Sprouts Farmers Market, Inc. (NASDAQ:SFM) Q4 2023 Earnings Call Transcript

Sprouts Farmers Market, Inc. (NASDAQ:SFM) Q4 2023 Earnings Call Transcript February 22, 2024

Sprouts Farmers Market, Inc. beats earnings expectations. Reported EPS is $0.49, expectations were $0.45. SFM 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 and welcome to the Sprouts Farmers Market Fourth Quarter 2023 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 today Susannah Livingston, Vice-President, Investor Relations and Treasurer. You may begin.

Susannah Livingston: Thank you and good afternoon, everyone. We are pleased you are joining Sprouts on our fourth-quarter and full-year 2023 Earnings Call. Jack Sinclair, Chief Executive Officer; and Curtis Valentine, Chief Financial Officer are with me today. The earnings release announcing our fourth-quarter and full-year 2023 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. As we review our year-end accomplishments, I’m once again pleased with our performance and encouraged about our future. We grew sales 7% for the year while maintaining our stable margin with a slight expansion in 2023. Moreover, our adjusted diluted earnings per share rose 19%, demonstrating attractive profit growth. Our strategic approach and specialty positioning allow us to focus on a highly profitable slice of the $1.6 trillion food-at-home space instead of competing with everyone for every customer. And we believe these results clearly indicate that this strategic shift is resonating with our target customers. We are becoming a leading specialty food retailer. We continue to focus on our target customers striving to deliver more of what they want, a broader assortment of differentiated, healthy, fresh, high-quality products that are hard to find anywhere else.

Approximately 15% of our assortment was new, including 400 new Sprouts brand products. We ended the year with the company’s best customer service scores by focusing on the customer experience through better service and improving our in-stocks. As part of expanding access to our differentiated assortment, we opened 13 new stores in our new smaller prototype, and we experienced good momentum, especially so in Florida. We created capacity in the supply chain to support our long-term growth by establishing a new distribution center in Southern California, expanding our Texas DC and adding ripening rooms to improve product quality. None of this will be possible without our amazing team. In 2023, we continued fostering a workplace culture that we believe will maintain a sustainable and profitable business for years to come.

We enhanced our development programs for team members so that everyone can grow a great career at Sprouts. We created approximately 3,000 new jobs and promoted 20% of our 32,000 team members in 2023. I’m also pleased to announce another internal promotion to our executive leadership team. Duston Hamilton has replaced Dan Sanders as our Chief Stores Officer. Dustin had been serving as our Regional VP of California, delivering great results and building a teams steeped in our values. Dan has decided to retire in March after eight years at Sprouts and many more years in the industry. I want to thank Dan for his lasting impact on Sprouts. In summary, our achievements in 2023 have positioned us well for the future, and we will continue working to unlock Sprouts’ full potential.

I’ll talk more about our journey in 2024 in a few moments. For now I’ll hand it over to Curtis to review our 2023 financial performance in the fourth quarter, the full year and our 2024 outlook. Curtis?

Curtis Valentine: Thanks, Jack, and good afternoon, everyone. For the fourth quarter, total sales were $1.7 billion, up $122 million or 8% from the same period last year. This increase was driven by comparable store sales growth of 3.3% and the addition of new stores. Traffic was positive both in store and online throughout the quarter. As expected, average unit retails and units per basket continued to stabilize sequentially. Our e-commerce sales grew approximately 17%, representing 12.4% of our total sales for the quarter. During the quarter, we also launched our partnership with Uber Eats to acquire new customers and expand their access to Sprouts. Along with Instacart and DoorDash, we now have three e-commerce partnerships performing well highlighting the appeal of our differentiated assortment.

We continue to see strong performance in categories with the most differentiation, including grocery, dairy, frozen and meat. Sprouts has experienced exceptional growth in attribute-driven categories within these departments such as grass-fed beef and no antibiotic-ever proteins. These categories have gained popularity due to their superior quality and health benefits, making them a top choice for our customers who prioritize healthy eating. This was true during the holidays with strong growth from the return of Sprouts brand seasonal favorites and our convenient attribute-based holiday meal bundles. Sprouts brand made up 21% of our total sales in the fourth quarter as our unique products continue to appeal to our target customers. Our fourth quarter gross margin was 36.5%, an increase of nearly 20 basis points from the same period last year.

