# Sprouts Farmers Market, Inc. (SFM) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Sprouts Farmers Market, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1575515/000095017023005723/sfm-20230101.htm
Accession: 0000950170-23-005723
Filing date: 2023-03-02
Report date: 2023-01-01
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SFM/
All MD&A years: /company/SFM/mda/
Previous year: /company/SFM/mda/fy2022/ (FY 2022)
Next year: /company/SFM/mda/fy2023/ (FY 2023)

Item 7. 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 the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K as well as "Part II—Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the fiscal year ended January 2, 2022 filed with the SEC on February 24, 2022, which provides comparisons of fiscal 2021 and fiscal 2020, and which is incorporated by reference herein. 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 Annual Report on Form 10-K. Please also see the section entitled “Special Note Regarding Forward-Looking Statements.”

Business Overview

Sprouts Farmers Market offers a unique grocery experience featuring an open layout with fresh produce at the heart of the store. Sprouts inspires wellness naturally with a carefully curated assortment of better-for-you products paired with purpose-driven people. We continue to bring the latest in wholesome, innovative products made with lifestyle-friendly ingredients such as organic, plant-based and gluten-free. Headquartered in Phoenix with 386 stores in 23 states as of January 1, 2023, we are one of the largest and fastest growing specialty retailers of fresh, natural and organic food in the United States.

Our Heritage

In 2002, we opened the first Sprouts Farmers Market store in Chandler, Arizona. From our founding in 2002 through January 1, 2023, we have grown rapidly, significantly increasing our sales, store count and profitability, including successfully rebranding 43 Henry’s Farmers Market and 39 Sunflower Farmers Market stores added in 2011 and 2012, respectively, to the Sprouts banner through acquisitions. These three businesses all trace their lineage back to Henry’s Farmers Market and were built with similar store formats and operations including a strong emphasis on value, produce and service in smaller, convenient locations.

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Outlook

Since 2020, we have focused on our long-term growth strategy that we believe is transforming our company and driving profitable growth. We continue to execute on this strategy, focusing on the following areas:

•
Win with Target Customers. We are focusing attention on our target customers, identified through research as ‘health enthusiasts’ and ‘selective shoppers’, where there is ample opportunity to gain share within these customer segments. We believe our business can continue to grow by leveraging existing strengths in a unique assortment of better-for-you, quality products and by providing a full omnichannel offering through delivery or pickup via our website or the Sprouts app.

•
Update Format and Expand in Select Markets. We are delivering unique smaller stores with expectations of stronger returns, while maintaining the approachable, fresh-focused farmer’s market heritage Sprouts is known for. In 2021, we opened three stores and remodeled one store featuring our new format, and in 2022, we opened nine new format stores. Our geographic store expansion and new store placement will intersect where our target customers live, in markets with growth potential and supply chain support, which we believe will provide a long runway of at least 10% annual unit growth beginning in 2024.

•
Create an Advantaged Fresh Supply Chain. We believe our network of fresh distribution centers can drive efficiencies across the chain and support growth plans. To further deliver on our fresh commitment and reputation, as well as to increase our local offerings and improve financial results, we aspire to ultimately position fresh distribution centers within a 250-mile radius of stores. With the opening of two fresh distribution centers in 2021, we now have more than 85% of our stores within 250 miles of a distribution center.

•
Refine Brand and Marketing Approach. We believe we are elevating our national brand recognition and positioning by telling our unique brand story rooted in product innovation and differentiation. We are investing savings from largely removing our weekly promotional print ad into increasing engagement and personalization with our target customers through digital and social connections, driving additional sales growth and loyalty.

•
Inspire and Engage Our Talent to Create a Best Place to Work. Subsequent to the initial launch of our long-term growth strategy, we have added the focus area of inspiring and engaging our talent through our culture, acquisition and development and total rewards program to attract and retain the talent we believe we need to execute on our strategic goals and transform our company into a premier place to work.

•
Deliver on Financial Targets and Box Economics. We are measuring and reporting on the success of this strategy against a number of long-term financial and operational targets. With the implementation of our strategy beginning in 2020, we have significantly improved our margin structure above our 2019 baseline.

