Q3 2020 Sprouts Farmers Market Inc Earnings Call

October 28, 2020

[music].

Ladies and gentlemen, thank you for standing by and welcome to Sprouts farmers market third quarter 2020 earnings conference call. At this time, all participants are listen only mode. After the speakers presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your telephone please be advised that todays.

The conference is being recorded if you require any further.

That's right.

Okay.

[noise].

It is now my pleasure to introduce Vice President Investor Relations and Treasury Susanna Livingston.

Thank you and good afternoon, everyone. You're pleased we're pleased you have taken the time to join sprouts on our third quarter 2020 earnings call, Jack Sinclair, Chief Executive Officer, and deep Denise Paulonis Chief Financial Officer are with me today, the earnings release announcing our third quarter 2000.

20 results and the webcast of this call can be accessed through the Investor Relations section of our website at investors that sprout dot com.

During this call management may make certain forward looking statements, including statements regarding expectations for 2020 and beyond.

These statements involve a number of risks and uncertainties that could cause actual 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 along with commentary on forward looking statements at the end of our earnings release issued today.

Our remarks today include references to non-GAAP measures for a reconciliation of our non-GAAP measures to the GAAP figures. Please see the tables in our earnings release.

With that let me hand, it over to Jack.

Thank you Suzanne and good afternoon, everyone. Thank you for joining our call.

We delivered strong results in the third quarter with sales up 9.5% on comp sales up 4.2%. Our E. Commerce business grew 337% outpacing most he called mass growth rates in the industry. We ended the quarter with Eecol Macs, representing 11% of our sales our gross margin.

<unk> increased 400 basis points versus last year as a result, our adjusted earnings before interest and taxes were up $81 million up 104% on an adjusted EPS of 52 cents was up 136% bashes last year.

As we started Twentytwenty, we were focused on executing on our five year strategy of creating a highly profitable differentiated spatiality grocer with a long growth runway.

Overall, the coal we didnt vitamin has allowed us to fast forward certain aspects of our strategic plan, which has provided many financial benefits.

We pivoted quickly to shift our print ads to digitalize, providing shorter lead times on the flexibility to source better buy and build smarter promotions that are not lost leaders.

These changes along with shrink benefits have helped us achieve many structural and sustainable margin improvement.

As a result today, we all thought differentiated speciality grocer financially stronger than ever.

Well, we still have plenty of work to do to realize our five year vision to double the size of our business I am more convinced than ever about potential.

Before I provide an update on a few pillars of our strategy I want to emphasize that we continue to prioritize the health and wellbeing of our team members and our customers.

I mean focused on serving our customers no matter, how do they choose to interact with us for the healthy groceries their families need.

I'm pleased with how far we have come on above all I want to thank the team during this never ending pandemic for providing service to our communities taking care of our co workers on delivering strong results for our shareholders.

Turning to our strategy I want to share some progress in three key areas innovation marketing and E Commerce.

And I want to highlight the importance of our produce merchandising and sourcing strategies.

Innovation is moving us forward or non perishable departments like grocery and frozen are resonating with our customers with comps higher than the company average and Twentytwenty, we've launched more than three and a half those and new and unique products focused purely on innovation and taste some of these.

The exciting new products include our seasonal and then I'd hatch, Chile items like our grain free Paleo envied unfriendly chip sprouts private label label began much alafi protein powder on remedy organics cold brewed coffee with MCT oil differentiated pond based Quito and private label and a note.

Categories are all excelling as these unique categories are targeted to our desired customer base.

As we speak we're working through a deep dive of all of our categories to understand the needs and wants of our target customers and ensure that our innovation engine is primed to bring even more new innovative branded and private label offerings to every department in our store.

Turning to marketing in the Middle of August we launched new branding through TV, social digital unreal onto the campaign spreads where goodness grows the campaign, which includes our first mainstream commercial on farm fresh goodness drives home or farmers market experience by higher.

I think procedures the heart of our store uninspired health enthusiasts ondeck speeding seekers to engage with our brand.

To date, the new branding has been well received we continue to see our net promoter scores among our frequent shoppers rank best in class with a P.S. brand building takes time, but our digital impressions have been impressive with more than 1.4 billion impressions of our master brand since its launch.

On over 2 billion overall media impressions as we extend our reach.

With our target customer groups, the health enthusiasts and the experience he can.

Involved advertising strategies are aimed at our target customers instead of attempting to blanket fly us to everyone in our market areas.

Well no reaching more than 17 million can found the views of our weekly digital flywheel. That's is the 21 million print flies distributed in the past.

Additionally, we are leveraging the flexibility of digital communications to make our customers aware of what is new and different in our stores real time, we use digital marketing to highlight unique seafood variety said, we don't regularly county, which is tied to a seafood showcase this was activated on show.

No just a few weeks ago, and we saw seafood sales beat expectations.

This supports the power of our differentiated assortment and targeted digital communications that we will leverage more in the future.

From a pricing standpoint, we have a better balance of more everyday accessible prices on fewer odd items and fight in the produce department, we are seeing customers buying more items on everyday retails at lower prices on historic trends due to our investment in everyday price on fewer <unk>.

Comes in.

In summary, we are in the early stages of brand development, but I'm pleased with the initial response the opportunity lies with us to properly communicate and grew our target customers on their baskets overtime.

We had a 6 billion dollar grocer and a 1.2 trillion dollar market, we only need a small portion of market share to double in size.

As I mentioned earlier, we're excited this approach said one of the fastest growing E commerce businesses in the second quarter unlikely the third quarter.

It is more important than ever to have a full omnichannel offering as many customers use both in store and online for the grocery needs. They complement each other and the third quarter, we launched delivery in curbside pickup through shop sprouts Dot com, so customers can order directly from sprays.

Hi, there through our web site or the sprouts app on their phone.

Well the service utilizes the Instacart order management technology, that's improvement keeps the customer in sprague's ecosystem allows us to leverage data for customer insights and does not require the customer to have an instacart to Kent to place an order, creating a seamless sprouts experience for the customer.

When end shop Dot sprite dot com customers can apply sprouts exclusive digital coupons and speed up reordering with favorites on previous order history.

Somewhat can even sachin filter surprise product catalog by key attributes such as new on sale inorganic to find and discover products more easily.

