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 3, 2021 filed with the SEC on February 25, 2021, which provides comparisons of fiscal 2020 and fiscal 2019, 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. Since our founding in 2002, we have grown rapidly, significantly increasing our sales, store count and profitability. Headquartered in Phoenix with 374 stores in 23 states as of January 2, 2022, 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 2, 2022, 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, through acquisitions to the Sprouts banner. These three businesses all trace their lineage back to Henry’s Farmers Market and were built with similar store formats and operations including a strong emphasis on value, produce and service in smaller, convenient locations.
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Outlook
In 2020, we announced the initial steps of our new long-term growth strategy that we believe will transform our company and drive profitable growth. We are executing on this strategy, focusing on the following areas:
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Win with Target Customers. We are focusing attention on our target customers, identified through research as ‘health enthusiasts’ and ‘experience seekers’, 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.
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Update Format and Expand in Select Markets.We are beginning to deliver 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. 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 2023.
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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 improve financial results, we will 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.
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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 removing our print ad into increasing customer engagement through digital and social connections, driving additional sales growth and loyalty.
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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, 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 2021 was a 52-week year ending on January 2, 2022. Fiscal 2020 was a 53-week year ending on January 3, 2021. Fiscal 2019 was a 52-week year ending on December 29, 2019.
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.
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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. To account for the 53rd week in fiscal 2020, when computing comparable store sales growth, we shifted each week back one week, thereby ignoring the first week of fiscal 2020 to better align holidays for comparable purposes.
Historically, our net sales have increased as a result of new store openings and comparable store sales growth. However, as we cycled periods of 2020 where our results benefitted from the initial onset of the COVID-19 pandemic, we reported declines in 2021 year over year net sales and comparable store sales growth. Additional factors that influence comparable store sales growth and other sales trends include:
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general economic conditions and trends, including levels of disposable income and consumer confidence;
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product price inflation or deflation;
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our competition, including competitive store openings in the vicinity of our stores and competitor pricing and merchandising strategies;
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consumer preferences and buying trends;
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our ability to identify market trends, and to source and provide product offerings that promote customer traffic and growth in average ticket;
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the number of customer transactions and average ticket;
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the prices of our products, including the effects of factors beyond our control, such as inflation, deflation and tariffs;
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opening new stores in the vicinity of our existing stores; and
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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 supplies. Cost of sales also includes 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 costs incurred related to store closures, including impairment charges of long-lived assets, severance and any exit costs associated with closing a store. One-time disaster recovery and executive severance costs are also included here.
Factors Affecting Comparability of Results of Operations
COVID-19 Pandemic
Our results of operations for the year ended January 3, 2021 were impacted by increased demand from our customers initially stockpiling groceries and wellness products at the onset of the COVID-19 pandemic and continuing to consume more food at home throughout the year as restaurants were not fully reopened to pre-pandemic levels, and we in turn made significant investments in compensation, benefits and personal protective equipment for our front-line store team members, as well as enhanced store sanitation procedures. We also incurred increased ecommerce fees as consumers increasingly used online shopping alternatives to purchase our products during the pandemic. Conversely, as we cycled periods of 2020 where our results benefited from the initial onset of the COVID-19 pandemic, our results of operations for the year ended January 2, 2022 reflect declines in year over year net sales and comparable store sales growth as stockpiling behaviors declined and state economies reopened to pre-pandemic levels throughout the country during the year.
Additional Week in 2020
Fiscal 2020 consisted of 53 weeks. The 53rd week resulted in additional sales and expenses as further discussed in “—Comparison of Fiscal 2021 to Fiscal 2020” below.
Results of Operations for Fiscal 2021, 2020 and 2019
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 2021 and Fiscal 2019 consisted of 52 weeks, while Fiscal 2020 consisted of 53 weeks.
(in thousands, except per share data)
Consolidated Statement of Income Data:
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Other Operating Data:
Comparable store sales growth (6.7 )% 6.9 % 1.1 %
Closed — — (1 )
(1)
Stores opened is exclusive of one store relocation during fiscal 2021 and 2019.
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Comparison of Fiscal 2021 to Fiscal 2020
Net sales
(dollars in thousands)
Comparable store sales growth (6.7 )% 6.9 %
Net sales during 2021 totaled $6.1 billion, decreasing 6% over the prior fiscal year. The sales decrease was primarily due to a 6.7% decrease in comparable store sales as a result of cycling the elevated demand driven by the COVID-19 pandemic in the prior year, as well as the 53rd week in 2020. These decreases were partially offset by sales from new stores. Comparable stores contributed approximately 97% of total sales for 2021 and approximately 92% for the prior fiscal year.
Cost of sales and gross profit
(dollars in thousands)
Gross profit decreased during 2021 compared to 2020 by $170.1 million to $2.2 billion. Gross margin decreased by 0.6% to 36.2%, compared to 36.8%. The decreases were primarily driven by the decreased sales volume resulting from cycling elevated demand in the prior year period due to the COVID-19 pandemic. The impact of the 53rd week in the prior year on gross margin was insignificant.
Selling, general and administrative expenses
(dollars in thousands)
Percentage of net sales 28.7 % 28.8 % (0.1 )%
Selling, general, and administrative expenses decreased $115.7 million or 6% as compared to 2020 due to lower compensation and other COVID-19 driven costs in the current year and reduced costs from the 53rd week in 2020, partially offset by new stores opened since the comparable period in the prior year.
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Depreciation and amortization
(dollars in thousands)
Percentage of net sales 2.0 % 1.9 % 0.1 %
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. As a percentage of net sales, depreciation and amortization expenses (exclusive of depreciation included in cost of sales) increased slightly to 2.0% from 1.9% as a result of sales deleverage. The impact of the 53rd week in 2020 on depreciation and amortization was insignificant.
Store closure and other costs, net
(dollars in thousands)
Percentage of net sales 0.1 % — 0.1 %
Store closure and other costs, net in 2021 of $4.7 million includes $4.8 million of impairment losses related to the write-down of leasehold improvements and right-of-use assets. Store closure and other costs, net in 2020 primarily represented a recognized gain on the assignment of the lease for one of our closed locations in the first quarter of 2020, partially offset by ongoing activity associated with our closed store locations.
Interest expense, net
(dollars in thousands)
Capital and financing leases 906 970 (64 ) (7 )%
The decrease in interest expense, net was primarily due to the decrease in the average balance outstanding under the Amended and Restated Credit Agreement. This was partially offset by the interest expense paid as a result of an unfavorable interest rate swap. See Note 13, “Long-Term Debt and Finance Lease Liabilities” and Note 21, “Derivative Financial Instruments.”
