Sprouts Farmers Market, Inc. (SFM) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing-by, and welcome to the Sprouts Farmers Market Third Quarter 2019 Earnings Conference Call. At this time all participants are in a listen only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I’d now like to hand the conference over to your speaker today Susannah Livingston, Investor Relations. Thank you. Please go ahead, madam.

Thank you, and good afternoon, everyone. We are pleased you have taken the time to join Sprouts on our third quarter 2019 earnings call. Jack Sinclair, Chief Executive Officer; and Chip Molloy, Board Member and Interim Chief Financial Officer are also on the call with me today. The earnings release announcing our third quarter 2019 results and the webcast of this call 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 2019 expectations and guidance. 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 a commentary on forward-looking statements at the end of our earnings release issued today. In addition, 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, Susannah, and good afternoon, everyone. Thank you for joining our call today. I recently passed my 100th day here at Sprouts and I’m even more excited now about the future of this company than I was three short months ago. Sprouts unique offering from both a product and experience perspective has enormous potential for growth. We pioneered making healthy eating accessible to every day grocery shoppers and this trend is stronger today than ever before. That said, we do have challenges to overcome. We must continue to stabilize the business in the near-term, while also creating the platform to accelerate growth – profitable growth in the future. Our results in the third quarter were slightly better than we expected, which Chip will speak to in a moment. I’m very pleased with how diligently the team is working towards improving the business, while at the same time focusing on the long-term potential growth of this brand. After Chip is finished, I will return to provide more detail on how we are working towards our future. Chip?

Thanks, Jack and good afternoon, everyone. I will begin by discussing our business during the third quarter and then review our guidance for the remainder of 2019. For the third quarter net sales were $1.4 billion, up 8% compared to the same period last year. Comparable store sales increased 1.5%, traffic was down slightly, while basket was up. Our home delivery sales were up more than 200% this quarter, as customers adopt this added convenience. A significant portion of our online business came from repeat customers. We also continued to learn from our click and collect test. Early results suggest that this service is not as attractive to our customers as home delivery. For the third quarter, gross profit increased by 8% to $477 million and our gross margin rate was 33.1%, a 25 basis point decline when compared to the same period last year. Efforts to manage promotions to better balance traffic, sales and margins resulted in gross margin stabilizing in the back half of the quarter. SG&A increased 12% to $404 million or 28.1% of sales compared to 27.3% in the same period last year. 35 basis points of this deleverage is from the adoption of the new lease accounting standard. The remaining deleverage is due to investments in new stores, expansion of our home delivery program and higher healthcare costs. For the third quarter, our depreciation and amortization costs increased 12% to $31 million or 2.1% of sales, an increase of 5 basis points compared to the same period last year. Store closure and other costs mainly related to executive severance and hurricane preparedness were $2 million. Our interest expense was $6 million and our effective tax rate was 23% compared to 17% a year ago. Third quarter diluted and adjusted diluted earnings per share was $0.22 compared to diluted EPS of $0.29 and adjusted diluted EPS of $0.27 in the same period last year. As a reminder, the lease accounting standard will result in a net incremental expense of $0.04 per share for fiscal 2019 or $0.01 a quarter. Shifting to the balance sheet and liquidity. We continue to utilize our strong operating cash flow from operations $323 million a year-to-date to support our unit growth and sales initiatives. So far we’ve invested $130 million in capital expenditures, net of landlord reimbursement primarily for new stores. During the third quarter, we opened nine new stores resulting in 335 stores in 21 states. We remain on track to open 28 stores in 2019. We ended the quarter with $80 million in cash and cash equivalents, $515 million borrowed on our $700 million revolving credit facility, $55 million available under our current share repurchase authorizations, and a net debt to EBITDA ratio of 1.4x. Year-to-date, we have repurchased 7.3 million shares for a total investment of $163 million. Now let me turn to guidance for the remainder of 2019. For the fourth quarter, we expect net sales to grow 6.5% to 7.5% with comps in the zero to 1% range. Gross margins should be flat to slightly negative when compared to the fourth quarter of last year. We do expect to be more selective with promotions than we were last year. For the fourth quarter, earnings per share is expected to be between $0.12 and $0.15, and for 2019 fiscal year between $1.10 and $1.13. We expect our 2019 CapEx spend to be between $150 million to $160 million net of landlord reimbursement. We have seen sequential progress during the quarter. That said, there is work to be done developing the platform of people, process and infrastructure, so that we can accelerate the expansion of our brand. This will take some time. However, we are confident more than ever that we’re moving in the right direction. Let me now turn it over to Jack.