The additional data insight God that allow us to customize our marketing spend on capture trade funds.

From a fulfillment standpoint, we utilize a hybrid model and stock comp performs the home delivery and our team members performed the pick up in store. We believe our model is right for us leverage in the scale of the Instacart marketplace, while rapidly growing adoption of our owned E commerce experience with.

The ability for the customer to purchase directly from our website well we capture meaningful data.

Finally, I want to highlight the importance of our produce business as we look to the future our produce will be fresher more differentiated individually and boy did by volume oriented special buys that you're not loss leaders are part of your strategy is only enhancing who we already are fresh produce I'd say great volume it's.

As part of our DNA.

The addition of our two new Dcs in Colorado, and Florida in Twentytwenty, one will allow us to be closer to our stores, which will create a fresher presentation to our customer.

It will also allow us to take advantage of local and seasonal buying not available today.

This year, we restructured restructured approach who's buying department.

We created a centralized buying team focused on specific large quantity project categories and regional buying teams that fosters deep relationships with the farming community and create partnerships for unique unique or new varietals in the future.

These meaningful far more partnerships help us bring new and innovative products to our customers and write the eylea wave of new varietals before they become commoditized.

For example, today, we're working with a small group who are focused on organic honey nut squash. The quantities are too small for many of the large chain. However, future flexibility, we do not need the products in every store instead, it becomes a treasure hunt to find just spreads.

This hybrid model provides us the ability to be nimble and react to pricing in the market and provides us with the agility to flex on size based on availability. These.

These relationships allow us to be a great partner to the farming community I know is rewarded when we other farmers first call when the heavy on product.

These spot buys provide us favorable pricing, which allows us to pass these savings on to the customer through great deals or every two retailers.

This project start to de allows us to build a path forward and grow with the farmers, which enables us to continue to surprise and delight our customers with fresh product you varietals on special buys.

Now, let me hand, it off to the needs to speak to the financials. Thanks, Jack and good afternoon, everyone.

In the third quarter net sales grew 9.5% to $1.6 billion fueled by sales from new stores and comparable store sales, which are up 4.2% compared to the same period last year Arthur.

Our third quarter profitability finished strong with adjusted EBIT of 104% driven by ongoing strategic changes as well as sales leverage let.

Let me provide a little color on our comparable store sales.

First during the quarter, we were cycling an intensely promotional period from last year with August and September having heavier promotions in July.

Our data shows that purchases from highly price sensitive shoppers 200 for deals on our print AD slowed during the quarter as it continued to shift our marketing strategies to target customers with greater interest in assortment.

Instead, it was expected as we continue to execute our new strategy.

And second regarding customer dynamics trip consolidation appears to be a new norm. During the pandemic. We don't believe we benefit from this trend as we only carrying limited assortment of traditional CPG products like paper goods and cleaning supplies.

As well our geographic mix of stores is more weighted to regions of the country. That's off slower overall food at home growth later in the quarter as indicated by credit card data.

Well pandemic related dynamics and the cycling of week to week promotional on even eat unevenness from 2019 are likely to persist in the near term, we're confident that our strategic actions will result in a long runway of profitable sales growth.

Speaking of profit for the third quarter gross profit increased by 23% to $585 million and our gross margin was 37.1% a positive increase of 400 basis points compared to the same period last year.

Numerous strategic changes, we began late last year like everyday great prices with less AD mix the elimination of loss leaders and shrink initiatives continue to benefit gross margins.

As well lower sales on high shrink items like Deli and salad bar positively impacted the margin.

We estimate approximately 250 basis points were enabled by coven.

We're excited to see the strategic structural changes to our margin taking hold.

At Genie Sen with $475 million or 30.1% of sales de leveraging 200 basis points compared to the same period last year.

Similar to recent quarters, we continue to reward our team members in the stores for special bonuses as we lived through a year. Unlike any other in recent history.

In total we estimate the additional SGN a cost associated with over 19 was approximately $34 million for the quarter driving the de leverage.

Additionally, with our high ecommerce sales, we incurred increased ecommerce fees, which were offset by other efficiencies and leveraging fixed costs on our higher sales.

Moving down the rest of the income statement, our depreciation amortization costs for the third quarter were $31 million or 2% of sales a decrease of 10 basis points compared to the same period last year.

For the quarter, our adjusted earnings before interest and taxes were $81 million, an increase of 104% when compared to the same period last year.

Our interest expense was $3 million and our effective tax rate was 20%.

Third quarter diluted earnings per share was 51 cents and adjusted diluted earnings per share was 52 cents compared to diluted and adjusted diluted EPS of 22 cents in the third quarter of 2019, an increase of 136%.

We continue to generate strong cash flow and maintain ample liquidity year to date, we have generated cash flow from operations of $410 million up 27% from last year and have invested $76 million in capital expenditures net of landlord reimbursement primarily for new stores.

Additionally, during the quarter, we paid down $176 million of outstanding debt, resulting in $275 million outstanding on our revolver and $138 million in cash and cash equivalents.

Reflective of our strong balance sheet, we ended the quarter with a net debt to adjusted EBITDA ratio of 0.3 times.

For the third quarter, we opened six new stores ending the quarter with 356 stores in 23 states.

As of today, we've opened 20 stores with an intent to open two more stores this year.

We're still in our journey to open new stores at a minimum of 10% annual unit growth rate.

Due to the pandemic in 2021, we expect to open a similar number of stores that we did in 2020 and more backend loaded.

Our expectation is to open all 2021 vintage stores with a smaller footprint adopting as many features as possible from our new format.

Turning to the fourth quarter, you will remember that this quarter. We are lapping the first phase of our promotional efficiency efforts drove merchandise margin improvements starting in the fourth quarter of 2019, even.

Even with that we expect to expand gross margins in the fourth quarter.

As well we will end the two dollar per hour looked back on us, but we'll continue to offer a bonus is tied to performance for all store team members over the holiday season.

A reward not offered by many grocers in the space.

We continue to expect additional expenses to keep our stores clean and safe for all.

Bring all that together in the fourth quarter, we expect comp store sales to be in the low single digits and inclusive of the 50 Threerd week adjusted diluted EPS to be between 36, and 40 cents, which translates to a full year 2020, adjusted diluted EPS range of $2 and 26 to $2 in the third.

Any sense on a 53 week basis.

