Sprouts Farmers Market, Inc. Q1 FY2023 Earnings Call

Good afternoon and thank you for standing by. Welcome to the First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Susannah Livingston, Vice President, Investor Relations and Treasurer. Please go ahead.

Thank you, and good afternoon, everyone. We are pleased you are taking the time to join Sprouts on our first quarter 2023 earnings call. Jack Sinclair, Chief Executive Officer; and Chip Molloy, Chief Financial Officer are with me today. The earnings release announcing our first quarter 2023 results, the webcast of this call and quarterly slides can be accessed through the Investor Relations section of our website at investors.sprouts.com. During this call, management may make certain forward-looking statements including statements regarding our expectations for 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.

Thanks, Susannah, and good afternoon, everyone. I want to begin our call by thanking our 31,000 team members for their continued dedication in creating a best-in-class experience for our customers seeking fresh, high quality and healthy foods. We are pleased with our first quarter. We believe our long-term growth strategy is gaining traction and driving positive performance. Our results included comparable store sales growth of 3.1% and total sales growth of 6%, and adjusted diluted earnings per share growth of 24%. Our traffic trends are improving and our newer stores on average are exceeding our internal expectations. During the first quarter, we opened eight new stores, grew our innovative and Sprouts brand offerings, improved our marketing spend, enhanced our supply chain and developed positive programs for the environment. I will follow-up with more on our journey in just a bit. For now, let me hand it over to Chip to review our financial performance in the first quarter and our 2023 outlook. Chip?

Thanks, Jack, and good afternoon, everyone. For the first quarter, total sales were $1.7 billion, up $92 million or 6% from the same period in 2022. New stores combined with comparable store sales growth of 3.1% drove this increase. Comparable sales were supported by positive comparable transactions or traffic and a net increase in basket due to retail inflation, partially offset by a slight decrease in items in the basket from a year-over-year perspective. We are especially pleased with our e-commerce sales, which grew double digits and represented 12.2% of our total sales for the quarter. We are also encouraged by the positive trends in our newer markets as we densify and create more brand awareness. And as Jack already pointed out, we are pleased that our new stores on average are exceeding our expectations. We continue to experience strong performances in categories with the most differentiation, such as grocery, bakery, dairy, and deli. Our Sprouts brand, now at 20% of total sales, performed well as customers continue to seek uniqueness and quality. Our first quarter gross margin was 37.5%, an increase of approximately 20 basis points compared to last year. Category mix shift and continued promotional optimization contributed to the gross margin improvement. SG&A for the quarter totaled $486 million. Excluding the impact of special items, adjusted SG&A totaled $483 million, an increase of $23 million. This increase was primarily driven by the addition of new stores, higher wages, utility costs, and higher e-commerce fees, partially offset by approximately $4 million shifted to the back half of the year. Store closures and other costs totaled approximately $28 million for the quarter and were primarily related to the charges associated with the decision to close 11 stores in 2023. Excluding the impact of special items, adjusted store closures and other costs were immaterial. Depreciation and amortization, exclusive of depreciation included in cost of sales was $34 million for the quarter. Excluding special items associated with the store closing decision, the adjusted depreciation and amortization totaled $30 million. For the quarter, our earnings before interest and taxes were $102 million and interest expense was $2 million. Net income was $76 million. Diluted earnings per share were $0.73. Excluding the impact of special items, adjusted earnings before interest and taxes were $137 million. Adjusted net income was $103 million and adjusted diluted earnings per share were $0.98, an increase of 24% compared to the same period in the prior year. Now let’s turn to the balance sheet and cash flow highlights. Sprouts has always had robust cash flow generation and a strong balance sheet. During the first quarter, our cash generation allowed us to invest in our business by opening eight new stores, purchasing the two previously licensed stores, spending $45 million in capital expenditures, net of landlord reimbursements, paying down $25 million of our bank revolver and returning $98 million to our owners by repurchasing 3 million shares. We ended the first quarter with $295 million in cash and cash equivalents, $225 million outstanding on our $700 million revolver, and $22 million of outstanding letters of credit. Turning to our current expectations for 2023. The consumer environment remains uncertain. However, we remain committed to our business strategy, which we believe can continue to deliver ongoing profitable growth. For the full year, we expect sales growth of 5% to 6% and comp sales growth of 2% to 3%. We expect gross margins to be flat to slightly up and slight deleverage in SG&A. The deleverage is due to the acceleration of new store growth, a new fee structure with our largest e-commerce partner, and rising labor costs. We expect adjusted earnings before interest and taxes to be between $370 million and $385 million. Adjusted earnings per share should be between $2.58 and $2.68, which assumes no additional share repurchases. That said, we do expect to continue to repurchase shares opportunistically. We are on track to open at least 30 new stores this year, all of which are in our current prototype, and we expect capital expenditures, net of landlord reimbursements, to be between $210 million and $230 million. For the second quarter of the year, we expect comp sales of approximately 3% and adjusted earnings per share between $0.61 and $0.65. And with that, I will turn it back to Jack.