Thanks, Chip. In the last 100 days, I’ve focused on visiting many of our markets and stores, speaking with our customers and team members. I visited distribution centers, met with vendors and work with our leadership team to gain a deeper understanding of what is working and where we have opportunities for improvement. As I indicated in my opening remarks, I’m encouraged by our 30,000 team members commitment to our mission and dedication to improve the business. I believe more everyday that we can significantly expand our brand and do so profit certainly. At all levels in our business, we have the advantage of team members, who are experts in the industry and passionate about both the products we sell as well as the customers they serve, with engaging enterprise wide with the team, who interact with our customers’ every day, by encouraging all 30,000 team members to contribute to improving our business. We’ve introduced some new processes to capture these ideas and I’m excited already about some of the potential outcomes. Our format is unique in terms of product offering, department of categories and how we differentiate ourselves with stores that feature clear sight lines across the store. I’m delighted to see that our offering is differentiated, relevant and the assortment has debt in many categories like grocery, frozen, dairy, and produce. Our private label focus continues to grow with significant future expansion available. All these come together with our small store – small scale store layout to create a trust in our brand that is hard to come by in today’s environment. What truly amazes me is the love our customers have for our brand, especially in markets, where we have created density and awareness. After a 100 days, I’m firmly of the belief that overcoming our challenges as within our own control. By the size of our store prototype has only increased slightly over the last few years. The cost to build has increased significantly. As we’ve adjusted a bit from the core elements of how we best serve our customers. New stores have been increasingly more complicated and become more expensive to operate and build. Interestingly, our smaller stores tend to be more productive than our larger stores. Our fresh sales distribution works effectively where we have density, where we don’t, it is suboptimal, which creates shrink and cost inefficiency. Going forward, the expansion of our store network and associated logistical support will be more coordinated and concentrated, driving efficiency in distribution and transportation. On the marketing front, we spend the majority of our dollars on print advertising, which is an ineffective way to build our brand. Our current price and promotion strategy have led to margin and stability. The Sprouts brand is differentiated and has real salience for both existing and potential customers, but we are not telling the brand story to the best of our ability. Private label continues to be a great growth vehicle for sales, but we have multiple brand names under the Sprouts brand of collection of products. We plan to build a cohesive private label brand streamlining and improving our communication to customers that maximize the Sprouts position as the affordable, healthy living grocer. We have diligently developing our longer term strategy and will deleveraging external expertise to support us during this time. While we anticipate discussing our full strategy in more detail in early 2020, let me highlight a few key points today focused on our brand unit growth and profitability. We can build our brand, modify our store format, and rebalance our pricing and promotions investments. There are so many great stories that we can bring to life as we transition our marketing spend to what more digital and less print. We have the opportunity to build one of the strongest grocery brands in the United States by making healthy eating affordable to all, through improved marketing efforts. Our customers should know our product that is far superior to compare to our competitors. As an example, Sprouts’ frozen department carries one of the largest selections of dairy free alternative ice creams I’ve ever seen. In produce, offering specialty items allows us to decommodify this category for a short period of time, every year, we carried Cotton Candy Grapes, literally bursting with real cotton candy flavor. And because of our strong produce partnerships, we always receive a disproportionate amount. As we evaluate and potentially modify our store format, we’re going to slightly slow growth to approximately 20 store openings in 2020. This selection will include stores that already in flight and/or in premiere locations. Our expectation in 2021 is that we will return to or exceed our current rates of growth. We have confidence that with the optimal prototype Sprouts has a long runway of unit growth ahead. Our better balance of everyday low prices and promotions is important to the financial health of the business. This will take time. While, we experienced some early wins. These changes could lead to unevenness in comps as we cycle highly promotional periods. Overall these changes will stabilize margins in the near term and create a stable and loyal customer base in the long term. This is a new chapter for Sprouts and I’m energized by the opportunities still to be implemented and convinced we can control our destiny, but a significant work to do, as we move through these critical steps and we’re confident, it will position us for longer term profitable growth. With that, we would like to open up the call for questions.

Thank you, sir. [Operator Instructions] Our first question comes from Paul Trussell from Deutsche Bank. Please go ahead.

Good morning and good quarter. I’m just curious if you could give a little bit more detail on how you’re going to approach new stores going forward, particularly in terms of some of the areas that you are looking at potentially modifying the geographies and where you’re going to focus on building and exactly what size box, you’re thinking about putting up? Thanks.

Yes, thanks Paul. I think I’d have gone round looking at the stores, particularly the new stores of it. I think, as I said in my remarks that the cost has crept up a little bit and they’ve probably got a little bit too big. I think we can deliver the proposition in slightly smaller stores, but in terms of exactly what that say is, as we run at that point, yet, we’re working through some format work to get as in that place. So that’s the kind of format side of it. With regard to the geography, there’s clearly be some inefficiencies in creating stores far away from our distribution center, which has created some costs and efficiencies as our sort of room, I outlined in my remarks. And it also compromises our fresh farmers’ market position and sat in stores as well. So we’ll be looking at more geographically concentrated store growth going forward once we get the format exactly the way we want to get it going forward.

Thanks. And just as a follow-up, if we could talk a little bit more about how you’re looking to manage promotions, maybe talk about the competitive landscape as well as any actions you feel are needed in terms of retail pricing and maybe kind of what you’re seeing on the inflation, deflation front as a part of that gross margin conversation? Thanks.