Income tax provision
(dollars in thousands)
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Income tax provision decreased by $11.2 million to $78.2 million for 2021 from $89.4 million for 2020, primarily related to a decrease in income before income taxes. The effective income tax rate increased to 24.3% in 2021 from 23.7% in 2020 primarily due to benefits recognized from amended returns in 2020, partially offset by increased charitable contribution deductions in 2021.
Net income
(dollars in thousands)
Percentage of net sales 4.0 % 4.4 % (0.4 )%
Net income decreased $43.3 million primarily due to decreased net sales and unfavorable margin impact, partially offset by lower selling, general and administrative expenses. Net income growth was also negatively impacted by the benefit of the 53rd week in 2020.
Diluted earnings per share
(shares in thousands)
Diluted earnings per share $ 2.10 $ 2.43 $ (0.33 ) (13 )%
The decrease in diluted earnings per share of $0.33 was driven by lower net income, partially offset by fewer diluted shares outstanding compared to the prior year, due primarily to the 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 (capital lease prior to adoption of ASC 842). 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 twelve-month average.
As numerous methods exist for calculating ROIC, our method may differ from methods used by other companies to calculate their ROIC. It is important to understand the methods and the differences in those methods used by other companies to calculate their ROIC before comparing our ROIC to that of other companies.
Our calculation of ROIC for the fiscal years indicated was as follows:
(dollars in thousands)
Special items, net of tax (3), (4) — 6,565 377
ROIC, including operating leases 12.1 % 14.8 % 9.7 %
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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. 2019 special items include the direct costs associated with store closure.
(4)
Net of tax amounts are calculated using the normalized effective tax rate for the periods presented.
(5)
2021, 2020 and 2019 estimated interest on operating leases is calculated by multiplying operating leases by the 6.7%, 7.2% and 7.5% discount rate, respectively, for each lease recorded as rent expense within direct store expense.
(6)
2021 and 2020 average operating leases represents the average net present value of outstanding lease obligations over the trailing four quarters. 2019 average operating leases represents the net present value of outstanding operating lease obligations.
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):
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 Amended and Restated Credit Agreement, interest on our Amended and Restated 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 decreased $129.2 million to $364.8 million in 2021 compared to $494.0 million in 2020. The decrease in cash flows from operating activities is primarily a result of changes in working capital in addition to a decrease in net income. The decrease in net income is primarily due to decreased net sales and unfavorable margin impact related to COVID-19, as well as the benefit of the 53rd week in the prior year.
Cash flows (used in)/ from operating activities from changes in working capital were ($13.2 million) in 2021, compared to $83.4 million in 2020. The decrease was primarily driven by the payout of incentive compensation amounts earned in the prior year and inventory stock recovery in the current year after levels were depleted during the height of the pandemic in the prior year.
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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 $102.4 million and $122.0 million for 2021 and 2020, respectively. The decrease in cash flows used in investing activities is primarily due to fewer stores under construction in 2021 as compared to 2020.
We expect capital expenditures to be in the range of $150 - $170 million in 2022, including expenditures incurred to date, net of estimated landlord tenant improvement allowances, primarily to fund investments in new stores, remodels, maintenance capital expenditures and corporate capital expenditures. We expect to fund our capital expenditures with cash on hand and cash generated from operating activities. We do not have any material contractual commitments for future capital expenditures as of January 2, 2022.
Financing Activities
Cash flows used in financing activities were $186.9 million for 2021 compared to $287.4 million for 2020. During 2021, cash flows used in financing activities primarily consisted of $188.3 million for share repurchases. During 2020, cash flows used in financing activities primarily consisted of $288.0 million of payments on the Amended and Restated Credit Agreement.
Long-term Debt and Credit Facilities
Long-term debt outstanding was $250.0 million as of January 2, 2022 and January 3, 2021.
See Note 13, “Long-Term Debt and Finance Lease Liabilities” for a description of our Amended and Restated Credit Agreement and our Former Credit Facility (as defined therein).
Share Repurchase Program
On March 3, 2021, the Company’s board of directors authorized a $300 million share repurchase program for its common stock.
The shares under the Company’s repurchase program may be purchased on a discretionary basis from time to time through March 3, 2024, subject to general business and market conditions and other investment opportunities, through open market purchases, privately negotiated transactions, or other means, including through Rule 10b5-1 trading plans. The board’s authorization of the share repurchase programs does not obligate our company to acquire any particular amount of common stock, and the repurchase programs may be commenced, suspended, or discontinued at any time. We have used borrowings under our Former Credit Facility and Amended and Restated Credit Agreement to assist with the repurchase programs. See 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, for more details.
Share repurchase activity under our repurchase programs for the periods indicated was asfollows (total cost in thousands):
Year Ended
Number of common shares acquired 7,416,357 —
Average price per common share acquired $ 25.40 $ —
Total cost of common shares acquired $ 188,343 $ —
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Shares purchased under our repurchase programs were subsequently retired and the excess of the repurchase price over par value was charged to retained earnings.
Subsequent to January 2, 2022 and through February 24, 2022, we repurchased an additional 0.2 million shares of common stock for $5.7 million.
Factors Affecting Liquidity
We can currently borrow under our Amended and Restated 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 Amended and Restated Credit Agreement. We have previously utilized borrowings under our Amended and Restated Credit Agreement to fund our share repurchase program as described above. The interest rate we pay on our borrowings increases as our leverage ratio increases.
The Amended and Restated Credit Agreement contains financial, affirmative and negative covenants. The negative covenants include, among other things, limitations on our ability to:
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incur additional indebtedness;
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grant additional liens;
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enter into sale-leaseback transactions;
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make loans or investments;
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merge, consolidate or enter into acquisitions;
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pay dividends or distributions;
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enter into transactions with affiliates;
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enter into new lines of business;
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modify the terms of debt or other material agreements; and
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change our fiscal year.
Each of these covenants is subject to customary and other agreed-upon exceptions.
In addition, the Amended and Restated Credit Agreement requires that we and our subsidiaries maintain a maximum total net leverage ratio not to exceed 3.25 to 1.00 and minimum interest coverage ratio not to be less than 1.75 to 1.00. Each of these covenants is tested on the last day of each fiscal quarter, starting with the fiscal quarter ended April 1, 2018.
We were in compliance with all applicable covenants under the Amended and Restated Credit Agreement as of January 2, 2022.
Our Amended and Restated 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.
