Sprouts Farmers Market, Inc. (NASDAQ:SFM) Q1 2024 Earnings Call Transcript

Sprouts Farmers Market, Inc. (NASDAQ:SFM) Q1 2024 Earnings Call Transcript May 1, 2024

Sprouts Farmers Market, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by. Welcome to the First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker, Susannah Livingston, Vice President, Investor Relations and Treasurer. Please begin.

Susannah Livingston: Thank you, and good afternoon, everyone. We are pleased you are joining Sprouts on our first quarter 2024 earnings call. Jack Sinclair, Chief Executive Officer; and Curtis Valentine, Chief Financial Officer are with me today. The earnings release announcing our first quarter 2024 results, the webcast of this call and financial slides can be accessed through the Investor Relations section of our website at investors.sprouts.com. During this call, management may make certain forward-looking statements, including statements regarding our expectations for 2024 and beyond. These statements involve several risks and uncertainties that could cause results to differ materially from those described in the forward-looking statements.

For more information, please refer to the risk factors discussed in our SEC filings and the commentary on forward-looking statements at the end of our earnings release. Our remarks today include references to non-GAAP measures. Please see the tables in our earnings release to reconcile our non-GAAP measures to the comparable GAAP figures. With that, let me hand it over to Jack.

Jack Sinclair: Thanks, Susannah and good afternoon, everyone. I want to start by thanking our 42,000 hardworking team members, who worked together to create a great experience for our customers, which in turn delivered impressive financial results. Our sales have grown by 9% with comparable store sales growing by 4% and diluted earnings per share growing by 14%, compared to adjusted diluted earnings per share in the same period last year. These positive results reflect the effectiveness of our strategy and the exceptional execution by our team. It has been a strong start to the year and we’re encouraged by the continued momentum in our business. Our entire approach across the business remains centered around our target customer.

We’ve aligned our merchandising, marketing, operations, new store design and supply chain strategies to provide the freshest most innovative attribute driven products in the marketplace. We’ve also created a unique and easy to shop format with great service. During the first quarter, we organized Sprouts brand and organic events, which were highly successful. These events and others led to positive customer traffic growth in the first quarter. We are pleased to bring Sprouts to more communities across the country. The new store program continues to gather pace. We opened seven for the quarter and are on track for the year, And we’re committed to helping our customer live and eat better with every new store opening across the country. I’ll follow-up with more on our journey in just a bit, But for now, I’ll hand you over to Curtis to review our financial performance in the first quarter and our 2024 outlook.

Curtis?

Curtis Valentine: Thanks, Jack, and good afternoon, everyone. For the first quarter, total sales were $1.9 billion up $150 million or 9% from the same period last year. This increase was driven by comparable store sales growth of 4% and the addition of new stores. We had another quarter of positive traffic and as expected, average unit retails and units per basket continued to stabilize sequentially. Our business continues to be resilient. Our comp performance highlights the categories with the most differentiation such as grocery, dairy, frozen and meat continue to attract our target customers and drive our results. Sprouts brand growth continued to outpace total company performance and contributed 21% of our total sales for the quarter.

Our e-commerce sales grew approximately 25%, representing 14% of our total sales for the quarter. This included incremental sales from our recently launched Uber Eats partnership and all three of our online partners joined us in promoting healthy trends to create momentum in the New Year. The fact so many of our target customers seek out Sprouts online continues to highlight the appeal of our differentiated assortment. Our first quarter gross margin was 38.3%, an increase of approximately 80 basis points from the same period of the prior year. This improvement was primarily due to a significant turnaround in our fresh shrink performance, driven by our continued focus on inventory management. We also continue to see year-over-year margin improvement due to promotional optimization efforts carrying over from 2023.

SG&A for the quarter totaled $540 million, an increase of $57 million or approximately 80 basis points of deleverage compared to adjusted SG&A from the same period of the prior year. As anticipated, the first quarter was impacted by approximately $4 million in holiday pay, with the New Year’s Day falling in the 1st day of fiscal 2024. Our strong sales performance led to higher e-commerce fees, as well as higher incentive compensation for the team. Last quarter, we shared our plan to invest $15 million in 2024 to build a foundation for sustainable long-term earnings growth and we are on track with approximately $2 million spend in the first quarter. Store closure and other costs totaled approximately $2 million for the quarter. These are primarily related to the ongoing occupancy costs from our 2023 store closures.