As we review the whole prep, I think I indicated this in the last call that the balance of investment in high – low pricing and invest in everyday pricing got out of sync and that we were kind of do both at the same time. And that created I think, some dilution in our comp sales and certainly had a detrimental effect in our margin over the last couple of years. As we’ve looked to stabilize that. The first place we’ve looked at as well – the place where there’s a lot of volatility and volatility in our produce depends a lot on how we source our produce. And we’ve spent a lot of time trying to figure out what the right way to price our produce businesses, which is such a big part of our operation. And we’re finding ourselves to be in a very strong position competitively across the marketplace and not having to be quite as aggressive on price on our flyer program. So that’s something that we continue to test new ways of attempting to figure how to maximize our margins, while also not diluting the price position that we’re in. I’m not seeing across the competitive landscape and if that’s worrying me in terms of what anyone is doing to make it more difficult for us to do that going forward. And when we look to our different categories – we’re all looking at different categories and trying to be surgical in terms of where we need to be in terms of our pricing to be at the value position that we want to be, which is the healthiest best priced grocers in the marketplace and there’ll be more tests we’ll be doing over the next little while in different categories where we may have to be more aggressive and in other categories where we may be able to be less aggressive in the future. So we’re right in the middle of the number of tests on that, Paul.

Thank you. Best of luck.

Thanks.

Thank you. Our next question comes from Judah Frommer from Credit Suisse. Please go ahead.

Hi. Thanks for taking the question. First you did mention, I think, you had mentioned a negative traffic in the comp. I was wondering if you could give us any color on the elasticity you saw from pulling back on promotion in the second half of the quarter and how that makes you think about driving traffic across the banner longer term?

Sure, Judah. This is Chip. The traffic has been slightly negative throughout the year and interesting for us as we started to – we’ve lack of a better expression, sort of unwind some of the aggressive promotions. We found that the traffic trends really didn’t change. They didn’t go – they didn’t get worse and they didn’t get better. But at the same time, we were able to pick up a little on your side, which helps comps and at the same time we’re able to start to stabilize margins. And as I said in the remarks, as we got the back half of the quarter, our margins were stable from year-over-year perspective.

Yes. As we build forward, just to build on what Chip just said there, I think the way to drive traffic in the business is a lot about how we invest in our marketing dollars. We’ve got fairly – okay, marketing dollars budget in terms of what we go, but we spend a disproportionate amount of that on print. And I think what we’ve done some really interesting little tests about trying to use digital and mobile in a more effective way, communicate more directly. The reason for I coming to Sprouts. And I think ultimately those will be the determining factor about as and when we get our traffic growing. And that said me, we’re determined to get there. But in the short term, we’re doing a number of tests as to how the best way to spend our dollars differently. We send 21 million pay per flyers every week, so there’s a lot of scope for us to take send a few less flyers and spend some money on different ways of driving traffic. And by market, we’ve got a number of tests that we’ve started and the number of tests that we’re about to implement, which will give us some confidence as we go through next year that we can start to use our marketing dollars more effectively to drive traffic.

Okay, great. And Jack, I think you mentioned kind of bringing in some external expertise in potentially bulking up the team and operationally needing kind of a more solid platform. Where have you seen Sprouts potentially lacking in terms of the infrastructure, be it operationally, real estate, supply chain or otherwise that you’d maybe like to improve before you embark on getting back to kind of current levels of store footage growth?

As I said in the remarks, I’m really, really pleased by the spirit of the people in our stores. It’s actually blowing me away, the quality of the people, the interface with the customers that our managers have in the right across the store, particularly in a vitamin supplement department where we’ve got real expertise and I’ve been really pleased with that. I think behind the scenes, how do we create an infrastructure to be more effective at managing our inventory, to be more effective at managing our distribution flow and to be more effective at making life a little bit easier for our stores in terms of what we do here to support those stores. A day in the life of the back of our stores has been something that I’ve found very helpful to understand the number of deliveries we’ve got coming in. The amount of inventory this got coming in and the effectiveness of that is something that an infrastructure and our matching diet, distribution and logistics departments will help that going forward. And with regard to the external support, we’ve got that support. It’s primarily going to help us with the strategic view going forward and those up, so there is a bandwidth issue within our business and that we’ve got a lot of very committed people but in order to deal with some of the short term things I’ve just talked about, we probably, and we do need some external support to help us with the longer term thinking here.

That makes sense. Thanks and good luck.

Thank you. Our next question comes from Ken Goldman from JPMorgan. Please go ahead.

Hey, good afternoon. Thank you. Two questions for me if I can. The first is, you mentioned, I think the term you said was some unevenness in comps ahead. As we cycle highly promotional periods. I know you’re not giving guidance in the future, but it would help us for modeling purposes. Are there any quarters that stand out in the next two or three that we have to think about as per – maybe a difficult lap?