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Contractual Obligations
Our principal contractual obligations and commitments consist of obligations under our Amended and Restated Credit Agreement, interest on our Amended and Restated Credit Agreement, operating and finance leases, purchase commitments and self-insurance liabilities. See Note 13, “Long-Term Debt and Finance Lease Liabilities,” Note 7, "Leases," Note 18, "Commitments and Contingencies" and Note 15, "Self-Insurance Programs" 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 27, 2023 maturity date of our Amended and Restated Credit Agreement based on the outstanding amounts as of January 2, 2022 and LIBOR rates in effect at the time of this filing, are estimated to be approximately $12.0 million. These payments are $10.3 million in 2022 and approximately $1.7 million thereafter.
Real estate obligations, including legally binding minimum lease payments for leases executed but not yet commenced, were $451.5 million as of January 2, 2022. These obligations are $4.1 million in 2022 and $447.4 million thereafter.
Our purchase commitments under noncancelable service and supply contracts that are enforceable and legally binding totaled $14.3 million as of January 2, 2022. These commitments are $7.9 million in 2022 and $6.4 million thereafter. 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.
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. 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 most recently from inflationary pressures due primarily to supply chain disruptions complicated by the COVID-19 pandemic, 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 judgements: 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 2, 2022 and January 3, 2021.
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 stop-loss limits. As of January 2, 2022, the consolidated self-insurance reserve balance was $50.5 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 2, 2022, 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 2021, 2020 or 2019 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 $4.8 million and $4.1 million in 2021 and 2019, 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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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Sensitivity
As described in Note 13, “Long-Term Debt and Finance Lease Liabilities” to our accompanying audited consolidated financial statements located elsewhere in this Annual Report on Form 10-K, we have an Amended and Restated Credit Agreement that bears interest at a rate based in part on LIBOR. Accordingly, we could be exposed to fluctuations in interest rates. Based solely on the $250.0 million principal outstanding under our Amended and Restated Credit Agreement as of January 2, 2022, each hundred basis point change in LIBOR would result in a change in interest expense by $2.5 million annually. We entered into an interest rate swap agreement in December 2017 to manage our cash flow associated with variable interest rates. The notional dollar amount of the one outstanding swap at January 2, 2022 and the two outstanding swaps at January 3, 2021 was $250.0 million, respectively, under which we pay a fixed rate and receive a variable rate of interest (cash flow swap). Taking into account the interest rate swaps, based on the $250.0 million principal outstanding under our Amended and Restated Credit Agreement as of January 2, 2022, each hundred basis point change in LIBOR would result in no change in interest expense annually.
This sensitivity analysis assumes our mix of financial instruments and all other variables will remain constant in future periods. These assumptions are made in order to facilitate the analysis and are not necessarily indicative of our future intentions.
We do not enter into derivative financial instruments for trading purposes (see Note 21, “Derivative Financial Instruments”).
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Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
Consolidated Financial Statements for
Sprouts Farmers Market, Inc. and Subsidiaries:
Report of Independent Registered Public Accounting Firm (PCAOB ID 238) 55
Consolidated Balance Sheets as of January 2, 2022 and January 3, 2021 58
Notes to Consolidated Financial Statements 63
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Sprouts Farmers Market, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Sprouts Farmers Market, Inc. and its subsidiaries (the “Company”) as of January 2, 2022 and January 3, 2021, and the related consolidated statements of income, of comprehensive income, of stockholders’ equity and of cash flows for each of the three years in the period ended January 2, 2022, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of January 2, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of January 2, 2022 and January 3, 2021, and the results of its operations and its cash flows for each of the three years in the period ended January 2, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 2, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Change in Accounting Principle
As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation of Self-insurance Reserves
As described in Notes 3 and 15 to the consolidated financial statements, the Company is self-insured for costs related to workers’ compensation, general liability and employee health benefits up to certain stop-loss limits. As of January 2, 2022, the Company’s recorded amounts for general liability, workers’ compensation and team member health benefit liabilities was $50.5 million, with the most significant portion of the reserve balance related to workers’ compensation and general liability self-insurance reserves. Management estimates the self-insurance reserves based on independent actuarial estimates, which are based on historical information and assumptions about future events. Management utilizes 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. When estimating the self-insurance reserves, several factors are considered by management, including (i) loss development factors, which include the development time frame and expected claim reporting and settlement patterns, and (ii) expected loss costs, which include the expected frequency and severity of claim activity.
The principal considerations for our determination that performing procedures relating to the valuation of self-insurance reserves is a critical audit matter are (i) the significant judgment by management when estimating the self-insurance reserves due to the use of various techniques to estimate the cost to settle reported claims and claims incurred but not yet reported; (ii) the high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence related to the loss development factors and expected loss costs; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge.
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Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of self-insurance reserves, including controls over the historical information and assumptions about future events used in the actuarial valuation methods. These procedures also included, among others (i) evaluating management’s self-insurance program agreements and (ii) testing the completeness and accuracy of the underlying historical claims data used in management’s assessment. Professionals with specialized skill and knowledge were used to assist in testing management’s process for estimating the valuation of the self-insurance reserves, including evaluating (i) the appropriateness of the actuarial valuation methods and (ii) the reasonableness of significant assumptions related to loss development factors and expected loss costs by considering (i) current and past claim and settlement activity and (ii) whether the assumptions were consistent with evidence obtained in other areas of the audit.
/s/ PricewaterhouseCoopers LLP
Phoenix, Arizona
February 24, 2022
We have served as the Company’s auditor since 2011.
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SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
Current assets:
Prepaid expenses and other current assets 35,468 27,224
Property and equipment, net of accumulated depreciation 716,029 726,500
Intangible assets, net of accumulated amortization 184,960 184,960
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of operating lease liabilities 151,755 135,739
Current portion of finance lease liabilities 1,078 959
Commitments and contingencies (Note 18)
Stockholders’ equity:
Accumulated other comprehensive loss (3,758 ) (8,474 )
The accompanying notes are an integral part of these consolidated financial statements.
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SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended
Net income per share:
Weighted average shares outstanding: -
The accompanying notes are an integral part of these consolidated financial statements.
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SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
Year Ended
Other comprehensive income (loss), net of tax
Total other comprehensive income (loss) $ 4,716 $ (3,792 ) $ (5,816 )
The accompanying notes are an integral part of these consolidated financial statements.
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SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Other comprehensive income (loss) — — — — (5,816 ) (5,816 )
Share-based compensation — — 8,949 — — 8,949
Impact of adoption of ASC 842 related to leases — — — 11,426 — 11,426
Other comprehensive income (loss) — — — — (3,792 ) (3,792 )
Other comprehensive income (loss) — — — — 4,716 4,716
The accompanying notes are an integral part of these consolidated financial statements.