Favorable merchandise margins were partially offset by the expected pressure from our new and recently expanded distribution centers. SG&A for the quarter totaled $513 million, an increase of $41 million or approximately 25 basis points of deleverage from the same period of the prior year. We continue to see pressure from wages and benefits. This was partially offset by a positive impact from holiday pay, with the New Year’s Day shifting into fiscal 2024. Store closure and other costs totaled approximately $5 million for the quarter. This is primarily related to noncash store asset impairments and ongoing occupancy costs from store closures. For the quarter, our earnings before interest and taxes were $69 million. Interest expense was $400,000 and our effective tax rate was 27%.

Net income was $50 million and diluted earnings per share were $0.49, an increase of 17% from the same period last year. For the fiscal year 2023, total sales increased 7% to $6.8 billion driven by comparable store sales growth of 3.4% and new stores. Comp sales for the full year were also supported by an increase in basket due to retail inflation and positive traffic partially offset by a slight reduction of items in the basket. Our e-commerce sales grew 15%, which accounted for 12.2% of our total sales for the year. Our focus on innovation and assortment differentiation continues to resonate with our target customers and drive our sales. Attribute-driven products such as organic, grass-fed, vegan and keto, grew faster than the company average throughout the year.

Gross margin, both on a GAAP basis and adjusted to exclude the impact of special items, was 36.9%, an increase of approximately 25 basis points compared to adjusted gross margin in the prior year. The year-over-year increase resulted from continued promotion optimization and category mix shifts slightly offset by pressure from higher distribution costs from our new and recently expanded warehouses. SG&A expenses for the year, both on a GAAP basis and adjusted to exclude the impact of special items, totaled $2 billion, an increase of $136 million or approximately 15 basis points of deleverage on an adjusted basis. The increase in cost is mainly attributable to the opening of new stores, and increased investments in team member wages, restructured store bonuses and training.

In addition, we experienced higher e-commerce and credit card fees linked to higher sales. Labor efficiencies and contract savings partially offset this as the team continued to find ways to manage costs despite the challenging inflationary environment. For fiscal year 2023, store closures and other costs totaled $39 million, primarily related to the charges associated with the decision to close 11 stores earlier in the year. Excluding the impact of special items, store closures and other costs were $11 million. Depreciation and amortization, excluding depreciation included in the cost of sales, was $132 million. Excluding the impact of special items associated with the store closing decision, the adjusted depreciation and amortization totaled $126 million.

For the year, our earnings before interest and taxes were $350 million. Interest expense was $6.5 million. Our effective tax rate was 25%, net income was $259 million and diluted earnings per share were $2.50. Excluding the impact of special items, adjusted earnings before interest and taxes were $396 million, and adjusted net income was $293 million. Adjusted diluted earnings per share were $2.84, an increase of 19% compared to the prior year. During the year, we opened 30 new stores, acquired two previously licensed stores and closed 11 stores. All 30, 2023 openings were our new smaller format store. We ended the year with 407 stores across 23 states. Our financial performance has been underpinned by a strong and healthy balance sheet. We generated $465 million in operating cash flow, which allowed us to invest $213 million in capital expenditures, net of landlord reimbursement to grow our business.

With our robust cash flow, we also paid down $125 million of our bank revolver and returned $203 million to our owners by repurchasing 5.9 million shares. We ended the year with $202 million in cash and cash equivalents, $125 million outstanding on our $700 million revolver and $22 million of outstanding letters of credit. Our diluted weighted average shares outstanding were down 5.3% compared to the last year, and we have $208 million remaining under our current share repurchase authorization. Since 2019, we have made significant improvements to our business operations. We changed our strategy, streamlined our store labor model and implemented key systems to support our growth. We also increased compensation and added training hours for our store team members, a critical investment to create the differentiated store experience our target customers love.

As a result, our gross margins have improved by 300 basis points, and our adjusted EBIT margins improved by approximately 190 basis points. Our four year adjusted diluted earnings per share CAGR was 23%, and our adjusted EBIT per square foot increased by 59%. All in line with our strategic targets. While we’re pleased with our progress, significant opportunities remain. As we look ahead to our expectations for 2024, we remain focused on delivering earnings growth while investing to unlock our opportunities and drive sustainable growth for years to come. We are planning to invest approximately $15 million, primarily focused on the build-out of our loyalty program. We also continue to invest in our technology and data foundation to improve our inventory management and scale our personalization capabilities.

For the full year, we expect total sales growth to be 5.5% to 7.5% and comp sales in the range of 1.5% 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 $397 million and $412 million, and adjusted earnings per share are expected to be between $2.85 and $2.95 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 26%. 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, we expect gross margins to be up and as we continue to focus on initiatives to improve shrink and annualize the promotional optimization work from 2023.