Ken, this is chip. So as it relates to the quarters and the outlook, we’re just now working through our budget for next year. So how that plays out into next year is to be determined and we gave guidance for the fourth quarter, the guidance for the fourth quarter is slightly lower than we just delivered in Q3. But if you look on a two year basis, it looks fairly similar. So that’s kind of how we’re planning it as it relates to next year. It’s going to be a year that we worked through as we worked through our strategy as we worked through as you heard. The stores are going to be in the 20-ish range as we prepare the infrastructure for the following year. But long term, I mean this is a business that if we want to build square footage long term, to be able to create an earnings growth environment, you have to do 2.5 plus comp. And that’s the goal for us is to get to a place where we’re able to deliver the kind of comp with stable gross margins that creates a meaningful earnings growth while you’re still building square footage. And that’s going to take a little time. But for right now, as you get – we gave you Q4, next year is probably we’re going look. Right now we’re working it out. It probably won’t look a whole heck of a lot different than this year. But as we get into 2021, that’s where we’re really focused.

Sorry, I missed, what you said, what you do look that different next year. I apologize.

Full year, next year, we’re still working it out. But I don’t think it’ll look much different than this year from a total comp perspective. I wouldn’t expect it too.

Okay, that’s helpful. And then, I guess I’ll follow up with another question about next year and I’m sure that’s not what you want to answer, but I’ll try anyway. Do you have talked about a couple of headwinds and tailwinds and things that you won’t get to a 2.5% comp and so forth. But I think the big missing piece for me and maybe some other people on the call is, how much you need to spend to get back on the business, right? Whether it’s capital spending, operating expenditures, systems, I guess when people are trying to figure out really is, okay, if the comp is similar next year, are we looking at a much more difficult overall EBITDA margin because of these investments? Or is it something where you feel like what notes little minor tweaks maybe here and there? And next year still be an investment year, but it won’t be as big as feared perhaps?

I’ll start with the capital side. The capital side clearly will probably be with just only 20 stores. You just saw us reduce our CapEx for the projection for this year full year. And that’s because of the less capital we’re putting out right now for stores. It should be opening next year. So my expectation on the capital front next year shouldn’t – if anything, it’ll go down. And then if we decide in 2021 and beyond to grow faster or with more stores, you think about part of what we’re doing here is to try to reduce the cost to build. Our stores have gone up over 40% and cost to build in the last four, we have a strong belief that there’s a lot of that cost that we can eliminate and build our stores less expensively. So therefore, I don’t see capital ever really getting higher than the $150 million to call it $200 million in the next several years for that new stores, whether it be DCs, whether it be infrastructure, we probably will build some more DCs because we want to be much more effective and efficient as it relates to operating those stores. But I just don’t see the capital again going any higher than what I just said over the next several years. On the operating expense side, we’re going to get to a place where, yes, we’ll have initiatives, but we’re going to do that in the confines of we can only grow expenses so much to at least in a stable gross margin environment to create some sort of acceptable earnings growth. And so we have control over that and I think we’re working towards the puts and takes right now that will get us to a place where we hopefully won’t get deleverage, but we think we can at least get flat to some leverage over the course of the next couple of years.

Thank you so much.

Sorry, just to think the – in fact on that Chip’s point on stabilizing our margins, which we feel confident we can do.

Understood. Thanks so much.

Thank you. Our next question comes from John Heinbockel from Guggenheim Securities. Please go ahead.

So two questions. Number one, what do you think what mature store comp would be embedded in 2.5 overall comp? And is the bigger opportunity, because you talk about customers that are passionate, who know what the brand stands for? The bigger opportunity, non-customers getting a better appreciation for what you stand for? Number one. And then number two, it sounds like click and collect probably does not get expanded from here that that kind of dices in, the focus will be on home delivery.

I’ll go – well a couple of things, I’ll talk to both and then Jack, you can jump in. From a brand perspective, we believe there’s a tremendous opportunity from a brand reach perspective, customers that – potential customers who don’t know us today, those are – how are we going to reach them? More effective marketing in the markets we’re in and the markets we’re going to, but also entering new markets and doing it in a more concentrated way. And we can start to put more marketing dollars in those markets and leverage that. We can get more word of mouth, we can talk more radio, we can talk more in whatever medium we can. So there is brand reach opportunities here in existing markets and in new markets and you will get much more effective in the way we go to those new markets. On the click and collect front, we’re not going to stop to click and collect. Customers – there’s customers are going to want that service. It doesn’t cost us a lot of extra money to do that service. It isn’t – it hasn’t taken – we do six times an average store that has click and collect versus an average store that has delivery. We do 6x on the delivery side than we do on click and collect right now. But we’re still going to offer that service and we’ll grow as the costumer grows up.

Yes. So just to reinforce them, the message on brand awareness, John, the reality for me is that when we have such sporadic geography in our development, in our new store, is very hard to get effective marketing communication and the opportunity for awareness is very real and we can see that in the data that there’s a lot of people just don’t know who we are. And as we go to our market, one store at a time, it’s harder to get that message over, particularly, when you do it in a program of sending price down through flyers. It doesn’t tell the message or the story of who we are. And I’m very actually excited about what that may drive for us in terms of additional traffic when we get it up and running and making working. With regard to click and collect, I think our farmers don’t lend themselves as much to as some of the larger format, some of the mass format. Having said that to Chip’s point, we’ll meet the customer, where the customer wants to be met. I’ll be pretty really interested about how people in places like the Bay Area have been accessing our delivery. We met people have been accessing the brand pretty effectively in certain stores. And there I’m intrigued by how we may develop that going forward in terms of again meeting the customer where they want to be to be met going forward.

