Change in Accounting Principle In the fourth quarter of fiscal 2018, the Company made a voluntary change in its accounting policy for the classification of certain expenses. Historically, the Company has presented store occupancy costs and buying costs in cost of goods sold. Under the new policy, the Company is presenting these expenses within selling, general and administrative expenses ("SG&A"). In addition, the Company changed the classification of depreciation and amortization (exclusive of supply chain-related depreciation included in cost of sales) from direct store expenses ("DSE") and SG&A to a separate financial statement line item and combined DSE and store pre-opening costs into SG&A. These reclassifications had no impact on sales, income from operations, net income or earnings per share. In addition, there was no cumulative effect to retained earnings, equity, or net assets. The Company made this voluntary change in accounting policy in order to better reflect the direct costs of acquiring products and making them available to its customers in cost of sales. Store occupancy costs and buying costs, which are largely sales and marketing driven, are more appropriately reflected in SG&A. The new presentation of operating expenses now largely disaggregates cash from non-cash operating expenses, which the Company believes provides better information to its financial statement users. The Company believes these changes are preferable because they enhance the comparability of its financial statements with those of many of its industry peers and align with how the Company internally manages and reviews costs and margin. These changes in presentation have been retrospectively applied to all prior periods. Refer to the tables below for the impact to the years currently presented: Cost of sales Gross profit Direct store expenses Selling, general and administrative expenses Depreciation and amortization (exclusive of depreciation included in cost of sales) Store pre-opening costs Year Ended December 31, 2017 Change in Accounting Unadjusted Principle As Adjusted $3,314,487 $ (216,905) $3,097,582 1,350,125 216,905 1,567,030 962,894 (962,894) 148,408 1,097,232 1,245,640 94,194 94,194 (11,627) 11,627 Cost of sales Gross profit Direct store expenses Selling, general and administrative expenses Depreciation and amortization (exclusive of depreciation included in cost of sales) Store pre-opening costs Year Ended January 1, 2017 Change in Accounting Unadjusted Principle As Adjusted $2,864,379 $(181,442) $2,682,937 1,182,006 181,442 1,363,448 828,943 (828,943) 126,929 945,066 1,071,995 78,293 78,293 (12,974) 12,974 SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Description of Business Sprouts Farmers Market, Inc., a Delaware corporation, through its subsidiaries, operates as a healthy grocery store that offers fresh, natural and organic food through a complete shopping experience that includes fresh produce, bulk foods, vitamins and supplements, packaged groceries, meat and seafood, baked goods, dairy products, frozen foods, beer and wine, natural body care and household items catering to consumers' growing interest in health and wellness. As of December 30, 2018, the Company operated 313 stores in 19 states. For convenience, the "Company" is used to refer collectively to Sprouts Farmers Market, Inc. and, unless the context requires otherwise, its subsidiaries. The Company's store operations are conducted by its subsidiaries. 2. Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries in accordance with accounting principles generally accepted in the United States of America ("GAAP"). All material intercompany accounts and transactions have been eliminated in consolidation. The Company has one reportable and one operating segment, healthy grocery stores. The Company categorizes the varieties of products it sells as perishable and non-perishable. Perishable product categories include produce, meat, seafood, deli, bakery, floral and dairy and dairy alternatives. Non-perishable product categories include grocery, vitamins and supplements, bulk items, frozen foods, beer and wine, and natural health and body care. The following is a breakdown of the Company's perishable and non-perishable sales mix: Perishables Non-Perishables 2018 57.5% 42.5% 2017 58.0% 42.0% 2016 58.1% 41.9% All dollar amounts are in thousands, unless otherwise indicated. Certain prior period amounts have been reclassified, such as those relating to store occupancy, buying, direct store expenses, pre-opening expenses and depreciation and amortization (exclusive of depreciation included in cost of sales), due to the Company's change in accounting principle in fiscal 2018. See Note 3, "Significant Accounting Policies" for further information. 