Thanks, Chip. We are encouraged by our most recent performance, a direct result of the strategic changes we have made over the past few years to differentiate ourselves as a specialty health and food retailer. We believe these changes are gaining traction now that we are on the other side of the pandemic. This year, we are focused on expanding category leadership, creating a unique assortment, focusing on product innovation, building a more efficient and effective supply chain, accelerating our store unit growth, and growing customer engagement. Let me touch on a few highlights from each of these initiatives. For the first quarter, our focus on curation and innovation is inspiring our customers. We stocked ourselves with innovative attribute-friendly specialty products which appeal to our target customers. We are building a strong affinity for our Sprouts brand, including many products only available at key seasonal times. Our customers recognize that the Sprouts brand provides quality offerings that taste great and are good for you. Amid the high inflationary environment, we brought in more value-forward offerings like multipack grocery items and value-sized meat and dairy offerings, while continuing to offer great pricing in our produce department and on important items, such as our Sprouts brand cage-free eggs at $3.99 and our healthy sandwiches at $4.99. Moving on, we continue to improve the efficiency of our supply chain, capturing both in-store and distribution centers. Categories with perpetual inventory computer-assisted ordering, or PICAO, are already experiencing better on-shelf in-stocks. Most categories will be completed this second quarter, removing the guesswork from our inventory process. Our investment in the new Southern California distribution center is on target to open later this month. Not only will the new distribution center support our growing capacity needs and be in a more robust labor market, but it will also be LEED Silver Certified, contain solar on the roof, reduce miles on the road, and carry an electrified jockey truck to ensure our sustainability efforts reach the distribution centers. In the first half of this year, we will complete the addition of ripening rooms in our Arizona, Texas, and Southern California distribution centers, along with expanding our Texas distribution center later in the year. These initiatives will expand our capabilities, improve our quality and freshness, and leverage our supply chain to support our future unit growth. Speaking of unit growth, our smaller, more cost-effective format is rolling out quickly this year. We opened eight new stores in the first quarter. All of this year’s stores will be in the new prototype. At the same time, we are experiencing improved performance with our more recent vintages, especially in newer markets, where we are gaining density and growing brand awareness. Our pipeline is also growing with 90 approved new stores and 60 executed leases, helping us gain traction towards our goal of 10% unit growth per year. We believe we will be on track to achieve that goal by 2024. During the first quarter, we also purchased two previously licensed stores in Chula Vista, California. These two stores were part of a unique legacy licensing agreement. The purchase provides complete control of the Sprouts brand and expansion opportunities in portions of the San Diego market that were previously restricted by the agreement. Over 60% of our business is driven by our high-frequency customers. Our goal is to drive our current core customers to shop more often and to encourage trials from new customers who are also within our target audience. We will drive this growth through customer engagement. First, we are driving customer engagement in our stores as a foundational focus. We are elevating the level of service in our stores to meet the needs of our customers and distinguish ourselves from the competition. The team is focused on ramping up our sampling program, particularly with our unique Sprouts brand offerings, increasing speed at checkout, and proactively helping our customers navigate the store while finding products that align with their dietary needs. Our customer survey scores, already strong, continue to rise. Our second area of customer engagement has been expanding and improving Sprouts’ unique omnichannel experience. The flexibility of ordering online and picking up or having their Sprouts favorites delivered provides a much-desired option for our core audience. Our e-commerce growth continues to outpace our overall growth, signaling that our differentiated products resonate with customers. We recently improved our site design and digital experience to improve conversion and sales. Our own site, shop.sprouts.com, and our Instacart and DoorDash partnerships continue to support our current customer's needs while also bringing in new customers. Our e-commerce sales represented 12.2% of our total sales for the first quarter. Our third area of customer engagement is targeting our core audience with data-driven media. We have improved the return on investment on our media spend with a more targeted driven approach to our media mix, leveraging our first-party data and consumer insights to identify our customers better. In many markets, we are still relatively new, so we are driving awareness with more storytelling about the brand, speaking to our local producers, and presenting offers for trial. In turn, our awareness numbers have improved in markets like Florida. We have seen higher returns in our established markets by driving consideration and reminding customers to visit our stores. Finally, we are deeply focused on our personalization strategy and are still in the early innings. Our customers are discerning in what they eat, and our ability to know them, share content with them, and provide offers for what they love is driving spend. In Q1 we improved our speed and capability and outperformed our expectations. As I have noted, this is a longer journey, but we are committed to building capability, and our customers are responding. Lastly, our ESG efforts continue to develop and grow. Central to our identity is a genuine commitment to social and environmental responsibility. We work collaboratively with our supply chain partners, community organizations, and industry experts to understand our material impacts and prioritize where we direct our environmental, social, and governance efforts. In 2022, some of our highlights included nearly 26% of total sales came from organic products, approximately $200 million in sales of products produced by diverse-owned suppliers; we sold $145 million in local produce; less carbon-intensive plant-based product sales increased 21%; we recovered 87% of food waste and we donated the equivalent of 27 million meals; we also recycled more than 800,000 pieces of plastic from customer return bags and product shipping wrap; and this year, we have already launched new programs to better serve our customers, our communities, and the environment; rescued organics in California and the launch of our elimination of single-use bags at checkout. Based on our ESG accomplishments, Sprouts was named one of the 100 most sustainable companies in the world by Corporate Knights. Better eating and healthy eating is not a trend; it’s a fast-growing movement of customers seeking a healthier lifestyle, even during challenging economic conditions. Given our leadership in being a destination for health, wellness, and innovation, Sprouts is well-positioned to grow. Our commitment to our strategic changes is beginning to show results, attracting more customers and visits, and doing so profitably. I look forward to speaking with many of you in the coming months. And with that, I’d like to turn it over to the Operator for questions.