Okay. Thank you.

Thank you. Our next question comes from Karen Short from Barclays. Please go ahead.

Hi, thanks. I wanted to just go back to the store opening comments. So for 2020 openings, I guess the first question is, do you have the ability to tweak the cost to build for the 2020 class and then if so, what exactly do you think you’ll be adjusting?

Well, in terms of the cost, there is some opportunity for us to improve the 2020 build costs, but not by as much as what we think it can be going forward in terms of making the store slightly smaller. So in terms of that opportunity, that would be the kind of the cost per square foot can come down by making the total cost will come down as a cost per square foot. As that square footage goes down, the cost per square foot can come down a little bit as we mature our sourcing effectively or some of the things that we’ve put into our stores of enhanced format stores. Does that answer your question, Karen?

Yes. And then I guess just on that class of stores, so I mean, I understand that you were not involved in the approval process of those locations, so can you maybe give a little color on what gives you confidence that locations are optimal?

Well. Hey, Karen, it’s Chip. Well, we’ve looked at all the stores that were in flight for next year knows that we felt like really we’re on the fringe and we really would prefer from a supply chain perspective or a cost perspective, we’ve done our best to unwind those. The ones that are still on the list are what we believe are the better locations of the class. And they’re also in many cases, they’re ones that we think we have some control at this point to reduce the costs on those stores. So we’re doing, we’re working our way through that class and trying to make it as effective as we can, recognizing that most of those, if not all of those leases were signed. As it relates to 2021, our expectation is we’ll get back to at least 30 a year and we’ll have a lot more control over those. And we’re just now – we’re not approving those yet until we really refine the way we want that prototype to look.

And the real estate, we’ve done really good job at developing these stores and getting them, but then maybe a strategy that we’re going to change going forward. But I think as they mature their focus on how we cost them, I think we can make some short term benefits as well.

Okay. And then just a question on pricing. I mean, obviously, you’ve talked a lot about high, low in EDLP. I just was wondering if you could give some initial color, and this is aside from high, low EDLP, some thoughts on your pricing in non-perishables, because obviously, one of your primary competitors has been making progress on pricing, especially in like grocery non-perishable. So just some early thoughts on where you stand on that and whether there is anything that needs to be adjusted there?

I think as you go through the whole non-perishable side of the business, when we are successful and you can see in our farm, just trying, we are very differentiated assortment. And then pricing becomes less of sensitivity in terms of – if you’re selling things that nobody else is selling, you can actually manage it effectively as a value play. And when I look at coffee particularly somewhere like frozen foods where when I walk up and down our frozen cabinets, we’ve got a very different offer to what I would find in a traditional grocery store. And that allows us, I think to get the kind of pricing that reflects what the customer sees as value as opposed to reflects what our competitors are pricing something out. And we find the same at our fund based business. We found the same in our dairy business that when we’ve got real differentiation that pricing hasn’t got the same sensitivity as it might have in us when other grocers are comparing themselves with other grocers in that space. We’re taking a good look at our vitamins and hopper business to see whether that’s as competitive as we need it to be. So there’s a little bit of work going on that, but in the rest of our non-perishables, I think we’re in a pretty good place on pricing and if we keep bringing innovation to the marketplace and keeping ahead of it, I’m pretty confident those categories are well-priced.

Great. Thanks so much.

Thank you. Our next question comes from Scott Mushkin from R5 Capital. Please go ahead.

Hey guys, thanks for taking my questions and I’m sorry I’m a little bit on the street here. So I guess, my question is about the stores. I mean, the idea of spending more and going into kind of a slightly larger box had to do with adding a lot of stuff into those boxes, expanded Deli as an example, some more food service. And I believe that was part of the reason the stores were coming out of the box pretty solid. So I guess I just wanted to understand a little bit more about the decision to maybe go to a smaller box with less of these services and how we would – how you were kind of thinking about it? Because it seemed like the company when away from the smaller box and added stuff in because the competition had gotten a little more fierce particularly in the fresh area?

Yes. And I think, as I go around our newer bigger stores with the enhanced Deli proposition in it, the customers like them. They’re just costing a little bit too much for us and they’re taking up a little bit too much space. And when I compare those stores to some of the stores that we have done in a smaller stores, as I think Chip made in a remark, our smaller stores actually carry as much for the customer in terms of what they can get. You could argue the experience is different because it’s smaller. We’ve built an expediential improvement in our daily business, in our enhanced stores. But in terms of a Farmers Market feel, the smaller stores create that Farmers Market feel that we’re trying to kind of replicate and it’s got the assortment and product offer that we wanted to have. So I think that’s a middle ground tier in terms of where we get to. We don’t know exactly how it’s going to play out, but when you look at the cost per square foot, we need to find a way of not spending as much money. And I think we can get a lot more stores into 2021 and 2022 with an approach that makes them a little smaller.