Depreciation and amortization, excluding depreciation included in the cost of sales was $32 million. For the quarter, our earnings before interest and taxes were $148 million, interest expense was approximately $1 million and our effective tax rate was 23%. Net income was $114 million and diluted earnings per share were $1.12, an increase of 14% compared to adjusted diluted earnings per share from the same period of the prior year. During the first quarter, we opened seven new stores ending the quarter with 414 stores across 23 states. A strong and healthy balance sheet has underpinned our financial performance. We generated $220 million in operating cash flow, allowing us to self-fund our investments of $46 million in capital expenditures, net of landlord reimbursement to grow the business.

We also returned $60 million to our shareholders by repurchasing nearly 1 million shares. We have $148 million remaining under our current share repurchase authorization. We ended the quarter with $312 million in cash and cash equivalents, $125 million outstanding on our $700 million revolver and $21 million of our outstanding letters of credit. Turning to our outlook, for the full-year, we expect total sales growth to be between 7% to 8% and comp sales in the range of 2.5% to 3.5%. We plan to open approximately 35 new stores, all in our current prototype. Adjusted earnings before interest and taxes are expected to be between $415 million and $425 million and adjusted earnings per share are expected to be between $3.05 and $3.13 assuming no additional share repurchases.

That said, we do expect to continue to repurchase shares opportunistically. We also expect our corporate tax rate to be approximately 25%. During the year, we expect capital expenditures net of landlord reimbursements to be between $225 million and $245 million. To add a bit more color to the full-year, we expect gross margins to be up as we continue to focus on initiatives to improve shrink and annualize our promotional optimization work from 2023. On the cost front, we expect ongoing wage increases, new store deleverage and our strategic investments to pressure SG&A resulting in additional deleverage in 2024. For the second quarter of the year, we expect comp sales in the range of 3% to 4% and adjusted earnings per share between $0.75 and $0.79.

We are expecting more moderate year-over-year impacts in both gross margins and SG&A as we lap fewer outliers in our second quarter comparison, resulting in gross margins up slightly, while SG&A will deleverage slightly. And with that, I’ll turn it back to Jack.

Jack Sinclair: Thanks, Curtis. We remain committed to serving our customers, our health enthusiasts with products that help them live and be better. Our team is dedicated to finding innovative and distinctive products with attributes such as organic, gluten free, grass fed or vegan that set us apart from others. The success of our foraging program has continued as sales on our innovation center continue to grow and we believe we have become the destination for exciting entrepreneurial food companies to introduce their unique products to the marketplace. This innovative spirit lives within our Sprouts brand and culinary teams as they continue to add hundreds of new items like hot honey chicken tenders, non-dairy frozen desserts, and flavored cauliflower rice.

Additionally, as I mentioned earlier, in store experience and customer engagement remain paramount for us. Part of our appeal is our friendly and knowledgeable team members who help customers navigate differentiated assortment available to them. The team’s dedication to our customers in the first quarter resulted in some of the highest customer service scores in our history, a remarkable achievement. Sprouts is incredibly fortunate to have the support of many customers who truly love our brand. As a complementary shop, we have an opportunity to deepen our engagement with our customers and grow their share of wallet through a loyalty program. Our vision is to distinguish our program by enhancing what our brand already does, helping our customers and their passion to live and be better.

This is a multiyear endeavor that will enable Sprouts to build a thriving community where our customers can engage with our brand and we can provide them with personalized content catering to their unique shopping preferences. Our upcoming beta launch of Sprouts Reward in two markets this quarter is just the beginning, and we’re excited to continuously improve the program by incorporating feedback from our customers and team members to enhance the experience, functionality, and technology over time. One of the reasons our customers and team members love Sprouts is because our values are aligned. We all care deeply for our communities and the planet. We recently published our 2023 impact report highlighting our work in areas we believe matter most to our target customers.

Areas such as responsible sourcing of sustainable products, waste reduction, and supporting the communities we serve. In 2023, $3.3 billion of our sales were from products with social or environmental attributes. Our transition to reusable bags removed approximately 130 million single use bags from circulation and our stores donated 29 million meals to those in need within our communities. It was exciting to see our team members support our Healthy Communities Foundation by donating over 5,500 service hours to build school gardens that help kids grow healthy through nutrition education. I encourage you to read through the report to get a flavor of our focus areas and impact. I was delighted with the opening of several new stores during first quarter from Cuddy, California to Bartonsville, Maryland.

In the first quarter, we launched seven new stores and are on track to open approximately 35 by the end of the year. We have an extensive pipeline of approximately 100 approved new stores and 70 executed leases, a testament to our commitment to expanding our brand and access to healthy foods in more communities across the country. We’ve also seen improved new store openings this year and we attribute much of the success to better brand awareness as we continue to densify markets and we have growing confidence in our real estate site selection model, which continues to evolve. These improved openings coupled with continued comp momentum in newer markets and our robust pipeline will support our growth aspirations. Internally, our team is making great progress in building a best-in-class workplace through our values and culture.

