Sprouts Farmers Market, Inc.: Form 10-Q for the period ended Jun 30, 2024

You should read the following discussion of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the 2023 fiscal year, filed on February 22, 2024 (“Form 10-K”) with the Securities and Exchange Commission. All dollar amounts included below are in thousands, unless otherwise noted.

Business Overview

Sprouts Farmers Market offers a unique specialty 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. From our founding in 2002, we have grown rapidly, significantly increasing our sales, store count and profitability. Headquartered in Phoenix with 419 stores in 23 states as of June 30, 2024, we are one of the largest and fastest growing specialty retailers of fresh, natural and organic food in the United States.

Our Growth Strategy

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

• Win with Target Customers. We are focusing attention on our target customers, identified through research as ‘health enthusiasts’ and ‘selective shoppers’, where there is ample opportunity to gain share within these customer segments. We believe our business can continue to grow by leveraging existing strengths in a unique assortment of better-for-you, quality products and by providing a full omnichannel offering through delivery or pickup via our website or the Sprouts app.
• Update Format and Expand in Select Markets. We are delivering unique smaller stores with expectations of stronger returns, while maintaining the approachable, fresh-focused farmer’s market heritage Sprouts is known for. From 2021 through June 30, 2024, we opened 54 new 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 approximately 10% annual unit growth.
• Create an Advantaged Fresh Supply Chain. We believe our network of fresh distribution centers can drive efficiencies across the chain and support our growth plans. To further deliver on our fresh commitment and reputation, as well as to increase our local offerings and improve financial results, we aspire to ultimately position fresh distribution centers within a 250-mile radius of stores. Following the opening of two fresh distribution centers in fiscal 2021 and the relocation of our Southern California distribution center, closure of our Georgia distribution center and partnership with a third-party fresh distribution center in the Northeast in fiscal 2023, we are better leveraging our existing distribution center capacity, and approximately 80% of our stores were within 250 miles of a distribution center as of June 30, 2024.
• 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 increasing our use of data analytics and insights. We believe this data-driven intelligence will increase customer engagement through personalization efforts with digital and social connections to drive additional sales growth and loyalty.
• Inspire and Engage Our Talent to Create a Best Place to Work. Subsequent to the initial launch of our long-term growth strategy, we have added the focus area of inspiring and engaging our talent through our culture, acquisition and development and total rewards program to attract and retain the talent we believe we need to execute on our strategic goals and transform our company into a premier place to work.
• Deliver on Financial Targets and Box Economics. We are measuring and reporting on the success of this strategy against a number of long-term financial and operational targets. With the implementation of our strategy beginning in 2020, we have significantly improved our margin structure above our 2019 baseline.

Results of Operations for Thirteen Weeks Ended June 30, 2024 and July 2, 2023

The following tables set forth our unaudited results of operations and other operating data for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. All dollar amounts are in thousands, unless otherwise noted.

Unaudited Quarterly Consolidated Statement of Income Data:

Comparison of Thirteen Weeks Ended June 30, 2024 to Thirteen Weeks Ended July 2, 2023

Net sales

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Net sales during the thirteen weeks ended June 30, 2024 totaled $1.9 billion, an increase of $201.3 million or 12%, compared to the thirteen weeks ended July 2, 2023. The sales increase was driven by sales from new stores opened in the last twelve months and a 6.7% increase in comparable store sales. Comparable stores contributed approximately 94% of total sales for the thirteen weeks ended June 30, 2024 and approximately 96% of total sales for the thirteen weeks ended July 2, 2023.

Cost of sales and gross profit

Gross profit totaled $718.4 million during the thirteen weeks ended June 30, 2024, an increase of $92.4 million or 15%, compared to the thirteen weeks ended July 2, 2023, driven by increased sales volume. Gross margin increased by 0.9% to 37.9% for the thirteen weeks ended June 30, 2024, compared to 37.0% for the thirteen weeks ended July 2, 2023, primarily driven by improved inventory management and continued promotional optimization as well as positive leverage on our supply chain from the increase in sales.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $58.4 million or 12%, compared to the thirteen weeks ended July 2, 2023. The increase was primarily due to the increase in new stores opened since the comparable period last year. As a percentage of net sales, selling, general and administrative expenses remained relatively flat as a result of sales leverage, which was partially offset by higher incentive compensation costs and ecommerce fees due to strong sales performance and higher professional fees and other costs incurred related to strategic initiatives.