Please standby for our next question. The first question comes from Mark Carden with UBS. Your line is now open.

Good afternoon. Thanks so much for taking the question. So to start, your 3.1% comp came in meaningfully above your guidance, the highest level you have seen since 2020. Within that, where were the biggest differences relative to your initial expectations? Did traffic accelerate more than expected? You called out the slight decrease in units per basket, but is that starting to stabilize a bit faster than you expected or is it really something else driving it in the back half of the period?

Hey, Mark. This is Chip. It’s generally it’s traffic. The Average Unit Retail and the units are in line with what we thought. We had slightly better traffic in Q1 than we thought we were going to have at the beginning of the year.

Okay. Great. And then just in terms of you talked about your new stores exceeding expectations. Now that you guys have had a few quarters or even building the new prototype, are you noticing any consistent differences in how customers are shopping these stores from a mix perspective relative to your legacy boxes?

We are optimistic about the benefits of having smaller stores, particularly regarding their cost-effectiveness and the returns they generate. Post-pandemic, we've observed positive trends in our vitamins and supplements department, as customers are increasingly focused on immunity. Our stores have effectively captured this demand. Additionally, our bulk business has rebounded well after facing operational challenges during the pandemic. We've made significant investments in our stores, including adding ready meals that focus on health and plant-based options, which we believe will stand out in the market. We've also introduced an innovation center in many of our stores, featuring a rotating selection of unique products that customers can't find elsewhere. In areas such as meals, innovation, vitamins, and bulk, we are seeing encouraging results. Moreover, our grocery, dairy, and frozen food segments have performed well, especially since we've allocated more space for frozen items in our newer stores, which has also yielded positive returns.

Great. Thanks so much, guys, and good luck.

Thanks, Mark.

Thanks, Mark.

Please standby for our next question. The next question comes from Ken Goldman with JPMorgan. Your line is now open.

Hey. Good afternoon. Thank you. I just wanted to get a quick sense of what you are seeing from the competitive environment. It doesn’t seem like there is a significant amount of pricing pressure or intensification of promotions out there. We are certainly heading in that direction. But it doesn’t feel like there’s anything dramatic yet. But I am just curious what you are seeing and what you are hearing out there and if there’s anything that you are more or less concerned by than what you might have expected a few months ago?