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 2022 and fiscal 2021 were 52-week years ending on January 1, 2023 and January 2, 2022, respectively. Fiscal 2020 was a 53-week year ending on January 3, 2021.

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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. See Note 3, “Significant Accounting Policies” for additional information on revenue recognition related to gift cards. We do not include sales taxes in net sales.

We monitor our comparable store sales growth to evaluate and identify trends in our sales performance. 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 on the day of closure. This practice may differ from the methods that other retailers use to calculate similar measures.

Historically, our net sales have increased as a result of new store openings and comparable store sales growth. Additional factors that influence comparable store sales growth and other sales trends include:

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

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

•
consumer preferences and buying trends;

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

•
the number of customer transactions and average ticket;

•
the prices of our products, including the effects of factors beyond our control, such as inflation, deflation and tariffs;

•
opening new stores in the vicinity of our existing stores; and

•
advertising, in-store merchandising and other marketing activities.

Cost of sales 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, and depreciation and amortization expense for distribution centers and supply chain-related assets. Merchandise incentives received from vendors, which 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 largely depend upon competitive market conditions.

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

Selling, general and administrative expenses

Selling, general and administrative expenses primarily consist of salaries, wages and benefits costs, share-based compensation, store occupancy costs (including rent, property taxes, utilities, common area maintenance and insurance), advertising costs, buying costs, pre-opening and other administrative costs.

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Depreciation and Amortization

Depreciation and amortization (exclusive of depreciation included in cost of sales) primarily consists of depreciation and amortization for buildings, store leasehold improvements, and equipment.

Store closure and other costs, net

Store closure and other costs, net primarily reflects impairment charges of long-lived assets and costs incurred related to store closures, including severance and any exit costs associated with closing a store, in addition to occupancy costs associated with closed store locations. One-time disaster recovery and executive severance costs are also included here.

Results of Operations for Fiscal 2022, 2021 and 2020

The following tables set forth our results of operations and other operating data for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. Fiscal 2022 and 2021 consisted of 52 weeks, while Fiscal 2020 consisted of 53 weeks.

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Fiscal 2020"],["","","(in thousands, except per share data)"],["Consolidated Statement of Income Data:"],["Net sales","","$","6,404,223","","","$","6,099,869","","","$","6,468,759"],["Cost of sales","","","4,055,659","","","","3,890,657","","","","4,089,470"],["Gross profit","","","2,348,564","","","","2,209,212","","","","2,379,289"],["Selling, general and administrative expenses","","","1,855,649","","","","1,748,205","","","","1,863,869"],["Depreciation and amortization (exclusive of depreciation included in cost of sales)","","","123,530","","","","122,258","","","","124,124"],["Store closure and other costs, net","","","11,025","","","","4,673","","","","(369",")"],["Income from operations","","","358,360","","","","334,076","","","","391,665"],["Interest expense, net","","","9,047","","","","11,684","","","","14,787"],["Income before income taxes","","","349,313","","","","322,392","","","","376,878"],["Income tax provision","","","88,149","","","","78,235","","","","89,428"],["Net income","","$","261,164","","","$","244,157","","","$","287,450"],["Weighted average shares outstanding - basic","","","108,232","","","","115,377","","","","117,821"],["Dilutive effect of equity-based awards","","","907","","","","700","","","","403"],["Weighted average shares and equivalent shares outstanding - diluted","","","109,139","","","","116,077","","","","118,224"],["Diluted net income per share","","$","2.39","","","$","2.10","","","$","2.43"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Fiscal 2020"],["Other Operating Data:"],["Comparable store sales growth","","","2.2","%","","","(6.7",")%","","","6.9","%"],["Stores at beginning of period","","","374","","","","362","","","","340"],["Opened (1)","","","16","","","","12","","","","22"],["Closed","","","(4",")","","","\u2014","","","","\u2014"],["Stores at end of period","","","386","","","","374","","","","362"],["Selling square feet at the end of the period","","","10,894,396","","","","10,625,686","","","","10,344,669"],["Average store size at the end of the period (selling square feet)","","","28,224","","","","28,411","","","","28,576"]]
[[/GREPCENT_TABLE]]

(1)
Stores opened is exclusive of one store relocation during fiscal 2021.

