$	1,315,882			$	1,829,675
Pro forma adjustments(a)			617,732				751,677				973,543				616,776				196,140				196,140				—
Pro forma net sales		$	1,058,788			$	1,239,370			$	1,490,359			$	1,722,655			$	1,990,963			$	1,512,022			$	1,829,675
Pro forma comparable store sales growth(b)			9.0	%			2.6	%			2.3	%			5.1	%			9.7	%			10.1	%			9.7	%

 

(a)

Pro forma adjustments reflect the net sales of Sprouts Arizona and Sunflower, as if the Transactions had been consummated on the first day of fiscal 2008.

(b)

Pro forma comparable store sales growth is calculated as if the Transactions had been consummated on the first day of fiscal 2007.

 

(9)	As a result of a change in reporting entity from Henry’s to us in connection with the Henry’s Transaction in fiscal 2011, we acquired 56 Sprouts Arizona stores in the Henry’s Transaction. We also acquired 37 stores in connection with the Sunflower Transaction in fiscal 2012.

 

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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The following unaudited pro forma condensed consolidated financial information presents the unaudited pro forma condensed consolidated statement of operations for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 and September 29, 2013 after giving effect to the transactions and adjustments as described in the accompanying notes.

The unaudited pro forma condensed consolidated financial information includes our historical results of operations and the results of operations of Sunflower, after giving pro forma effect to:

 

Ÿ

the Sunflower Transaction and the related financing (in the case of fiscal 2012 and the thirty-nine weeks ended September 30, 2012 only) (presented as “Pro Forma for Sunflower Transaction” in the unaudited pro forma condensed consolidated statement of operations); and

 

Ÿ

our April 2013 Refinancing and the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock being issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses) and the application of $340.0 million of the proceeds to us from the sale of such shares by us to repay certain indebtedness as described herein (referred to collectively as the “Pro Forma Offering” and, together with “Pro Forma for Sunflower Transaction,” presented as “Pro Forma Sprouts Farmers Market, Inc.” in the unaudited pro forma condensed consolidated financial information).

The unaudited pro forma condensed consolidated statement of operations for fiscal 2012 and the thirty-nine weeks ended September 30, 2012 reflects the Sunflower Transaction and the Pro Forma Offering as if they occurred on January 2, 2012, the first day of fiscal 2012. The unaudited pro forma condensed consolidated statement of operations for the thirty-nine weeks ended September 29, 2013 gives pro forma effect to the Pro Forma Offering as if it occurred on January 2, 2012.

The historical financial information has been adjusted to give pro forma effect to events that are directly attributable to the Sunflower Transaction and other transactions described above, have an ongoing effect on our statement of operations and are factually supportable. Our unaudited pro forma condensed consolidated financial information and explanatory notes present how our financial statements may have appeared had the business actually been combined and had our capital structure reflected the above transactions as of the dates noted above. The unaudited pro forma condensed consolidated statement of operations shows the impact on the combined statement of operations of the acquisition method of accounting under Financial Accounting Standards Board ASC 805, Business Combinations. Under the acquisition method of accounting, the total purchase price is allocated to the assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The excess purchase price over the amounts assigned to tangible and intangible assets acquired and liabilities assumed is recognized as goodwill.

The unaudited pro forma condensed consolidated financial information was prepared in accordance with Article 11 of Regulation S-X, using the assumptions set forth in the notes to the unaudited pro forma condensed consolidated financial information. The following unaudited pro forma condensed consolidated financial information is presented for illustrative purposes only and does not purport to reflect the results the consolidated company may achieve in future periods or the historical results that would have been obtained had the above transactions been completed as of January 2, 2012. The unaudited pro forma condensed consolidated financial information also does not give effect to the potential impact of current financial conditions, any anticipated synergies, operating efficiencies or cost savings that may result from the Sunflower Transaction. Furthermore, the unaudited pro forma condensed consolidated statement of operations does not include certain nonrecurring charges and the related tax effects which result directly from the Sunflower Transaction and the Pro Forma Offering as described in the notes to the unaudited pro forma condensed consolidated financial information.

The unaudited pro forma condensed consolidated financial information is derived from and should be read in conjunction with our historical financial statements and related notes included elsewhere in this prospectus.

 

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SPROUTS FARMERS MARKET, INC.

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

For the Fiscal Year Ended December 30, 2012

(in thousands, except per share amounts)

 

		Historical Sprouts Farmers Market, Inc.(1)				Historical Sunflower(1)				Pro Forma Adjustments for								Notes				Pro Forma for Sunflower Transaction(2)				Pro Forma Adjustment for Pro Forma Offering(3)				Notes				Pro Forma Sprouts Farmers Market, Inc.(3)
										Sunflower Fiscal Period Alignment(2)				Sunflower Transaction(2)
Net sales		$	1,794,823			$	197,612			$	(1,472	)		$	—							$	1,990,963			$	—							$	1,990,963
Cost of sales, buying and occupancy			1,264,514				138,880				(1,011	)			775				(2)(a)				1,403,158				—								1,403,158
Gross profit			530,309				58,732				(461	)			(775	)							587,805				—								587,805
Direct store expenses			368,323				35,956				(287	)			(261	)			(2)(b)				403,731				—								403,731
Selling, general and administrative expenses			86,364				13,386				(90	)			(8,049	)			(2)(c)				91,611				—								91,611
Store pre-opening costs			2,782				2,450				(14	)			—								5,218				—								5,218
Store closure and exit costs			2,155				59				—				—								2,214				—								2,214
Income from operations			70,685				6,881				(70	)			7,535								85,031				—								85,031
Interest expense			(35,488	)			(2,019	)			14				(2,757	)			(2)(d)				(40,250	)			11,937				(3)(a)				(28,313	)
Other income			562				88				(1	)			—								649				—								649
Loss on extinguishment of debt			(992	)			—				—				—								(992	)			—								(992	)
Income before income taxes			34,767				4,950				(57	)			4,778								44,438				11,937								56,375
Income tax (provision) benefit			(15,267	)			(2,796	)			14				(1,863	)			(2)(e)				(19,912	)			(4,656	)			(3)(b)				(24,568	)
Net income		$	19,500			$	2,154			$	(43	)		$	2,915							$	24,526			$	7,281							$	31,807
Per Share Information:
Net income—basic		$	0.16																(2)(f)			$	0.20								(3)(c)			$	0.22
Net income—diluted		$	0.16																(2)(f)			$	0.19								(3)(c)			$	0.22
Weighted Average Shares:
Basic			119,427																(2)(f)				125,510								(3)(c)				144,399
Diluted			121,781																(2)(f)				127,864								(3)(c)				146,247

 

The accompanying notes are an integral part of, and should be read together with, this unaudited pro forma condensed consolidated financial information.