Our retention rates are currently at an all-time high, which is a tribute to the intentionality behind this work. We’re seeing improvement across the board in our team member engagement scores and believe this focus on culture is translating into the great customer service scores that we’re seeing. We know that our journey towards improving our culture is ongoing and we are excited for the progress we’ve made thus far. In addition to the culture work, we’re focused on preparing our leaders for growth. We aim to have a pool of skilled team members ready for future assignments. We typically promote close to 60% of store managers from within. To prepare them for leadership roles, we have developed Assistant Store Manager leadership tracks. Over 30 graduated this year from our initial cohort and another 50 team members entered the program in 2024.

In closing, the continued momentum we are seeing is a demonstration of the effectiveness of our execution. We’re delighted to receive encouraging feedback from our customers, which confirms that our collective efforts are making a meaningful impact. Our store distribution center and supporter office teams are ambitious for Sprouts future and are determined to deliver on the opportunities that lie ahead. Moving forward, we remain focused on execution, both day-to-day in our stores and on our investments for the future, all while keeping customers our top priority. Thank you for your support and we look forward to connecting with many of you in the coming months. And with that, I’d like to turn it over for questions. Operator?

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Q&A Session

Operator: Certainly. [Operator Instructions]. Our first question will be coming from Leah Jordan of Goldman Sachs. Your line is open.

Leah Jordan: Thank you. Good afternoon and great job on the quarter. Just wanted to start off on the comp. What was the primary driver for the outperformance versus your expectations? How did traffic trend throughout the quarter? And what do you attribute to the recent market share gains?

Curtis Valentine: Hi, Leah. Thanks for the note there. So yes, comps outperform, it’s really coming from a lot of different things. I think it’s a little bit of everything just being a little bit better than we expected. So continued positive solid traffic, the AUR and the unit stabilizing as expected, and the business just continuing to come along. So we’re pleased with the performance in Q1.

Jack Sinclair: Yes, we’re seeing positive traffic in both e-comm and in our bricks and mortar business. We’re seeing positive traffic in terms — positive basket in both of those panels that we have. So we’re kind of feeling positive about that. And basically, everything seems to be in good shape.

Leah Jordan: Okay, great.

Jack Sinclair: And the market share gain question you asked, Leah, just to comment on that a little bit. We kind of — market share is difficult for us. We kind of look at our own business and see how well it’s doing, because it’s very difficult to define what we do within the context of the total grocery market share. But certainly in the last — since the pandemic, I think people have been more comfortable in shopping in more places, which suits us as a complementary shop.

Leah Jordan: Okay, great. That’s very helpful. And then a number of follow-up. I just wanted to ask about gross margin. I mean, it came in really strong expansion in the quarter. You talked about some of the tailwinds earlier. Just how should we think about it for the balance of the year? How much of the magnitude will moderate on the promote optimization side for the rest of the year? And then you said it would be up for the full-year. Any more color compared to last quarter when you said it would be up 20 to 25 basis points given the strength in the first quarter?

Curtis Valentine: Yes, sure. I think so for the year, I would say up approximately 50 now. So certainly we got better flow through in the first quarter than we expected and it was really a shrink story. And we talked about on the last call, but we had challenges throughout last year and particularly in the second half and really credit to the teams, they got on top of it late last year, and that turnaround just happened a little faster than we expected and resulted in really good performance. Really just to focus on inventory management and some of the things that we’re investing in and the teams really working together, be it operations, merchandising, some of our analytics teams and our IT team coming together to help the business, figure things out and get things moving in the right direction. But yes, for the full-year, I’ve expect it up about 50 on the gross side.

Leah Jordan: Thank you.

Operator: And one moment for our next question. And our next question will be coming from Mark Carden of UBS. Mark, your line is open.

Mark Carden: Great. Thanks so much for taking the questions and nice quarter. So to start, maybe a follow-up on that last gross margin question. Obviously, a lot’s going right now, clearly benefited from shedding coupon clippers. 1Q is historically your strongest quarter from a seasonality perspective, the strong performance inventory management. Just thinking about 1Q relative to maybe 1Q next year, was this pretty much a perfect backdrop for you guys? Are you approaching upper bound? Or do you still see more room to go from here? So in other words, when you think about the benefit in the back half of the year, is that just these current tailwinds or do you see really more rooms go up?