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Comparison of Fiscal 2022 to 2021

Net sales

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Net sales","","$","6,404,223","","","$","6,099,869","","","$","304,354","","","","5","%"],["Comparable store sales growth","","","2.2","%","","","(6.7",")%"]]
[[/GREPCENT_TABLE]]

Net sales during 2022 totaled $6.4 billion, increasing 5%, over the prior fiscal year. The sales increase was primarily due to a 2.2% increase in comparable store sales as well as sales from new stores opened since the prior year. The increase in comparable store sales was due in part to an increase in basket value due to retail price inflation, partially offset by a slight reduction in the number of items per basket. Comparable store sales contributed approximately 97% of total sales for both 2022 and 2021.

Cost of sales and gross profit

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Net sales","","$","6,404,223","","","$","6,099,869","","","$","304,354","","","","5","%"],["Cost of sales","","","4,055,659","","","","3,890,657","","","","165,002","","","","4","%"],["Gross profit","","","2,348,564","","","","2,209,212","","","","139,352","","","","6","%"],["Gross margin","","","36.7","%","","","36.2","%","","","0.5","%"]]
[[/GREPCENT_TABLE]]

Gross profit increased during 2022 compared to 2021 by $139.4 million to $2.3 billion driven by increased sales volume for the reasons discussed above. Gross margin increased by 0.5% to 36.7% compared to 36.2%. The increase was a result of strategic initiatives to improve shrink, less promotional activity and better management of prices in line with inflationary product cost increases.

Selling, general and administrative expenses

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Selling, general and administrative expenses","","$","1,855,649","","","$","1,748,205","","","$","107,444","","","","6","%"],["Percentage of net sales","","","29.0","%","","","28.7","%","","","0.3","%"]]
[[/GREPCENT_TABLE]]

Selling, general and administrative expenses increased $107.4 million, or 6%, compared to 2021 due to the net increase in new stores opened since the prior year as well as inflationary conditions driving increases in store costs including wages, utilities and supplies. In addition, we experienced the effects of higher credit card fees as more consumers shifted to credit compared to the prior year and higher ecommerce costs resulting from an increase in ecommerce sales compared to the prior year.

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Depreciation and amortization

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Depreciation and amortization","","$","123,530","","","$","122,258","","","$","1,272","","","","1","%"],["Percentage of net sales","","","1.9","%","","","2.0","%","","","(0.1",")%"]]
[[/GREPCENT_TABLE]]

Depreciation and amortization expense (exclusive of depreciation included in cost of sales) was $123.5 million in 2022, compared to $122.3 million in 2021. Depreciation and amortization expenses (exclusive of depreciation included in cost of sales) primarily consists of depreciation and amortization for buildings, store leasehold improvements, and equipment for new stores as well as remodel initiatives in older stores.

Store closure and other costs, net

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Store closure and other costs, net","","$","11,025","","","$","4,673","","","$","6,352","","","","136","%"],["Percentage of net sales","","","0.2","%","","","0.1","%","","","0.1","%"]]
[[/GREPCENT_TABLE]]

Store closure and other costs, net in 2022 of $11.0 million primarily consisted of $8.1 million of impairment losses related to the write-down of leasehold improvements and right-of-use assets, in addition to inventory loss and expenses incurred by several of our stores impacted by Hurricane Ian and costs associated with the closing of four stores. Store closure and other costs, net in 2021 of $4.7 million primarily included $4.8 million of impairment losses related to the write-down of leasehold improvements and right-of-use assets.