 

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SPROUTS FARMERS MARKET, INC.

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

For the Thirty-Nine Weeks Ended September 30, 2012

(in thousands, except per share amounts)

 

		Pro Forma Adjustments for																				Pro Forma for Sunflower Transaction(2)				Pro Forma Adjustments for Pro Forma Offering(3)				Notes(3)				Pro Forma Sprouts Farmers Market, Inc.(3)
		Historical Sprouts Farmers Market, Inc.(1)				Historical Sunflower(1)				Sunflower Fiscal Period Allignment(2)				Sunflower Transaction(2)				Notes
Net sales		$	1,315,882			$	197,612			$	(1,472	)		$	—							$	1,512,022			$	—							$	1,512,022
Cost of sales, buying and occupancy			921,955				138,880				(1,011	)			749				(2)(g)				1,060,573				—								1,060,573
Gross profit			393,927				58,732				(461	)			(749	)							451,449				—								451,449
Direct store expenses			268,279				35,956				(287	)			(222	)			(2)(h)				303,726				—								303,726
Selling, general and administrative expenses			64,846				13,386				(90	)			(8,033	)			(2)(i)				70,109				—								70,109
Store pre-opening costs			2,070				2,450				(14	)			—								4,506				—								4,506
Store closure and exit costs			3,552				59				—				—								3,611				—								3,611
Income from operations			55,180				6,881				(70	)			7,506								69,497				—								69,497
Interest expense			(25,414	)			(2,019	)			14				(2,933	)			(2)(j)				(30,352	)			8,966				(3)(d)				(21,386	)
Other income			201				88				(1	)			—								288				—								288
Loss on extinguishment of debt			(992	)			—				—				—								(992	)			—								(992	)
Income before income taxes			28,975				4,950				(57	)			4,573								38,441				8,966								47,407
Income tax (provision) benefit			(12,816	)			(2,796	)			14				(1,784	)			(2)(k)				(17,382	)			(3,498	)			(3)(e)				(20,880	)
Net income		$	16,159			$	2,154			$	(43	)		$	2,789							$	21,059			$	5,468							$	26,527
Per LLC Unit and Share Information:
Net income—basic		$	0.14																(2)(l)			$	0.17								(3)(f)			$	0.18
Net income—diluted		$	0.14																(2)(l)			$	0.17								(3)(f)			$	0.18
Weighted Average LLC Units and Shares:
Basic			116,791																(2)(l)				125,363								(3)(f)				144,252
Diluted			118,441																(2)(l)				127,013								(3)(f)				145,443

 

The accompanying notes are an integral part of, and should be read in conjunction with, this unaudited pro forma condensed consolidated financial information.

 

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SPROUTS FARMERS MARKET, INC.

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

For the Thirty-Nine Weeks Ended September 29, 2013

(in thousands, except per share amounts)

 

		Historical Sprouts Farmers Market, Inc.(1)				Pro Forma Adjustment for Pro Forma Offering(3)				Notes		Pro Forma Sprouts Farmers Market, Inc.(3)
Net sales		$	1,829,675			$	—					$	1,829,675
Cost of sales, buying and occupancy			1,278,623				—						1,278,623
Gross profit			551,052				—						551,052
Direct store expenses			367,064				—						367,064
Selling, general and administrative expenses			60,259				—						60,259
Store pre-opening costs			5,254				—						5,254
Store closure and exit costs			1,670				—						1,670
Income from operations			116,805				—						116,805
Interest expense			(30,346	)			9,190			(3)(g)			(21,156	)
Other income			447				—						447
Loss on extinguishment of debt			(17,682	)			17,208			(3)(h)			(474	)
Income before income taxes			69,224				26,398						95,622
Income tax (provision) benefit			(27,178	)			(10,295	)		(3)(i)			(37,473	)
Net income		$	42,046			$	16,103					$	58,149
Per Share Information:
Net income—basic		$	0.32							(3)(j)		$	0.40
Net income—diluted		$	0.31							(3)(j)		$	0.39
Weighted Average Shares:
Basic			130,538							(3)(j)			144,850
Diluted			134,529							(3)(j)			149,334

 

The accompanying notes are an integral part of, and should be read in conjunction with, this unaudited pro forma condensed consolidated financial information.

 

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SPROUTS FARMERS MARKET, INC.

NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION

1. Basis of Presentation and Description of Transactions

Effective May 29, 2012, we acquired all of the outstanding common and preferred stock of Sunflower in the Sunflower Transaction, a transaction accounted for as a business combination, which was financed through the issuance of debt and 14.9 million of our shares. Additionally, in April 2013, we completed the April 2013 Refinancing, which consisted of a refinancing of our debt, a distribution to our equity holders of $282 million and payments to vested option holders of $13.9 million. For further information about the Sunflower Transaction, see Note 4 to our audited consolidated financial statements included elsewhere in this prospectus. For further information about the April 2013 Refinancing, see Note 26 to our audited consolidated financial statements included elsewhere in this prospectus. In conjunction with our IPO, we used proceeds received in the offering to repay $340.0 million of our existing indebtedness, which is further reflected in these unaudited pro forma condensed consolidated financial statements. For further information about the $340.0 million repayment, see Note 7 to our unaudited consolidated financial statements included elsewhere in this prospectus.

The historical Sprouts Farmers Market, Inc. results of operations for fiscal 2012 are derived from our audited consolidated financial statements included elsewhere in this prospectus. Consolidated statements of operations data for the thirty-nine weeks ended September 30, 2012 and September 29, 2013 are derived from our unaudited consolidated financial statements for the periods then ended also included elsewhere in this prospectus. The historical Sunflower results of operations for the period January 1, 2012 to May 28, 2012, were derived from the Sunflower pre-combination unaudited financial statements not included in this prospectus. Certain amounts from the Sunflower pre-combination unaudited financial statements have been reclassified to conform to our presentation.

