Sprouts Farmers Market, Inc. (SFM) Earnings Call Transcript & Summary

Yes, I think I'd just add 2 small things, which is -- I think you talked a lot about the movement to the smaller stores. I want to be clear because we get this question from folks a lot. It's not about reducing the selling space in the store. It's actually about, as Jack said, go back to the older format, which is we don't need as much backroom space. We don't need an eat-in area for customers, right? We added space to make it feel like a bigger store, but not necessarily more selling square footage. That's where we're really cutting back. So when we talk about being able to kind of maintain the level of sales you see in an existing store, it's a point that, I think, comes up quite a bit, and we wanted to reinforce. And then one that's a little lesser-known that I would just add is you might remember that in the old world, when we opened a new store, we did it with a really big bang. So it went really deep for weeks on end, which could be great for that new customer attraction, but when you think about the natural ramp and flywheel that would come from comp sales growth year-over-year, when you did such that deep investment when you first opened that store, the model kind of get turned upside down. And so what we've been doing this year already, and we'll continue as we go forward, is open with great promotion, great activity to get people excited about the store but not do the prolonged kind of opening the way we did in the past, which really challenge comps in the next year.

Yes. Yes, that's great. Denise, you touched on this earlier. As it relates to your special -- your employee incentive program that are unique to you all. I'm curious so as we've been in this environment of elevated sales and the impetus to provide elevated bonus incentives to your employees deservingly, kind of what's the paradigm that you're using or thinking about around employee bonuses and increased pay during this time period? What's the lens you're looking through to think about making those decisions?

Yes. So I can jump in or Jack can -- and Jack, please pile on here. Overall, I think our philosophy has always been to really reward and pay for performance, to be really competitive in the marketplaces in which we compete to have that benefit be available. Something that's really new that since Jack had come to the company was moving to a quarterly bonus structure for the stores, where all team members are eligible, which really creates that vested interest for folks in the stores. We've recently also moved to a 6-month review period. So people have an opportunity earlier in their tenure to have wage reviews, to have opportunities to move up in the organization. So our overall philosophy is our store team members are our stores. They are our company. And making sure that they are appropriately rewarded is the primary focus. We want to do that through how we think about paying them every day rather than are necessarily being just be focused on COVID.

Yes. And I think one of the things that's been very clear this year, and it's been quite heartwarming, is the fact that people working in grocery stores and people working in Sprouts, the regard with which they're being held by the communities that they serve has been transformed. It's very heartwarming when you see some of the cards and letters and what -- it will be applying across the industry. This isn't just -- all right. The way the customers across grocery have been kind of reacting to this kind of frontline worker almost and the support that they've had, it's been very encouraging. On the other hand -- on the other side of that, people are coming to work and they're kind of frightened, to be quite honest about, especially in the early days of this pandemic exactly what does it mean being in front of so many people. And that whole PPE and the protection and the cleanliness and the hygiene has put a lot of pressure on our teams as well. So this year, we have focused very hard on making sure -- I think we always should and always would, but we focused very hard on making sure that, as best we can, we take care of them, as best we can, we compensate people appropriately within the context of the world that we're living in. Going forward, one of the strengths of our NPS scores are the interface that our teams have with the -- with our customers. Specialty areas like vitamins -- our vitamin leads and the people working in those departments have become quite a trusted source for people in the context of this. That building up of service and the interface of how customers are interacting with our people, whether it be at the butchery counter, whether it be in the vitamin department, whether it's talking to the guys in the produce department, whether it's getting guidance on diets and those kind of things, that's an important part of our proposition. And we're going to evolve and develop how we can incentivize people to be really good at that kind of side of things as we evolve through this. I think we've done a pretty good job this year at doing what we've had to do in difficult circumstances. But the longer term principles, as Denise said, talk about how do we get real buy-in to what we're trying to achieve. And again, when you talk to our people, and I've been encouraged by this, there's a sense of pride in what we do in and that it's more than just a job. And we need to kind of keep reinforcing that in the work that we're doing.

