Sprouts Farmers Market, Inc. (NASDAQ:SFM) Q4 2022 Earnings Call Transcript

Sprouts Farmers Market, Inc. (NASDAQ:SFM) Q4 2022 Earnings Call Transcript March 2, 2023

Operator: Good day, and thank you for standing by. Welcome to the Sprouts Fourth Quarter 2022 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. 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.

Susannah Livingston: Thank you, and good morning, everyone. We are pleased you have taken the time to join Sprouts on our fourth quarter and full year 2022 earnings call. Jack Sinclair, Chief Executive Officer; and Chip Molloy, Chief Financial Officer are with me today. The earnings release announcing our fourth quarter and full year 2022 results, the webcast of this call, and quarterly slides can be accessed through our 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 2023 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 morning, everyone. We ended 2022 on a strong note with fourth quarter results that included comparable store sales growth of 2.9%, total sales growth of 6% and diluted earnings per share growth of 31%. For the full year, our diluted earnings per share growth was 14%, which is in line with our long-term strategy. Highlights for the year include opening 16 new stores, 60% in our new smaller prototype, growing sales of our Sprouts brand to over $1 billion increasing sales of local produce by over 100%, creating 1,600 new jobs, launching approximately 8,400 new innovative products and digitally connecting with 13% more customers. I want to take a moment and commend our 31,000 team members for driving these results in another very challenging year across the consumer landscape.

Their continued dedication and commitment to making Sprouts a place for discovering healthy eating continues to make me proud. In a few moments, I’ll follow-up with more on our journey in 2023. For now, let me hand it to Chip to review our financial performance in the fourth quarter, the full year and our 2023 outlook. Chip?

Chip Molloy: Thanks, Jack, and good morning, everyone. For the fourth quarter, total sales were $1.6 billion, up $84 million or 6% from the same period in 2021, driven by new stores and comparable store sales growth of 2.9%. Comp sales were supported by an increase in basket due to retail inflation, partially offset by a slight reduction of items in the basket. Our e-commerce sales grew 16.5%, representing 11.4% of our total sales for the quarter. During the quarter, we also launched our partnership with DoorDash to acquire new customers and expand their access to Sprouts. DoorDash is now available in every store and continues to grow with each passing month. Deli continue to be a strong performer in the fourth quarter as healthy prepared meal solutions are favored by our customers in-store and online.

We experienced relatively strong performances in categories with the most differentiation such as dairy, frozen, grocery and bakery, bulk is also experiencing a positive turnaround as customers take advantage of the value and flexibility our offering provides. Our fourth quarter gross margin was 36.3%, an increase of approximately 60 basis points compared to last year. As you may remember, during the fourth quarter of 2021, our margins compressed as our price changes lagged input cost. This past quarter as we did during all of 2022, we kept our price changes more in line with input costs. SG&A for the quarter totaled $473 million, an increase of $24 million. New stores, additional marketing spend, increases in labor costs and higher commodity prices were the primary drivers.

Store closure and other costs relating to non-cash store asset impairments totaled approximately $8 million for the quarter. For the quarter, our earnings before interest and taxes were $62 million. Interest expense was $1 million and our effective tax rate was 25%. Net income was $45 million and diluted earnings per share were $0.42 an increase of 31% compared to the same quarter in the prior year. During the fourth quarter, we opened seven new stores spent $41 million in capital expenditures net of landlord reimbursements and repurchased 1.5 million shares. For the fiscal year 2022, total sales increased 5% to $6.4 billion driven by new stores and comparable store sales growth of 2.2%. Comp sales for the full year were also supported by an increase in basket due to retail inflation, partially offset by slight reduction of items in the basket.

Our annual gross margin was 36.7%, up 45 basis points compared to last year. The year-over-year increase results from slightly less promotional mix, managing overall price changes more in line with cost increases and reducing shrink via operational improvements and system support. SG&A expenses for the year increased $107 million to $1.86 billion. The increase is due primarily to additional stores, inflationary conditions driving increases in store costs, credit card fees, and increased e-commerce fees associated with higher sales. The strides we’ve made in improving our labor management tools helped to offset rising labor costs. For the year, our earnings before interest and taxes were $358 million. Interest expense was $9 million and our effective tax rate was 25%.