2. Pro Forma for Sunflower Transaction

The historical results of operations have been adjusted to give pro forma effect to events that are (i) directly attributable to the Sunflower Transaction, (ii) factually supportable and (iii) expected to have a continuing impact on the combined results, as if the Sunflower Transaction occurred on the first day of fiscal 2012 (referred to as “Pro Forma Adjustments for Sunflower Transaction”).

Unaudited Pro Forma Condensed Consolidated Statement of Operations—Fiscal 2012

Sunflower’s fiscal 2012 commenced one day earlier than our fiscal 2012. Pro forma adjustments for Sunflower Fiscal Period Alignment reflect the pro forma impact of deducting one day from the historical Sunflower results of operations. Additional pro forma adjustments for the Sunflower Transaction consist of the following:

^(a) Reflects pro forma adjustments attributable to the application of acquisition accounting to the Sunflower Transaction comprised of (i) a $0.7 million increase in rent expense, resulting principally from straight-line adjustments to rent expense as a result of the new basis in the acquired Sunflower leases as of the acquisition date and (ii) a $0.1 million net increase in amortization expense related to the fair value of favorable lease intangible assets and unfavorable lease liabilities recognized in the Sunflower Transaction. Management has assumed a weighted average useful life of 11.6 years for amortization of favorable and unfavorable leases in arriving at the pro forma amortization adjustment.

^(b) Reflects pro forma adjustments to historical Sunflower depreciation related to the fair values of acquired buildings, leasehold improvements and furniture, fixtures and equipment, which are being amortized and depreciated over their estimated useful lives on a straight-line basis. Measurement of these assets in acquisition accounting is based on acquisition date fair value which was lower than

 

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Sunflower pre-acquisition carrying value, primarily due to declines in real estate values and occupancy rates as a result of the recession and deferred maintenance associated with acquired furniture, fixtures and equipment. We also reduced remaining useful lives of certain acquired assets, which accelerated depreciation of those assets. The net effect of the reduction in carrying values and remaining useful lives of the acquired assets resulted in a reduction to pro forma depreciation expense compared to historical depreciation expense. Management has assumed weighted average useful lives of 38.4 years, 7.6 years and 4.7 years for buildings, leasehold improvements and furniture, fixtures and equipment, respectively, in arriving at the pro forma depreciation adjustments.

^(c) Reflects costs associated with the Sunflower Transaction, which have been excluded from pro forma results due to the absence of a continuing effect on our business. The costs consist of (i) $3.2 million of transaction expenses we incurred in 2012 in connection with the Sunflower Transaction, consisting primarily of professional fees, (ii) $3.5 million of transaction expenses, consisting primarily of professional fees, recorded in Sunflower’s historical pre-combination financial statements, and (iii) $1.1 million of share-based compensation expense associated with a change in control as a result of our acquisition of Sunflower recorded in Sunflower’s historical pre-combination financial statements. Additionally, the pro forma adjustment includes (i) a $0.3 million decrease to historical Sunflower depreciation related to the fair value of acquired furniture and fixtures used for general and administrative purposes, which are being depreciated over their estimated useful lives on a straight-line basis and (ii) a $0.1 million increase to historical amortization expense associated with the Sunflower trade name. Management has assumed weighted average useful lives of 0.4 years for the acquired furniture and fixtures and 10 years for the Sunflower trade name in arriving at the pro forma depreciation and amortization amounts.

^(d) In May 2012, we borrowed an additional $100.0 million, net of $0.5 million in financing fees and $2.7 million of issue discount, under our Former Term Loan and received net proceeds of $35.0 million from the issuance of our 10% Senior Subordinated Promissory Notes due 2019 (referred to as the “Notes”) to finance the Sunflower Transaction. The pro forma adjustment represents (i) the incremental interest expense of $4.0 million from our variable rate Former Term Loan and Notes, including amortization of issue discount and deferred financing fees, based on an interest rate of 6% in effect for the Former Term Loan and 10% for the Notes, (ii) the reversal of historical Sunflower interest expense of $0.9 million, as the pre-combination Sunflower debt was paid off in connection with the Sunflower Transaction, and (iii) a decrease in interest of $0.4 million resulting from the new basis in Sunflower finance and capital lease obligations acquired in the Sunflower Transaction. A one-eighth percentage change in the interest rate would increase or decrease interest expense by $0.1 million for the year ended December 30, 2012.

^(e) The pro forma adjustment to income tax (provision) benefit is derived by applying a blended federal and state statutory tax rate of 39.0% to the above pro forma adjustments.

^(f) Pro forma net income per weighted average basic and diluted shares outstanding reflects the issuance of 14,898,136 shares to finance the Sunflower Transaction, as if the Sunflower Transaction occurred on the first day of fiscal 2012.

Unaudited Pro Forma Condensed Consolidated Statement of Operations—Thirty-Nine Weeks Ended September 30, 2012

Pro forma adjustments for the Sunflower Transaction consist of the following:

^(g) Reflects pro forma adjustments attributable to the application of acquisition accounting to the Sunflower Transaction comprised of (i) a $0.8 million increase in rent expense, resulting principally from straight-line rent adjustments to rent expense as a result of the new basis in the acquired

 

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Sunflower leases as of the acquisition date and (ii) a $0.1 million decrease in amortization expense related to the fair value of favorable lease intangible assets and unfavorable lease liabilities recognized in the Sunflower Transaction. Management has assumed a weighted average useful life of 11.6 years for amortization of favorable and unfavorable leases in arriving at the pro forma amortization adjustment.

^(h) Reflects pro forma adjustments to historical Sunflower depreciation related to the fair values of acquired buildings, leasehold improvements and furniture, fixtures and equipment, which are being amortized and depreciated over their estimated useful lives on a straight-line basis. Measurement of these assets in acquisition accounting is based on acquisition date fair value which was lower than Sunflower pre-acquisition carrying value, primarily due to declines in real estate values and occupancy rates as a result of the recession and deferred maintenance associated with acquired furniture, fixtures and equipment. We also reduced remaining useful lives of certain acquired assets, which accelerated depreciation of those assets. The net effect of the reduction in carrying values and remaining useful lives of the acquired assets resulted in a reduction to pro forma depreciation expense compared to historical depreciation expense. Management has assumed weighted average useful lives of 38.4 years, 7.6 years and 4.7 years for buildings, leasehold improvements and furniture, fixtures and equipment, respectively, in arriving at the pro forma depreciation adjustments.