Interest expense, net

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Long-term debt","","$","7,930","","","$","4,601","","","$","3,329","","","","72","%"],["Capital and financing leases","","","852","","","","906","","","","(54",")","","","(6",")%"],["Deferred financing costs","","","800","","","","564","","","","236","","","","42","%"],["Interest rate hedge and other","","","(535",")","","","5,613","","","","(6,148",")","","","(110",")%"],["Total interest expense, net","","$","9,047","","","$","11,684","","","$","(2,637",")","","","(23",")%"]]
[[/GREPCENT_TABLE]]

The decrease in interest expense, net was primarily due to higher interest income and lower credit facility fees. See Note 13, “Long-Term Debt and Finance Lease Liabilities” and Note 22, “Derivative Financial Instruments.”

Income tax provision

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Income tax provision","","$","88,149","","","$","78,235","","","$","9,914","","","","13","%"],["Effective income tax rate","","","25.2","%","","","24.3","%","","","0.9","%"]]
[[/GREPCENT_TABLE]]

Income tax provision increased by $9.9 million to $88.1 million for 2022 from $78.2 million for 2021, primarily related to an increase in income before income taxes. The effective income tax rate increased to 25.2% in 2022 from 24.3% in 2021 primarily due to decreased charitable contribution deductions in 2022 from the lapsing of benefits initially provided for in the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the "CARES Act").

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Net income

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(dollars in thousands)"],["Net income","","$","261,164","","","$","244,157","","","$","17,007","","","","7","%"],["Percentage of net sales","","","4.1","%","","","4.0","%","","","0.1","%"]]
[[/GREPCENT_TABLE]]

Net income increased $17.0 million primarily due to increased net sales and favorable margin impact, partially offset by higher selling, general and administrative expenses and a higher effective tax rate for the reasons discussed above.

Diluted earnings per share

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Change","","","% Change"],["","","(shares in thousands)"],["Diluted earnings per share","","$","2.39","","","$","2.10","","","$","0.29","","","","14","%"],["Diluted weighted average shares outstanding","","","109,139","","","","116,077","","","","(6,938",")"]]
[[/GREPCENT_TABLE]]

The increase in diluted earnings per share of $0.29 was driven by higher net income, in addition to fewer diluted shares outstanding compared to the prior year, due to our repurchase of approximately 6.9 million shares for a total cost of $200.0 million under our share repurchase program.

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Return on Invested Capital

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

We define ROIC as net operating profit after-tax (“NOPAT”), including the effect of operating leases, divided by average invested capital. Operating lease interest represents the add-back to operating income driven by the hypothetical interest expense we would incur if the property under our operating leases were owned or accounted for as a finance lease. The assumed ownership and associated interest expense are calculated using the discount rate for each lease as recorded as a component of rent expense within selling, general and administrative expenses. Invested capital reflects a trailing four-quarter average.

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

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

[[GREPCENT_TABLE]]
[["","","2022","","","2021","","","2020(1)"],["","","(dollars in thousands)"],["Net income (2)","","$","261,164","","","$","244,157","","","$","287,450"],["Special items, net of tax (3), (4)","","","\u2014","","","","\u2014","","","","6,565"],["Interest expense, net of tax (4)","","","6,764","","","","8,848","","","","11,272"],["Net operating profit after-tax (NOPAT)","","$","267,928","","","$","253,005","","","$","305,287"],["Total rent expense, net of tax (4)","","","154,626","","","","150,047","","","","146,630"],["Estimated depreciation on operating leases, net of tax (4)","","","(87,775",")","","","(88,015",")","","","(80,944",")"],["Estimated interest on operating leases, net of tax (4), (5)","","","66,851","","","","62,032","","","","65,686"],["NOPAT, including effect of operating leases","","$","334,779","","","$","315,037","","","$","370,973"],["Average working capital","","","271,604","","","","193,900","","","","101,622"],["Average property and equipment","","","704,786","","","","712,496","","","","735,651"],["Average other assets","","","568,609","","","","568,744","","","","567,188"],["Average other liabilities","","","(96,583",")","","","(101,339",")","","","(100,531",")"],["Average invested capital","","$","1,448,416","","","$","1,373,801","","","$","1,303,930"],["Average operating leases (6)","","","1,259,362","","","","1,222,513","","","","1,196,822"],["Average invested capital, including operating leases","","$","2,707,778","","","$","2,596,314","","","$","2,500,752"],["ROIC, including operating leases","","","12.4","%","","","12.1","%","","","14.8","%"]]
[[/GREPCENT_TABLE]]

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(1)
Fiscal 2020 includes 53 weeks.