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SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended
Operating activities
Changes in operating assets and liabilities:
Investing activities
Financing activities
Proceeds from revolving credit facilities — — 265,405
Payments on revolving credit facilities — (288,000 ) (180,405 )
Payments on finance lease liabilities (685 ) (754 ) (690 )
Other — — (319 )
Increase in cash, cash equivalents, and restricted cash 75,563 84,656 84,537
Supplemental disclosure of cash flow information
Supplemental disclosure of non-cash investing and financing activities
The accompanying notes are an integral part of these consolidated financial statements.
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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, offers a unique grocery experience featuring an open layout with fresh produce at the heart of the store. The Company continues to bring the latest in wholesome, innovative products made with lifestyle-friendly ingredients such as organic, plant-based and gluten-free. As of January 2, 2022, the Company operated 374 stores in 23 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:
All dollar amounts are in thousands, unless otherwise indicated. Certain prior period amounts have been reclassified to conform with the current year presentation.
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 2021 ended on January 2, 2022 and included 52 weeks. Fiscal year 2020 ended on January 3, 2021 and included 53 weeks. Fiscal year 2019 ended on December 29, 2019 and included 52 weeks. Fiscal years 2021, 2020, and 2019 are referred to as 2021, 2020, and 2019, respectively.
Significant Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s critical accounting estimates include inventories, lease assumptions, self-insurance reserves, goodwill and intangible assets, impairment of long-lived assets, and income taxes. Actual results could differ from those estimates.
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Cash and Cash Equivalents
The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. The Company’s cash and cash equivalents are maintained at financial institutions in the United States of America. Deposits in transit include sales through the end of the period, the majority of which were paid with credit and debit cards and settle within a few days of the sales transactions. The amounts due from banks for these transactions at each reporting date were as follows:
As Of
Due from banks for debit and credit card transactions $ 78,558 $ 93,130
Restricted Cash
Restricted cash relates to the Company’s defined benefit plan forfeitures and the Company’s healthcare, general liability and workers’ compensation plan benefits of approximately $1.7 million as of January 2, 2022 and January 3, 2021, and is included in prepaid expenses and other current assets in the accompanying consolidated balance sheets.
Accounts Receivable
Accounts receivable primarily represents billings to vendors for scan, advertising and other rebates, receivables for ecommerce sales and billings to landlords for tenant allowances. Accounts receivable also includes receivables from the Company’s insurance carrier for payments expected to be made in excess of self-insured retentions. The Company provides an allowance for doubtful accounts when a specific account is determined to be uncollectible.
Inventories
Inventories consist of merchandise purchased for resale, which are stated at the lower of cost or net realizable value. The cost method is used for distribution center and store perishable department inventories by assigning costs to each of these items based on a first-in, first-out (FIFO) basis (net of vendor discounts).
The Company’s non-perishable inventory is valued at the lower of cost or net realizable value using weighted averaging, the use of which approximates the FIFO method.
Inventories are reduced for estimated losses related to shrinkage. The Company believes that all inventories are saleable and no allowances or reserves for obsolescence were recorded as of January 2, 2022 and January 3, 2021.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Expenditures for major additions and improvements to facilities are capitalized, while maintenance and repairs are charged to expense as incurred. When property is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in the consolidated statements of income. Depreciation expense, which includes the amortization of assets recorded as finance leases, is computed using the straight-line method over the estimated useful lives of the individual assets. Terms of leases used in the determination of estimated useful lives may include renewal options if the exercise of the renewal option is determined to be reasonably certain.
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The following table includes the estimated useful lives of certain of the Company’s asset classes:
Computer hardware and software 3 to 5 years
Furniture, fixtures and equipment 7 to 20 years
Leasehold improvements up to 15 years
Buildings 40 years
Store development costs, which include costs associated with the selection and procurement of real estate sites, are also included in property and equipment. These costs are included in leasehold improvements and are amortized over the remaining lease term of the successful sites with which they are associated.
Self-Insurance Reserves
The Company uses a combination of insurance and self-insurance programs to provide for costs associated with general liability, workers’ compensation and team member health benefits. Liabilities for self-insurance reserves are estimated based on independent actuarial estimates, which are based on historical information and assumptions about future events. The Company utilizes 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. Amounts expected to be recovered from insurance companies are included in the liability, with a corresponding amount recorded in accounts receivable.
Goodwill and Intangible Assets
Goodwill represents the cost of acquired businesses in excess of the fair value of assets and liabilities acquired. The Company’s indefinite-lived intangible assets consist of trade names related to “Sprouts Farmers Market” and liquor licenses. The Company also held intangible assets with finite useful lives consisting of the “Sunflower Farmers Market” trade name. The trade name related to “Sunflower Farmers Market” met the definition of a defensive intangible asset and is fully amortized.
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. The Company’s 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. The Company’s qualitative assessment considered factors including changes in the competitive market, budget-to-actual performance, trends in market capitalization for the Company and its peers, turnover in key management personnel and overall changes in macroeconomic environment. If this qualitative assessment indicates it is more likely than not that the estimated fair value of a reporting unit exceeds its carrying value, no further analysis is required and goodwill is not impaired. Otherwise, we compare the estimated fair value of the reporting unit to its carrying amount with an impairment loss recognized for the amount, if any, by which carrying value exceeds estimated fair value.
The impairment evaluation for the Company’s indefinite-lived intangible assets consists of a qualitative assessment similar to that for goodwill. If the 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. Otherwise, the Company compares the estimated fair value of the asset to its carrying amount with an impairment loss recognized for the amount, if any, by which carrying value exceeds estimated fair value.
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The Company has determined its business consists of a single reporting unit, healthy grocery stores. The Company has had no goodwill impairment charges for the past three fiscal years. See Note 8, “Intangible Assets” and Note 9, “Goodwill” for further discussion.
Impairment of Long-Lived Assets
The Company assesses its long-lived assets, including property and equipment and right-of-use assets, for potential impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. These events primarily include current period losses combined with a history of losses or a projection of continuing losses, a significant decrease in the market value of an asset or a decision to close or relocate a store. The Company groups and evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which independent identifiable cash flows are available. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset group to the future undiscounted cash flows expected to be generated by that asset group. The Company’s impairment analysis contains management assumptions about key variables including sales growth rate, gross margin, payroll and other controllable expenses.