⁽ⁱ⁾ Reflects costs associated with the Sunflower Transaction, which have been excluded from pro forma results due to the absence of a continuing effect on our business. The costs consist of (i) $3.2 million of transaction expenses we incurred in 2012 in connection with the Sunflower Transaction, consisting primarily of professional fees, (ii) $3.5 million of transaction expenses, consisting primarily of professional fees, recorded in Sunflower’s historical pre-combination financial statements, and (iii) $1.1 million of share-based compensation expense associated with a change in control as a result of our acquisition of Sunflower recorded in Sunflower’s historical pre-combination financial statements. Additionally, the pro forma adjustment includes (i) a $0.3 million decrease to historical Sunflower depreciation related to the fair value of acquired furniture and fixtures used for general and administrative purposes, which are being depreciated over their estimated useful lives on a straight-line basis and (ii) a $0.1 million increase to historical amortization expense associated with the Sunflower trade name. Management has assumed weighted average useful lives of 0.4 years for the acquired furniture and fixtures and 10 years for the Sunflower trade name in arriving at the pro forma depreciation and amortization amounts.

^(j) In May 2012, we borrowed an additional $100.0 million, net of $0.5 million in financing fees and $2.7 million of issue discount, under our Former Term Loan and received net proceeds of $35.0 million from the issuance of the Notes to finance the Sunflower Transaction. The pro forma adjustment represents (i) the incremental interest expense of $4.0 million from our variable rate Former Term Loan and Notes, including amortization of issue discount and deferred financing fees, based on an interest rate of 6% in effect for the Former Term Loan and 10% for the Notes, (ii) the reversal of historical Sunflower interest expense of $0.9 million, as the pre-combination Sunflower debt was paid off in connection with the Sunflower Transaction and (iii) a decrease in interest expense of $0.2 million resulting primarily from the addition of financing leases acquired in the Sunflower Transaction. A one-eighth percentage change in the interest rate would increase or decrease interest expense by $0.1 million during the thirty-nine weeks ended September 30, 2012.

^(k) The pro forma adjustment to income tax (provision) benefit is derived by applying a blended federal and state statutory tax rate of 39.0% to the pro forma adjustments described above.

^(l) Pro forma net income per weighted average basic and diluted shares outstanding reflects the issuance of 14,898,136 shares to finance the Sunflower Transaction, as if the Sunflower Transaction occurred on the first day of fiscal 2012.

 

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3. Pro Forma Sprouts Farmers Market, Inc.

Unaudited Pro Forma Condensed Consolidated Statement of Operations—Fiscal 2012

The Pro Forma Sprouts Farmers Market, Inc. condensed consolidated statement of operations data for fiscal 2012 includes the Pro Forma for Sunflower Transaction and further reflects the pro forma effect of the April 2013 Refinancing and the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses) and the application of $340.0 million of the proceeds to us from the sale of such shares by us to repay certain indebtedness as described herein as if these events had occurred on the first day of fiscal 2012, as follows:

^(a) The pro forma adjustment to interest expense represents the net decrease to pro forma interest expense on the Credit Facility related to the April 2013 Refinancing and the subsequent repayment on our Credit Facility using proceeds from our IPO. The pro forma adjustment of $11.9 million is based on an effective interest rate of 4.0%, which includes a 0.5% reduction to the interest rate of 4.5% due to our IPO.

^(b) The pro forma adjustment to income tax (provision) benefit is derived by applying a blended federal and state statutory tax rate of 39.0% to the pro forma adjustment to interest expense described above.

^(c) Pro forma net income per weighted average basic and diluted shares outstanding gives effect to the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses).

No adjustment has been made to the unaudited pro forma condensed consolidated statement of operations to reflect the $9.0 and $8.2 million loss on early extinguishment of debt, as these amounts are a non-recurring charges incurred as a result of the April 2013 Refinancing and the Credit Facility repayment using proceeds from our IPO.

Unaudited Pro Forma Condensed Consolidated Statement of Operations—Thirty-Nine Weeks Ended September 30, 2012

The Pro Forma Sprouts Farmers Market, Inc. condensed consolidated statement of operations data for the thirty-nine weeks ended September 30, 2012 includes the Pro Forma for Sunflower Transaction and further reflects the pro forma effect of the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses) and the application of $340.0 million of the proceeds to us from the sale of such shares by us to repay certain indebtedness as described herein as if these events had occurred on the first day of fiscal 2012, as follows:

^(d) The pro forma adjustment to interest expense represents the decrease in pro forma interest expense on the Credit Facility related to the repayment on our Credit Facility. The pro forma adjustment of $9.0 million is based on an effective interest rate of 4.0%, which includes a 0.5% reduction due to our IPO.

^(e) The pro forma adjustment to income tax (provision) benefit is derived by applying a blended federal and state statutory tax rate of 39.0% to the pro forma adjustment to interest expense described above.

^(f) Pro forma net income per weighted average basic and diluted shares outstanding gives effect to the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining

 

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1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses).

Unaudited Pro Forma Condensed Consolidated Statement of Operations—Thirty-Nine Weeks Ended September 29, 2013

The Pro Forma Sprouts Farmers Market, Inc. condensed consolidated statement of operations data for the thirty-nine weeks ended September 29, 2013 includes the pro forma effect of the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses) and the application of $340.0 million of the proceeds to us from the sale of such shares by us to repay certain indebtedness as discussed above as if these events had occurred on the first day of fiscal 2012, as follows:

^(g) The pro forma adjustment to interest expense represents the decrease in pro forma interest expense on the Credit Facility related to the repayment on our Credit Facility. The pro forma adjustment of $9.2 million is based on an effective interest rate of 4.0%, which includes a 0.5% reduction due to our IPO.