Net income was $261 million and diluted earnings per share were $2.39, an increase of 14% compared to the prior year. During the year, we opened 16 new stores, nine in our new smaller format and closed four. We ended the year with 386 stores across 23 states. Now let’s turn to the balance sheet and cash flow highlights. We ended the year with $293 million in cash and cash equivalents, $250 million outstanding on our $700 million revolver and $25 million of outstanding letters of credit. Cash flow generation remained strong for the year. We generated $371 million in operating cash flow and spent $112 million in capital expenditures net of landlord reimbursements. Our robust cash flow generation allowed us to invest in the growth of our business, predominantly new stores, while also returning cash to our owners through our ongoing share repurchase program.

For the year, we repurchased 6.9 million shares of common stock for a total investment of $200 million. Our diluted weighted average shares outstanding were down 6% compared to last year, and we have $412 million remaining under our current share repurchase authorization. Turning to our current expectations for 2023. We continue to operate in a challenging consumer environment, focusing on what we can control to drive meaningful results. One area of focus is ensuring our store portfolio’s ongoing health and profitability. We are pleased with the performance of our more recent store openings, especially the smaller prototypes. We’re also encouraged by the momentum of those newer markets as we begin to densify and establish more brand awareness.

In 2023, we plan to open at least 30 new stores, all of which are our current prototype. Back in early 2020, we consider closing some underperforming locations as we shifted our store growth strategy to a smaller, more productive prototype. We consciously decided not to close those stores as the pandemic struck, so our communities would continue to have access to fresh healthy groceries. We recently revisited that decision and as you may have seen in our release this morning, we plan to close 11 stores in 2023. These stores on average are approximately 30% larger than our current prototype and generate negative four-wall cash flow. One store will close during the first quarter as its lease expires and the remaining stores will close during the second quarter.

Team members from the closed stores will be transferred to other stores if they so desire. On the supply chain front, we will relocate our Southern California distribution center to a larger brand new facility in the second quarter. In addition to supporting our growing capacity needs, the facilities location will reduce the miles travel to our stores and is in a more robust labor market. There will be special transition costs associated with this relocation. The total cost for the store closings and supply chain transition will be approximately $40 million to $50 million pre-tax, of which close to 75% will be non-cash. With this backdrop, for the full year, we expect total sales growth of 4% to 6% and comp sales in the low single digits. We expect gross margins to be flat to slightly up and slight deleverage in SG&A costs.

Adjusted earnings before interest and taxes are expected to be between $355 million and $370 million, and adjusted earnings per share are expected to be between $2.41 and $2.53, assuming no additional share repurchases. That said, we do expect to continue to repurchase shares opportunistically. Both adjusted EBIT and EPS exclude the store closing and supply chain transition costs. During the year, we expect capital expenditures net of landlord reimbursement to be between $210 million and $230 million. Most of the CapEx is for the 30 new stores and the new distribution center. Other areas include technology enhancements, ongoing refresh and remodel expenditures, merchandising initiatives and maintenance. Ongoing, we expect CapEx to be approximately 3.5% of sales annually.

For the first quarter of the year, we expect comp sales in the range of 1.5% to 2.5%, and adjusted earnings per share between $0.83 and $0.87. And with that, I’ll turn it back to Jack.

Jack Sinclair: Thanks, Chip. Nearly three years ago, we embarked on a journey under a new strategy, which happened to correspond directly with a global pandemic. As the noise of the erratic past few years begins to fade, our progress is clear. We are a stronger, more profitable company and expect to sustain this business performance. Our mission was to transform Sprouts into a more relevant healthy living brand. We defined a clear cut target customer then sought to expand and market our product differentiation to our customers, reduce our store size to reinforce our farmers market appeal, grow our store base, integrate and expand our supply chain, inspire our team and drive attractive profit growth along the way. Despite all the challenges in the world in the last few years, this strategy has progressed and resulted in a financially stronger company.