(2)
Net income amounts represent total net income for the past four trailing quarters.

(3)
2020 special items include professional fees related to our strategic initiatives.

(4)
Net of tax amounts are calculated using the normalized effective tax rate for the periods presented.

(5)
2022, 2021 and 2020 estimated interest on operating leases is calculated by multiplying operating leases by the 7.1%, 6.7% and 7.2% discount rate, respectively, for each lease recorded as rent expense within direct store expense.

(6)
2022, 2021 and 2020 average operating leases represents the average net present value of outstanding lease obligations over the trailing four quarters.

Liquidity and Capital Resources

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

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","","Fiscal 2021","","","Fiscal 2020"],["Cash, cash equivalents and restricted cash at end of period","","$","295,192","","","$","247,004","","","$","171,441"],["Cash from operating activities","","$","371,329","","","$","364,799","","","$","494,035"],["Cash used in investing activities","","$","(124,010",")","","$","(102,378",")","","$","(121,968",")"],["Cash used in financing activities","","$","(199,131",")","","$","(186,858",")","","$","(287,411",")"]]
[[/GREPCENT_TABLE]]

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

Operating Activities

Cash flows from operating activities increased $6.5 million to $371.3 million in 2022 compared to $364.8 million in 2021. The increase in cash flows from operating activities was primarily a result of higher net income, partially offset by changes in working capital. The increase in net income was primarily due to increased net sales and favorable margin impact.

Cash flows used in operating activities from changes in working capital were $28.6 million in 2022, compared to $13.2 million in 2021. The increase was primarily driven by higher inventories impacted by inflationary cost increases on our purchases in the current year and higher prepaid expenses and other current assets primarily due to the timing of marketing spend, partially offset by the higher payout of COVID related incentive compensation amounts earned in 2020 and paid in 2021.

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Investing Activities

Cash flows used in investing activities consist primarily of capital expenditures in new stores, including leasehold improvements and store equipment, capital expenditures to maintain the appearance of our stores, sales enhancing initiatives and other corporate investments. Cash flows used in investing activities were $124.0 million and $102.4 million for 2022 and 2021, respectively. The increase in cash flows used in investing activities was primarily due to more stores under construction in 2022 as compared to 2021.

We expect capital expenditures to be in the range of $210 - $230 million in 2023, net of estimated landlord tenant improvement allowances, primarily to fund investments in new stores, remodels, maintenance capital expenditures and corporate capital expenditures. We expect to fund our capital expenditures with cash on hand and cash generated from operating activities. We do not have any material contractual commitments for future capital expenditures as of January 1, 2023.

Financing Activities

Cash flows used in financing activities were $199.1 million for 2022 compared to $186.9 million for 2021. During 2022, cash flows used in financing activities primarily consisted of approximately $200 million for share repurchases and $3.4 million in debt issuance costs in connection with our Credit Agreement, partially offset by $5.0 million in proceeds from the exercise of stock options. During 2021, cash flows used in financing activities primarily consisted of $188.3 million for share repurchases.

Long-term Debt and Credit Facilities

Long-term debt outstanding was $250.0 million as of January 1, 2023 and January 2, 2022.

See Note 13, “Long-Term Debt and Finance Lease Liabilities” for a description of our Credit Agreement and our Former Credit Facility (as defined therein).

Share Repurchase Program

Our board of directors from time to time authorizes share repurchase programs for our common stock. The following table outlines the share repurchase programs authorized by our board, and the related repurchase activity and available authorization as of January 1, 2023.