Depreciation and amortization

Depreciation and amortization expense (exclusive of depreciation included in cost of sales) was $31.5 million for the thirteen weeks ended June 30, 2024, compared to $34.0 million for the thirteen weeks ended July 2, 2023. Depreciation and amortization expense primarily consists of depreciation and amortization for buildings, store leasehold improvements, and equipment for new stores as well as remodel initiatives in older stores. Depreciation and amortization for the thirteen weeks ended July 2, 2023 was inclusive of $1.9 million in accelerated depreciation in connection with the decision to close certain underperforming stores during 2023. See Note 12, “Store Closures” of our unaudited consolidated financial statements.

Store closure and other costs, net

Store closure and other costs, net for the thirteen weeks ended June 30, 2024 of $3.2 million and for the thirteen weeks ended July 2, 2023 of $2.4 million was primarily related to ongoing occupancy costs associated with our closed store locations. See Note 12, “Store Closures” of our unaudited consolidated financial statements.

Interest (income) expense, net

The decrease in interest (income) expense, net for the thirteen weeks ended June 30, 2024 compared to the thirteen weeks ended July 2, 2023 was primarily due to lower average debt outstanding and higher interest income driven by higher interest rates. See Note 4, “Long-Term Debt and Finance Lease Liabilities” of our unaudited consolidated financial statements.

Income tax provision

Income tax provision differed from the amounts computed by applying the U.S. federal income tax rate to pretax income as a result of the following:

The effective tax rate increased to 25.2% for the thirteen weeks ended June 30, 2024 from 24.7% for the thirteen weeks ended July 2, 2023. The increase in the effective tax rate was primarily due to a prior period refund of interest from amended returns, partially offset by a tempered impact to the effective tax rate for executive compensation due to increased pre-tax income.

Net income

Net income increased $28.0 million primarily due to higher gross profit, partially offset by higher selling, general and administrative expenses for the reasons discussed above.

Diluted earnings per share

The increase in diluted earnings per share of $0.29 was driven by higher net income and fewer diluted shares outstanding compared to the prior year, due primarily to the share repurchase program.

Results of Operations for Twenty-six Weeks Ended June 30, 2024 and July 2, 2023

The following tables set forth our unaudited results of operations and other operating data for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. All dollar amounts are in thousands, unless otherwise noted.

Unaudited Quarterly Consolidated Statement of Income Data:

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Comparison of Twenty-six Weeks Ended June 30, 2024 to Twenty-six Weeks Ended July 2, 2023

Net Sales

Net sales during the twenty-six weeks ended June 30, 2024 totaled $3.8 billion, an increase of $351.8 million, or 10%, over the same period of the prior fiscal year. The sales increase was primarily due to new stores opened in the last twelve months and a 5.4% increase in comparable store sales. Comparable stores contributed approximately 94% of total sales for the twenty-six weeks ended June 30, 2024 and approximately 96% of total sales for the twenty-six weeks ended July 2, 2023.

Cost of sales and gross profit

Gross profit totaled $1.4 billion during the twenty-six weeks ended June 30, 2024, an increase of $164.6 million, or 13%, compared to the twenty-six weeks ended July 2, 2023, driven by increased sales volume. Gross margin increased to 38.1% for the twenty-six weeks ended June 30, 2024, compared to 37.3% for the twenty-six weeks ended July 2, 2023, due to improved inventory management and continued promotional optimization efforts as well as leverage on our supply chain from higher sales.

Selling, general and administrative expenses

Selling, general and administrative expenses increased by $112.0 million, or 11%, compared to the twenty-six weeks ended July 2, 2023. The increase was primarily driven by the increase in new stores opened since the prior year period. As a percentage of net sales, selling, general and administrative expenses increased due to higher incentive compensation costs and ecommerce fees driven by strong sales performance and higher professional fees and other costs incurred related to strategic initiatives.

Depreciation and amortization

Depreciation and amortization expense (exclusive of depreciation included in cost of sales) was $63.7 million for the twenty-six weeks ended June 30, 2024, compared to $68.0 million for the twenty-six weeks ended July 2, 2023. 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. Depreciation and amortization for the twenty-six weeks ended July 2, 2023 was inclusive of $5.9 million in accelerated depreciation in connection with the closing of certain underperforming stores during 2023. See Note 12, “Store Closures” of our unaudited consolidated financial statements.