^(h) The pro forma adjustment to loss on extinguishment of debt includes $8.2 million related to our April 2013 Refinancing and $9.0 million related to the $340.0 million repayment discussed above.

⁽ⁱ⁾ The pro forma adjustment to income tax (provision) benefit is derived by applying a blended federal and state statutory tax rate of 39.0% to the pro forma adjustment to interest expense and loss on extinguishment of debt described above.

^(j) Pro forma net income per weighted average basic and diluted shares outstanding gives effect to the issuance of 18,888,889 shares of common stock in our IPO (excluding the remaining 1,588,326 shares of common stock issued in that offering, which were deemed to have been used to pay underwriting discounts, offering expenses in such offering and general corporate expenses).

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with “Selected Consolidated Historical and Pro Forma Financial and Other Data,” “Unaudited Pro Forma Condensed Consolidated Financial Information” and the consolidated financial statements and related notes that are included elsewhere in this prospectus. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or in other parts of this prospectus. Please also see the section entitled “Special Note Regarding Forward-Looking Statements.”

Business Overview

Sprouts Farmers Market is a high-growth, differentiated, specialty retailer of natural and organic food focusing on health and wellness at great value. We offer a complete shopping experience that includes fresh produce, bulk foods, vitamins and supplements, grocery, meat and seafood, bakery, dairy, frozen foods, body care and natural household items catering to consumers’ growing interest in eating and living healthier. Since our founding in 2002, we have grown rapidly, significantly increasing our sales, store count and profitability. With pro forma fiscal 2012 net sales of $2.0 billion and 167 stores in eight states as of September 29, 2013, we are one of the largest specialty retailers of natural and organic food in the United States. According to research conducted for us by Buxton Company, a customer analytics research firm, we have significant growth opportunities in existing and new markets across the United States with the potential for approximately 1,200 locations operating under our current format.

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, and knowledgeable team members who we believe provide best-in-class customer service and product education.

Our History

In 2002, we opened the first Sprouts Farmers Market store in Chandler, Arizona. In 2010, we had 54 stores and reached over $620 million in net sales and approximately 3,700 team members. In April 2011, we partnered with the Apollo Funds, and added 43 stores by merging with Henry’s and its Sun Harvest-brand stores. Our merger with Henry’s brought us to 103 total stores located in Arizona, California, Colorado and Texas as of the end of 2011. In May 2012, we added another 37 stores through our acquisition of Sunflower and extended our footprint into New Mexico, Nevada, Oklahoma and Utah. On August 1, 2013, our common stock began trading on the NASDAQ Global Select Market and on August 6, 2013, we closed our IPO.

Outlook

We are pursuing a number of strategies designed to continue our growth, including expansion of our store base, driving comparable store sales growth, enhancing our operating margins 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 achieve 12% or more annual new store growth for at least the next five years.

 

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We also believe we can continue to improve our 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 believe our operating margins will continue to benefit from scale efficiencies, information technology systems, continued cost discipline and enhancements to our merchandise offerings. 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, all of which promote our mission of “Healthy Living for Less.”

Components of Operating Results

We report our results of operations on a 52- or 53-week fiscal year ending on the Sunday closest to December 31, with each fiscal quarter generally divided into three periods consisting of two four-week periods and one five-week period. Fiscal 2010, 2011 and 2012 were 52-week years ending on January 2, 2011, January 1, 2012 and December 30, 2012, respectively.

Net Sales

We recognize sales revenue at the point of sale, with discounts provided to customers reflected as a reduction in sales revenue. Proceeds from sales of gift cards are recorded as a liability at the time of sale, and recognized as sales when they are redeemed by the customer. We do not include sales taxes in net sales.

We monitor our pro forma comparable store sales growth to evaluate and identify trends in our sales performance. Pro forma comparable store sales growth reflects comparable store sales growth calculated as if the Transactions had occurred on the first day of fiscal 2007. Our practice is to include sales from a store in comparable store sales beginning on the first day of the 61st week following the store’s opening and to exclude sales from a closed store from comparable store sales beginning on the day of closure. We include sales from an acquired store in comparable store sales on the later of (i) the day of acquisition or (ii) the first day of the 61st week following the store’s opening. This practice may differ from the methods that other retailers use to calculate similar measures. We use pro forma comparable store sales to calculate pro forma comparable store sales growth. See “Selected Consolidated Historical and Pro Forma Financial and Other Data” for a reconciliation of historical net sales to pro forma net sales and a presentation of pro forma comparable store sales growth for fiscal 2008 through fiscal 2012 and for the thirty-nine weeks ended September 30, 2012 and September 29, 2013.

Our net sales have increased substantially as a result of the Transactions. Net sales are also affected by store openings and closings and comparable store sales growth. Factors that influence comparable store sales growth and other sales trends include:

 

Ÿ

general economic conditions and trends, including levels of disposable income and consumer confidence;

 

Ÿ

consumer preferences and buying trends;

 

Ÿ

our ability to identify market trends, and to source and provide product offerings that promote customer traffic and growth in average ticket;

 

Ÿ

the number of customer transactions and average ticket;

 

Ÿ

the prices of our products, including the effects of inflation and deflation;

 

Ÿ

opening new stores in the vicinity of our existing stores;

 

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Ÿ

advertising, in-store merchandising and other marketing activities; and

 

Ÿ

our competition, including competitive store openings in the vicinity of our stores and competitor pricing and merchandising strategies.

Cost of sales, buying and occupancy and gross profit

Cost of sales includes the cost of inventory sold during the period, including direct costs of purchased merchandise (net of discounts and allowances), distribution and supply chain costs, buying costs and supplies. Merchandise incentives received from vendors are reflected in the carrying value of inventory when earned or as progress is made toward earning the rebate or allowance, and are reflected as a component of cost of sales as the inventory is sold. Inflation and deflation in the prices of food and other products we sell may periodically affect our gross profit and gross margin. The short-term impact of inflation and deflation is largely dependent on whether or not we pass the effects through to our customers, which will depend upon competitive market conditions. In the first half of fiscal 2012, we experienced produce price deflation, which contributed to higher gross margins in our business during that period and the full fiscal year.

Occupancy costs include store rental, property taxes, utilities, common area maintenance, amortization of favorable and unfavorable leasehold interests and property insurance. Occupancy costs do not include building depreciation, which is classified as a direct store expense.