[[GREPCENT_TABLE]]
[["Effective date","","Expiration date","","Amount authorized","","","Cost of repurchases","","","Authorization available"],["March 3, 2021","","March 2, 2022","","$","300,000","","","$","200,200","","","$","\u2014"],["March 2, 2022","","December 31, 2023","","$","600,000","","","$","188,123","","","$","411,877"]]
[[/GREPCENT_TABLE]]

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The shares under our current repurchase program may be purchased on a discretionary basis from time to time through the applicable expiration date, subject to general business and market conditions and other investment opportunities, through open market purchases, privately negotiated transactions, or other means, including through Rule 10b5-1 trading plans. Our board’s authorization of the share repurchase program does not obligate us to acquire any particular amount of common stock, and the repurchase program may be commenced, suspended, or discontinued at any time.

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

[[GREPCENT_TABLE]]
[["","","Year Ended"],["","","January 1, 2023","","","January 2, 2022"],["Number of common shares acquired","","","6,897,082","","","","7,416,357"],["Average price per common share acquired","","$","28.99","","","$","25.40"],["Total cost of common shares acquired","","$","199,980","","","$","188,343"]]
[[/GREPCENT_TABLE]]

Shares purchased under our repurchase programs were subsequently retired and the excess of the repurchase price over par value was charged to retained earnings.

On August 16, 2022, the Inflation Reduction Act of 2022 (“IRA”) was signed into law. Among other provisions, the IRA includes a 1% excise tax on stock repurchases made after December 31, 2022. The IRA is not expected to have a material impact on our consolidated financial statements.

Subsequent to January 1, 2023 and through February 28, 2023, we repurchased an additional 2.0 million shares of common stock for $64.0 million.

Factors Affecting Liquidity

We can currently borrow under our Credit Agreement, up to an initial aggregate commitment of $700.0 million, which may be increased from time to time pursuant to an expansion feature set forth in the Credit Agreement. We have previously utilized borrowings under our Credit Agreement to fund our share repurchase program as described above. The interest rate we pay on our borrowings increases as our net leverage ratio increases and may increase or decrease based upon the achievement of certain diversity and sustainability-linked metric thresholds.

The Credit Agreement contains financial, affirmative and negative covenants. The negative covenants include, among other things, limitations on our ability to:

•
incur additional indebtedness;

•
grant additional liens;

•
enter into sale-leaseback transactions;

•
make loans or investments;

•
merge, consolidate or enter into acquisitions;

•
pay dividends or distributions;

•
enter into transactions with affiliates;

•
enter into new lines of business;

•
modify the terms of debt or other material agreements; and

•
change our fiscal year.

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

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In addition, the Credit Agreement requires that we and our subsidiaries maintain a maximum total net leverage ratio not to exceed 3.75 to 1.00, which ratio may be increased from time to time in connection with certain permitted acquisitions pursuant to conditions as set forth in the Credit Agreement, and a minimum interest coverage ratio not to be less than 3.00 to 1.00. Each of these covenants is tested on the last day of each fiscal quarter, starting with the fiscal quarter ended April 3, 2022.

We were in compliance with all applicable covenants under the Credit Agreement as of January 1, 2023.

Our Credit Agreement is defined and more fully described in Note 13, “Long-Term Debt and Finance Lease Liabilities” of our audited consolidated financial statements contained elsewhere in this Annual Report on Form 10-K.

Contractual Obligations

Our principal contractual obligations and commitments consist of obligations under our Credit Agreement, interest on our Credit Agreement, operating and finance leases, purchase commitments and self-insurance liabilities. See Note 7, "Leases," Note 13, “Long-Term Debt and Finance Lease Liabilities,” Note 15, "Self-Insurance Programs" and Note 19, "Commitments and Contingencies" to our consolidated financial statements located elsewhere in this Annual Report on Form 10-K for more information on the nature and timing of these obligations.

The future amount and timing of interest payments are expected to vary with the outstanding amounts and then prevailing contractual interest rates, net of interest rate swaps. Interest payments through the March 25, 2027 maturity date of our Credit Agreement based on the outstanding amounts as of January 1, 2023 and interest rates in effect at the time of this filing, are estimated to be approximately $52.5 million. These payments are estimated to be approximately $15.2 million in 2023 and approximately $37.3 million thereafter.