And Scott, I would add. Just think about the fact that if you make your stores more expensive, and yes, your enhancements do create a return. But the returns, yes, they do create shareholder value. But if you take the alternative approach and say, what if I can still present the core customer value proposition and I can do it a lot less expensively and the returns on these individual sites are higher. It affords me the right to take more risk, go into markets more concentrated, create more brand awareness, et cetera. So that’s the lean we still have work to do to get proven out. But we have stores today as Jack pointed out, that are significantly smaller, create the same – the core brand proposition that are incredibly productive. And so that’s what leads us to at least a hypothesis and something that we need to work through.

Those are all older stores, so correct, the ones you’re referring to with that productivity?

Most of our older stores, that’s true. And I’m not expecting to get the same kind of volume in those very established deep entrenched stores. But if I can get the same volume I’m getting today in a newer store and it costs me 40% less to get in there. I’m just getting basically the same volume, the returns are exponentially larger.

That’s perfect. Thanks for the long answer, but the detailed answer. So my second question, my follow-up question goes to the delivery business and how we should think about the economics of that as it grows? And then I’ll yield. Thank you.

You mean home delivery business, Scott?

Yes, correct, correct.

Yes. As I said to you, what we’re finding is, we’re finding pockets of real customer interest in this. And it’s tends to be pockets and it’s not all right across the chain. We need to understand that as we evolve and develop it. It clearly does cost us more. The margin isn’t as strong on that and there’s ways that we can mitigate that negativity in terms of margin play. As I said, we’d go to meet the customer where the customer wants to be met. If we get this right experientially our home delivery in terms of in-store, our home delivery business will now appropriately alongside it so that you’ve got people doing both things. And then if we can get that basket growth that comes from customers being committed to the Sprouts brand, whether they’re having to come to the store or having it delivered, I think we can mount the margin in such a way that we can manage it effectively. But we’re doing a lot of work on that as we speak in the external people that are helping us on this, and this will help understand, this will work better.

All right guys. Thanks very much.

Thank you. Our next question comes from Kelly Bania from BMO Capital. Please go ahead.

Hi, good evening. Thanks for taking my questions. Just wanted to ask a couple more on the stores and the decision to, it sounds like more densely locate the stores. Maybe just an update on cannibalization, how that tracked this year and what it could look like in 2020 and beyond as you start to kind of more densely populate those stores.

Hey Kelly, it’s Chip. Cannibalization, I’ll start with this year. Cannibalization has been decreasing as the negative impact for us as a company. We’ve been very – the company has been very focused on it. I think for us as we’ve been focused on it, we haven’t really thought about the bigger play here, which is, if I could go attack a market and I can go attack it with 20 stores because of the projected returns are a lot higher and I have supply chain, I have a distribution center there to support it. The efficiency of the distribution center to help support it and the brand presentation because of distribution center is closer and you can do a lot more stores. We think that that would be a better answer. I’m not suggesting where they are quite yet, but we’re working toward is, we think that would be a better answer and the need to worry about cannibalization is it just becomes something that we shouldn’t worry about as much.

On the context of cannibalization, for me it comes back to the conversation we’ve been having about brand awareness. Within each market place if we can get a more dense store proposition, I do believe if we market it effectively and get awareness, even in markets where people know us, there’s a lot of people that don’t know who we are and what we do. And I think there’s an opportunity for us to really invest in marketing appropriately to drive awareness and dilute the effect of cannibalization. And if you do smaller stores, you need less deals as well within that to make the economics work, so both of those things are hypothesis either the theory that we’ve got at the moment.

Okay, that’s helpful. And then maybe just another one on the stores. With the 20 that you’re expecting next year, should we expect that that has some sort of modified Deli component or that still have the Deli that we’re used to seeing in the stores. And when we get back to – when the target is to get back to 30 in 2021 is there – does that depend on where comps go next year or how this 20 stores performs? I’m just curious like what that is – what kind of you’re gauging to get back to that level of growth?

With the gestation period kind of stores, the 20 stores that we’re doing last year, are going to be buying a lot of the same as the stores you’ve seen in the enhanced prototypes with the larger deli. And as I said, the customers like them, so I think that they’ll perform well going forward, how can we replicate the experience that customers are getting without spending as much money in smaller stores would be the attempt that we’re going to make in the work that we’re going to be doing over the next few months. But the 2020 stores will look the same as the stores 2018. We won’t be able to change them even if we wanted to. I think we can do them a little cheaper, simply because we’ve hope to do it more effectively as the team been working on this, we’ve hope to do it. Going forward after 2021, I believe that we can go at least back to where we were in terms of the number of stores that we’re building. I would actually hope, we’re able to do more than that going forward.

And Kelly, I would also add. Our confidence in getting back to the 30 isn’t because – it’s there, because we’re not overly disappointed with the stores that we’re building today. We just believe we could do it better. Worst case scenario, we’re building 30 in 2021 that look just like the ones we’ve been building. But we just have a belief that we can do it different and better. So we’re going to work through that and then go out with that. That’s why we’re confident, we can get to at least 30, and if we can do it better and work cheaply and we think it’s more effective, we can build more than that.