Curtis Valentine: Yes, I think we’re pleased with there’s a lot in that. So I’ll try to tackle them piece-by-piece, but we feel good about our margins. Certainly bottom line, we expect to be a stable business and the gains we’re experiencing there in gross margin, there’s nothing in there that was particularly one time in nature. It was a soft compare year-over-year, which definitely helped from our overall magnitude perspective. It won’t be quite that big going forward. But again, we feel good about the work that we’re doing and we feel like it’s sustainable and that we’re kind of changing the water level and shrink here moving forward, and it will be a little bit better here in 2024 than it was in 2023. And longer-term, we’ve — we talk about it a fair amount. We’re still a fairly immature business, so there are opportunities. There are pressure points as well and net-net, we plan to manage the business to stable on the bottom line and continue to grow the business.

Jack Sinclair: And Mark, the gross margins particularly, there’s kind of buckets that we look at, shrink certainly been a big benefit for us in this quarter. And I think there’s continued opportunity. As Curtis said, the immaturity in our business as we get better at managing inventory with some of the systems that we put in and are applying increasingly more effectively. I think there’s some further benefits on that going forward. We’re getting a little bit better at promoting more effectively and understanding the elasticities of when were that’s been an ongoing thing over the last few years. And I think we’re just gradually getting a little bit better of being efficient at promoting when we do promote. And there’s been some drivers on mix, which I think will continue to help us in terms of mix towards organic and mix towards some of the more attribute based products that we work increasingly getting a reputation for.

I think those three buckets will help us going forward.

Mark Carden: Great. That’s helpful. And then as a follow-up, we’ve heard about some pressure on restaurant demand recently. Do you think Sprouts has been experiencing much trade in from outside of food at home? Have you seen any uptick in prepared food sales or do you think it’s mainly just coming from within food at home?

Jack Sinclair: No, I think we’ve got — we have had some benefit from that. I’ve been very pleased by the investments we’ve made that the team have made inside the stores. We’ve put a number of new cabinets in to support the meals space from both the meat business and the dairy business and we’ve seen some good benefits on that. Our frozen business has been strong. So there kind of three big buckets that come basically from people eating at home as opposed to eating in restaurants. I do think we’ve had a bit of a benefit from that. And who knows how the economy is going to go over the next six, nine, 12 months. But I think it’s more likely to be a benefit than a disbenefit going forward.

Mark Carden: Makes sense. Thanks so much and good luck.

Jack Sinclair: Thanks, Mark.

Curtis Valentine: Thanks, Mark.

Operator: And one moment for our next question. Our next question will come from Michael Montani of Evercore ISI. Your line is open.

Michael Montani: Hey, thanks for taking the question. Wanted to focus in on two areas, if I could. One was just on shrink. I think for you all, it’s more a story of efficiency gains versus theft. But just wondering if you can give us some incremental color there, Jack, in terms of what you’ve seen and what the opportunity could be? And then secondly, on the wage and benefit front, so can you just provide an update about what you all are experiencing there and what you’re looking for this year in that line item?

Jack Sinclair: Sure, Michael. I’ll let Curtis add a little bit more color on the two buckets. Shrink, we’ve made some benefits particularly in our fresh shrink. And as you correctly say, it’s less likely — we don’t experience the kind of theft that you’re hearing from a lot of the non-food retailers going forward, partly because our attribute products are so differentiated. I think it’s harder for people to steal them and sell them on to be honest with you. So I think we’re getting — we’re not seeing the kind of issue in that space that a lot of other people are doing, although we continue to watch it. The real benefit lies in how we manage our fresh inventory and we’ve got a bigger fresh mix than most. So the opportunity is bigger going forward as we get into these much more better replenishment systems.

We’ve got an initiative around here called FARM, which is Forecasting Allocation Replenishment Management, which is allowing us to — I think get better at putting the right amount of inventory in the stores at the right time. And we’re immature in this, Mike. So that remains a continued opportunity going forward. And we’re kind of I’m very pleased the way the teams and the operations teams have really got made some progress on that with a lot of support from the merchants and the IT teams. With regards to wages and benefits, one things we’re very encouraged about is the retention rates that we’re having in our stores, and we think that’s having a positive benefit. You don’t have to pay as much for training. You don’t have to pay as much for enrollment.

So the fact that we’re operating a very significant improvement on retention gives me a lot of confidence that the way the teams are managing each other is a positive and is working well. And as I alluded to in my remarks, I think some of the work that we’ve done on culture and values and purpose is beginning to pay dividends in actual improved retention. Wages are going to continue to rise and we’ve got that in the numbers going forward. And our benefit — one of the reasons that we think retention is working as we’re doubling down on communicating the benefits that we get whether it’d be health care benefits and bonuses. We pay bonuses quite a number of stores, everybody in the store gets a bonus. The leadership team well over 90% of the leadership team in every store got a bonus and that’s those numbers are significantly rising and it’s also financing.