Store closure and other costs, net

Store closure and other costs, net decreased $25.5 million to $5.2 million, compared to $30.7 million for the twenty-six weeks ended July 2, 2023. Store closure and other costs, net during the twenty-six weeks ended June 30, 2024 was primarily related to ongoing occupancy costs associated with our closed store locations. Store closure and other costs, net during the twenty-six weeks ended July 2, 2023 primarily consisted of $27.8 million of impairment losses related to the write-down of leasehold improvements and right-of-use assets as well as other costs incurred in association with the closing of 11 underperforming stores during 2023. See Note 12, “Store Closures” of our unaudited consolidated financial statements.

Interest (income) expense, net

Interest (income) expense, net decreased to $0.7 million for the twenty-six weeks ended June 30, 2024, compared to $4.4 million for the twenty-six weeks ended July 2, 2023 primarily due to lower average debt outstanding and higher interest income earned as a result of higher interest rates. See Note 4, “Long-Term Debt and Finance Lease Liabilities” of our unaudited consolidated financial statements.

Income tax provision

Income tax provision differed from the amounts computed by applying the U.S. federal income tax rate to pretax income as a result of the following:

The effective tax rate decreased to 23.8% for the twenty-six weeks ended June 30, 2024 from 24.0% in the same period last year. The decrease in the effective tax rate was primarily due to an increase in excess tax benefits associated with share-based payment awards and a tempered impact to the effective tax rate for executive compensation due to increased pre-tax income, partially offset by a prior period refund of interest from amended returns.

Net income

Net income increased $65.9 million primarily due to higher gross profit and lower store closure and other costs, partially offset by higher selling, general and administrative expenses for the reasons discussed above.

Diluted earnings per share

The increase in diluted earnings per share of $0.68 was driven by higher net income and fewer diluted shares outstanding compared to the prior year due primarily to the share repurchase program.

Return on Invested Capital

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

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

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

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

(dollars in thousands)

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

(2) Special items related to store closure, supply chain transition and acquisition related charges net of tax.

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

(4) 2024 and 2023 estimated interest on operating leases is calculated by multiplying operating leases by the 7.2% and 7.1% discount rate, respectively, for each lease recorded as rent expense within direct store expense.

(5) Average operating leases represents the average net present value of outstanding lease obligations over the past four trailing quarters.

Liquidity and Capital Resources

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

We have generally financed our operations principally through cash generated from operations and borrowings under our credit facilities. Our primary uses of cash are for purchases of inventory, operating expenses, capital expenditures primarily for opening new stores, remodels and maintenance, repurchases of our common stock and debt service. Our principal contractual obligations and commitments consist of obligations under our Credit Agreement, interest on our Credit Agreement, operating and finance leases, purchase commitments and self-insurance liabilities. Our operating and finance leases for the rental of land, buildings, and for rental of facilities and equipment expire or become subject to renewal clauses at various dates through 2046. We believe that our existing cash, cash equivalents and restricted cash, and cash anticipated to be generated from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including new store openings, remodel and maintenance capital expenditures at existing stores, store initiatives and other corporate capital expenditures and activities. Our cash, cash equivalents and restricted cash position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within days from the related sale.

Operating Activities

Cash flows from operating activities increased $16.5 million to $311.3 million for the twenty-six weeks ended June 30, 2024 compared to $294.8 million for the twenty-six weeks ended July 2, 2023. The increase in cash flows from operating activities was primarily a result of higher net income adjusted for non-cash items of $50.2 million, partially offset by a decrease in cash flows provided by operating activities from changes in working capital of $16.8 million and higher payments on our operating lease liabilities of $15.0 million due to growth.

Cash flows provided by operating activities from changes in working capital were $36.4 million in the twenty-six weeks ended June 30, 2024 compared to $53.2 million in the twenty-six weeks ended July 2, 2023. This $16.8 million decrease in cash flow from changes in working capital was primarily attributable to a $33.9 million change in accounts payable and accrued liabilities, primarily due to timing differences of payments for goods and services, partially offset by a $10.4 million change in accounts receivable driven by the timing of collections. Certain other immaterial items combined to result in an additional $6.7 million net increase in cash flows from changes in working capital.

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 as well as cash outlays for acquisitions. Cash flows used in investing activities were $108.9 million and $111.7 million, for the twenty-six weeks ended June 30, 2024 and twenty-six weeks ended July 2, 2023, respectively. Cash flows used in investing activities during the twenty-six weeks ended July 2, 2023 included our acquisition of Ronald Cohn, Inc. See Note 13, "Business Combination" of our unaudited consolidated financial statements.