The past few years, we have reset our margin structure, improved our labor productivity, and implemented needed systems. Since 2019, our gross margins have improved by 300 basis points. We estimate that about two-thirds of this was through decisive actions to promote more effectively. The remaining one-third were operational improvements such as less shrink from an expanded and well-placed fresh supply chain and systems that improved our ordering and in-stock positions. As part of our improved strategy, we intentionally changed our tactics to narrow our focus on our health conscious target customers, and we also made numerous investments in our business, such as increased wages for team members and systems for improved labor management inventory and financials among others.

As a result, our EBIT margins improved by 170 basis points. Our three years earning per share CAGR was 24% and our EBIT per square foot increased by 49%. Our ROIC has also improved by 270 basis points, all in line with our strategic goals. These foundational initiatives have allowed us to move onto the next leg of our journey. We have plenty of work to do. To build on this foundation in 2023, we’ll be focused on growing customer engagement, expanding category leadership and product innovation, a more efficient and effective supply chain, and accelerate our store unit growth. On the customer front, we continue to focus on driving engagement with health enthusiasts. Last quarter, we conducted a comprehensive research study to understand better what is most important to our customers post-pandemic.

They consistently told us they’re looking for us to help them take new measures to be healthy. Freshness, quality, innovative variety and commitment to sustainability are all key drivers for our customers. These learnings prompted us to pivot our marketing positioning to launch our new Find Your Healthy campaign in January. The campaign connects by sharing several ways customers can create their own health journey at Sprouts and is anchored by what customers tell us they love, our fresh, high quality and innovative products you can’t find anywhere else. This differentiates us and creates a sense of discovery for our customers. As I stated at the beginning of the call, Sprouts brand hit $1 billion in sales late last year. A remarkable accomplishment, largely due to our focus on innovation.

We plan to accelerate this growth even more in 2023, you will see additional new Sprouts brand products, an increased focus on seasonal programs and a brand style and packaging redesign that is already showing promising results. In 2022, we invested in growing our convenience meals and plan to double down again in 2023. We bring differentiation to this growing category with higher quality and healthier options. Our customers will find even more chef-driven creations in seasonal offerings, added plant-based and health attribute options and additional family meals. We doubled our local produce sales in 2022 with more than 11% of our produce sales now from local growers. We believe our relationships with farmers, scale and expertise in fresh produce enable us to own and grow this space.

That advantage led to the launch of a rescued organics produce program in California, benefiting our farmers and customers and helping to combat food waste. The farmer gets the added benefit of selling produce that is still completely fresh and tasty, but it could have otherwise ended up being wasted all because of a regular shape, sizes or blemishes. So customers can buy delicious organic fruits and vegetables, which simply don’t meet visual specifications at a great price. We also learned that our customers strongly desire to engage with Sprouts more often, especially regarding more convenient occasions. Proof point of this is that our e-commerce growth has been one of the fastest in grocery at 400% since 2019. Building on this last quarter, Sprouts launched a partnership with DoorDash to provide a new channel of e-commerce focused on the convenience of delivery to customers.

These channels offer new opportunities for engagement for our high value customers. Lastly, to connect with customers more effectively, we are scaling our personalization efforts to develop a stronger one-to-one relationship. We’re investing significantly with the right partners to build a more robust marketing and technology platform. These investments will continue to be a top priority to meet customer needs for additional engagement. Ultimately boosting customer loyalty. Chip has briefly spoken about investments to create an advantage supply chain from which we can grow. More than 85% of our stores are within 250 miles of our distribution channels up 20% from 2019. This year we’ll be focused on investments at our current DCs, replacing our so-called DC and expanding our Texas DC to account for growing demand while adding ripening rooms to our Arizona, Texas, and Southern California DCs to deliver even better produce to our customers.