Real estate obligations, consisting of legally binding minimum lease payments for leases executed but not yet commenced, were $504.5 million as of January 1, 2023, including $7.2 million in 2023 and $497.3 million thereafter through 2044.

Our purchase commitments under noncancelable service and supply contracts that are enforceable and legally binding totaled $19.8 million as of January 1, 2023, including $9.8 million in 2023 and $10.0 million thereafter through 2027. Obligations under contracts that we can cancel without a significant penalty are not included in purchase commitments.

We periodically make other commitments and become subject to other contractual obligations that we believe to be routine in nature and incidental to the operation of the business. Management believes that such routine commitments and contractual obligations do not have a material impact on our business, financial condition or results of operations.

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Impact of Inflation and Deflation

Inflation and deflation in the prices of food and other products we sell may periodically affect our sales, gross profit and gross margin. Food inflation, when combined with reduced consumer spending, could also reduce sales, gross profit margins and comparable store sales. Inflationary pressures on compensation, utilities, commodities, equipment and supplies may also impact our profitability. Food deflation across multiple categories, particularly in produce, could reduce sales growth and earnings if our competitors react by lowering their retail pricing and expanding their promotional activities, which can lead to retail deflation higher than cost deflation that could reduce our sales, gross profit margins and comparable store sales. The short-term impact of inflation and deflation is largely dependent on whether or not the effects are passed through to our customers, which is subject to competitive market conditions.

Food inflation and deflation is affected by a variety of factors and our determination of whether to pass on the effects of inflation or deflation to our customers is made in conjunction with our overall pricing and marketing strategies, as well as our competitors’ responses. Although we may experience periodic effects on sales, gross profit, gross margins and cash flows as a result of changing prices, including pressures we experienced in fiscal 2022 due to product cost inflation which we largely passed along to retail pricing, we do not expect the effect of inflation or deflation to have a material impact on our ability to execute our long-term business strategy.

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Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, cash flow and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

We believe that of our significant accounting policies, which are described in Note 3, “Significant Accounting Policies” to the audited consolidated financial statements included in this Annual Report on Form 10-K, the following accounting policies involve the most difficult, complex or subjective judgments: inventories, lease assumptions, self-insurance reserves, goodwill and intangible assets, impairment of long-lived assets, and income taxes. Accordingly, we believe these are the most critical to fully understand and evaluate our financial condition and results of operations.

Inventories

We value our inventory at the lower of cost or net realizable value. The significant estimate used in inventory valuation is the estimate of inventory shrinkage.

Shrink expense is accrued as a percentage of sales based on historical shrink trends. We perform physical inventories regularly, and our shrink accrual represents the loss estimate since the last physical inventory date through the reporting date. Actual physical inventory losses could vary significantly from our estimates due to changes in market conditions and other internal or external factors.

We believe that all inventories are saleable and no allowances or reserves for obsolescence were recorded as of January 1, 2023 and January 2, 2022.

Lease Assumptions

The most significant estimates used by management in accounting for leases and the impact of those estimates are as follows:

Expected lease term—Our expected lease term includes both contractual lease periods and option periods that are determined to be reasonably certain. The expected lease term is used in determining whether the lease is accounted for as an operating lease or a finance lease. An increase in the expected lease term will increase the probability that a lease will be considered a finance lease and will generally result in higher interest and depreciation expense for a leased property recorded on our balance sheets.

Incremental borrowing rate—The incremental borrowing rate is primarily used in determining whether the lease is accounted for as an operating lease or a finance lease. An increase in the incremental borrowing rate decreases the net present value of the minimum lease payments and reduces the probability that a lease will be considered a finance lease. For finance leases, the incremental borrowing rate is also used in allocating our rental payments between interest expense and a reduction of the outstanding obligation.

Fair market value of the leased asset—The fair market value of leased retail property is generally estimated based on comparable market data provided by third-party sources and evaluated using the experience of our development staff. Fair market value is used in determining whether the lease is accounted for as an operating lease or a finance lease.