Yes, Ken, we haven't observed significant changes in how competitors are adjusting their pricing. We're not seeing any notable moves from the major players. As I've mentioned in previous calls, we closely monitor produce in detail, and there hasn't been much activity there. Our assortment remains quite distinct from others. While we do keep an eye on competitor actions, particularly with produce, we haven't noticed much. However, even if we did, we believe we have a strong advantage due to our unique assortment and differentiation. This positions us well to handle any potential shifts in the pricing landscape moving forward.

Thanks for the follow-up. Regarding produce, there has been significant rainfall in California, with some areas experiencing excessive amounts. I'm interested in your forecast for supply during the summer and whether you anticipate it will be a positive or negative influence on your overall financial performance. It may be early to tell, but I want to understand your perspective on this situation.

Well, actually we see a lot of volatility in this going forward and it has been quite tight over the last few months. There’s been some challenges, both in terms of weather and some of the challenges of getting the crops out of the ground. So there has been some issues in terms of making that work. I think we are feeling more confident and less confident going forward on produce sourcing. We think there will be some ups and downs depending on how it all plays out. But I think, if anything, we are feeling more confidence rather than less confident about being able to access products. We are trying hard on trying to source more and more organic products, and I think that’s something that will play well to our customers and we think we will probably be in good shape through the summer to work that one through. We are also working pretty hard more than ever on local sourcing. So as we have opened our Orlando distribution center, Florida, when it hits the season later in the year will be in good shape for us. And so, I think, we are probably more positive than less positive about the supply challenges going forward.

Great. Thanks so much.

Thanks.

Please standby for our next question. The next question comes from Edward Kelly with Wells Fargo. Your line is now open.

Hi. Good afternoon, guys.

Hi, Ed.

Hey. I wanted to ask about your expectation for inflation as the year progresses. I mean, it does certainly look like the pricing aspect is easing quite a bit, kind of curious as to what’s in your guidance for that? And then how do you think consumer behavior, your own traffic items in the basket, things like that change as the year progresses? I think there’s concern that as it slows, right, that hurts the comp, but I don’t think that that’s how you necessarily see it in the guidance. So just curious as to what the rest of us are missing for those that are worried about that?

Let me provide some general comments before passing it over to Chip for more specific details. Over the past year, the situation around food inflation has been quite unusual, influenced by various macro factors, especially the availability of fertilizer and grain, along with pressures stemming from the Ukraine-Russia conflict. I am uncertain whether this situation will resolve soon, and the resulting volatility is affecting different commodities in the market. Our forecast indicates that while we do not anticipate continued acceleration in these rates, we also do not expect any deflation as we move through the year. Now, I'll hand it over to Chip.

We initially expected that traffic would remain relatively flat for the year. We anticipated continued benefits from Average Unit Retail due to inflation, stemming from last year's changes, although we thought these benefits would start to diminish on a year-over-year basis while becoming more stable sequentially. Regarding the number of units in the basket, it has decreased year-over-year, but as the year progresses, we are beginning to see a stabilization in the sequential decline. Consequently, our comparable sales are aligning with our guidance, reflecting less traffic, reduced benefits from Average Unit Retail, and a smaller negative impact from unit sales.

Great. Thank you. And then just a follow-up one on SG&A. You talked about slight deleverage. You did deleverage a bit this quarter. It seems like maybe that deleverage is more back half weighted. Maybe could you talk about that, I know there’s a new e-comm fee structure; I am not sure the magnitude of that either? And then just the last part of all this is that you haven’t had any EPS adjustments for the last couple of years; I am curious as to what we are seeing this quarter. Do you expect more adjustments going forward or is this kind of like one and done around the store closures?

Yeah. So as it relates to SG&A, SG&A is, as we migrate through the year, there will be some deleverage in the back half as you sort of through. It’s driven by three things. One is the acceleration to store growth. The second is the e-commerce fees, as you mentioned, because as we got out of our exclusive contract, that structure changed, which was a decision that we made. And then thirdly, is labor costs on the stores specifically. Last year, we thought the cost per labor hour increases in the beginning of the year, not really what we wanted to do, but it was hard to staff the stores. But beginning in the second half of last year, we were able to find some efficiencies via a lot of the systems we have been implementing over the years, and we were able to take some hours out of the stores. So that’s running through until the first half this year, but then you start to get in the back half, and those efficiencies will now have been anniversaried. So we will get some slight deleverage in the back half of the year, and net-net will be slightly negative for the year.

And just on the one-timers, just curious any like...

So one-timers…

Yeah. Thank you.