3. Significant Accounting Policies Fiscal Years The Company reports its results of operations on a 52- or 53-week fiscal calendar ending on the Sunday closest to December 31. Fiscal year 2018 ended on December 30, 2018 and included 52-weeks. Fiscal year 2017 ended on December 31, 2017 and included 52-weeks, fiscal year 2016 ended on January 1, 2017 and included 52-weeks. Fiscal years 2018, 2017, and 2016 are referred to as 2018, 2017, and 2016, respectively. 10. (9 points) Calculate the following profitability ratios for the current year and give a one sentence description of each result. a. Profit Margin Ratio b. Rate of return on Total Assets Page 1 c. Return on Common Stockholders' Equity (ROE) 11. (6 points) Calculate the following solvency ratios for the current year and give a one sentence description of each result. a. Debt to assets ratio b. Debt to Equity ratio (total liabilities / total equity) c. Times Interest Earned Ratio 12. (2 points) Calculate the free cash flow of the company for the most current year (Hint: use the formula given in the book on page 17-17) FOR QUESTIONS 13 15: LOOK AT THE NOTES TO THE FINANCIAL STATEMENTS (beginning on page 6) 13. (1 Point) In what state did Sprouts Farmers Market, Inc. incorporate? 14.(1 Point) For 2018, what percentage of the company's sales were from Perishables"? 15. (1 Point) What does the company estimate for the useful life of its buildings for depreciation purposes? Formula Purpose or Use Ratio 1. Liquidity 1. Current ratio Measures short-term debt-paying ability Current assets Current liabilities 2. Quick or acid-test ratio Measures immediate short-term liquidity Cash, marketable securities, and receivables (net) Current liabilities Net cash provided by operating activities Average current liabilities 3. Current cash debt coverage ratio Measures a company's ability to pay off its current liabilities in a given year from its operations II. Activity 4. Receivables turnover Measures liquidity of receivables 5. Inventory turnover Measures liquidity of inventory Net sales Average trade receivables (net) Cost of goods sold Average inventory Net sales Average total assets 6. Asset turnover Measures how efficiently assets are used to generate sales III. Profitability 7. Profit margin on sales Net income Net sales Measures net income generated by each dollar of sales 8. Rate of return on assets Measures overall profitability of assets Net income Average total assets Net income minus preferred dividends Average common stockholders' equity Measures profitability of owners' investment 9. Rate of return on common stock equity 10. Earnings per share Measures net income earned on each share of common stock 11. Price-earnings ratio Net income minus preferred dividends Weighted shares outstanding Market price of stock Earnings per share Cash dividends Net income Measures the ratio of the market price per share to earnings per share Measures percentage of earnings distributed in the form of cash dividends 12. Payout ratio IV. Coverage 13. Debt to total assets Measures the percentage of total assets provided by creditors Total debts Total assets Income before interest expense and taxes Interest expense 14. Times interest earned Measures ability to meet interest payments as they come due SPROUTS FARMERS MARKET, INC. AND SUBSIDIARII CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) December 30, 2018 $ 158,536 110,749 799 683 4,115 14,512 23,333 (7,666) (34,824) (2,908) (5,086) 4,366 3,039 24,731 294,379 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense Amortization of financing fees and debt issuance costs Loss on disposal of property and equipment Store closure and other costs Share-based compensation Deferred income taxes Changes in operating assets and liabilities: Accounts receivable Inventories Prepaid expenses and other current assets Other assets Accounts payable and other accrued liabilities Accrued salaries and benefits Other long-term liabilities Cash flows from operating activities Cash flows from investing activities Purchases of property and equipment Proceeds from sale of property and equipment Purchase of leasehold interests Cash flows used in investing activities Cash flows from financing activities Proceeds from revolving credit facilities Payments on revolving credit facilities Payments on capital and financing lease obligations Payments of deferred financing costs Cash from landlord related to capital and financing lease obligations Repurchase of common stock Proceeds from exercise of stock options Excess tax benefit for exercise of stock options Other Cash flows used in financing activities (Decrease) increase in cash, cash equivalents, and restricted cash Cash, cash equivalents, and