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Self-Insurance Reserves

We are self-insured for costs related to workers’ compensation, general liability and employee health benefits up to certain self-insured retentions and stop-loss limits. As of January 1, 2023, the consolidated self-insurance reserve balance was $47.6 million, of which a majority of the balance related to workers' compensation and general liability reserves. Liabilities for self-insurance reserves are estimated based on independent actuarial estimates, which are based on historical information and assumptions about future events. We utilize various techniques, including analysis of historical trends and actuarial valuation methods, to estimate the cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date. The actuarial valuation methods consider loss development factors, which include the development time frame and expected claim reporting and settlement patterns, and expected loss costs, which include the expected frequency and severity of claim activity. We believe our assumptions are reasonable, but the estimated reserves for these liabilities could be affected materially by future events or claims experiences that differ from historical trends and assumptions.

Goodwill and Intangible Assets

Goodwill represents the cost of acquired businesses in excess of the fair value of assets and liabilities acquired. Our indefinite-lived intangible assets consist of trade names related to “Sprouts Farmers Market” and liquor licenses.

Goodwill and indefinite-lived intangible assets are evaluated for impairment on an annual basis during the fourth fiscal quarter, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Our impairment evaluation of goodwill consists of a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If this qualitative assessment indicates it is more likely than not the estimated fair value of a reporting unit exceeds its carrying value, no further analysis is required, and goodwill is not impaired. Our qualitative assessment considers factors including changes in the competitive market, budget-to-actual performance, trends in market capitalization for us and our peers, turnover in key management personnel and overall changes in macroeconomic environment.

Our impairment evaluation for our indefinite-lived intangible assets consists of a qualitative assessment similar to that for goodwill. If our qualitative assessment indicates it is more likely than not that the estimated fair value of an indefinite-lived intangible asset exceeds its carrying value, no further analysis is required, and the asset is not impaired.

If our qualitative assessments indicate that it is more likely than not that the estimated fair value is less than carrying value, we compare the estimated fair value of the reporting unit or asset to its carrying amount with an impairment loss recognized for the amount, if any, by which carrying value exceeds estimated fair value. There are significant judgments and estimates in determining the estimated fair value of the reporting unit or asset; it is therefore possible that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change.

As of January 1, 2023, our consolidated goodwill balance was $368.9 million, and our consolidated indefinite-lived intangible assets balance was $185.0 million. No impairment of goodwill or indefinite-lived intangible assets was recorded during fiscal 2022, 2021 or 2020 because the fair value of those assets was substantially above carrying value.

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Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. This evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows from the operation and/or disposition of the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Fair value is measured using discounted cash flows or independent opinions of value, as appropriate. Our estimates of cash flows used to assess impairment involve significant judgment and are based upon assumptions on variables such as sales growth rate, gross margin, payroll and other controllable expenses. Application of alternative assumptions and definitions could produce significantly different results.

We recorded an impairment loss of $8.1 million and $4.8 million in 2022 and 2021, respectively, during the normal course of business. No impairment was recorded in 2020. See Note 3, “Significant Accounting Policies” and Note 6, “Property and Equipment".

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We record interest and penalties related to unrecognized tax benefits as part of income tax expense.

During the ordinary course of business, there are many transactions and calculations for which the ultimate tax settlement is uncertain. Under applicable accounting guidance, we are required to evaluate the realizability of our deferred tax assets. The realization of our deferred tax assets is dependent on future earnings. Applicable accounting guidance requires that a valuation allowance be recognized when, based on available evidence, it is more likely than not that all or a portion of deferred tax assets will not be realized due to the inability to generate sufficient taxable income in future periods. In circumstances where there is significant negative evidence, establishment of a valuation allowance must be considered. A pattern of sustained profitability is considered significant positive evidence when evaluating a decision to reverse a valuation allowance. Further, in those cases where a pattern of sustained profitability exists, projected future taxable income may also represent positive evidence, to the extent that such projections are determined to be reliable given the current economic environment. Accordingly, our assessment of our valuation allowances requires considerable judgment and could have a significant negative or positive impact on our current and future earnings.

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