If impairment is indicated, a loss is recognized for any excess of the carrying value over the estimated fair value of the asset group. The fair value of the asset group is estimated based on the discounted future cash flows using a discount rate commensurate with the related risk or comparable market values, if available. The Company recorded an impairment loss of $4.8 million in 2021 as part of the normal course of business primarily related to the write-down of right-of-use assets and leasehold improvements. There were no impairment charges in 2020. In 2019, the Company recorded an impairment loss of $4.1 million as part of the normal course of business primarily related to the write-down of leasehold improvements. These charges are recorded as a component of Store closure and other costs, net in the accompanying consolidated statements of income.
Deferred Financing Costs
The Company capitalizes certain fees and costs incurred in connection with the issuance of debt. Deferred financing costs are amortized to interest expense over the term of the debt using the effective interest method. For the Amended and Restated Credit Agreement and Former Credit Facility (as defined in Note 13, “Long-Term Debt and Finance Lease Liabilities”), deferred financing costs are amortized on a straight-line basis over the term of the facility. Upon prepayment, redemption or conversion of debt, the Company accelerates the recognition of an appropriate amount of financing costs as loss on extinguishment of debt. The current and noncurrent portions of deferred financing costs are included in prepaid expenses and other current assets and other assets, respectively, in the accompanying consolidated balance sheets.
Leases
The Company leases all stores, distribution centers, and administrative offices. The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease assets, current portion of operating lease liabilities and noncurrent portion of operating lease liabilities in the accompanying consolidated balance sheets. Finance leases are included in property, plant, equipment, net, current portion of finance lease liabilities, and long-term debt and finance lease liabilities in the accompanying consolidated balance sheets. Operating lease payments are charged on a straight-line basis to rent expense, a component of selling, general and administrative expenses, over the lease term and finance lease payments are charged to interest expense and depreciation and amortization expense using a debt model over the lease term.
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The Company’s lease assets represent a right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Lease assets and liabilities and the related rent expense are recognized at the lease commencement date (date on which the Company gains access to the property) based on the estimated present value of lease payments over the lease term, net of landlord allowances expected to be received. The Company accounts for the lease and non-lease components as a single lease component for all current classes of leases.
Most of the Company’s lease agreements include variable payments related to pass-through costs for maintenance, taxes, and insurance. Additionally, some of the Company’s lease agreements include rental payments based on a percentage of retail sales over contractual levels. These variable payments are not included in the measurement of the lease liability or asset and are expensed as incurred.
As most of the Company’s lease agreements do not provide an implicit rate, the Company uses an estimated incremental borrowing rate, which is derived from third-party information available at the lease commencement date, in determining the present value of lease payments. The rate used is for a secured borrowing of a similar term as the lease.
Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to twenty years or more. The exercise of lease renewal options is at the Company’s sole discretion. The lease term includes the initial contractual term as well as any options to extend the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of 12 months or less (“short-term leases”) are not recorded on the balance sheet. The Company does not currently have any material short-term leases. Additionally, the Company’s lease agreements do not contain any residual value guarantees or material restrictive covenants.
The Company subleases certain real estate to third parties, which have all been classified as operating leases. The Company recognized sublease income on a straight-line basis.
Fair Value Measurements
The Company records its financial assets and liabilities in accordance with the framework for measuring fair value in accordance with ASC 820. This framework establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value:
Level 1: Quoted prices for identical instruments in active markets.
Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
Fair value measurements of nonfinancial assets and nonfinancial liabilities are primarily used in the valuation of derivative instruments, impairment analysis of goodwill, intangible assets, and long-lived assets. Impairment losses related to store-level assets are calculated using significant unobservable inputs including the present value of future cash flows expected to be generated using a risk-adjusted market based weighted-average cost of capital, comparable store sales growth assumptions, and third party property appraisal data. Therefore, these inputs are classified as a level 3 measurement in the fair value hierarchy.
Cash, cash equivalents and restricted cash, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued salaries and benefits and other accrued liabilities approximate fair value because of the short maturity of those instruments.
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Derivative Financial Instruments
The Company records derivatives at fair value. The designation of a derivative instrument as a hedge and its ability to meet the hedge accounting criteria determine how the Company reflects the change in fair value of the derivative instrument in its financial statements. A derivative qualifies for hedge accounting if, at inception, the derivative is expected to be highly effective in offsetting the underlying hedged cash flows, and the Company fulfills the hedge documentation standards at the time it enters into the derivative contract. The Company designates its hedge based on the exposure it is hedging. For qualifying cash flow hedges, the Company records changes in fair value in other comprehensive income (“OCI”). The Company releases the derivative’s gain or loss from OCI to match the timing of the underlying hedged item’s effect on earnings.
The Company reviews the effectiveness of its hedging instruments quarterly. The Company recognizes changes in the fair value for derivatives not designated as hedges or those not qualifying for hedge accounting in current period earnings. The Company discontinues hedge accounting for any hedge that is no longer evaluated to be highly effective.
The Company does not enter into derivative financial instruments for trading or speculative purposes, and it monitors the financial stability and credit standing of its counterparties in these transactions.
Share-Based Compensation
The Company measures share-based compensation cost at the grant date based on the fair value of the award and recognizes share-based compensation cost as expense over the vesting period. As share-based compensation expense recognized in the consolidated statements of income is based on awards ultimately expected to vest, the amount of expense has been reduced for actual forfeitures as they occur. The Company uses the Black-Scholes option-pricing model to determine the grant date fair value for each option grant. See Note 25, “Share-Based Compensation” for a discussion of assumptions used in the calculation of fair values. Application of alternative assumptions could produce different estimates of the fair value of share-based compensation and, consequently, the related amounts recognized in the accompanying consolidated statements of income. The grant date fair value of restricted stock units (“RSUs”), performance share awards (“PSAs”), and restricted stock awards (“RSAs”) is based on the closing price per share of the Company’s stock on the grant date. The Company recognizes compensation expense for time-based awards on a straight-line basis and for performance-based awards on the graded-vesting method over the vesting period of the awards.
Revenue Recognition
The Company’s performance obligations are satisfied upon the transfer of goods to the customer, which occurs at the point of sale, and payment from customers is also due at the time of sale. Proceeds from the sale of gift cards are recorded as a liability at the time of sale and recognized as sales when they are redeemed by the customer and the performance obligation is satisfied by the Company. The Company’s gift cards do not expire. Based on historical redemption rates, a small and relatively stable percentage of gift cards will never be redeemed, referred to as "breakage." Estimated breakage revenue is recognized over time in proportion to actual gift card redemptions and was not material in any period presented.
(1) net of estimated breakage
The nature of goods the Company transfers to customers at the point of sale are inventories, consisting of merchandise purchased for resale.