That’s helpful. If I could just ask maybe one more on just the pricing. I think for Sprouts histories, I’m aware they’ve talked about kind of 20% to 30% price gap versus traditional supermarket peers and produce at least. And just with your comments so far, talking a little bit about that category and the front page ads, is that still the case that you’re seeing with your pricing analysis? Or where do you think Sprouts needs to be in order to get back to the comp that it’s targeting?

By enlarge we’re still operating at 20% lives on our produce business. The more we can create differentiation, I think we’re going to invest a lot more people and resorts in local sourcing so that in Colorado or Florida, we’re actually much more effective at bringing local products and replicating what a Farmers Market. I would think, if we’re going to be a great Farmers Market, we need to really source product on the ground locally, more effective than we are at the moment. We’re investing people behind that and then it changes the whole price equation in terms of how you can work it. But by enlarge, we’re still at 20% cheaper. The promotions are now quite as aggressive as they were. We’re not seeing any effects on our traffic and our margins are tweaking up a little bit. So I think we’ll keep doing that for a little while and then see what it takes us.

Thank you.

Thank you. Our next question comes from Edward Kelly from Wells Fargo. Please go ahead.

Yes. Hi, guys. Good afternoon. I wanted to ask you a question about new store returns and what’s reasonable to target. So, when you went public, if I remember correctly, you had a payback period of probably in the neighborhood of like 3.5 to 4 years. As we think about, where things are today, I can look at your EBITDA margins on that and they are 300 basis points lower and the cost is 40% higher. So I’m just kind of curious where – what the new store returns look like now? And then what’s a reasonable target for us to think about if you decide that, the new model works and that you would accelerate growth upon that.

Yes. Honestly, I think it would be premature at this point to go through that level of detail. I would tell you that at some point that is something that we would provide. But it’s just too early for us to do that because we don’t know – we’re all leaning one direction, but what that finally looks like doesn’t necessarily mean. We don’t want to assume that we’re absolutely right. We’re leaning that direction as we’ve implied on the call. But give us a little time, give us a couple quarters and we’ll get back to you on that one.

All right. And any thoughts on store closures as well as what all of this means to the East Coast strategy?

We’re sorting through that as well. That’s going to be an area of focus for us. It is really, we have come to believe, as we should. Supply chain and new stores have to go hand in hand. They have to. And so as we look across the country and we look for those areas of opportunity to build stores and we look for where we have stores today, we’re going to be evaluating all of that. And it’s critical for us to make sure that our supply chain, especially on the produce side, which we pretty much control all within our own house, it needs to be much more dense.

So shorter lines of distribution will lead us to focus on exactly where we build the stores on the strategy of supply chain, logistics and new stores comes together pretty well. But with regards to the East Coast comment that we’re excited about Florida going forward, I think some real for opportunities in that market.

All right. One last one for you, just on supply chain. Obviously Sprouts has prided itself on value in produce. Selling prices over the years that retail obviously have come down. What’s happened on the supply side though for Sprouts? What I mean is, what you’re buying this product? Has there been any negative impact by the fact that scale grows and the type of deals that you see are maybe different than what they were, right, the larger you get, you start to become more of a mainstream sort of sourcer. Can you still price product at that discount conventional, you see what I’m asking?

Yes. I see the question you’re asking and I think the reality of this, I have been involved in this and all over the place over the years. The quality of your sourcing team and the thinking behind specifications is one of the things that allows you to be very appropriate and work well with the growing community. One of the things, we brought some new people into that space and we’ll bring some more people into that space. When you get the right relationship with the growers, you can manage this effectively. There’s a lot of volatility and being on top of that volatility from one week to the next, from one month to the next and from one geographic location to the next, allows you to be very effective at having competitive prices in the right way going forward. And more and more as you get to scale, it’s about developing the type of relationships that build long-term growing plans with your growers. And I’ve been excited about the dialogue that we’re having in that to not only keep our price position and our value position but bring differentiation in terms of the specifications, the things like larger blueberries or sweeter grapes and getting into how you get varietal develop in tomatoes and those kinds of things. The team are doing a nice job on that and that will allow us to continue to have a differentiation and keep produce at the forefront of what a Farmers Market needs to be.

Great. Thanks guys.

Thank you. Our next question comes from Mark Carden from UBS. Please go ahead.

Good afternoon and thanks a lot for taking the questions. So you guys inherited a number of different initiatives, ones that were already in place like Fresh Item Management and Workday Financials. Are you seeing the desired results thus far? And then even beyond cost standpoint, given the sheer number of it that were already in place, when you guys fully took the keys, does it limit the degree of incremental change that you think you can make next year? Thanks.

Hey, Mark, it’s Chip. We’re happy with FIM and we’re happy with Workday. We’ve gotten through those and we’re getting some of the benefits from FIM, many of which we thought we were going to get. And those are showing up. Workday is a better way to work. And we went through a massive call an ERP for that and we’re on the other side of it. And we’re getting benefits there as well. So we’re very pleased with that as it relates to going forward. What was the second part of your question? I apologize.

Just in terms of the added degree of complexity from all, what you can do next year?