Our cost of sales, buying and occupancy and gross profit are correlated to sales volumes. As sales increase, gross margin is affected by the relative mix of products sold, pricing strategies, inventory shrinkage and improved leverage of fixed costs of sales, buying and occupancy.

Direct store expenses

Direct store expenses consist of store-level expenses such as salaries and benefits, related equity-based compensation, supplies, depreciation and amortization for buildings, store leasehold improvements, equipment and other store specific costs. As sales increase, direct store expenses generally decline as a percentage of sales.

Selling, general and administrative expenses

Selling, general and administrative expenses primarily consist of salaries and benefits costs, equity-based compensation, advertising, acquisition-related costs and corporate overhead.

We charge third-parties to place advertisements in our in-store guide and newspaper circulars. We record consideration received from vendors in connection with cooperative advertising programs as a reduction to advertising costs when the allowance represents reimbursement of a specific and identifiable cost. Advertising costs are expensed as incurred.

We expect our selling, general and administrative expenses will increase in future periods as a result of incremental share-based compensation, legal, accounting and other compliance-related expenses associated with being a public company and increases resulting from growth in the number of our stores.

Store pre-opening costs

Store pre-opening costs include rent expense during construction of new stores and costs related to new store openings, including costs associated with hiring and training personnel and other miscellaneous costs. Store pre-opening costs are expensed as incurred.

 

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Store closure and exit costs

We recognize a reserve for future operating lease payments associated with facilities that are no longer being utilized in our current operations. The reserve is recorded based on the present value of the remaining non-cancelable lease payments after the cease use date less an estimate of subtenant income. If subtenant income is expected to be higher than the lease payments, no accrual is recorded. Lease payments included in the closed store reserve are expected to be paid over the remaining terms of the respective leases. Our assumptions about subtenant income are based on our experience and knowledge of the area in which the closed property is located, guidance received from local brokers and agents and existing economic conditions. Adjustments to the closed store reserve relate primarily to changes in actual or estimated subtenant income and changes in actual lease payments from original estimates. Adjustments are made for changes in estimates in the period in which the change becomes known, considering timing of new information regarding market, subleases or other lease updates. Changes in reserve estimates are classified as store closure and exit costs in the consolidated statements of operations. Store closure and exit costs in fiscal 2011 and fiscal 2012 consisted primarily of reserves to close redundant store locations and facilities following the Transactions. Store closure and exit costs in fiscal 2012 also include adjustments to estimates recorded in fiscal 2011.

Benefit (provision) for income taxes

Prior to the Henry’s Transaction, Henry’s was included in the consolidated federal and certain state income tax groups of its previous parent for income tax reporting purposes. Henry’s was not a separate taxpaying entity before the Henry’s Transaction. However, for the periods presented through the Henry’s Transaction, the consolidated financial statements have been prepared on the basis as if Henry’s prepared its tax returns and accounted for income taxes on a separate company basis. As a result of the Henry’s Transaction, for tax purposes, Henry’s was acquired in a taxable asset acquisition. The purchase price was allocated to all identifiable assets with the residual assigned to tax deductible goodwill. The resulting basis differences between the new tax values and historical amounts resulted in a deferred tax asset of $47.6 million being recorded through stockholders’ equity. See Note 18 to our audited consolidated financial statements included elsewhere in this prospectus for a discussion of the tax deductibility of goodwill.

Since the Henry’s Transaction, our income tax (provision) benefit has been based on the new tax return filing group. Although we were structured as a limited liability company, we elected to be taxed as a corporation for income tax purposes. We are subject to federal income tax as well as state income tax in various jurisdictions of the United States in which we conduct business. Income taxes are accounted for under the asset and liability method.

On July 29, 2013, Sprouts Farmers Markets, LLC, a Delaware limited liability company, converted into Sprouts Farmers Market, Inc., a Delaware corporation and the issuer of the shares of common stock offered by this prospectus. See “—Factors Affecting Comparability of Result of Operations—Corporate Conversion.” The corporate conversion has not had a material impact on our results of operations, financial position or cash flows since we were treated as a corporation for income tax purposes prior to the conversion.

In September 2013, the Internal Revenue Service issued final regulations related to tangible property, which govern when a taxpayer must capitalize or deduct expenses for acquiring, maintaining, repairing and replacing tangible property. The regulations are effective for tax years beginning January 1, 2014; however, early adoption is permitted. We have analyzed the impacts of the tangible property regulations, and have determined we are in compliance with the regulations. The adoption of the regulations will not have a significant effect on our consolidated financial statements.

 

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Factors Affecting Comparability of Results of Operations

Henry’s Transaction

Apollo held a controlling interest in Henry’s former parent prior to the Henry’s Transaction and continued to hold a controlling interest in the Company afterwards. Due to Apollo’s continued controlling interest, the Henry’s Transaction resulted in Henry’s financial statements becoming the financial statements of the Company, followed immediately by the acquisition by the Company of the Sprouts Farmers Market business. As a result, the Company was determined to be the accounting acquirer, effective April 18, 2011. Accordingly, the results of operations for fiscal 2010 and for the period from January 3, 2011 through April 18, 2011 reflect the sales and expenses directly attributable to Henry’s operations and allocations of direct expenses from Henry’s previous parent company. These expenses were allocated to Henry’s on the basis that was considered to reflect fairly or reasonably the utilization of the services provided to, or the benefit obtained by, Henry’s. Historical financial statements for Henry’s prior to April 18, 2011 do not reflect the interest expense Henry’s might have incurred if it had been a stand-alone entity. Additionally, we would have expected to incur other expenses, not reflected in our historical financial statements prior to April 18, 2011, if Henry’s were to operate as a stand-alone entity. Commencing on April 18, 2011, our consolidated financial statements also include the financial position, results of operations and cash flows of Sprouts Arizona.

Sunflower Transaction

In May 2012, we acquired Sunflower in the Sunflower Transaction. Commencing on May 29, 2012, our consolidated financial statements also include the financial position, results of operations and cash flows of Sunflower.

Pro Forma Information

The effects of the Transactions have a material effect on the comparability of our results of operations. Consequently, we have supplemented the comparative discussion of our results of operations for fiscal 2012 and fiscal 2011 and for the thirty-nine weeks ended September 30, 2012 and September 29, 2013 with a comparative discussion of our historical results of operations on a pro forma basis for fiscal 2012, fiscal 2011 and the thirty-nine weeks ended September 30, 2012. In this discussion, pro forma statement of operations information for fiscal 2011 gives pro forma effect to the Transactions as if they were consummated on the first day of fiscal 2011, as set out in “—Unaudited Supplemental Fiscal 2011 Pro Forma Information” below. The unaudited supplemental pro forma information for fiscal 2011 was prepared in a manner comparable to the requirements of Article 11 of Regulation S-X, but does not comply with Article 11 in that Rule 11-02(c) of Article 11 does not allow for the presentation of pro forma condensed statements of operations prior to the most recent year. The unaudited supplemental pro forma information for fiscal 2011 reflects the impact of the Transactions using the assumptions set forth in the notes to the unaudited supplemental pro forma information for fiscal 2011. Pro forma statement of operations information for fiscal 2012 and for the thirty-nine weeks ended September 30, 2012 gives effect to the Sunflower Transaction as if it was consummated on the first day of fiscal 2012 as set out under “Pro Forma for the Sunflower Transaction” in “Unaudited Pro Forma Condensed Consolidated Financial Information.” This fiscal 2012 and thirty-nine weeks ended September 30, 2012 pro forma information presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” does not include the impact of the April 2013 Refinancing or the IPO since these transactions do not affect the comparability of our historical results of operations.

 

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April 2013 Refinancing

In April 2013, we completed the April 2013 Refinancing, a transaction in which we refinanced our debt and made a distribution to our equity and option holders, as further discussed in “—Liquidity and Capital Resources” below. The April 2013 Refinancing resulted in an increase in borrowings and reduction in interest rate commencing in April 2013.

Corporate Conversion

In connection with our IPO, on July 29, 2013, Sprouts Farmers Markets, LLC, a Delaware limited liability company, converted into Sprouts Farmers Market, Inc., a Delaware corporation and the issuer of the shares offered by the selling stockholders by this prospectus. As part of the corporate conversion, holders of membership interests of Sprouts Farmers Markets, LLC in the form of Class A and Class B units received 11 shares of our common stock for each unit held immediately prior to the corporate conversion, and options to purchase units became options to purchase 11 shares of our common stock for each unit underlying options outstanding immediately prior to the corporate conversion, at the same aggregate exercise price in effect prior to the corporate conversion. For the convenience of the reader, except where the context otherwise requires, information in this prospectus has been presented giving effect to the corporate conversion. The corporate conversion has not had a material impact on the comparability of our results of operations, since we were treated as a corporation for income tax purposes prior to the conversion.

IPO

On August 6, 2013, we completed our initial public offering of 21,275,000 shares of common stock of Sprouts Farmers Market, Inc., including 2,775,000 shares of common stock issued as a result of the exercise in full of the underwriters’ option to purchase additional shares, at a price of $18.00 per share. We sold 20,477,215 shares of common stock, including the additional shares, and certain stockholders sold the remaining 797,785 shares.

We received net proceeds from our IPO of approximately $344.1 million, after deducting underwriting discounts and offering expenses. We used the net proceeds to repay $340.0 million of outstanding indebtedness under the Term Loan and for general corporate purposes.

 

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Results of Operations for Thirty-Nine Weeks Ended September 29, 2013 and September 30, 2012

The following tables set forth our unaudited results of operations, supplemental pro forma information 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
		September 30, 2012 (As Reported)				September 30, 2012 (Pro Forma)				September 29, 2013 (As Reported)
		(in thousands)
Unaudited Quarterly Consolidated Statement of Operations Data and Supplemental Pro Forma Information(1):
Net sales		$	1,315,882			$	1,512,022			$	1,829,675
Cost of sales, buying and occupancy			921,955				1,060,573				1,278,623
Gross profit			393,927				451,449				551,052
Direct store expenses			268,279				303,726				367,064
Selling, general and administrative expenses			64,846				70,109				60,259
Store pre-opening costs			2,070				4,506				5,254
Store closure and exit costs			3,552				3,611				1,670
Income from operations			55,180				69,497				116,805
Interest expense			(25,414	)			(30,352	)			(30,346	)
Other income			201				288				447
Loss on extinguishment of debt			(992	)			(992	)			(17,682	)
Income before income taxes			28,975				38,441				69,224
Income tax provision			(12,816	)			(17,382	)			(27,178	)
Net income		$	16,159			$	21,059			$	42,046

 

(1)

Unaudited supplemental pro forma information for the thirty-nine weeks ended September 30, 2012 gives effect to the Sunflower Transaction as if it was consummated on the first day of fiscal 2012. See “Unaudited Pro Forma Condensed Consolidated Financial Information” for pro forma information for the thirty-nine weeks ended September 30, 2012 presented as “Pro Forma for Sunflower Transaction.”

 

		Thirty-Nine weeks ended
		September 30, 2012				September 29, 2013
Pro forma comparable store sales growth(2)			10.1	%			9.7	%
Other Operating Data:
Stores at beginning of period			103				148
Opened			9				19
Acquired			37				—
Closed			(1	)			—
Stores at end of period			148				167

 

(2)	See the explanation of “pro forma comparable store sales growth” above under “Components of Operating Results—Net Sales.”

 

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Comparison of Thirty-Nine Weeks Ended September 29, 2013 to Thirty-Nine Weeks Ended September 30, 2012 and Pro Forma Thirty-Nine Weeks Ended September, 2012

Net sales

 

		Thirty-Nine weeks ended
		September 30, 2012 (As Reported)				September 29, 2013				Change				% Change
Net sales		$	1,315,882			$	1,829,675			$	513,793				39	%

		Thirty-Nine weeks ended
		September 30, 2012 (Pro Forma)				September 29, 2013				Change				% Change
Net sales		$	1,512,022			$	1,829,675			$	317,653				21	%
Pro forma comparable store sales growth			10.1	%			9.7	%

Net sales increased during the thirty-nine weeks ended September 29, 2013 as compared to the thirty-nine weeks ended September 30, 2012, primarily as a result of (i) stores added through the Sunflower Transaction in fiscal 2012, (ii) new store openings and (iii) sales growth at stores operated prior to the thirty-nine weeks ended September 30, 2012.