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The Company does not have any material contract assets or receivables from contracts with customers, any revenue recognized in the current period from performance obligations satisfied in previous periods, any contract performance obligations, or any material costs to obtain or fulfill a contract as of January 2, 2022.
Cost of Sales
Cost of sales includes the cost of inventory sold during the period, including the direct costs of purchased merchandise (net of discounts and allowances), distribution and supply chain costs, supplies and depreciation and amortization for distribution centers and supply chain related assets. The Company recognizes vendor allowances and merchandise volume related rebate allowances as a reduction of inventories during the period when earned and reflects the allowances as a component of cost of sales as the inventory is sold.
The Company’s largest supplier accounted for approximately 44%, 42% and 40% of total purchases during 2021, 2020, and 2019, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses primarily consist of salaries, wages and benefits costs, share-based compensation, occupancy costs (including rent, property taxes, utilities, common area maintenance and insurance), advertising costs, buying costs, pre-opening and other administrative costs.
The Company charges certain vendors to place advertisements in the Company’s in-store guide and circulars under a cooperative advertising program. The Company records rebates received from vendors in connection with cooperative advertising programs as a reduction to advertising costs when the allowance represents a reimbursement of a specific incremental and identifiable cost. Advertising costs are expensed as incurred. Advertising expense, net of rebates, was $45.9 million, $54.4 million and $57.2 million for 2021, 2020, and 2019, respectively.
Depreciation and amortization
Depreciation and amortization expense (exclusive of depreciation included in cost of sales) primarily consists of depreciation and amortization for buildings, store leasehold improvements, 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 basis 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. The Company’s deferred tax assets are subject to periodic recoverability assessments. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that more likely than not will be realized. Realization of the deferred tax assets is principally dependent upon achievement of projected future taxable income offset by deferred tax liabilities. Changes in recognition or measurement are reflected in the period in which the judgment occurs.
The Company files income tax returns for federal purposes and in many states. The Company’s tax filings remain subject to examination by applicable tax authorities for a certain length of time, generally three years, following the tax year to which those filings relate. The Company’s U.S. federal income tax returns for the fiscal years ended December 31, 2017, and January 1, 2017, are currently under examination by the Internal Revenue Service.
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The Company recognizes the effect of uncertain 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. The Company records interest and penalties related to unrecognized tax benefits as part of income tax expense.
Share Repurchases
The Company has elected to retire shares repurchased to date. Shares retired become part of the pool of authorized but unissued shares. The Company has elected to record purchase price of the retired shares in excess of par value directly as a reduction of retained earnings.
Net Income per Share
Basic net income per share is calculated by dividing net income by the weighted average number of shares outstanding during the fiscal period.
Diluted net income per share is based on the weighted average number of shares outstanding, plus, where applicable, shares that would have been outstanding related to dilutive options, PSAs, RSAs, and RSUs.
Comprehensive Income
Comprehensive income consists of net income and the unrealized gains or losses on derivative instruments that qualify for and have been designated as cash flow hedges, for all periods presented.
Recently Adopted Accounting Pronouncements
Income Taxes –Accounting for Income Taxes
In December 2019, the FASB issued ASU no. 2019-12, “Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes.” Among other things, the amendment removes certain exceptions for periods with operating losses, and reduces the complexity surrounding franchise tax, step up in tax basis of goodwill in conjunction with a business combination, and timing of enacting changes in tax laws during interim periods. The Company adopted this standard effective January 4, 2021 on a prospective
basis. There was no impact on the Company’s consolidated financial statements.
Financial Instruments – Credit Losses
In June 2016, the FASB issued ASU no. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this update introduce a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Subsequent to the initial standards, the FASB has also issued several ASUs to clarify specific topics. The Company adopted ASU 2016-13 effective December 30, 2019, using the modified retrospective approach. There was no impact to opening retained earnings as of December 30, 2019 or on the Company’s consolidated financial statements.
Compensation – Fair Value Disclosures
In August 2018, the FASB issued ASU No. 2018-13, “Fair value measurement (Topic 820) – Disclosure framework – Changes to the disclosure requirements for fair value measurement.” The amendments in this update improve the effectiveness of fair value measurement disclosures. The Company adopted this standard effective December 30, 2019. There was no impact on the Company’s disclosure in its consolidated financial statements.
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Leases
In February 2016, the FASB issued ASU No. 2016-02, “Leases (ASC 842).” ASU No. 2016-02 requires lessees to recognize a right-of-use asset and corresponding lease liability for all leases with terms greater than twelve months. Recognition, measurement and presentation of expenses will depend on classification as a financing or operating lease.
The Company adopted the standard as of December 31, 2018, the first day of fiscal year 2019. The Company elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, permits companies not to reassess prior conclusions on lease identification, lease classification and initial direct costs. The Company did not elect the hindsight practical expedient.
The adoption of the standard resulted in the recognition of operating lease assets and liabilities of approximately $1.0 billion and $1.1 billion, respectively, as of December 31, 2018, including recognition of operating lease assets and liabilities for certain third-party operated distribution center locations. Included in the measurement of the new lease assets and liabilities is the reclassification of balances historically recorded as deferred rent and unfavorable and favorable leasehold interests. Additionally, the Company recognized a cumulative effect adjustment, which increased retained earnings by $11.4 million, net of tax. This adjustment was driven by the derecognition of approximately $114.0 million of lease obligations and $102.6 million of net assets related to leases that had been classified as financing lease obligations under the former failed-sale leaseback guidance, and are now classified as operating leases as of the transition date.
This reclassification also resulted in the recognition of rent expense beginning December 31, 2018, which was previously reported as interest expense under the former failed sale-leaseback guidance. Lastly, the adoption of this standard resulted in a change in naming convention for leases classified historically as capital leases. These leases are now referred to as finance leases. The adoption of this standard did not have any impact on the Company’s liquidity or cash flows.
Refer to Note 7, “Leases”, for additional information related to the Company’s leases.
Recently Issued Accounting Pronouncements Not Yet Adopted
Reference Rate Reform
In March 2020 and January 2021, the FASB issued ASU no. 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” and ASU 2021-01, “Reference Rate Reform (Topic 848): Scope,” respectively. The amendments in these updates provide optional expedients and exceptions for a limited period of time to ease the potential burden in accounting for contracts, hedging relationships, and other transactions affected by reference rate reform. Generally, the guidance allows contract modifications related to reference rate reform to be considered events that do not require remeasurements or reassessments of previous accounting determinations at the modification date. These updates only apply to modifications made prior to December 31, 2022. No such modifications occurred in the year ending January 2, 2022. The Company expects to utilize this optional guidance but does not expect it to have a material impact on its consolidated financial statements.