Yeah. So the one-timers, we will still have a little bit going forward. So most of it is behind us as it relates to store closings. But net-net, we approximated around $45 million for the full year, all in. We just did $35 million, so we got about $10 million to go. Some of that will be in supply chain costs, as it relates to the San Diego or Southern California distribution center, some transition costs there, and there’s a little bit more on the store closings really around severance.

Got it. Thank you.

Please standby for our next question. The next question comes from Michael Montani with Evercore. Your line is now open.

Hey. Thanks for taking the question. I just wanted to ask to start off, if you could discuss a little bit more the health of the consumer and particularly what you found in terms of the mix impact, as well as any kind of geographic color that you can share of how comps were in the quarter by region?

Yeah. Michael, we have seen a pretty consistent pattern across the country on this. There’s some difference in terms of the speed at which some of our stores in the live developed market. But, overall, the consumer behavior has probably been pretty consistent across the country; certainly, there’s pressure on the consumer. The one thing we have always said about our business is that, when you have a differentiated food assortment, the people that are interested in vegetarian, keto, or paleo, or specific diets, tend to be kind of resilient to that irrespective of the economic circumstances of our base. So we have seen a bit of a consistency in how consumers have reacted to the categories where we have got very significant differentiation. And that’s been part of the strategy along, which is how do we curate differently. But the behavior we have seen has been consistent across the country, and we have seen strength in those areas where we are differentiated, and that’s given us some encouragement that the strategy we have put in place is strong.

I would like to add that we have seen positive results in California, which is a significant market for us. California is performing well, and Florida is also doing strongly, especially where we've opened new stores. As those stores begin to reach comparable sales, it has generally been beneficial for us. In Arizona, our home market, we've seen steady performance. Overall, we've had a few strong areas, but some of this is not entirely driven by consumer behavior. As Jack mentioned, the differences among consumers are not substantial. A lot of what we are seeing is due to our strengths, and we are beginning to capitalize on them.

Great. Thank you. And just to follow up on the cost side.

Yeah.

I think you may have mentioned a $4 million shift in SG&A. So I just wanted to understand that, as well as the impairment cost of around $30 million. Was there any store operating expense in that or was that strictly closure related?

That was closure related. There’s some depreciation in that total number. So it should be totally outlined for you in our release. So we have that, and I apologize, Michael, what’s the first part?

Just I think you may have mentioned a $4 million shift in SG&A?

We have some internal initiatives that are being postponed to the third quarter, which we initially expected to complete in the first quarter. Therefore, I anticipate a shift in costs.

Please standby for our next question. The next question comes from Rupesh Parikh with Oppenheimer. Your line is now open.

Good afternoon. Thanks for taking my question. Just going back to your commentary on e-commerce growth, you guys called out strong double-digit growth and I know you are also lapping Omicron compares, so a very strong growth number. Just curious on the sustainability of the momentum there. And then I know you added DoorDash; just curious how incrementality has played out as you have added another provider there?

Well, we have been pleased, Rupesh, with the DoorDash. The launch of the DoorDash customers seem to have reacted well to and it seems to have brought some new customers to our platform. The way we are thinking about e-commerce is very much on an omnichannel basis that the customer will choose how they want to transact with Sprouts. The thing that’s encouraged us about the e-commerce growth is the environment is relatively easy for people to buy from whomever they feel like. And the fact that they can only get the assortment from Sprouts that we sell, gives me some confidence that customers are navigating their way to our curated assortment in a very positive way. In the context of we are very pleased with the work we do with both Instacart and DoorDash, and customers can choose how best to access e-comm. At the same time, our pickup business has grown as well over the period of time and our in-store traffic is going up a little bit. So we are getting a nice balance across the three, but our e-commerce business has been very strong over the course of the last year, and we are encouraged by it.

Great. I have a question about traffic. Looking at your initiatives, can you identify the factors contributing to the positive traffic? I've noticed improvements in store experience and sampling during my visits. I'm curious if there's anything specific you would highlight regarding this.

I believe the media efforts have been more effective recently, and we're communicating better with our target customers than before, which is encouraging. I'm also pleased with the in-store initiatives that were mentioned, especially as we adapt to the new post-pandemic environment, where the traditional sampling of innovative products in stores has been challenging. Our teams are working hard to revitalize that experience, and I think the combination of media efforts and in-store execution is making a difference. We're experimenting with various tactics to provide a more personalized communication with our customers, and while we're still in the early stages of this approach, I’m excited about what the future holds as we improve in identifying our target audience. Currently, 18% of our customers are sharing their information with us, which is a significant increase and presents a lot of potential as we continue to enhance our initiatives moving forward.