No. I don’t think it limits what we can do next year. You’ve already heard some of them. There are no limitations next year, sure. As it relates to, okay, we’re already in flight on a bunch of stores, so how do we make that, are there other things were in flight on? Absolutely. But none of those that really, I don’t think tire hands or limit us. And I don’t see any restrictions. It is going to take a little time. I think the pricing and promotions and as Jack has alluded to, working our way through that and doing it right without burning the house down. We want to make sure that that never happens. And so we’re – for lack of a better term, we’re unwinding a little bit of the very, very aggressive pricing promotions on top of promotions on top of promotions, which we’re not getting credit for from a traffic perspective or even a sales perspective. So we’re being very careful about that. But that’s probably the most difficult thing to work your way through with the difficult nature associated with what the outcome of that’s going to be. So that’s why we’re doing a lot of testing.

And to me there’s nothing in flight that I’m wanting to, we can not do if we don’t want to do it. The biggest thing that I’ve been pleased about is the mindset of the team to try different things, so they’re not weighted to a mindset where we were at. And that’s been very encouraging with the merchants and the operators and the team. And that’s going to make it easier for us to make changes going forward.

Great. That’s helpful. And then another question on delivery. One of your larger competitors recently announced it was eliminating fees. Does this make you rethink your own grocery delivering and grocery pickup fee structure? Or do you think that the overall value proposition should still allow you to gain share? Thanks.

Yes, I think, we watch what competitors are doing all the time. But I’m a big believer that if a retailer knows what it wants to be, we should stick to being good at what we are. We’ll watch what the competitors are doing. Our differentiation in terms of the product assortment that we have in terms of what we do in bulk, in terms of the advice we give in vitamins, in terms of the clarity that we have around our plant-based initiative, the clarity that we have around our vegan initiative, those kind of initiatives create a differentiation that will means people, we want people and we think people will migrate to the Sprouts brand and respect that particular initiative. It doesn’t over concern me.

Great. Thanks so much.

Thanks Mark.

Thank you.

Thank you. Our last question comes from Chuck Grom from Gordon Haskett. Please go ahead.

Thanks. Good afternoon. Just a couple from me. Earlier in the year you ran into some produce issues. As you sit here today, just how you thinking about produce, particularly given some of the issues in California? And then just the second is on the comps. When you think about the 1.5% that you delivered here in the third quarter, I’m curious how big a dispersion exists between older stores and new stores. And I guess I’ll let you define old versus new. Thanks.

Chuck, I think Jack will answer the first part and I’ll answer the second part.

Okay. So with regard to produce the dynamic changes all the time and not from one week to the next, from one growing region to the next. And if you can get produce one place you can get produce in other place. And the reality is, it’s about the talent and the expertise in the team. And as I’ve said a couple of times now, bringing new people on board, sourcing more effectively locally sourcing. So if you think of the places where we’re operating and Florida got a very different dynamic to California. Colorado’s got a very different dynamic to California. Arizona has got different dynamics. So the opportunities there for us to be effective from one week to the next or one month to the next, if we’ve got the right people in place. And as I said, I’ll be pleased with the way that it’s been working over the October.

Yes. Chuck, as far as the comps, really the vintage comps, while we’re comp at 1.5 and you’re doing 200% growth on your delivery, and you would hope that your newer vintages are comping year-over-year, you would get to a place that would say your oldest vintages are negative. And that’s a true statement. But it’s only slight, so it’s not – there’s nothing really bad. 2015 flyers slightly negative, but all of our newer vintages are positive and our delivery is extremely positive.

And just as a follow-up, can you just remind us what the penetration is on delivery? So that gets back into what the comp benefits helped you here in the quarter.

3%, I think it’s about 3%. We’re doing just over 3 million a week now.

And it’s growing, it’s growing up. Closer to 200% we’re growing up.

And I guess just to follow-up, it’s been Walmart and Target success on click and collect has been very well documented. It’s really supporting their comps. Just curious, why do you think it’s not being adopted by your customer much, just because it seems to be working there so well?

I think the format lends itself better, like I said. I think just a lot of their store gives more space for them to execute that effectively. But as certainly, our – we haven’t really marketed it. We’ll see what happens over the next little while. We haven’t abandoned it, as I said, if the customer wants to do it that way, we’ll do it that way. But our store setup isn’t as easy to do when you get smaller box.

When you think about it, we’re not a full shop. So we’re sort of a destination for those unique and differentiated items. And we’re also not kind of place that you’re going to go, we’re just the basics of the basics. You’re not going to buy a lot of floor cleaner, you’re not going to buy cleaning supplies or detergents, et cetera. So when you think about that, it makes some sense as to why click and collect is just not as attractive to our customers as it may be for some of the others.

And if we get our brands right, there’s a treasure hunt element of business is different today, consumable element does lend itself to click and collect more effectively.

Right. And you actually want the people coming into your stores on. Okay, great. Thanks very much.

Thank you.

Thank you. This concludes the Q&A session. At this time I’d like to turn the call over to Jack Sinclair, CEO for closing remarks.

Yes, thanks very much guys for spending time listen to us today. We really appreciate your interest in our business and I look forward to updating you in the future calls. Thanks so much.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. Good day.