On the cost front, we expect ongoing wage increases and our strategic investments to pressure SG&A, resulting in additional deleverage in 2024. Most of our CapEx spend will be for new stores, with the remainder focused on technology enhancements, merchandising initiatives and store refresh and maintenance. For the first quarter of the year, we expect comp sales in the range of approximately 2.5% to 3.5% and adjusted earnings per share between $0.98 and $1.02. Our SG&A will face additional pressure in quarter one due to strategic initiative investment and the timing shift of holiday pay for New Year’s Day, which fell on the first day of fiscal 2024. And with that, I’ll turn it back to Jack.

Jack Sinclair: Thanks, Curtis. Our initiatives for 2024 will continue to strengthen our foundation while setting the table for sustainable long-term growth. This year, we plan to drive even more innovation in Sprouts brand and across the store, win more loyalty from our target customers, strengthen and improve our advantaged supply chain, develop a best-in-class team across the business and build exceptional stores. Our intent is to become a leading provider in attribute, health-driven categories, such as organic, vegan, grass-fed and Keto, prioritizing winning and gaining market share in these differentiated categories. To achieve this, our foraging team is searching far and wide for new health trends and working with niche vendors to find differentiated products such as low caffeine annuity, Popadelics, a snackable mushroom chip and matcha bubble tea drops.

Looking ahead, we will continue launching new Sprouts brand products, expand our seasonal in and out programs, leverage our innovation centers in store and engaging more sampling to drive trial and basket. This focuses on our Sprouts brand, continuing to deliver growth ahead of company performance and provide customers with products they value and trust. In 2024, we have an opportunity to gain new health enthusiasts and increase our share of wallet among existing customers. We’ll continue to prioritize store execution to provide great in-store experience and exceptional customer service while maintaining an omnichannel approach to meet customers wherever they are. I’m particularly excited about our plans to introduce the first iteration of our new loyalty program this summer.

We see a big opportunity to grow share of wallet with our target customers by getting them to visit more often and add additional items to their basket. The program is designed to grow our identifiable customer base and gather valuable data on their preferences, enabling us to personalize the experience to their specific needs. We’re also optimistic about how the data will potentially unlock value across our business by deepening our insights on customers, aiding Sprouts’ brands product development, improving customer acquisition and providing a new asset to utilize with our vendors to grow our mutual business. We are investing to develop a long-term value driver for Sprouts. 2024 will be dedicated to testing the concept, listening to our customers’ feedback and establishing a program ready for full launch in 2025.

We’ve made significant progress in creating an advantaged supply chain to support our future growth. In 2024, we will improve our in-stocks by adding PICAO to our deli meat and bakery departments. We will also enhance our supply chain data and technology foundation. Over the last years, we’ve improved our systems for production planning, computer-assisted ordering and produce replenishment. There’s now an opportunity to connect the data and processes that rely on these systems to improve our overall forecasting and ordering. This will enable a more disciplined inventory management process allowing us to further leverage our supply chain in the future. Our team is the most important part of our business, and we have concentrated on building a best-in-class workplace culture and values over the past few years.

While it is always ongoing process, we have made significant improvements. As a result, our team member retention rate improved by more than 20% in 2023, which has led to improved store performance and supports our continued store growth. To provide more opportunities to our team while driving for results, we restructured our store bonus plan, prioritizing customer service, being in stock and faster growth. This year, our main focus is to develop our leaders for growth. We will improve our training, focus on talent development and create clear career paths for leaders at all levels. This is critical for achieving our growth aspirations. We have blended fresh perspectives and external expertise with internal promotions at the Executive VP and Director levels to create a deep bench to support our growth.

Our team is coming together to execute our strategic priorities and support our stores and customers. Lastly, we will accelerate unit growth again in 2024. In the first quarter of this year, we have already opened four new stores and plan to open approximately 35 total for the year. We have a robust pipeline of over 100 approved stores and nearly 70 executed leases. And we continue to improve our site selection process to maintain a strong pipeline moving forward. In closing, our main focus is executing our strategy to establish Sprouts as an exceptional specialty retailer with a differentiated better-for-you offering. Our results demonstrate that our strategic initiatives are paying off, and I’m confident these principles will guide us through another successful year.

Our collected efforts are resonating well with our customers, and our team is ready to face the many opportunities ahead. I’m excited to share our progress as the year unfolds. And with that, I’d like to turn it over for questions. Operator?