We expect capital expenditures to be in the range of $225 - 245 million in 2024, 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.

Financing Activities

Cash flows used in financing activities were $226.8 million for the twenty-six weeks ended June 30, 2024 compared to $216.6 million for the twenty-six weeks ended July 2, 2023. During the twenty-six weeks ended June 30, 2024, cash flows used in financing activities primarily consisted of $125.0 million in payments on our Credit Agreement and $104.5 million for stock repurchases, partially offset by $3.3 million in proceeds from the exercise of stock options.

During the twenty-six weeks ended July 2, 2023, cash flows used in financing activities primarily consisted of $148.3 million for stock repurchases and $75.0 million in payments on our Credit Agreement, partially offset by $7.2 million in proceeds from the exercise of stock options.

Long-Term Debt and Credit Facilities

The Company had no long-term debt outstanding as of June 30, 2024. Long-term debt outstanding as of December 31, 2023 was $125.0 million.

See Note 4, “Long-Term Debt and Finance Lease Liabilities” of our unaudited consolidated financial statements for a description of our Credit Agreement and our Former Credit Facility (each as defined therein).

Share Repurchase Program

Our board of directors from time to time authorizes share repurchase programs for our common stock. The following table outlines the share repurchase program authorized by our board, and the related repurchase activity and available authorization as of June 30, 2024:

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

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

Shares purchased under our repurchase programs were subsequently retired and the excess of the repurchase price over par value was charged to retained earnings. The cost of common shares repurchased included the 1% excise tax imposed as part of the Inflation Reduction Act of 2022.

Subsequent to June 30, 2024 and through the date of this filing, we repurchased an additional 0.1 million shares of common stock for $7.4 million, excluding excise tax.

Contractual Obligations

Our principal contractual obligations and commitments arising in the normal course of business consist of obligations under our Credit Agreement, interest on our Credit Agreement, operating and finance leases, purchase commitments and self-insurance liabilities. Except as otherwise disclosed in Note 4, “Long-Term Debt and Finance Lease Liabilities” of our unaudited consolidated financial statements, there have been no material changes outside the normal course of business as of June 30, 2024 in our contractual obligations and commitments from those reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Impact of Inflation and Deflation

Inflation and deflation in the prices of food and other products we sell may periodically affect our sales, gross profit and gross margin. Food inflation, when combined with reduced consumer spending, could also reduce sales, gross profit margins and comparable store sales. Inflationary pressures on compensation, utilities, commodities, equipment and supplies may also impact our profitability. Food deflation or declining levels of inflation across multiple categories, particularly in produce, could reduce sales growth and earnings, particularly 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, we do not expect the effect of inflation or deflation to have a material impact on our ability to execute our long-term business strategy.

Critical Accounting Estimates

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

There have been no substantial changes to these estimates, or the policies related to them during the thirteen and twenty-six weeks ended June 30, 2024. For a full discussion of these estimates and policies, see “Critical Accounting Estimates” in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Recently Issued Accounting Pronouncements

See Note 2, “Summary of Significant Accounting Policies” to our accompanying unaudited consolidated financial statements contained in this Quarterly Report on Form 10-Q.

As described in Note 4, “Long-Term Debt and Finance Lease Liabilities” to our unaudited consolidated financial statements located elsewhere in this Quarterly Report on Form 10-Q, our Credit Agreement bears interest at a rate based in part on SOFR. Accordingly, we could be exposed to fluctuations in interest rates. As of June 30, 2024, we had no outstanding borrowings under our Credit Agreement.

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) designed to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and is accumulated and communicated to our management, including our Chief Executive Officer (our principal executive officer) and Chief Financial Officer (our principal financial officer), as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures under the Exchange Act as of June 30, 2024, the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

During the quarterly period ended June 30, 2024, there were no changes in our internal controls over financial reporting that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

Certain factors may have a material adverse effect on our business, financial condition and results of operations. You should carefully consider the risks and uncertainties referenced below, together with all of the other information in this Quarterly Report on Form 10-Q, including our consolidated financial statements and related notes. Any of those risks could materially and adversely affect our business, operating results, financial condition, or prospects and cause the value of our common stock to decline, which could cause you to lose all or part of your investment.

There have been no material changes to the Risk Factors described under “Part I – Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.