No other new accounting pronouncements issued or effective during fiscal 2021 had, or are expected to have, a material impact on the Company’s consolidated financial statements.
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4. Accounts Receivable
A summary of accounts receivable is as follows:
As Of
The Company recorded allowances for certain vendor receivables of $0.7 million and $0.4 million at January 2, 2022 and January 3, 2021, respectively.
5. Prepaid Expenses and Other Current Assets
A summary of prepaid expenses and other current assets is as follows:
As Of
6. Property and Equipment
A summary of property and equipment, net is as follows:
As Of
Accumulated depreciation and amortization (820,751 ) (700,056 )
Depreciation expense was $124.1 million, $125.6 million and $121.3 million for 2021, 2020, and 2019, respectively. Depreciation expense is primarily reflected in depreciation and amortization on the consolidated statements of income.
Impairment expense was $4.8 million and $4.1 million for 2021 and 2019, respectively. There was no impairment expense recognized in 2020.
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7. Leases
Lease cost includes both the fixed and variable expenses recorded for leases. The components of lease cost are as follows:
Year Ended
Finance lease cost:
Amortization of Property and Equipment Depreciation and amortization 966 966 966
Interest on lease liabilities Interest expense 906 970 997
(1)
Supply chain-related amounts of $10.6 million, $7.8 million and $8.2 million were included in cost of sales for 2021, 2020 and 2019, respectively.
Supplemental balance sheet information related to leases is as follows:
As Of
Assets
Finance Property and equipment, net 8,251 9,218
Liabilities
Current
Operating Current portion of operating lease liabilities $ 151,755 $ 135,739
Finance Current portion of finance lease liabilities 1,078 959
Noncurrent
Finance Long-term debt and finance lease liabilities 9,656 10,459
Weighted average remaining lease term (years)
Weighted average discount rate
Operating leases 6.7 % 7.2 % 7.5 %
Finance leases 8.4 % 8.4 % 8.3 %
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Supplemental cash flow and other information related to leases is as follows:
Year Ended
Cash paid for amounts included in measurement of lease liabilities:
Operating cash flows for finance leases 906 970 997
Lease assets obtained in exchange for lease liabilities:
Finance leases $ — $ — $ —
A summary of maturities of lease liabilities is as follows:
Operating Leases(1), (2) Finance Leases Total
(1)
Operating lease payments include $105.5 million related to periods covered by options to extend lease terms that are reasonably certain of being exercised and exclude $451.5 million of legally binding minimum lease payments for leases executed but not yet commenced.
(2)
We have subtenant agreements under which we will receive $1.0 million in 2022, $0.9 million in 2023, $0.9 million in 2024, $0.9 million in 2025, $0.7 million in 2026, and $1.0 million thereafter.
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8. Intangible Assets
A summary of the activity and balances in intangible assets is as follows:
Balance at December 29, 2019 Adjustments/Transfers Balance at January 3, 2021
Gross Intangible Assets
Indefinite-lived liquor licenses 2,023 — 2,023
Accumulated Amortization
Total accumulated amortization $ (1,365 ) $ 365 $ (1,000 )
Balance at January 3, 2021 Adjustments/Transfers Balance at January 2, 2022
Indefinite-lived liquor licenses 2,023 — 2,023
(1)
Excludes the original cost and accumulated amortization of fully-amortized finite-lived intangible assets.
There was no amortization expense in 2021. Amortization expense was ($0.4) million and $0.2 million for 2020 and 2019, respectively.
9. Goodwill
The Company’s goodwill balance was $368.9 million as of January 2, 2022 and January 3, 2021. As of January 2, 2022 and January 3, 2021, the Company had no accumulated goodwill impairment losses. The goodwill was related to the acquisition of Sunflower Farmers Market stores and Henry’s Farmers Market stores.
10. Other Assets
As of January 2, 2022 and January 3, 2021, other assets of $13.5 million and $14.7 million, respectively, primarily consisted of deferred software as a service, capitalized durable supplies, sublease deferred rent, and miscellaneous other assets.
11. Accrued Liabilities
A summary of accrued liabilities is as follows:
As Of
Accrued occupancy related (CAM, property taxes, etc.) 20,649 19,939
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12. Accrued Salaries and Benefits
A summary of accrued salaries and benefits is as follows:
As Of
13. Long-Term Debt and Finance Lease Liabilities
A summary of long-term debt and finance lease liabilities is as follows:
As Of
Facility Maturity Interest Rate January 2,2022 January 3,2021
Senior secured debt
Finance lease liabilities (see Note 7, "Leases") Various n/a 9,656 10,459
Long-term debt and finance lease liabilities $ 259,656 $ 260,459
A summary of maturities of long-term debt is as follows:
$700 million Credit Agreement
Thereafter —
Senior Secured Revolving Credit Facility
March 2018 Refinancing
On March 27, 2018, the Company’s subsidiary, Sprouts Farmers Markets Holdings, LLC (“Intermediate Holdings”), as borrower, entered into an amended and restated credit agreement (the “Amended and Restated Credit Agreement”) to amend and restate the Company’s existing senior secured credit facility, dated April 17, 2015 (the “Former Credit Facility”). The Amended and Restated Credit Agreement provides for a revolving credit facility with an initial aggregate commitment of $700.0 million, an increase from $450.0 million from the Former Credit Facility, which may be increased from time to time pursuant to an expansion feature set forth in the Amended and Restated Credit Agreement.
Concurrently with the closing of the Amended and Restated Credit Agreement, all commitments under the Former Credit Facility were terminated, resulting in a $0.3 million loss on early extinguishment of debt, recorded in interest expense during the first quarter of fiscal year 2018. The loss was due to the write-off of a proportional amount of deferred financing costs associated with the Former Credit Facility as the result of certain banks exiting the Amended and Restated Credit Agreement in connection with the refinancing. No amounts were outstanding under the Former Credit Facility as of January 2, 2022.
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The Company capitalized debt issuance costs of $2.1 million related to the refinancing which combined with the remaining $0.7 million debt issuance costs for the Former Credit Facility, are being amortized on a straight-line basis to interest expense over the five-year term of the Amended and Restated Credit Agreement.
The Amended and Restated Credit Agreement also provides for a letter of credit subfacility and a $15.0 million swingline facility. Letters of credit issued under the Amended and Restated Credit Agreement reduce its borrowing capacity. Letters of credit totaling $28.0 million have been issued as of January 2, 2022, primarily to support the Company’s insurance programs.