As we expand our brick-and-mortar capabilities, we are also expanding our supply chain systems, allowing us to leverage our technology better to ensure we have the right products in the right location for our customers to enjoy. This includes a DC replenishment system expansion and perpetual inventory computer assisted ordering at our store operations. We started implementing PICAO in 2022 and I’ve experienced much success produce daily. Frozen and grocery are benefiting on the sales front from better in stocks and optimized inventory levels with more fast moving items and fewer slow movers. We have reduced our shrink by improving terms and freshness from transitioning to adjust in time replenishment model and we have experienced labor savings by allowing the computer to do the work for us.

Lastly, on the real estate front, we are expanding with our new 23,000 square foot store and every store opened this year will be in our new format. We’re excited about our robust pipeline of more than 80 approved stores and nearly 60 executed leases. We have already opened four new stores in this first quarter with a plan to open at least 30 stores this year, and we are on track to reach our 10% unit growth starting in 2024. In summary, we remain focused on advancing our strategy to differentiate Sprouts further as a unique specialty retailer focused on health and wellness, while expanding our footprint with an advantaged unique store format. We will also continue efforts to manage all costs during these uncertain times effectively. I firmly believe these general principles will guide us through another year of success and I’ll look forward to sharing our progress.

With that, I’d like to turn it over for questions. Operator?

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Q&A Session

Operator: Thank you. Our first question comes from Rupesh Parikh with Oppenheimer. You may proceed.

Erica Eiler: Great. This is actually Erica Eiler on for Rupesh. Thanks for taking our questions. So first I wanted to touch on comps here. So comp growth obviously accelerated on a multi-year basis, so I was hoping to get a better sense of what you’re seeing from the consumer here, from a trade down perspective or any other notable changes in consumer behavior lately?

Jack Sinclair: Well, I think the pattern over the past going in the fourth quarter was kind of consistent to what it’s been through the year. We’ve seen a kind of pretty steady traffic, which we’ve been encouraged by, and in terms of the consumer behavior with the level of food inflation, you’ve seen a trade down as we’ve talked about, people have been trading down in terms of both the number of items in the basket and trading down in certain categories. You’ve seen a little bit of a trade down in the protein space, you’ve seen a little bit of a trade down. You can see the strength of our Sprouts brands business. You’ve seen a little bit of a trade into that as well. So I think the consumer behavior in Q4 was pretty consistent to what it was throughout the year of 2022, and I think we’re seeing that same pattern as we go through this year.

Erica Eiler: Okay, that’s helpful. And then we know you have a difficult compare, with the King Soopers strike from last year, and then we’ve seen industry headwinds lately in the vitamin category. So just curious if there’s any more color you can provide to us quarter-to-date trends at this juncture, and then just, any commentary on the vitamin category, performance here.

Jack Sinclair: Well, specifically to the vitamin category. What you’re finding there is the patterns are trending very much around the ups and downs of COVID comparisons from the previous year. There was such extreme numbers in different directions across different years, so you’re seeing that pattern continue. The cold and flu what happens with cold and flu clearly affects the vitamin business pretty significantly as well. So, we see some great months and not so great months. So it’s fairly volatile and it continues to be a very important category to us and we’re very excited about the people that are operating in the middle of that vitamin department. What works really well for Sprouts is in the vitamin department, we’ve got a lot of expertise of people who can really understand, how vitamins and supplements can help our customers.

So, we’re excited about the team and excited about what’s happening, but there’s a lot of volatility in that. Maybe Chip could talk a little bit about the broader context of your question.

Chip Molloy: Yes, sure. So as we were going through the end of the year, obviously we’re competing against Omicron towards the end of the year and then into the beginning of this year, and then while we were competent against the King Soopers strike at the beginning of this year. So our comp compares a little bit more difficult coming into the beginning of the year, but we’re seeing it, we’re past that now, we’re steady and you can see in our guidance, we feel pretty good. We’re one and a half to two and a half compliment guidance there for the quarter.