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Q&A Session

Operator: [Operator Instructions] One moment for our first question. And our first question comes from John Heinbockel from Guggenheim Partners. Your line is now open.

John Heinbockel: So Jack, I wanted to start with, you’re adding assortment at the same time, right, you’re cutting square footage. So maybe talk about the foraging process and the planogramming process and sort of managing that in terms of taking out items that are not moving? And is there any — I don’t think you’re going to more vertical with your space. So is it kind of one in, one out or how are you dealing with that?

Jack Sinclair: Yeah. It’s a great question. It’s right to the heart of how we think about our business. When we reduce the square footage from 32,000 down to 23,000, we were very focused on losing not selling space, but actually cutting back on noncustomer-facing space, which allowed us to retain the SKU count that we had, apart from our vitamins and harbor department, which we took a few out in that department. Going forward with the foraging team, we introduced an innovation center in our stores, which is allowing us to move really fast with items that the foraging team are finding. And we put it into the stores into the innovation center. So that’s extra skews to what we would have had without the innovation center. What that then does gives us a couple of months to see whether the products sell, how the customers react to that section.

I’ve been delighted the way the customers have interfaced with that. It’s creating this treasure hunt of new items coming into the store, customers looking at the items checking and really being curating their own assortment from that and the discernment of our customers in that space is something that I think we’re — what we’re doing there is appealing to us. So in terms of the planograms, as those sales happen or don’t happen on the innovation center, the ones that are selling really well automatically flow into the original planograms, other products fall by the wayside. But effectively, we’re kind of — we’ve got a little bit of an increased SKU count because of the innovation center. As they get put in and come out the overall number, there are products coming out so that we can fit them into the planogram within the base fixture.

But that’s so that’s kind of part of how we’ve been operating this. And our business is all about broad assortment. It’s really important that we don’t compromise that assortment going forward. And so we’re always kind of trying to get more into the stores, to be honest with you rather than less.

John Heinbockel: All right. Maybe…

Jack Sinclair: Hope that answers your question, John.

John Heinbockel: Yeah. No, that was great. And one quick one on the loyalty program. So the $15 million, I assume that’s an operating — an OpEx item as opposed to capital. Is there a cost beyond ’24 that kind of correlates to the $15 million? And then I assume for the business case, you thought about what the top line uplift would be? You’re probably not going to tell us, but I don’t know if you can size it to get you comfortable with the ROI?

Jack Sinclair: So the way we — the $15 million isn’t all about loyalty. There’s some other things within that. But all of that is about investing in the business for the future, some infrastructure issues, some fundamental issues in investment in IT and the loyalty program that we’re working on. We’re very excited about it. The benefits for that will flow through in 2025. We clearly do have the numbers around the benefits of that. And as you see, we’re probably not going to share that with you today.

Curtis Valentine: And John, it is all — the $15 million is OpEx. And as a rule for the go-forward, yeah, we’ll manage it and plan into it as we go forward.

John Heinbockel: Okay. Thank you.

Jack Sinclair: Thanks, John.

Operator: And thank you. And one moment for our next question. And our next question comes from Mark Carden from UBS. Your line is now open.

Mark Carden: Good afternoon, and thanks so much for taking my questions. So to start, you guys have now outgrown the broader census category for several consecutive quarters. At this stage, are you still seeing much pressure from mainstream players adding to the natural organic offerings? Has that largely played out at this point? And then what else jumps out of you with respect to your ability to really buck the trend and grow sales faster than the overall channel?

Jack Sinclair: Well, I think we’ve talked a lot about this over the last few quarters, Mark, is that we don’t — we try to have such a differentiated assortment that what the other guys are doing — kind of we watch with interest. But what we found is that our niche, if you like, is something that we can really manage and be comfortable that we’re leading the way in that niche, as I said in our remarks earlier. What’s happening with the other guys is, yes, they are bringing the odd keto thing and they are bringing the odd item in. But they can’t for the target customers that we have, they simply can’t have the breadth of assortment to allow them to kind of be relevant to that customer. And it’s such a small proportion of the overall total.

It doesn’t give the — there’s no real benefit for the conventional guys to chase after this too hard because it would mean compromising some of their planograms and compromising what they’re able to do. And that’s how we’ve observed this over the course of the last few quarters, that it’s not something that we’re seeing. It’s certainly been a dialogue and we watch it, but it’s not something that we’re seeing as compromising our ability to be very relevant with our assortment to our target customers.

Mark Carden: Got it. That makes sense. And then as a quick follow-up, how did your comp trend from month to month? And what have you seen in 1Q to date?