So we’re very positive about the way our bonus programs have been working. So I don’t know whether you want to add something to that, Curtis?

Curtis Valentine: No, I think the only color maybe on shrink is about we talked about just about 75% of our shrink is in the fresh side. So just to add some context to that that tough piece is pretty small for us as Jack alluded to.

Michael Montani: Great. Thanks and good luck.

Jack Sinclair: Thanks, Mike.

Operator: One moment for our next question. And our next question will be coming from John Heinbockel of Guggenheim Securities. Your line is open.

John Heinbockel: So, Jack, let me start with, what do you want to learn from the two test markets with the loyalty program? And where do you think the benefit lies, right, traffic basket. And I don’t know if it’s hard for you to figure out your wallet share, but how do you think about that?

Jack Sinclair: Yes, John, great questions and they very much relate to — we first of all, the benefits will come in 2025. The work that we’re doing in 2024 is first of all to get the plumbing right and the pipework right, so that we’ve got the proper marketing technology behind creating a very efficient experience for the customer, So there’s seamless and efficient experience. The two test markets that we’re doing, we’ll learn whether that works or not and we’ll get it. We’ll iron out the kinks in that. And then by the end of the year, we’ll extend that to a pilot in a broader sense with more stores. So through 2024, we will learn how to do this as when it comes to 2025 and that will be an iterative process as well. What do we expect to happen?

As you alluded to, we’re expecting an increase in share of wallet of our target customers. I think we’ll be able to understand those customers so much better that we’ll be able to increase. And we’ve got a measure — some measure of what where we are in terms of share of wallet. And I think we’ve talked about that in the past. It’s double-digit, but it’s not hugely into the double-digits above the kind of low teens. And that context, that’s the context that we’ll be expecting to drive a little bit more of share of wallet from those target customers and that will more than fund this and pay for this thing going forward. So as I said, the benefits will come in 2025, the learnings will come in 2024. The first elements of the learnings are about technology and marketing technology.

The second elements of the learning are about understanding our customer, so that we can stimulate and create this feeling of being part of something special by being a Sprouts customer — by being part of the Sprouts ecosystem. And we’re pretty excited about it. The team are doing a lot of work behind the teams as you can imagine, and we’re excited about what’s going to come out at the other end, John.

John Heinbockel: Maybe second thing, right. You’re obviously adding a lot of stores this year and you did last year a little bit in the Northeast. So when you think about the timing right of that D.C., so how do you think about that now and how far can you push the envelope? I know the idea was going well beyond potentially well beyond produce, in all of the D.C.s. How far can you push that?

Jack Sinclair: Again, there are — we’ve created the infrastructure that allows us to have choice in this and linking back to what I was saying about our farm initiative. When we get our replenishment mode in place that I wanted to get in place, we’ll have a lot of optionality. We want to get more control of our Sprouts brand business going forward. We probably think there’s some elements of our fresh business that we can take hold of. We’ve got capacity to do that. As you alluded to, we’ve not quite got there in the Northeast yet, but we will be. There’s a lot of work going on about what’s the right distribution, where the right place for the distribution is and what the optionality is for us in that space. I’m hoping we’ll be there by 2026 at the latest in terms of having that in place. So we’ve got — we’re creating the optionality by the work we’re doing now. And going into 2025, you’ll definitely see us selling doing more than produce.

John Heinbockel: Thank you.

Jack Sinclair: Thanks, John.

Curtis Valentine: Thanks, John.

Operator: Thank you. And one moment for our next question. And our next question will be coming from Rupesh Parikh of Oppenheimer and Company. Your line is open.

Rupesh Parikh: Good afternoon. Thanks for taking my question. Also congrats on a nice quarter. So just on the e-commerce front, so as you’ve added Uber Eats, DoorDash in recent years, just curious if you’re seeing the incrementality at this point you would have expected with these additional partners?

Curtis Valentine: Yes. We’re really pleased with all three partners. We’ve seen strong business out of all three. They did a really nice job in the New Year, the healthy fresh start to the year that everyone goes through, it’s a big time for us and they were great partners in that respect. And yes, it’s been incremental as expected. So we’ve added both partners over the last two years and we’ve seen really strong results.

Jack Sinclair: And the good thing about it Rupesh as you’ve got DoorDash and Uber Eats, both got kind of different customer base. So I think we’re bringing some access to the assortment that we have to a slightly broader base. So it’s been working well as Curtis said.