Stores added through the Sunflower Transaction contributed $233.4 million, or 45%, of the increase in net sales in the thirty-nine weeks ended September 29, 2013. New store openings during the thirty-nine weeks ended September 29, 2013 contributed $123.0 million, or 24%, of the increase in net sales during the thirty-nine weeks ended September 29, 2013. The remaining $159.3 million, or 31%, of the increase in net sales resulted from net sales growth at stores operated prior to September 30, 2012. These increases were partially offset by $2.0 million of net sales related to a store closed in 2012.

Comparing the thirty-nine weeks ended September 29, 2013 to the pro forma thirty-nine weeks ended September 30, 2012, net sales increased primarily as a result of pro forma comparable store sales growth and new store openings during fiscal 2012 and the thirty-nine weeks ended September 29, 2013. Pro forma comparable store sales growth of 9.7% during the thirty-nine weeks ended September 29, 2013 contributed $144.0 million, or 45% of the increase in pro forma net sales. New store openings during the thirty-nine weeks ended September 29, 2013 contributed $123.0 million, or 39%, of the increase in net sales. The remaining $50.7 million, or 16%, of the increase in net sales was attributable to new store openings during fiscal 2012 not yet reflected in pro forma comparable store sales growth.

Cost of sales, buying and occupancy and gross profit

 

		Thirty-Nine weeks ended
		September 30, 2012 (As Reported)				September 29, 2013				Change				% Change
Net sales		$	1,315,882			$	1,829,675			$	513,793				39	%
Cost of sales, buying and occupancy			921,955				1,278,623				356,668				39	%
Gross profit			393,927				551,052				157,125				40	%
Gross margin			29.9	%			30.1	%			0.2	%

 

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		Thirty-Nine weeks ended
		September 30, 2012 (Pro Forma)				September 29, 2013				Change				% Change
Net sales		$	1,512,022			$	1,829,675			$	317,653				21	%
Cost of sales, buying and occupancy			1,060,573				1,278,623				218,050				21	%
Gross profit			451,449				551,052				99,603				22	%
Gross margin			29.9	%			30.1	%			0.2	%

Cost of sales, buying and occupancy increased during the thirty-nine weeks ended September 29, 2013 compared to the thirty-nine weeks ended September 30, 2012, primarily due to the increase in sales following the Sunflower Transaction, new store openings and comparable store sales growth, as discussed above. During the thirty-nine weeks ended September 29, 2013, gross profit increased $153.8 million as a result of increased sales volume and $3.3 million as a result of an increase in gross margin. The 20 basis point increase in gross margin during the thirty-nine weeks ended September 29, 2013 reflects decreases in occupancy expenses as a percentage of net sales due to operating leverage offset slightly by decreased food margin related to lower margins in produce driven by inflation in certain commodity items and lower margins in the vitamin and supplement and body care departments due to merchandise alignment across Sprouts and former Henry’s and Sunflower stores.

Comparing the thirty-nine weeks ended September 29, 2013 to the pro forma thirty-nine weeks ended September 30, 2012, cost of sales, buying and occupancy increased primarily due to the factors noted above.

Direct store expenses

 

		Thirty-Nine weeks ended
		September 30, 2012 (As Reported)				September 29, 2013				Change				% Change
Direct store expenses		$	268,279			$	367,064			$	98,785				37	%
Percentage of net sales			20.4	%			20.1	%			(0.3	)%
		Thirty-Nine weeks ended
		September 30, 2012 (Pro Forma)				September 29, 2013				Change				% Change
Direct store expenses		$	303,726			$	367,064			$	63,338				21	%
Percentage of net sales			20.1	%			20.1	%			—	%

Direct store expenses increased during the thirty-nine weeks ended September 29, 2013 compared to the thirty-nine weeks ended September 30, 2012, primarily due to $47.1 million of direct store expenses associated with additional stores we operated during the thirty-nine weeks ended September 29, 2013 related to the Sunflower Transaction and new store openings. Direct store expenses, as a percentage of net sales, decreased 30 basis points primarily related to a reduction in non-capitalizable store development costs as a percentage of sales.

Comparing the thirty-nine weeks ended September 29, 2013 to the pro forma thirty-nine weeks ended September 30, 2012, direct store expenses increased due to $25.2 million of direct store expenses associated with new store openings in 2013. The remainder of the increase is related to stores that were opened during or prior to 2012. Direct store expenses increased as a percentage of net sales were consistent with those of the thirty-nine weeks ended September 30, 2012.

 

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Selling, general and administrative expenses

 

		Thirty-Nine weeks ended
		September 30, 2012 (As Reported)				September 29, 2013				Change				% Change
Selling, general and administrative expenses		$	64,846			$	60,259			$	(4,587	)			(7	)%
Percentage of net sales			4.9	%			3.3	%			(1.6	)%
		Thirty-Nine weeks ended
		September 30, 2012 (Pro Forma)				September 29, 2013				Change				% Change
Selling, general and administrative expenses		$	70,109			$	60,259			$	(9,850	)			(14	)%
Percentage of net sales			4.6	%			3.3	%			(1.3	)%

The decrease in selling, general and administrative expenses during the thirty-nine weeks ended September 29, 2013 includes a $16.3 million decrease in acquisition and integration costs and $2.7 million related to settlement of a tradename dispute recorded in 2012. These decreases were partially offset by $3.2 million of bonuses paid in conjunction with our IPO, a $2.0 million increase in advertising, a $2.8 million increase in expenses related to technology initiatives, a $1.9 million increase in regional personnel and travel expenses related to increased store count, $1.2 million of increased equity-based compensation and payroll taxes including expense related to the anti-dilution payments made in April 2013, $1.0 million of IPO related expenses and $1.0 million in payroll and benefits. Selling, general and administrative expenses decreased as a percentage of net sales during the thirty-nine weeks ended September 29, 2013 due to improved leverage of fixed selling, general and administrative expenses, primarily as a result of comparable store sales growth, synergies achieved from the integration of the Sunflower Transaction and the decrease in acquisition and integration costs described above.