I think a lot of investors are focused on the difficult comparisons coming in 2021. For better or worse, that's the nature of the narrative: not knowing what the top line will do next year, facing uncertainties in the macro environment and facing the difficult comparisons. I'm curious, with what's in your control, I'm curious what you can control on margins, how you think about your margins and how they react in a potentially negative same-store sales growth environment. Just given the large numbers that you do have to lap, what do you think about in terms of alleviating the concerns of lapping over those numbers?

Yes. And I think, first of all, I'd say we're not lapping over as big numbers as everybody else are, as everyone keeps telling us. So we kind of like got that. We know that fundamental starting point because of the nature of our business, because of social distancing. We've seen -- we saw a really big peak in the March, April time, as you can imagine. But like, as you saw, it kind of leveled off a little bit more so for us than others. And that's kind of what we half expected. We weren't totally surprised. What will happen going forward, we don't have as much to lap. That's all I'd say to start with. That's one. What's going to happen overall? We've got -- it will be -- I don't know when the pandemic is going to end. I don't know when the vaccine is going to come through. So I don't think -- it would be lovely if January 1, 2021, we just -- that all ended, and we could just measure exactly what happens. That's clearly not the way it's going to flow through. So our challenge will be taking control, as you say, of the things we've got control of, the cost of running our business and our margins. We had those margin plans well in place before the pandemic, though they have built up over. And we're seeing a lot of progress on that. We will see further progress on that when we get the program and -- when we get the new DCs up and running, distribution costs will be coming down a little bit. Shrink cost will be coming down a little bit. So we've got some opportunities to continue to expand our margins and irrespective of what happens in terms of the top line. And we're feeling confident about a lot of the work that's coming together on that in terms of some systems from replenishment and some work that's happening in the stores. So we see shrink and distribution costs continue to enhancing our margin. What we're finding with regard to -- that creates, in my estimation, some arrows in our quiver, if that's the way to put it. That as we evolve through the dynamics of as things change, I want to invest in our customers that we're targeting and the marketing initiatives, really talking to the customers that are relevant to our proposition, irrespective of how they're choosing to, with how many stores they're going to or how they're shopping and how -- what's happening to restaurants, we can market very effectively to that target customer. And we're going to have the resources to be able to do that effectively. What we're not going to do, pre-pandemic, during the pandemic, post the pandemic is chase promotional activity because it -- fundamentally that plays into a scale conversation that we're not going to win. And I don't want to win a promotional battle. If we do win it, we won't do it at the kind of returns that we need to make. And that's one of the fundamental changes that are consistent pre, during and post the pandemic.

Yes. We touched on this earlier when we were talking about how COVID has impacted various elements of your plan, but clear as day the obvious impact on your business has been the online and digital business. We've seen that scale, accelerate tremendously. How big do you think that business can get? Because I think we've all kind of reassessed how big we thought online grocery could be given this environment. Customer behavior has changed tremendously. And how do you think about the profits of that revenue stream versus your in-store business? Can we reach scale -- parity of scale? What's the balance there?

I'll let you take that to start with, Denise, and then I'll going to come in.

Sure. So overall, you asked a great question. I think your answer would be as accurate as my answer might be about where will this go over time. Do we believe it will continue to grow because people have figured out it actually works? Sure. Is it likely to continue to accelerate at the pace we saw with COVID? I don't think any of us believe that. And just even watching other countries who are a little ahead of us in the pandemic, things have leveled off a bit. But you raised a couple of other good points. It's a really important part of our business. And fundamentally, we want to serve our customers however they want to be served. And for us, that just means we need to make this piece of the business as exciting to the customers coming into the store in the way that we can do that. When we talk about profitability and what we can do, the biggest thing I'd point to is think about the profit that we've generated this year, the margins we've been able to have this year, and we've expanded that business from 4% of our business to over 10% of our business. So while, of course, there are some extra costs associated with manning that business, it's usually also large baskets, large baskets with less promotional items in them. So there's a healthy offset in terms of the mix of how that business comes through that we think makes it very viable to continue to increase penetration over time, but we still believe the vast majority of people will want to be doing some or all of their grocery shopping in a store because, in a store like Sprouts, it's just a great experience. And it's an easy in and out. And you get to do a bit of treasure hunting as you're there. So I think very focused on growing it, growing it as profitably, but being where the customer wants us to be.

Yes. And I think just reinforcing that mix point I think what happens in -- from a profitability point of view, the mix in our business, whatever people buy, it's a fairly consistent margin because of the nature of our kind of proposition. When you go and look at the grocery baskets of more traditional grocers on online, you see this huge disparity in make -- in make margin mix and at the high-volume consumable items, the CPG items, tend to be at lower margins. And then the basket has to be made up by higher margins to make the thing work. We're not in that place. Our underlying margin profile works pretty well in that. So then I think we have to, as Denise said, we have to meet the customer where the customer wants to be. But fresh foods is a dynamic that ultimately, I think people want to migrate more in fresh foods to going to the physical -- buying the product themselves and experiencing the smells and the colors, and that's what our proposition has always been built on. And I think in e-commerce, for grocery, you'll see a very significant holding of the volumes on CPG items, big brands, consumable items, more so than you'll see what's happening in fresh foods.

Yes. Along those lines, you talked about people wanting to come into the store. Pickup is an offer, an interface for customers that's grown tremendously across the industry. Your model is a little bit different, but you're doing some pickup as well. How does that fit into your suite of offerings? What are you thinking customer engagement looks like with that post pandemic and over the intermediate to long term?

Yes. Well, again, when the pandemic started, we were at 55 stores in terms of pickup, and it was a pretty low percentage of our business. We immediately ramped it up, and the team did a really nice job of ramping up to all stores within a few weeks. We had managed to do that in 6 or 7 weeks. So we gave the option to the customer to pick up given the context of the pandemic, and we have seen a decent business on it over the -- as part of our e-commerce business. And I think it clearly was the right thing to do to give customers that option in terms of working it through, and we will continue to offer that option going forward as part of our proposition so that we can meet the customer where they want to be met in this context. The difference between us and pickup at some of the larger big-box stores or the [ Big 6 ] is that people are not buying all their consumables, the big high-weight things, big boxes of Coca-Cola and Keurig and all those kind of things. They're not buying that in the kind of scale paper towels and they're not buying it in that kind of scale in our organization. So pickup will never be as -- I think it's going to be much bigger for some of these other guys, but it will never be as big for us. Ultimately, that's not how our customer shops with us. But in the context of the pandemic, we have found that having that offer has been important for our customers. And I think, ultimately, that one, I don't think, will be as important to us 2, 3 years down the line as maybe the e-com side of it might be, the delivery side of it might be, simply because of the nature of our small stores. And if you're going to drive up to pick up, I might as well go in and see what they've got in terms of fresh foods. And I think that's what we're finding from people once you get past the pandemic.

Okay. Another element of your store and your historical build strategy has been deli. I think the deli interface has changed dramatically in the midst of COVID. You're talking about smaller stores, less seating, maybe no change in the selling space. How should we think about deli in the context of that new store and as a new operating environment post COVID?

Well, what happened in our business in our new stores and some of the new stores that we're still building, I think we're just about finished them now because of the gestation period in new store programs, have had a very, very big deli presence. So we invested a lot of space and money on a deli island and a fairly substantial deli island with kind of a few seats. But it was kind of a halfway house to some of the great operators that do this well, and it was costing us a little bit of money. And the proposition, the products we were giving the customer, was not substantially different. It was actually a much nicer environment. Customers liked it better. Not many people use the seats. I used to kid the team on about how I could never find anybody sitting in the seats. But the island itself actually made the operating model more difficult because you couldn't access the production as easily. So you have to go back and forward. So it costs a little bit more money to operate. It costs a little bit more money to build. There were some nice bells and whistles on it, is the way I would describe them. But when you go back to our original stores, the deli business and sandwich business in our San Diego stores are amazing, and we don't have these bells and whistles. The meals that they prepare do really, really well in some of the smaller stores. So we think we can replicate this effectively by going back to what we've done in the past. We're doing a little bit more work on meals and creating meals, and that's something that we can get better at within the context of the format that we're developing. So as an important category. It is a category that legitimately the previous management of this business, we're saying, we can do better in this because we go and visit some of these other guys. But the outcome of it was not enough for additional product, higher costs, a little bit higher shrink and higher operating costs and higher capital costs. So I think we can evolve our way through this to be in a better place. There's clearly, as I said earlier, there's a dynamic post-COVID that I think will be more about eating at home rather than away from home. I mean we need to be -- we need to be well placed and probably better placed than we are today to deal with that.

Yes, okay. There's been so much noise in the financials of grocers, your peers. But I think kind of circling back to the start of the conversation. You guys are in the midst of a strategic transformation. You're doing a lot of different things. I know, Jack, you said it well. It's not like we're going to get to January 1 and all of a sudden, it's a new day, and everything is clean from a number standpoint. But when we try to contextualize your business relative to your peers and competing investments for buy siders, what is Sprouts' growth algorithm? What should we be thinking about as a reasonable expectation for repeatable growth, growth algorithm over the next 3 to 5 years?

Well, we've got a 5-year plan. I don't know, Denise, if you want to have a go at that, and then I'll kind of build on it.

Sure. Yes. So I think go back to where Jack started at the beginning of the conversation. A blessing for us is we had, had this strategy developed, we had, had the strategy kind of ready to go out of the gate pre the pandemic. And so I think the foundation of all of that remains intact and as does the growth algorithm. What is uniquely different for us than many other players out there in the space is we do fundamentally believe in the white space opportunity of 10%-plus new store growth every year. As Jack mentioned, when we find our target customers, they love us. We don't necessarily have enough points of distribution to reach as many of them as we could possibly reach. And so that new store growth potential is a very real part of our equation. We think modest continued comp growth, we would love that to be faster. We'll work for that to be faster with our target customers. But our financials are really great, geared around low single-digit comps in a normal environment. And then the improvement in the 4-wall box economics that we've talked about. So fundamentally, these smaller stores can be more profitable stores. They can be more profit-generating stores with a 20% lower size, 20% lower cost to build and operate that promotes a great financial return. I think the piece that might be a little bit accelerated and different than what we talked about when we originally rolled out the strategies, I think we have done a step change in where we are with our margins. And so fundamentally, we said we were going to grow them over time. I think we've been able to show that we can do that and in fact, accelerate that. So the fundamentals of that growth algorithm in capturing the white space all remain intact. We'll complement that nicely with e-commerce where the customer wants to be served, but the core model really still intact.

Yes. And I think that if I had an aspiration, I'd like the investment community to kind of view us as different from our -- even the word peers, I keep saying to Denise, I just don't see ourselves as the same as the people they're calling our peers. And it's not in any way kind of trying to be difficult. I just think it's a very different mix business when you've got -- produce is a big way, way over 25%. You've got bulk, you've got vitamins, you've got meat, you've got -- it's a quasi kind of unique specialty grocer that clearly can give significantly better returns than when you're trying to chase all of that $1.4 trillion marketplace. Because when you do that, you have to chase everything. And if you're a big-box retailer or you're a big supermarket, you've got to chase everything. We are in a very unique position of being able to have a proposition that was so brilliantly evolved by the guys that invented this whole thing and made it all come alive. We've got this opportunity of being very distinctive and very unique, and I think a very unique investment proposition. So my -- again, my aspiration is that we don't get compared to peers because we don't have any peers. We're just Sprouts.

That's a good place to leave it. Jack, Denise, Susannah, thanks for your time today. Thanks, everybody, for listening. Have a good rest of the day, rest of the week, and Happy Thanksgiving to everyone.

Thank you.

Thanks very much. Take care, everyone.