On March 6, 2019, Intermediate Holdings entered into an amendment to the Amended and Restated Credit Agreement intended to align the treatment of certain lease accounting terms with the Company’s adoption of ASC 842. This amendment had no impact on borrowing capacity, interest rate, or maturity.
Guarantees
Obligations under the Amended and Restated Credit Agreement are guaranteed by the Company and all of its current and future wholly-owned material domestic subsidiaries (other than the borrower) and are secured by first-priority security interests in substantially all of the assets of the Company and its subsidiary guarantors, including, without limitation, a pledge by the Company of its equity interest in Intermediate Holdings.
Interest and Fees
Loans under the Amended and Restated Credit Agreement initially bore interest at LIBOR plus 1.50% per annum or prime plus 0.5%. The interest rate margins are subject to adjustment pursuant to a pricing grid based on the Company’s total net leverage ratio, as set forth in the Amended and Restated Credit Agreement. Under the terms of the Amended and Restated Credit Agreement, the Company is obligated to pay a commitment fee on the available unused amount of the commitments between 0.15% to 0.30% per annum, also pursuant to a pricing grid based on the Company’s total net leverage ratio. As of January 2, 2022, loans under the Amended and Restated Credit Agreement bore interest at LIBOR plus 1.25% per annum or prime plus 0.25%.
The interest rate on 100% of outstanding debt under the Amended and Restated Credit Agreement is fixed as of January 2, 2022, reflecting the effects of floating to fixed interest rate swaps (see Note 21, “Derivative Financial Instruments”).
As of January 2, 2022, outstanding letters of credit under the Amended and Restated Credit Agreement were subject to a participation fee of 1.25% per annum and an issuance fee of 0.125% per annum.
Payments and Borrowings
The Amended and Restated Credit Agreement is scheduled to mature, and the commitments thereunder will terminate on March 27, 2023, subject to extensions as set forth therein.
The Company may prepay loans and permanently reduce commitments under the Amended and Restated Credit Agreement at any time in agreed-upon minimum principal amounts, without premium or penalty (except LIBOR breakage costs, if applicable).
During fiscal year 2021, the Company made no additional borrowings or payments, resulting in total outstanding debt under the Amended and Restated Credit Agreement of $250.0 million as of January 2, 2022. During fiscal year 2020, the Company made no additional borrowings and made a total of$288.0 million of principal payments, resulting in total outstanding debt under the Amended and Restated Credit Agreement of $250.0 million as of January 3, 2021.
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Covenants
The Amended and Restated Credit Agreement contains financial, affirmative and negative covenants. The negative covenants include, among other things, limitations on the Company’s ability to:
•
incur additional indebtedness;
•
grant additional liens;
•
enter into sale-leaseback transactions;
•
make loans or investments;
•
merge, consolidate or enter into acquisitions;
•
pay dividends or distributions;
•
enter into transactions with affiliates;
•
enter into new lines of business;
•
modify the terms of debt or other material agreements; and
•
change its fiscal year.
Each of these covenants is subject to customary and other agreed-upon exceptions.
In addition, the Amended and Restated Credit Agreement requires that the Company and its subsidiaries maintain a maximum total net leverage ratio not to exceed 3.25 to 1.00 and minimum interest coverage ratio not to be less than 1.75 to 1.00. Each of these covenants is tested on the last day of each fiscal quarter, starting with the fiscal quarter ended April 1, 2018.
The Company was in compliance with all applicable covenants under the Amended and Restated Credit Agreement as of January 2, 2022.
14. Other Long-Term Liabilities
A summary of other long-term liabilities is as follows:
As Of
Long-term portion of self-insurance reserves $ 23,393 $ 23,291
15. Self-Insurance Programs
The Company is self-insured for costs related to workers’ compensation, general liability and employee health benefits up to certain stop-loss limits. The Company establishes reserves for the ultimate obligation of reported and incurred but not reported (“IBNR”) claims. IBNR claims are estimated using various techniques, including analysis of historical trends and actuarial valuation methods.
The Company purchases coverage from third-party insurers for exposures in excess of certain stop-loss limits and recorded receivables of $1.6 million and a $1.0 million from its insurance carriers for payments expected to be made in excess of self-insured retentions at January 2, 2022 and January 3, 2021, respectively. The Company recorded amounts for general liability, workers' compensation and team member health benefit liabilities of $50.5 million and $48.5 million at January 2, 2022 and January 3, 2021, respectively. See Note 11, “Accrued Liabilities” for current amounts recorded for general liability, workers’ compensation and team member health benefit liabilities.
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16. Defined Contribution Plan
The Company maintains the Sprouts Farmers Market, Inc. Employee 401(k) Savings Plan (the “Plan”), which is a defined contribution plan covering all eligible team members. Under the provisions of the Plan, participants may direct the Company to defer a portion of their compensation to the Plan, subject to the Internal Revenue Code limitations. The Company provides for an employer matching contribution equal to 50% of each dollar contributed by the participants up to 6% of their eligible compensation.
Total expense recorded for the matching under the Plan:
Year Ended
17. Income Taxes
Income Tax Provision
The income tax provision consists of the following:
Year Ended
Tax Rate Reconciliation
Income tax provision differed from the amounts computed by applying the U.S. federal income tax rate to pre-tax income as a result of the following:
Year Ended
Increase (decrease) in income taxes resulting from:
State income taxes, net of federal benefit 4.8 4.6 4.4
Enhanced charitable contribution impact (1.5 ) (1.0 ) (0.7 )
Change in uncertain tax position reserves — 0.1 (1.1 )
Amended returns (0.2 ) (1.0 ) —
Benefit of federal tax credit (0.4 ) (0.9 ) (1.6 )
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The effective income tax rate increased to 24.3% in 2021 from 23.7% in 2020 primarily due to benefits recognized from amended returns in 2020, partially offset by increased charitable contribution deductions in 2021. The effective income tax rate was 23.7% in 2020 and 2019. The effective income tax rate in 2020 was primarily affected by a decrease in federal tax credits and prior year release of uncertain tax positions, partially offset by an increase in charitable contribution deductions and the benefit recognized from amended returns.
Excess tax benefits or detriments associated with share-based payment awards are recognized as income tax benefits or expense in the income statement. The tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur. The income tax benefit resulting from share-based awards was $0.2 million for 2021 and is reflected as a reduction to the 2021 income tax provision. The income tax detriment resulting from share-based awards were $0.5 million and $1.6 million for 2020 and 2019, respectively, and are reflected as increases to the 2020 and 2019 income tax provisions.
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Deferred Taxes
Significant components of the Company’s deferred tax assets and deferred tax liabilities are as follows: