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

Good morning, everyone. I'm Mark Carden, the food retail and food distribution analyst from UBS. We are incredibly excited to have Sprouts with us today. Sprouts is one of the largest natural organic grocers in the United States, operating more than 370 stores across 23 states. We are super fortunate to have 2 esteemed guests with us. The first is Jack Sinclair, the company's Chief Executive Officer. Jack joined the company in June of 2019. We also have Chip Molloy who took over CFO in September of 2021 after serving on the company's Board of Directors since 2013. We're going to run through a number of topics this morning. If you have any questions during the presentation, please feel free to enter them into the app and we can try to weave them into the conversation. Before we start, I am required to read a legal disclaimer. As research analysts, we are required to provide certain disclosures relating to the nature of our own relationship and that of UBS with any company on which we express the view at this meeting today. These disclosures are available at www.ubs.com/disclosures. Alternatively, please reach out and we can provide them to you after the event.

So with that, let's dive into some topics. So to start, a lot of change over the last few years, obviously, with COVID. We've seen significant shifts in grocery shopping habits. Many of these changes are likely to be transitory, but at the same time, some of these are more likely to be permanent in nature. How are you guys thinking about that and how has Sprouts adapted its strategy going forward?

Yes, well, it's certainly been a tumultuous couple of years in terms of what's been happening, both in terms of trying to run our business and in terms of what's been happening for the consumer in the middle of it. It has been extraordinary, to be honest with you. And it's actually nice to come to a meeting like this, where we're actually physically talking to people rather than going through Zoom calls. So we appreciate the opportunity to actually be here. So thanks for having us. What's the consumer been doing? You've certainly seen a big increase in e-commerce, but when I started -- took the job, and I remember talking to the board when I took the job around, well, e-commerce doesn't really matter to us. We're all about experiential retailing, farmers market. We were operating about 2% of our business as e-comm. That at one point got to 14%; it's drifted back down to 10%. Will that be a permanent switch in our growth in grocery e-commerce? I believe so. I believe there's a significant uptick. Maybe not as big for us as it will be for other people, but I think that dynamic is here to stay, to be honest with you. The other dynamics that have changed a little bit, you've certainly seen a lot more cooking at home, a lot more baking at home, a lot more sales of -- we've been running out of yeast every 5 minutes, so just trying to keep things going as people operate differently at home. I think there might be a little bit of trend to that. I think as people think about feeding the -- getting the family together and feeding, I think there's been some positives in that. Maybe that will drift away in time, but not right away. And I think so. I think you're going to see a lot more of that. And then the other dynamic is the meal -- prepared meals. And I think we've maybe -- we've done pretty well with that, but across the industry, you're seeing a lot of people switching from restaurants to prepared meals in supermarkets, and we've done pretty well with that. I think that trend is likely to remain elevated certainly for some time. And in the inflationary environment we're getting into, we would anticipate that being something that's important to us in our strategy going forward, how well are we doing on prepared meals and getting prepared meals for customers? So we'll probably be doubling down on that in terms of space and capability and quality and using some of the development skills we've got in our business to create some of that dynamic. So as you think about that, e-comm, prepared meals, cooking at home, I think they're all at elevated stages going forward, and we'll be trying to accommodate that in much of what we're doing going forward.

That's great. In terms of, one of the key elements of the strategy shift that you guys have been doing has been really moving away from coupon clippers who might have supported your comp in the past, but they probably weren't the most profitable customers. At this point, do you think that you've mainly cycled out those coupon clippers or do you still think you have a little ways to go on that front?

I think we've cycled out of it. So we started that -- Jack showed up in the middle of 2019. And then if you just go back a couple of years prior to that, you watched our margins just constantly decline and our traffic was not comp positive. I think the last positive comp in traffic we had was in one of the quarters in 2018. And so we made the conscious decision in 2019, as we did some strategy work with a firm, a strategy consulting firm, and decided that we wanted -- we were differentiated. We had good produce pricing, but we had great products and we needed to make sure that we weren't burning down the house and playing the conventional game. And so we stopped really the paper high/low, in your face, every Wednesday that the conventionals were doing. COVID accelerated that. So when COVID hit, everybody went away from paper. That would've been probably a slow and painful bleed for us, but a positive that totally shifted, that went away. And so we saw traffic drop a bunch in 2020. Some of that was the consolidation. Some of that was the coupon clipping. We're now at a place where we feel we're really good. We're starting to see traffic trends improve and we're not having to give away margin to drive traffic. And we feel really good about that.

Great. And then we're lapping some pretty significant inflows of government stimulus from the year ago period. How much of a headwind is this typically for Sprouts, and could trade down from food away from home to food at home potentially offset some of the pressure?