restricted cash at beginning of the period Cash, cash equivalents, and restricted cash at the end of the period (177,083) (177,082) 233,000 (128,000) (4,517) (2,131) 3,643 (258,307) 21,843 (59) (134,528) (17,231) 19,479 2,248 $ Supplemental disclosure of cash flow information Cash paid for interest Cash paid for income taxes $ 27,086 15,527 Supplemental disclosure of non-cash investing and financing activities Property and equipment in accounts payable Property acquired through capital and financing lease obligations $ 12,001 9,081 December 30, 2018 (1) Net sales $ 5,207,336 Cost of sales 3,459,861 Gross profit 1,747,475 Selling, general and administrative expenses 1,404,443 Depreciation and amortization (exclusive of depreciation included in cost of sales) 108,045 Store closure and other costs 12,076 Income from operations 222,911 Interest expense (27,435) Other income 320 Income before income taxes 195,796 Income tax provision (37,260) Net income $ 158,536 Net income per share: Basic 1.23 Diluted 1.22 Weighted average shares outstanding: Basic 128,827 Diluted 129,776 A A SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Accumulated Other Comprehensive Income (Loss) (Accumulated Additional Deficit) Common Paid-in Retained Stock Capital Earnings 153 $ 577,393 $ 245,446 124,306 Shares 152,577,884 $ Total Stockholders' Equity 822,992 124,306 666,841 2,740 2,740 (13,242,483) (13) (294,252) (294,265) 3,737 13,399 597,269 $ 3,737 13,399 672,909 158,440 140,002,242 $ 140 $ 75,500 158,440 (784) (784) 2,144,669 2 9,298 9,300 Balances at January 3, 2016 Net income Issuance of shares under stock plans Repurchase and retirement of common stock Excess tax benefit for exercise of options Share-based compensation Balances at January 1, 2017 Net income Other comprehensive income (loss) Issuance of shares under stock plans Repurchase and retirement of common stock Share-based compensation Balances at December 31, 2017 Net income Other comprehensive income (loss) Issuance of shares under stock plans Repurchase and retirement of common stock Share-based compensation Balances at December 30, 2018 (9,696,819) (10) (203,382) (203,392) 14,221 14,221 132,450,092 $ 132 $ 620,788 $ (784) $ 30,558 158,536 650,694 158,536 1,918 1,918 3,227,693 3 21,840 21,843 (11,096,595) (11) (258,296) (258,307) 14,512 14,512 124,581,190 $ 124 $ 657,140 $ (69,202) $ 1,134 $ 589, 196 Change in Accounting Principle In the fourth quarter of fiscal 2018, the Company made a voluntary change in its accounting policy for the classification of certain expenses. Historically, the Company has presented store occupancy costs and buying costs in cost of goods sold. Under the new policy, the Company is presenting these expenses within selling, general and administrative expenses ("SG&A"). In addition, the Company changed the classification of depreciation and amortization (exclusive of supply chain-related depreciation included in cost of sales) from direct store expenses ("DSE") and SG&A to a separate financial statement line item and combined DSE and store pre-opening costs into SG&A. These reclassifications had no impact on sales, income from operations, net income or earnings per share. In addition, there was no cumulative effect to retained earnings, equity, or net assets. The Company made this voluntary change in accounting policy in order to better reflect the direct costs of acquiring products and making them available to its customers in cost of sales. Store occupancy costs and buying costs, which are largely sales and marketing driven, are more appropriately reflected in SG&A. The new presentation of operating expenses now largely disaggregates cash from non-cash operating expenses, which the Company believes provides better information to its financial statement users. The Company believes these changes are preferable because they enhance the comparability of its financial statements with those of many of its industry peers and align with how the Company internally manages and reviews costs and margin. These changes in presentation have been retrospectively applied to all prior periods. Refer to the tables below for the impact to the years currently presented: Cost of sales Gross profit Direct store expenses Selling, general and administrative expenses Depreciation and amortization (exclusive of depreciation included in cost of sales) Store pre-opening costs Year Ended December 31, 2017 Change in Accounting Unadjusted Principle As Adjusted $3,314,487 $ (216,905) $3,097,582 1,350,125 216,905 1,567,030 962,894 (962,894) 148,408 1,097,232 1,245,640 94,194 94,194 (11,627) 11,627 Cost of sales Gross profit Direct store expenses Selling, general and administrative expenses Depreciation and amortization (exclusive of depreciation