We remain confident in executing our long term unit growth plan, winning with our target customers, maintaining our strong balance sheet and delivering sustainable superior returns.

As we build out our 2021 plans, we are more focused than ever on maintaining the momentum we have captured in 2020, giving us confidence that our earnings before interest and taxes in 2021 will be in the range of $285 million to $305 million.

Now, let me turn it back over to Jack for some closing comments.

Today more customers are wanting natural and organic looking for fresh foods more interested in the provenance of where the food came from under the food was responsibly sourced on sprouts has positioned itself to take full advantage of this trend occur.

Across all aspects of our business. The team has done a phenomenal job in establishing who we are which is really getting back to the original sprouts model, we introduced years ago to self customers fresh healthy quality foods, a great everyday prices supported by innovation.

In fact over the last months as we go back to our roots. We have demonstrated that we can even get back to sprouts original IPO profit margins.

Last we are making tremendous progress on our strategy what excites me. The most is that we have so much more runway ahead on improved supply chain and use a smaller format continued product innovation and enhance customer analytics to market. Your core customers. We believe these initiatives will continue to improve our financial returns.

Driving industry, leading margins, while creating more opportunities for our team members and allowing us to serve even more customers with healthy an innovative offerings.

At this time to open up the call for questions operator.

Thank you.

As a reminder to ask a question you will need to press star one on your telephone [noise] to withdraw your question first apparently please stand by while we compile did you win a roster.

Your first question comes from the line of Paul Trussell with Deutsche Bank.

Hi, Good afternoon. This is actually extended to tie encore call.

I was just wondering if you could talk a little better about your comp underperformance relative to the broader grocery market. You did mention that you were cycling some deep promotions, but what else do you think is the driver behind that and also as we look at the fourth quarter you guided to a low single digit increase compared to some of your larger peers guiding to about high single digit rate and.

Then just longer term does this give you any sort of pause about your overall strategy.

Yeah, I think Kevin the reality is we're playing our own game in the middle of this at a time.

Time, Dan make under its something that we outlined well before the the the Corvidae dynamics have created a little bit of confusion. We are very set on the strategy that we've outlined which is targeting specific customers targeting oh I'm more not all customer.

Our base than trying to appeal to all people all times on the reality of it for us as though that's the few that takes us back to what we had originally which is targeting on those customers who are particularly interested in the in the products that we sell on the proposition that we put in front of people.

I'll work, we're very comfortable that that strategy is working well photos the relative comps that come from the quit the inherent in your question its not something that we.

Quite frankly are wanting a lot so, but we do things or some dynamics that Denise outlined in our remarks around the geographies a little bit different the category mix that we have is a little bit different and there's a few things that would make sense. When you don't sell a lot of the the core consumables part of the grocery makes you.

We're likely to get slightly lower comps and then the other than the than the comparative to you're giving us, but we're feeling really comfortable about where this is taking us in terms of returns where this is taking us in terms of growth. The fact that we've got a fairly significant new store growth are performing well fairly comfortable.

Well with the data that we're seeing from the customer base that we are targeting.

So as we continue to evolve the strategy in terms of innovation continue to evolve the strategy in terms of digital communication to the target customers under appropriate promotions that walk in terms of appealing to those customers, we're pretty comfortable that we can play our own game in the middle of us.

And the guidance, we're giving we're pretty comfortable with at the moment Denise I I just had one point I think it's important to bear in mind that our topline sales were 9.5% because we actually have a lot of new store growth fueling our growth as well and we in doing that and believe we acquired customer from other retailers.

And we've got a tremendous amount of white space can going ahead for us in the country as we outlined in our strategy and I think that's an equally important part for us to balances were also managing the comp.

No that is great. Thank you and I just wanted to ask one follow up for you did they add an EBIT target for next year in the range of 285 to 305 million can you just walk us through some of the key driver is that you need to achieve in order to hit these numbers and I guess, what is just your general level of confidence around.

Putting that I get like that.

Yes, I think you you know we'd would start early working on our 2021 plans. It's an interesting year to have to lap from 2020 and to what will happen next year, how long coven trends will persist kind of what that process will look like as we hosted the country will be reopening I think for US we're very excited.

Not having had the opportunity to reset our financials in 2020 and believe that the majority of the changes to our financials you will focus on our margins are structural and sustainable and that's a lot of what is driving our confidence in what we'll be able to deliver last year next year based upon what we're delivering in 2020 and.

I think we also see the runway of other improvements that we're going to be able to continue to make that will make it a great shopping experience for our customer, but also continue to fuel the profitability that we're able to drive with standing up our new Dcs.

The new smaller footprint stores, we're going to start to roll out continued focus on data analytics. The customer analytics. You know all things that are going to have our strategy continue to come to life, while we're leveraging the momentum that we gained from 2020 and our margin structure.

That is great. Thank you and good luck.

Thanks.

Thank you and our next question comes from the line of Mark Harvey with you yes.

Good afternoon. Thanks, a lot for taking my questions. So first as a covered pandemic and shifting consumer behavior caused you guys to make any changes to your new store prototype and by that are you planning to expand or pull back on any of your departments within stores relative to what you may have planned earlier this year. Thanks.

Yeah. It's a good question Mark and clearly the pandemic has had some dynamics have caused us to kind of second guess some things reinforce other things, but particularly with regard to E. Commerce I think that was the piece that maybe when I was talking about this at the backend of last year when I first joined we probably.

Finally, well as.

Focused on the growth in E. Commerce that means that 70 has happened and we can say we continue to think that will be a stronger element of our business going forward us people engage with our brand. So the format will take a little bit more accommodation for how to effectively service those needs. So the space for pickup there.

How do we handle pickup within the format that will evolve a little bad has evolved a little bit and I was thinking as you would expect and I think we were considered worked well, but even more focused on how important what we call center of plate is as people have become more kind of I suppose familiar with eating more at home.

We think that element was maybe going to be stronger than we envisaged again pre pandemic, which seems so long ago, but not pre the priest pandemic view with probably it we've evolved a bit in terms of how we're going to position and source on put in front of the customers. What we would call our sensor a plate meat plant based.

Answer plate products.

I suspect the baking cooking ingredients part of this whole proposition is going to be stronger as well going forward. So we've evolved a few things things Ive stayed the same we believed frozen foods was going to be strong and it's probably even stronger now and we were committed to giving a lot more space to that fellows to appeal to the customer base around the world.

Then in Paleo and vegetarian, which were very strong. So that's probably been reinforced as opposed to changed by the pandemic, but I'd give you a flavor of the kind of things were thinking about modeling.

Great and then a follow up on the quarter. Just how are you guys thinking about your market share performance on a comparable mix basis. You guys think you are performing in line with the market in the category you can do there.

Thanks.

Yeah, I think what what kind of outlined a little bit in the remarks, as we think what we're holding our own on grocery and frozen if not even doing a little bit better or not we think the consolidation of the trip as.

As Denise said, probably hasn't helped us with regard to the food show relative to other people within that but as we look at certain categories have been you know things like bulk, which I'm very pleased the way the team of dealing with it have been kind of compromised by the kinda restrictions have been built in our place I think Donald bounced back and that's been a significant part of.

Our business is not a significant part of many of the other people that were from the you are comparing us with so I think what think we're holding our own having said that we've also outlined the promotion changes year on year, which were very specific about how do we change the momentum of who we're speaking to I'm not got some implication.

In short term that we work our way through.

Great. Thanks, very much and good luck.

Thanks [noise].

Thank you and our next question comes from the line of Scott Mushkin with.

Five capital.

Hey, Thanks, guys I appreciate the appreciate the questions. So I was just wondering a Jack I mean, I heard the thoughts around the sales the sales slow down I guess I'm just trying to get my arms around it there will be used to be but I concur with you is really great for a net promoter scores.

From what we see in our research and then also the store execution, which seems like you can see the team has done such a great job. So it kind of leads you to think maybe there's some you know maybe some tour.

Torture tweaks that can be done on on the go to market strategy and I was wondering what you think regarding that you need to kind of tweak things just a little bit. So you know the the traffic and sales get more in line with the industry.

Yes, Dan its a good question Scott as we think that's one through we're learning and practicing in changing our thoughts as to how do we do this on the first thing that I've been trying to do is reestablished the base business model in the business, which is getting us to a point, where we are operating without compromising our margin to drive the sales and I think.

That's something that I'm, feeling pretty confident about as we experiment with new tactics on we're experimenting with new digital tactics as to how to effectively make that work I outlined a little bit in my remarks about the number of impressions that we're getting we're continuing to learn how to take those impressions and turn them into traffic in some of them.

To sales I kind of outlined the seafood thing, but that's a little thing that we're doing and there's a lot of other things would go in the helper to think through so it's by no means in the place where we've got this makes up for how we promote where we wanted to be and the key thing for us going forward as we.

We're really clear about the customers that we're targeting and we're really clear about how we want to approach those customers and we're really clear that that does not involve huge loss, leading grocery promotions that you would see across the industry. It's not what we are going to be good that is not what we're going to win west going forward.

I'm feeling very confident of the segmentation on the communication is the right direction for us to go in and we as a team as we learn how to do this well get ourselves much much better for us over the course of the next few months.

I appreciate that my follow up question is regarding the new format and the change the changes going on with the consumer and how you think you're going to maybe enhance kind of ready to eat ready to heat ready to cook.

Peter It does look like consumers going to walk through solutions in a much bigger way.

Going forward I, just wonder if you could maybe talk through how you guys are thinking about the merchandising has been has been shown to prototype comes out.

Yeah, but then as we want and then that'll affect more than just the new prototype as I talk through the different categories in terms of how things have evolved undeveloped baking cooking spaces dot read that assortment is something that we are evolving and developing on the nature of our business being very good at gluten free and very good.

The than the specific specificity of the ingredients on the attributes of those products. We have been doing a lot of work on non I'm pretty confident that we'll have that differentiated offer in those spaces, which I do think is going up some sustainability going forward frozen foods is something that as Ive said before were very strong on.

We will continue to evolve that on the grocery team have been going through category by category, taking on board the trends of this year and looking at the healthy enthusiast and the innovation CV experienced seeker customers that we're targeting on identifying those products are going to make that work when it comes over to the other side in terms of.

You're talking about regarding meals and ready to me on how to go we've got a pretty strong business on on PON meals, which is evolving and developing within our meat meat proposition and I'm very pleased with the progress with what we are going to be doing in the product and the new format with regard to our meat business onwards.

In regard to our plant based business, we're very strong in plant based on not coming together pretty well in terms of what we're going to have in terms of how we're going to put that in front of the customer and then with regard to me.

Meat and meals and we're going to be very well, we're going to focus in on those attributes that matter a lot and differentiates us grass fed nuance you buy or takes in the in the product the sourcing in the provenance of where the product comes from the animal husbandry. This involved in it we're going to be talking a lot both in our stores.

Talking a lot not to our customers and it's very clear to me that this combination of the healthy eating customers are interested in this provenance of the food and Watson enough. Good very much. So on the innovation seekers are looking for taste and credibility from the retail of itself. Some not on we're going to be very different in those.

Spaces in the format going forward.

And we will continue to develop our meals business, that's how to do that even better than most units at the moment.

Perfect. Thanks, so much.

Thank you and our next question comes from the line of Chuck Grom with Gordon Haskett.

Hey, Good afternoon. This is actually John Park on for Chuck I guess within like the Fourq Guide can you talk a little bit about your expectations for gross margin improvement as you lap some of those promotional changes from year ago, and then kind of the headwinds related to co bid and some of those ecommerce costs continuing.

Sure. So you know as we laid out in our guidance. We continue to believe that our gross margin will expand versus year ago, and even though in the year ago period. In Q4, we had started the promotional a journey that we're on in terms of resetting that base and getting away from inefficient promotions as we do believe that coveted still enabled us to.

Do more in that space on the margin front, but also importantly on the shrink front as well we could have done a step change this year and what we've been able to do to manage shrink. So those two items combined have us feeling great about continuing to deliver some additional gross margin improvement this year and on the ESG.

In a front as I mentioned in my comments, while we are stepping back from the two dollar look back of bonus we do still expect to see some other cobot costs come through so we continue to supply keep you need to our stores. We continue to maintain an extra levels of cleaning discipline and we are still offering a bonus for our team members in the quarter.

Unlike what some of those might normally do we have a firm we have a performance based bonus that our stores are eligible for each quarter, and we really communicated to them and double down on that piece as well as we're thinking about the quarter and but net net expect to have a expect to have a good quality quarter come through on both.

France is we're managing those s. unit costs, and pulling a bit about lapping compared to other quarters down and then continuing some gross margin strength.

Got it that's helpful. And then just kind of switching gears a little bit is there any update on a rolling up until loyalty program kind of here in the near term.

Yes, so I can speak to that a little bit I think what we wanted to make sure that folks understand is we should have the technology in place today to have a loyalty program and we do collect email addresses and have that information what weve never really done before is overly activate the use of that loyalty program in in terms of the rewards based program.

I am or some other kind of value to the customer we primarily used as a means to be able to communicate to our customer about the weekly AD upcoming on coupon new product innovation, we're exploring and thinking about ways that we might be able to expand that to make it a little bit broader that might increase the.

People have people belonging to the program and using that loyalty card, but overall you know we have the capability we're using it in a in a much more simplistic way today and are evaluating and Theres a plan in the future to expand that a bit more.

And were successfully expanded the number of emails that we have and then using that those emails to really target the customers over to that we've been talking about with the knowledge that the novel target that we have so and the short term, we're going to use emails much more effectively than we have in the past.

Got it so [noise].

Yes.

[noise]. Thank you.

Your next question comes from the line of Ken Goldman with JP Morgan.

Hi, good afternoon. Thanks.

I wanted to make sure I understood the comment correctly about getting back to original IPO margins.

Yes, grosses EBITDA margin peak that 8.7% in 2014 is.

Is that what you're talking about is the kind of level you can get back to sustainably.

It seems like a little bit to me of a high bar just given how much of the world has changed either.

Be margin dilutive and so forth. So I am just curious what the major drivers are to kind of get you back to that level.

Well, let me talk a little bit about the world might have changed or not changed since that period of time, and then I'll, let Denise talk a little bit more about the specific numbers, where we've made a huge progress over the course of this year and I think we've probably moved faster than than we anticipated when I talked about as well before the covance.

Environment.

The the the pie is so much bigger on natural and organic than it was.

When will then this IPO was originally done it doesn't take much for us to get huge growth in this market without taking huge market share because the pie is much bigger and because we are solely focused on it I think the point about when the IPO happen Ken was perhaps people were saying the lebron.

Just jumped on this bandwagon note, but first of all nobody's jumping on the bandwagon to the point that they don't want to do anything else, which means the limited in how they can do that on the pie is much much bigger so I'm feeling very it doesn't take much as I said of market share for us to be very confident that we can get.

Good growth, even this quarter the 9.3 growth with the new stores is pretty significant in the space in which we operate and so I think from.

From the point of view of the size of the price, it's pretty big on the point of view of the margin opportunity I think we've demonstrated this year exactly was out margin opportunity is in this space and there is a little bit about and cold, but not much of it has to do with Covance. So I'll, let you I'll pass on to Denise just to talk a little bit but going back to that.

These numbers that you described as a high high bar.

Thanks, Jack I think any comment on the numbers when we go back and look at the financials around the time of the IPO. We're really looking that there was an EBIT margin out there you know around five 5.5% range. This year has been a really good year in terms of us proving that we can get back into that range now as Jack.

I said I think what we did this year is prove that we can get into that range. We feel good about where we are there we know that we have levers to pull.

Whether that's the exact number that we're going to stick with over the long term and it's not necessarily setting a new target I think the element of communicating it was really saying is those numbers are not out of reach for what we can do given the results that were actually posting this year.

Okay.

And then my follow up is you talked about targeting specific customers getting back to a narrower base I understand the strategy, but I'm curious when do you think this sort of calling dynamics starts to laugh when I say, because it's a little difficult to their into necessarily model strong comps until we get just a little bit better visibility.

Realty into that dynamic.

And I guess I'm also curious what gives you confidence that you're not cutting into the bone of core customers right now the ones you really want to keep.

Yes, you have some loyalty, but it's it's email address is it's not a loyalty card I don't know how you necessarily know which customers are the core and which are not thank you.

So I mean, I think the thing that gives us a lot of confidence that the customers were targeting is the size of our basket. So we're getting through that on the NPS scores. The people that we are targeting truly love sprouts, and we just need to communicate to more of those type of people.

The opportunity is if they come into spreads go forward or not there's plenty all of them. We know that we know the size of the market. So the market opportunity or that what up 200, and something billion dollars as a market opportunity of the 1.2.

Two three year whatever the number is trillion dollars market. So that not innocent gives us confidence that there's enough people. There I know, we communicate with them effectively with regard to cutting into the bone I think I think I've said it a onetime of area with Kohl's was.

Well, we don't one is the promiscuity of shopping that week, we've had by having very aggressive growth story at a project is on grocery price points that are loss leaders those customers.

Are not the long term customers that are going to make it work for us and that's what we've been planning for well before covance. The confusion I suppose for all of US as we try and read does for next year and the year. After has been how much of these dynamics are being affected by the cove, it environment and how much of it.

As down to our very specific work that we're doing there is no doubt that there has been a consolidation of trips.

Which has probably lost does some of those customers that we that you're identifying in the in the non target space, but we're feeling pretty confident that the people that we're targeting.

Got plenty of room with us plenty of room for us to grow.

When we get past this covisint vitamins, so that we can truly understand it better.

And I think there's two data points toward tied to our stores that are also important indicators of how the target customer is working for us as well when we look at our stores in aggregate and we put them in desktop and then we stack up how many of our target customers are in that proximity or in that area around us around those stores versus how.

How many in a non target customers you see a direct correlation to kind of a death file a store performance and the customer count that we have this in those target customers in the MSC as a whole.

The other thing on a more narrow basis as we've actually gone back and looked at for new stores that we opened in the last 12 to 18 months and said if what we had used at the time was data around.

Our core customers are to our acute heart target customer segments around to those stores.

Verses the segmentation that had been variant being used previously to guide new store choice or disproportionately performing better in our new stores, where that target customer accounts on the new target customer base. This is higher than where we are otherwise, they're all doing fine, but you can see a bit of a.

A step change difference, where we're closer to those two target customer segments. Today. When you go look at what we opened through the 2019 period.

Thank you ladies.

Ladies and gentlemen, due to time constraints, we ask that you. Please limit yourself to one question.

Next question comes from the line of Greg Badishkanian with Wolfe Research.

Hi, This is Spencer handsets on for Greg I think in your prepared remarks, you mentioned that E. Commerce was 11% of sales into Threeq, you or are you expecting on mix to remain at that level as we head into for few and then when you 21, and then how do you think it with E commerce at that level and now moving potentially more of that business onto your own.

Website, how do you think that change will will impact your ability to manage the margin headwind there.

Well I think I think given that we're at 11% in Q3. The margin performance was pretty good kind of demonstrated in terms of the numbers that Denise went through a little bit while ago. The way, we manage dot they been pretty effective for us in terms of its a profitable mix in the basket is very strong with a not.

In terms of I think it will moderate a little bit, but who knows exactly no I don't think it will go back to where we well that's for sure and I think I I would see it moderating a bit from where we're not but I think we'll end up fairly significantly higher than where it was a mix of our business and I think that again when we look at the customer data then.

Switching thing for me is this omni channel customer Thats, so important to the I think the grocery space going forward and as I said earlier it has become more important in my mind for our company than it was a year ago that omnichannel customer.

Thank you for serving them well and if we can get the communication of the brand to those customers and then let the customer choose how to interact with the brand I think we'll be in a strong place to to do a good job as an omni channel retailer.

Combining the strength of the in store experience on the brand messaging in terms of letting people access what they want going forward. The other dynamics as we evolve through this I'm pleased about is I think we are going to be able to get much more customer data in terms of the way, we're evolving our E commerce business I'm not.

Data will serve us well in terms of how to understand how to service those customers even better in the future and I think we think Theres a great partnership between what we can do on our own website key people in our own ecosystem, who just want to experience sprouts, but we also don't lose the benefit of a good partnership with Instacart and good traffic.

An instacart site, where people are just looking for that convenience every day. So now what we're really able to offer folks is the choice between them and that they can make that we don't need to make for them.

Thank you. Your next question comes from the line of John Heinbockel with Guggenheim.

Hey, Jack maybe you can talk to you you mentioned before in and out a items and product introductions.

How about where do you see that going forward in terms of the intensity of introductions or how much do you want to be a treasure hunt retail.

Retail or has that as part of the mix and.

And then how do you manage the planograms around that if you. If you are going to have more treasure hunt items in the store.

Yes, again, it's a good question John and as we think through this I've been really pleased for example, right now in terms of the harvest items that we brought in private label to really have them in and out we've got some great seasonal items coming through in private label, which very much relate to that caused the target customer that we've got and I would see us.

Somewhere and I am the numbers going to somewhere between 20, and 25% it, especially in our grocery business I'd like to see that kind of level of innovation coming in and out to constantly create interest for the customer that particularly the experienced seeker customer I think we can be the destination further.

Kind of healthy in diet focused innovation customer across the market place and we're going to have it on your format stores Betty specific space for an innovation center, where we'll really make thats come alive and the teams are working very hard about how to get further upstream on energy.

Patient so that were closer to the new things that are happening both branded and what can we do private label. So I can see it being 20, 25% of our mix, particularly in the <unk> and the grocery business in terms of managing the planet grams behind that.

You're right one of the things I'm I'm trying to avoid us becoming is a super efficient planted grom driven retail business because I think if you do the kind of things I'm familiar with the technical back in the UK or Walmart here and in the U.S., where you get very disciplined about space in phases and I.

Homes, I think you meant something along the way so the work that we're doing doing on our system evolution and there's a lot going on behind the scenes on that in terms of how to make that work is creating a flexibility. So that we can be a farmers' markets. So that we can bring things in and take them out while having discipline in our inventory management.

And behind the scenes I'm.

And that's one of the as Denise talked about the runway ahead of US. It's one of the runways ahead of us is going to get as real differentiation and yeah bollen supposed to make that efficient without becoming if you relate to boarding and sometimes planograms meet you to boarding.

Thank you and our next question comes from the line of branded Fletcher with Bernstein.

Hey, guys.

One real quick question I'd like to put it to the new customer segmentation I think it's very disciplined.

We think the assortment changes make a lot of sense, we always look for kind of a second attribute to attract that customer and so if you can help us give a little clarity on either it's kind of a service offering that helps pull that targeted customer or it's just a convenience play as you get more and more stores rolled out help us understand kind of the other apps.

You got that pulls that segment you're after an addition.

To really quality assortment.

Yeah, and I think one of the things that appeal to me about spreads in the very first place with the sheer quality of two things the format itself. The low profile the centering of projects at the back of the store gives a very natural feel that targets well irrespective of the products are in it it targets very well on the other pizza.

It's pretty amazing is the quality of our people in terms of the service element to the customer I think.

Our NPS scores would suggest that were better than most of that if not even stronger I could maybe even be stronger but hope positive.

Positive our target customers feel about the interface that they get in our stores, whether it be the the guy behind the seafood cancer, whether it be the exactly the people we've got in our vitamin category, who are giving advice to people in terms of what they should be doing and how we should be thinking about things.

Yes.

Oh, so those two elements to me are pretty fundamental on differentiated not to do with product in terms of the format itself. How it comes alive, a low profile and people get confidence by looking run to the store and as I said I'm going to build some some better communication as to what that means and inside our store.

And then the people themselves, which is testament to what.

The team that built this thing originally it was based on the kind of the start up of our starting point of being communicating with customers and giving them a lot of confidence that those expertise.

I think you'd be hard pressed to find people that know motorboat the products are selling on the spreads folks.

And I think Thats, a huge plus in terms of the customer target we're going for.

Thank you.

And our next question comes from the line of Karen short with Barclays.

Hi, Thanks very much.

I don't think you said this or if you did I missed it when you look at your EBIT ranges for 2021 can.

Can you just give a little color on what you're assuming on comp.

And then I guess following up on that is when we think and history of food retailers, when you're lapping very high comps.

I wanted to get your rational irrespective of whether they should or shouldn't. So how are you thinking about the competitive landscape for next year is oh.

Oliver you lap these unusually high comps and then I had one on.

Sure Mike can we clearly we scratch our heads and talk about what's going to happen next year a lot in terms of the macro environment and there was some extraordinary March April June times in terms of comps across the industry and clearly lapping those that I think it's going to be I.

I think it's going to be more rational because its soy stream what happened last year. If I'm. All this sheet the year, what I know at the moment what happened earlier on in the year I think they'll be more rational because you're on and not normal environment town, where do you get a great number and then you think how am I going to elaborate I think most more street.

Retailers will be take particularly food retailers will be taken the view that was extraordinary unlocking that is going to be unrealistic without without killing any sense of profitability and I'm talking about other people in the conversation here with regard to as we talked about Thats long before the fund.

Make and were going to be talking about it long after the pandemic, how do we talk to our customers and how do we play our own game on that will deliver substantial growth for us going forward. The combination of new stores E commerce and in store comp.

We're very confident as we work the tactics through that we've got a long term runway of growth in our business how does that compare how that works within the environment, we will be being rational and we will be playing our own game as we talk to our customers that are very.

Ensuring with the proposition that we're putting in front of them and we do believe we're very different.

To a normal food.

Grocery retailer, who you would be traditionally seeing could affect AWS, if theres a rational environment. So one of the things that Ross the environment will be rational if it's not we're going to keep playing our own game, because we're pretty confident that that's the right place for us to be honest plenty of opportunities for us to grow.

Business, whether it be rational or irrational in the marketplace.

As we play our own game as I say.

Thank you I will now.

I'll turn now how do we think.

No.

Sorry.

I will now turn the call back over to CEO, Jack Sinclair for any closing remarks.

Hey, thanks ever so much guys for spending some time listening to us. This afternoon, we really appreciate your interest in our company and it's an exciting place to be at the moment, we're really thrilled to what's the opportunity that's in front of us here at sprouts and.

I appreciate you, taking some time and please stay safe and look up to your sales guys. Thanks, so much.

Ladies and gentlemen, thanks for participating in today's conference. This does conclude the program and you may now disconnect.

[music].

Ladies and gentlemen, thank you for standing by and welcome to Sprouts farmers market third quarter 2020 earnings conference call at this.

[music] cartilage only mode. After the speakers presentation, there will be a question and answer session.

So question during the session you will need to press star one on your telephone.

Please be advised that todays conference is being recorded if you're fighting for others.

[music].

Uh huh.

[music].

Okay.

No my pleasure to introduce Vice President Investor Relations and Treasury Susanna Livingston.

The old and the webcast of this call can be accessed through the Investor Relations section of our website at investors that sprouts Dot com. During this call management may make certain forward looking statements, including statements regarding expectations for 2020 and beyond.

These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those described in the forward looking statement tomorrow.

For more information please refer to the risk factors discussed in our FCC filing along with commentary on forward looking statements at the end of our earnings release issued today.

Our remarks today include references to non-GAAP measures for a reconciliation of our non-GAAP measures to the GAAP figures. Please see the tables in our earnings release.

With that let me hand, it over to Jack.

Thank you Susan and good afternoon, everyone. Thank you for joining our call.

We delivered strong results in the third quarter with sales up 9.5% on comp sales up 4.2% I recall mass business grew 337% outpacing most t. call mask growth rates in the industry. We ended the quarter with the call mass representing 11% of our sales our gross margin.

<unk> increased 400 basis points, that's his last year.

Result, our adjusted earnings before interest and taxes were up $81 million up 104% and our adjusted EPS of 52 cents was up 136%, especially as last year.

I'd be started Twentytwenty, we were focused on executing on our five year strategy of creating a highly profitable differentiated spatiality grocer with a long growth runway.

Overall, the Covisint vitamin has allowed us to fast forward Sefton aspects of our strategic plan, which has provided many financial benefits.

We pivoted quickly just shift our print shots to digital lots, providing shorter lead times and the flexibility to source better buys and build slots or promotions that are not lost leader. These.

These changes along with strength benefits have helped us achieve many structural and sustainable margin improvement.

As a result today, we all thought differentiated speciality gross a financially stronger than ever while we still have plenty of work to do to realize our five year vision to double the size of our business I am more convinced than outside of our potential.

Before I provide an update on a few pillars of our strategy I want to emphasize that we continue to prioritize the health and wellbeing of our team members and our customers.

We remain focused on serving our customers no matter, how do they choose to interact with us.

Well the healthy groceries their families need.

I'm pleased with how far we have come on above all I want to thank the team during this never ending pandemic, providing service to our communities taking care of our co workers on delivering strong results for our shareholders.

Turning to our strategy I want to share some progress in three key areas innovation marketing and E Commerce and I want to highlight the importance of our protest merchandising and sourcing strategies.

Innovation is moving us forward, our non perishable departments like grocery and frozen are resonating with our customers with comps higher than the company average and Twentytwenty, we have launched more than three and a half dozen new and unique products focused purely on innovation on taste. Some of these big.

18, new products include our seasonal and then I'd hatch, Chile items like our grain free Paleo Nvidia and frankly chip sprouts private label label began much allots a protein powder on remedy organics cold brew coffee with MCT oil differentiated plant based Quito and private label and an outcast.

You guys are all excelling as these unique categories are targeted to our desire to customer base.

As we speak we are working through a deep dive of all of our categories to understand the needs and wants of our target customers and ensure that our innovation engine is primed to bring even more new innovative branded and private label offerings to every department in our store.

Turning to marketing and the Middle of August we launched new branding through TV social digital on radio under the campaign spreads where goodness grows the campaign, which includes our first mainstream commercial on farm fresh goodness drives home our farmers market experience by highlight.

Think projects the heart of our store uninspired health enthusiasts and experience seekers to engage with our brand.

To date, the new branding has been well received we continue to see our net promoter scores among our frequent shoppers like best in class without Pierce brand building takes time, but our digital impressions have been impressive with more than 1.4 billion impressions of our master brand since its launch.

And over 2 billion overall media impressions as we extend our reach.

With our target customer groups, the health enthusiasts and the experience seca.

Evolved advertising strategies are aimed at our target customers instead of attempting to blanket flash to everyone in our market areas.

Well now reaching more than 17 million can be found the views of our weekly digital flywheel. That's is the 21 million print class distributed in the past.

Additionally, we are leveraging the flexibility of digital communications to make our customers aware of what is new and different in our stores real tight.

We use digital marketing to highlight unique seafood varieties that we don't regularly county, which is tied to our seafood showcase. This was activated on short notice a few weeks ago, and we saw a secret sales beat expectations.

This supports the power of our differentiated assortment and targeted digital communications that we will leverage more in the future.

From a pricing standpoint, we have a better balance of more everyday accessible prices on fewer odd items in five and the projects Department, we are seeing customers buying more items on everyday retails at lower prices than historic trends due to our investment in everyday price on fewer ads.

Comes in.

In summary, we are in the early stages of brand development, but I'm pleased with the initial response the opportunity lies with us to properly communicate and grow our target customers on their baskets overtime.

We had a 6 billion dollar grocer and a 1.2 trillion dollar market, we only need a small portion of market share to double in size.

As I mentioned earlier, we're excited that sprouts had one of the fastest growing E commerce businesses in the second quarter unlikely the third quarter.

It is more important than ever to have a full omnichannel offering as many customers use both in store and online for the grocery needs. They complement each other in the third quarter, we launched delivery in curbside pickup through shop Dot sprouts dot com, so customers can order directly from sprouts.

Either through our website or the sprouts app on their phone.

Well the service utilizes the Instacart order management technology, that's improvement keeps the customer and sprouts ecosystem.

Just to leverage data for customer insights and does not require the customer to evidenced a cots account to place an order, creating a seamless sprouts experience for the customer.

When end shocks dark spreads dot com customers can apply sprouts exclusive digital coupons and speed up reordering with favorites on previous order history.

Customers can even sachin filter surprise product catalog by key attributes such as new on sale inorganic to find and discover products more easily.

The additional data insight God that allow us to customize our marketing spend I capture trade funds.

From a fulfillment standpoint, we utilize a hybrid model and stock comp performed the home delivery and our team members performed the pickup in store. We believe our model is right for us leveraging the scale of the instacart marketplace, while rapidly growing adoption of our owned E commerce experience with.

The ability for the customer to purchase directly from our website, while we capture meaningful data.

Finally, I want to highlight the importance of our project business as we look to the future are projects will be fresher more differentiated inhibitor and volume by value oriented special buys that are not loss leaders. Our project strategy is only enhancing who we already are fresh.

Fresh produce I'd say great value. It is part of our DNA.

The addition of our two new Dcs in Colorado, and Florida in Twentytwenty, one will allow us to be closer to our stores, which will create a fresher presentation to our customer.

It will also allow us to take advantage of local and seasonal buying not available today.

This year, we restructured restructured our project buying department.

We created a centralized buying team focused on specific large quantity project categories, and reaching our buying teams that fosters deep relationships with the farming community and create partnerships for unique unique or new varietals in the future.

These meaningful far more partnerships help us bring new and innovative products to our customers and write the early wave of new varietals before they become commoditized.

For example, today, we are working with a small grow our focused on organic honey nut squash. The quantities are too small for many of the large chain. However, future flexibility, we do not need the products in every store instead, it becomes a treasure hunt item.

And just spreads.

This hybrid model provides us the ability to be nimble and react to pricing in the market and provides us with the agility to flex on size based on availability.

These relationships allow us to be a great partner to the farming community I know is rewarded when we have the pharmas first call when the heavy on product.

The spot buys provide us favorable pricing, which allows us to pass these savings onto the customer through great deals RFP to retailers.

This project starts it allows us to build a path forward and grow with the farmers, which enables us to continue to surprise and delight our customers with fresh product you varietals on special buys.

Now, let me hand, it off to the needs to speak to the financials.

Thanks, Jack and good afternoon, everyone.

In the third quarter net sales grew 8.5% to $1.6 billion fueled by sales from new stores and comparable store sales, which are up 4.2% compared to the same period last year our.

Our third quarter profitability finished strong with adjusted EBIT of 104% driven by ongoing strategic changes as well as sales leverage let.

Let me provide a little color on our comparable store sales.

First during the quarter, we were cycling an intensely promotional period from last year with August and September having heavier promotions in July.

Our data shows that purchases from highly price sensitive shoppers 200 for deals on our print ads slowed during the quarter as we continue to shift our marketing strategies to target customers with greater interest in assortment.

Instead, it was expected as we continue to execute our new strategy.

And second regarding customer dynamics took consolidation appears to be a new norm. During the pandemic. We don't believe we benefit from this trend as we only carry a limited assortment of traditional CPG products like paper goods and cleaning supplies.

As well our geographic mix of stores is more weighted to regions of the country. That's off slower overall food at home growth later in the quarter as indicated by credit card data.

Well pandemic related dynamics and the cycling of week to week promotional uneven unevenness from 2019 are likely to persist in the near term. We are confident that our strategic actions will result in a long runway of profitable sales growth.

Speaking of profit for the third quarter gross profit increased by 23% to $585 million and our gross margin was 37.1% a positive increase of 400 basis points compared to the same period last year.

Numerous strategic changes, we began late last year like everyday great prices with less AD mix the elimination of loss leaders and shrink initiatives continued to benefit gross margins.

As well lower sales of high shrink items like Deli and salad bar positively impacted the margin.

We estimate approximately 250 basis points were enabled by Covance.

We're excited to see the strategic structural changes to our margin taking on.

At Genie sense with $475 million or 30.1% of sales de leveraging 200 basis points compared to the same period last year.

Similar to recent quarters, we continue to reward our team members in the source for special bonuses as we live through year. Unlike any other in recent history into.

In total we estimate the additional SGN any cost associated with over 19 was approximately $34 million for the quarter driving the de leverage.

Additionally, with our high ecommerce sales, we incurred increased ecommerce fees, which were offset by other efficiencies and leveraging fixed costs on our higher sales.

Moving down the rest of the income statement, our depreciation and amortization costs for the third quarter were $31 million or 2% of sales a decrease of 10 basis points compared to the same period last year.

For the quarter, our adjusted earnings before interest and taxes were $81 million, an increase of 104% when compared to the same period last year.

Our interest expense was $3 million and our effective tax rate was 20%.

Third quarter diluted earnings per share was 51 cents.

Adjusted diluted earnings per share was 52 cents compared to diluted and adjusted diluted EPS of 22 cents in the third quarter of 2019 and increase of 136%.

We continue to generate strong cash flow and maintain ample liquidity.

Year to date, we have generated cash flow from operations of $410 million.

27% from last year and have invested $76 million in capital expenditures net of landlord reimbursement primarily for new stores.