Great. Thank you.

Please standby for our next question. The next question comes from Krisztina Katai with Deutsche Bank. Your line is now open.

Hi. Good afternoon and congratulations on a great quarter. I wanted to follow-up on…

Thanks, Krisztina.

Hey, Jack. Just wanted to follow up on the personalization especially because it sounds very exciting. But as we think about the effect of inflation on Sprouts with the items for basket decreasing by those 1 or 2 units, do you see the moderation in inflation, especially in fresh food, as an opportunity to really start to add those items back? And this is where I think personalization comes in and I know it’s early days. But are you finding success to drive those more frequent trips and with more items per basket with your targeted consumer?

We are making progress in figuring out how to do this more effectively. Inflation has clearly caused volume declines across the industry, and we are noticing this trend within our products, as mentioned in previous calls. Typically, when inflation decreases slightly, the volume of units changes a bit. This leads to an adjustment in the level of reduction, which stabilizes itself, and we have observed this in several categories recently. The main aspect of personalization you’re asking about is how we can target more effectively. In relation to that, our in-store sampling program is showing very positive results on a product-by-product basis. When we present those products to customers, we are encouraged by the outcomes, and we plan to invest more in this strategy moving forward, which is crucial for increasing the number of units per transaction. We believe that managing inflation and improving execution in stores will help achieve that. Additionally, personalized communication with our customers will enable more direct promotions, which will be essential. The business is concentrating on two main objectives: increasing store transactions and boosting basket size when customers visit our stores or use our e-commerce platform. Chip, would you like to add anything?

Yeah. I just want to add that our expectations, Krisztina, as inflation dissipates, we are not assuming for now that you will see a massive reversal in units in the basket. We will just see a similar stabilization. So all the things that Jack’s talking about are opportunities to drive better results than what we are assuming today.

Great. Thank you for that both of you. And then just a follow-up, I mean, it does sound like industry promotions remain very rational. But now that the supply chain is in a much better place, large peers seem to be back to their historical and stock and service levels, and trade spend is starting to return, especially in the center of store, and I know that your overlap is relatively limited, but does that change at all the way that you view your price gap currently?

We continuously assess what others in the industry are doing. We believe we have significant differentiation in many categories, particularly in vitamins and supplements, which remain strong for us. The bulk segment presents a substantial opportunity in a challenging market where few competitors engage. Our sales in plant-based, keto, and paleo categories differ greatly from those of others. Therefore, we don’t perceive a potential grocery price war impacting our key categories significantly. While we do monitor produce pricing closely and will continue to do so, we are confident that our margin growth is sustainable. We expect to maintain this despite any changes in the competitive grocery landscape.

Great. Thank you so much. Best of luck.

Thanks.

Please standby for our next question. The next question comes from Leah Jordan with Goldman Sachs. Your line is now open.

Good afternoon. Thank you for taking my question. First, I wanted to ask about produce. How are you thinking about your price gaps in that category specifically, and has there been any change to kind of the strategy of around 10% to 15% below traditional?

That's a great question, Leah, and it's something we give a lot of thought to. Different competitors have always had varying approaches to produce, and we see that we have larger gaps with some market players and smaller gaps with others. We're noticing that the Texas market is more competitive than others, while Florida and California markets are less so. Our strategy focuses on aggressive pricing for organic produce, which makes up a significant portion of our sales compared to our competitors. We have larger and wider gaps than you mentioned. I'm more focused on the more commoditized products, a sector where we believe we can excel. While others may increase their margins on organic, our goal is to maintain flatter margins. This gives us the chance to stand out on price for organic products. We identify opportunities in areas where we can be less competitive, and in some regions where we are more so. Ultimately, we aim to position ourselves at the forefront of pricing in the marketplace, striving to perform exceptionally well in the best markets.

Okay. Great. That’s very helpful. Thank you.

Thanks.

Please standby for our next question. The next question comes from Karen Short with Credit Suisse. Your line is now open.

Hey. Thanks very much. Just a couple of questions. So when you look at the charges that you took this quarter for the closed stores. Can you maybe give us some color, because the dollar amount per store seems very high. So that’s my first question. And then my second question is just looking forward on actual new store productivity, how we should think about that going forward as a percent, but the dollar amount on the closure is kind of more just...

Well, it aligns with what we guided at the beginning of the year. We incurred $20 million in store closure and related costs this quarter, along with some depreciation and a couple million in SG&A expenses, totaling $35 million. When closing stores, we need to account for the total asset cost and adjust it down, considering any landlord arrangements or subleasing. If a store still has several years left on its lease, it impacts the write-down significantly, especially for stores that may still have seven or eight years remaining.

Okay. But to be clear, so going forward, there should be no more store closures. These were like...

The only expenses that should be there going forward relate to a few one-time costs in the supply chain, which will impact the cost of goods by a couple of million dollars in the second quarter. In the second quarter, you will also see some SG&A expenses, but there will be no charges related to store closures moving forward.

Okay. And then so going forward, as you open stores, what would be the right way to think about new store productivity in general?

It's increasing. We do have a target related to a new store from year zero to year five. However, as you can see from the calculations, our projections have improved; they're now around 75% or better.

So as we model it, and again, I get it; it's timing and it depends on when in the quarter. But if I am modeling it, I should look at new store productivity at like 75%, is that fair?

If you analyze the situation, the algorithm hasn't changed from our original assumptions. You can expect an average of $13 million, with an initial investment of $3.8 million. That equates to a 75% return at maturity, and you should break even in the first year, with cash returns projected to be 30% to 35% year-on-year by the fourth year.

We are encouraged that new stores are opening again. It was challenging to open stores during the pandemic as customers were hesitant to try new things. However, we are seeing strength in the most recent stores we've opened as the pandemic begins to ease. This is promising in light of the numbers that Chip is discussing.

Okay, Jack, if you don’t mind me asking, just a quick question. The new format is very different, right? You only have one entrance and are focused on ROIC for the stores. But is there any inclination to change what the new format looks like in terms of balancing ROIC with sales?

Well, the key aspect…

I fully understand what you are doing in terms of ROIC, but?

The principle behind our approach a few years ago was to maintain the same overall level of sales in smaller stores, which improves returns. Our goal was not solely to increase return on invested capital but to offer customers an effective experience in a 23,000 square foot store as we do in a 30,000 square foot store. During my observations, I noticed a lot of unused space, particularly in areas not visible to customers, which we can optimize to maintain the same product assortment and achieve similar sales at a lower cost. Overall, we are on this path moving forward. We are making adjustments and I am glad we made changes in one location, specifically for vitamins and supplements, to manage risks associated with crime. This has been working well for us. We are also refining a few other aspects, such as our bakery operations and meal preparations. While we are tweaking certain items, we remain committed to our foundational principles and are optimistic about the results.

Okay. Thank you.

Thanks, Karen.

Please standby for our next question. The next question comes from Chuck Cerankosky with Northcoast Research. Your line is now open.

Good evening, everyone. Great quarter.

Thanks.

Jack and Chip, could you give us an idea of what inflation was through the first quarter and where you think it will be at year-end and then how that might be reflected in volume?

The first quarter is still experiencing double-digit growth. By the end of the year, we expect to see a significant decline from a year-over-year perspective. However, as I mentioned earlier, we do not anticipate a reversal in units per basket; rather, we expect them to stabilize sequentially. As this happens, instead of facing a high single-digit loss in units, we expect to see a low single-digit decline year-over-year, while remaining flat sequentially.

When you say single, you are talking about percentage changes.

Yes. Yes, sir.

Yeah.

Yes. Percentage change. Apart from inflation, can you tell if your customers are experiencing economic anxiety that affects the number of units in their baskets? It seems you are making great strides in providing value with bulk items, private label products, and value packs, particularly in the meat department.

We have discussed this a bit, Chuck. Our produce business is experiencing a slight decline. We believe part of this is due to people managing their consumption at home. Instead of buying two packs of salad, consumers are opting for one to avoid running out. This shift is something we've noticed, with sales volumes in our produce section decreasing slightly. For example, customers may choose to buy just one strawberry instead of two pints. This behavior appears to be a significant factor in customer purchasing patterns. In other areas of the store, we are encouraged by some of the numbers we’re seeing, particularly among customers with specific dietary needs or interests in certain product attributes. These customers tend to be less willing to compromise on those preferences. However, they are more likely to buy less overall, which aligns with what we are currently observing from our customers.

All right. Thank you. Good luck for the rest of the year.

Thanks, Chuck.

Please standby for our next question. The next question comes from Robbie Ohmes with Bank of America. Your line is now open.