included in cost of sales) Store pre-opening costs Year Ended January 1, 2017 Change in Accounting Unadjusted Principle As Adjusted $2,864,379 $(181,442) $2,682,937 1,182,006 181,442 1,363,448 828,943 (828,943) 126,929 945,066 1,071,995 78,293 78,293 (12,974) 12,974 SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Description of Business Sprouts Farmers Market, Inc., a Delaware corporation, through its subsidiaries, operates as a healthy grocery store that offers fresh, natural and organic food through a complete shopping experience that includes fresh produce, bulk foods, vitamins and supplements, packaged groceries, meat and seafood, baked goods, dairy products, frozen foods, beer and wine, natural body care and household items catering to consumers' growing interest in health and wellness. As of December 30, 2018, the Company operated 313 stores in 19 states. For convenience, the "Company" is used to refer collectively to Sprouts Farmers Market, Inc. and, unless the context requires otherwise, its subsidiaries. The Company's store operations are conducted by its subsidiaries. 2. Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries in accordance with accounting principles generally accepted in the United States of America ("GAAP"). All material intercompany accounts and transactions have been eliminated in consolidation. The Company has one reportable and one operating segment, healthy grocery stores. The Company categorizes the varieties of products it sells as perishable and non-perishable. Perishable product categories include produce, meat, seafood, deli, bakery, floral and dairy and dairy alternatives. Non-perishable product categories include grocery, vitamins and supplements, bulk items, frozen foods, beer and wine, and natural health and body care. The following is a breakdown of the Company's perishable and non-perishable sales mix: Perishables Non-Perishables 2018 57.5% 42.5% 2017 58.0% 42.0% 2016 58.1% 41.9% All dollar amounts are in thousands, unless otherwise indicated. Certain prior period amounts have been reclassified, such as those relating to store occupancy, buying, direct store expenses, pre-opening expenses and depreciation and amortization (exclusive of depreciation included in cost of sales), due to the Company's change in accounting principle in fiscal 2018. See Note 3, "Significant Accounting Policies" for further information. 3. Significant Accounting Policies Fiscal Years The Company reports its results of operations on a 52- or 53-week fiscal calendar ending on the Sunday closest to December 31. Fiscal year 2018 ended on December 30, 2018 and included 52-weeks. Fiscal year 2017 ended on December 31, 2017 and included 52-weeks, fiscal year 2016 ended on January 1, 2017 and included 52-weeks. Fiscal years 2018, 2017, and 2016 are referred to as 2018, 2017, and 2016, respectively. 10. (9 points) Calculate the following profitability ratios for the current year and give a one sentence description of each result. a. Profit Margin Ratio b. Rate of return on Total Assets Page 1 c. Return on Common Stockholders' Equity (ROE) 11. (6 points) Calculate the following solvency ratios for the current year and give a one sentence description of each result. a. Debt to assets ratio b. Debt to Equity ratio (total liabilities / total equity) c. Times Interest Earned Ratio 12. (2 points) Calculate the free cash flow of the company for the most current year (Hint: use the formula given in the book on page 17-17) FOR QUESTIONS 13 15: LOOK AT THE NOTES TO THE FINANCIAL STATEMENTS (beginning on page 6) 13. (1 Point) In what state did Sprouts Farmers Market, Inc. incorporate? 14.(1 Point) For 2018, what percentage of the company's sales were from Perishables"? 15. (1 Point) What does the company estimate for the useful life of its buildings for depreciation purposes? Formula Purpose or Use Ratio 1. Liquidity 1. Current ratio Measures short-term debt-paying ability Current assets Current liabilities 2. Quick or acid-test ratio Measures immediate short-term liquidity Cash, marketable securities, and receivables (net) Current liabilities Net cash provided by operating activities Average current liabilities 3. Current cash debt coverage ratio Measures a company's ability to pay off its current liabilities in a given year from its operations II. Activity 4. Receivables turnover Measures liquidity of receivables 5. Inventory turnover Measures liquidity of inventory Net sales Average trade receivables (net) Cost of goods sold Average inventory Net sales Average total assets 6. Asset turnover Measures how efficiently assets are used to generate sales III. Profitability 7. Profit margin on sales Net income Net sales Measures net income generated by each dollar of sales 8. Rate of return on assets Measures overall profitability of assets Net income Average total assets Net income minus preferred dividends Average common stockholders' equity Measures profitability of owners' investment 9. Rate of return on common stock equity 10. Earnings per share Measures net income earned on each share of common stock 11. Price-earnings ratio Net income minus preferred dividends Weighted shares outstanding Market price of stock Earnings per share Cash dividends Net income Measures the ratio of the market price per share to earnings per share Measures percentage of earnings distributed in the form of cash dividends 12. Payout ratio IV. Coverage 13. Debt to total assets Measures the percentage of total assets provided by creditors Total debts Total assets Income before interest expense and taxes Interest expense 14. Times interest earned Measures ability to meet interest payments as they come due SPROUTS FARMERS MARKET, INC. AND SUBSIDIARII CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) December 30, 2018 $ 158,536 110,749 799 683 4,115 14,512 23,333 (7,666) (34,824) (2,908) (5,086) 4,366 3,039 24,731 294,379 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense Amortization of financing fees and debt issuance costs Loss on disposal of property and equipment Store closure and other costs Share-based compensation Deferred income taxes Changes in operating assets and liabilities: Accounts receivable Inventories Prepaid expenses and other current assets Other assets Accounts payable and other accrued liabilities Accrued salaries and benefits Other long-term liabilities Cash flows from operating activities Cash flows from investing activities Purchases of property and equipment Proceeds from sale of property and equipment Purchase of leasehold interests Cash flows used in investing activities Cash flows from financing activities Proceeds from revolving credit facilities Payments on revolving credit facilities Payments on capital and financing lease obligations Payments of deferred financing costs Cash from landlord related to capital and financing lease obligations Repurchase of common stock Proceeds from exercise of stock options Excess tax benefit for exercise of stock options Other Cash flows used in financing activities (Decrease) increase in cash, cash equivalents, and restricted cash Cash, cash equivalents, and restricted cash at beginning of the period Cash, cash equivalents, and restricted cash at the end of the period (177,083) (177,082) 233,000 (128,000) (4,517) (2,131) 3,643 (258,307) 21,843 (59) (134,528) (17,231) 19,479 2,248 $ Supplemental disclosure of cash flow information Cash paid for interest Cash paid for income taxes $ 27,086 15,527 Supplemental disclosure of non-cash investing and financing activities Property and equipment in accounts payable Property acquired through capital and financing lease obligations $ 12,001 9,081 December 30, 2018 (1) Net sales $ 5,207,336 Cost of sales 3,459,861 Gross profit 1,747,475 Selling, general and administrative expenses 1,404,443 Depreciation and amortization (exclusive of depreciation included in cost of sales) 108,045 Store closure and other costs 12,076 Income from operations 222,911 Interest expense (27,435) Other income 320 Income before income taxes 195,796 Income tax provision (37,260) Net income $ 158,536 Net income per share: Basic 1.23 Diluted 1.22 Weighted average shares outstanding: Basic 128,827 Diluted 129,776 A A SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Accumulated Other Comprehensive Income (Loss) (Accumulated Additional Deficit) Common Paid-in Retained Stock Capital Earnings 153 $ 577,393 $ 245,446 124,306 Shares 152,577,884 $ Total Stockholders' Equity 822,992 124,306 666,841 2,740 2,740 (13,242,483) (13) (294,252) (294,265) 3,737 13,399 597,269 $ 3,737 13,399 672,909 158,440 140,002,242 $ 140 $ 75,500 158,440 (784) (784) 2,144,669 2 9,298 9,300 Balances at January 3, 2016 Net income Issuance of shares under stock plans Repurchase and retirement of common stock Excess tax benefit for exercise of options Share-based compensation Balances at January 1, 2017 Net income Other comprehensive income (loss) Issuance of shares under stock plans Repurchase and retirement of common stock Share-based compensation Balances at December 31, 2017 Net income Other comprehensive income (loss) Issuance of shares under stock plans Repurchase and retirement of common stock Share-based compensation Balances at December 30, 2018 (9,696,819) (10) (203,382) (203,392) 14,221 14,221 132,450,092 $ 132 $ 620,788 $ (784) $ 30,558 158,536 650,694 158,536 1,918 1,918 3,227,693 3 21,840 21,843 (11,096,595) (11) (258,296) (258,307) 14,512 14,512 124,581,190 $ 124 $ 657,140 $ (69,202) $ 1,134 $ 589, 196