Hey, thanks for taking my question. I actually have a few follow-up questions regarding the modeling. I believe these are mostly directed at you, Chip. First, adjusted depreciation and amortization was approximately $30 million in the first quarter. Is that the figure we should anticipate for depreciation and amortization in the next three quarters?

Yes. There will be slightly higher between 30% and 35% for the next three quarters.

Got you. And then I might have missed it, the store closings, did you close all 11 in the first quarter or are they closing in the second quarter some of them or?

No. We closed one in the first quarter. The other 10 are in the second quarter. But when you make the decision to close the stores is when you have to book the charge. So since we made the decision in Q1, we had to take the charge in Q1, the bulk of it.

Got it. And can you give us the rough new store openings by quarter?

One second. We finished Q1 with 395, currently in Q2 at 392, expecting Q3 to be at 401, and Q4 at 407, plus or minus.

That’s not the stores that we are opening. That’s our total store.

I think we can back into it with…

Right.

That’s helpful. And the last one maybe for both of you, is just the adjusted EBIT margin was super high or very nice this quarter. How are you thinking about the sustainable EBIT margin annually for Sprouts?

You are talking longer term?

This year and longer term; should we be thinking like a 6-plus?

I believe the adjusted EBIT margin of over 6% is based on our full-year guidance. This quarter was significant for us. Traditionally, the first quarter tends to be the strongest due to increased sales as people start their new year’s diets. Currently, we are in the mid-5% range, and looking ahead, we expect gross margins to remain stable while also working to keep our G&A flat. Therefore, our operating margin should remain steady while we continue to grow our square footage by 10%.

Got it. That’s tremendously helpful, Chip. Thanks so much, guys.

Thank you.

Thanks.

Please standby for our next question. The next question comes from Kelly Bania with BMO Capital Markets. Your line is now open.

Hi. Good evening. Thanks for taking our questions. I was curious if you could talk a little bit about the magnitude of traffic. I think I heard in an earlier question about maybe double-digit inflation and a high single-digit decline in units per basket. So just curious if you could talk about the magnitude of traffic and how that trended?

The traffic in the first part of the quarter was down as we were comparing against Omicron and the King Super strike from last year, but it rebounded. Overall, we don't disclose the specific number, but it was moderate. If we could achieve that level every quarter, it would be ideal for us.

Okay. Okay. And you kind of touched on a little bit Q1 maybe seasonally strong, but as we look at this gross margin this quarter and even for the past really two years, that your Q1 gross margin is typically your highest and then it kind of moderates from there maybe by 80 basis points to 100 basis points. Is that a similar kind of pattern that we should expect this year or maybe just any other factors that as you think about and are planning gross margin, any color that you could share?

That is very similar. In the first quarter, this is driven by two factors. First, due to higher volumes, we gain more leverage on distribution and transportation costs, affecting the fixed costs associated with them. Second, the product mix is different, as this is our strongest quarter of the year, leading to a slightly varied mix compared to the other three quarters.

That's very helpful. I would like to add one more point since those were quick. I believe you mentioned that 60% of your business comes from high-frequency customers, which was a new insight for me. Could you elaborate on how you are obtaining that information, what actions you are taking based on it, and what trends you are noticing in terms of traffic from those high-frequency customers compared to the remaining 40%? Please expand on that data point for us.

Those are our most important customers and we are working to attract more of them while encouraging increased spending. We are improving at recognizing who these customers are in terms of their purchasing behavior. Currently, 18% of our customers are sharing their information with us, allowing us to better understand them. Our high-frequency customers are well-aligned with our product offerings and have specific needs that we aim to address. This group is one we intend to invest significantly in moving forward, as capturing the lifetime value of these customers is crucial to our personalization efforts. This approach aligns with our strategy as a focused specialty retailer rather than a broad mass-market entity, which is promising as we see these customers starting to increase their spending with us. We believe they are engaging with us in an omnichannel manner, and we are gaining a better understanding of this interaction than we previously had. We will continue to improve in this area, as we have identified a vital group that we are dedicating considerable thought and resources to.

Thank you.

Thank you.

Thanks, Kelly.

I show no further questions at this time. I would now like to turn the conference back to Jack Sinclair for closing remarks.

Well, thank you everybody for taking the time to listen to our story and I appreciate your commitment to us, and thanks everyone so much. Take care.

This concludes today’s conference call. Thank you for participating. You may now disconnect.