Well, that particular pressure -- there are some pressures coming our way, but that particular pressure is not one that we're super worried about. We're not super worried about it because we don't have much of it to start with. We just don't have that dynamic of the amount of food stamps in our mix that many other people have. So it will neither hinder us nor help us going forward, that dynamic. So having said that, the pressures that are coming in around inflation, the pressures that are coming in the context of a changing marketplace, it is something that we're having to pay attention to in terms of what's happening to different products, what's happening to the dynamic of price and what does price do to the capability and spend. I think -- to the second part of your question, I think as people come under pressure for gas prices, people come under pressure for food price increases, inflation generally, it's likely that they're more likely to migrate back to staying at home as opposed to being in restaurants. So I think that might benefit us going forward. It's a kind of unknown. I think that -- so if you think about your question, we're unlikely to get the downside, we might get some of the upside, would be the way I would describe it.

All right. I think another thing that everyone's trying to figure out is we're facing a really uncertain geopolitical backdrop with a really sad situation just continuing to evolve in the Ukraine. I mean from what we understand, Sprouts of course has very little direct exposure to the situation. That said, does your supply chain have much indirect exposure to the crisis? And would you expect the broader U.S. grocery sector to see much of an impact or would you expect for it to be more focused overseas?

I think from our point of view, we're clearly not operating outside of the United States, so we don't have that direct impact in terms of what's happening. From supply chains, I think we've had a tough time on supply chain. We bring a lot of stuff in from Europe. We bring a lot of stuff in from South America. So supply chains will be under pressure and likely to get more under pressure. Whereas we expected it to get better, we think it's probably going to get worse. So that will put some impact on this flow of goods into our business that probably is going to accentuate that challenge going forward. And we have to, kind of, watch for that. On the broader food issue, the fact that Ukraine and Russia, and you're right, a desperate situation there, you, kind of, contextualize it. It's more important than anything else we're going to talk about. But wheat pricing and food pricing that comes from that, kind of, bread basket that exists in the Ukraine and Russia, is likely to put pressure on all of the processed foods around the world in terms of food pricing, more -- even more than what has been happening so far. And I think we'll all feel, kind of, the effect of that going forward. I think that's something that's pretty clear from what's happening so far. So supply chains and commodity food pricing are probably the 2 big impacts that are going to affect our business.

Okay. And then on a related note, just inflation, how much flexibility does Sprouts have to really shift around your assortment during periods of high inflation? And has the recent inflationary backdrop changed at all how you guys think about private label in terms of what penetration you guys might ultimately like to be at?

Well, as it relates to inflation, first, we are a secondary or a tertiary shop. So people are coming to us as a destination for certain reasons. Either they're health conscious and they're looking for that special, unique product that they can't get at other places; or they've started a new diet and we're the place to go. And they are coming to us for great fresh produce at great prices. And our prices are going up, just like everyone else's, as we pass most of the inflation onto the consumer. Is the consumer being affected by it? Yes. In some ways, as it relates to, in our produce section, you will see, as Jack gave an example earlier today, is people are buying smaller avocados. It a big business for us. If I go from bigger avocado to smaller avocado, I can still make guacamole, but I just can't make as much, or it's going to be smaller. Other than that, most of the pricing, we're watching it. We're watching the elasticity really closely, but we're seeing the consumers still absorb the other products. Meat is probably the one space -- it's not as big a business as it is at other places, for us, but it is a good business for us. It is a high price point. We do have -- that's a place where we do have some opening price points and we do have other products and a breadth of products to help the consumer. But that's probably the one area that inflation becomes a challenge you've got to manage through.

And with regard to private label, which I think a lot of other people will be talking at this conference about, trading -- people trading down to private label. We are in a slightly different dynamic for that because our private -- we're not really pitching private label against the brand and trying to, buy this a bit cheaper and it's just as good quality. Our private label tends to be pretty bespoke to what we are trying to target against our target customers. So I think it's an important part of our business. It will be as important, no more or no less important going forward. We're working hard on it, and putting some people in place to make that come alive. And in this inflationary environment, maybe something that we're concerned about, but we're working hard to think about, is how do we keep encouraging these innovative brands? The people that have got these, kind of -- some people might describe them as weird and wonderful brands that, kind of, come in and cater for very specific dietary needs, and keto and paleo and vegan and vegetarian. That's -- we really want to encourage those brands to bring that and we want -- we're creating a -- we're trying to become a destination for those brands. And in an inflationary environment, we want to double down on encouraging that to try and make sure that we keep on being different. Maybe there's an opportunity for us in the middle of that to actually make us even more different in the middle of this environment.

Makes sense. And then thinking towards the back half of the year, we could have some pretty tough inflation comparisons. Do you think there's much of a chance of seeing some deflation and if that occurs, how would that impact Sprouts' margin?

Deflation, that's another whole different game.

It's not...

Lack of inflation is okay. I think when you see what's driving a lot of the inflation, a lot of it's wage cost for drivers. It's getting product from point A to point B and a lot of that is here to stay. So I don't know -- if we all -- if anyone in this room could really predict where inflation go, you wouldn't be in the room, right? If you really -- we had a crystal ball. But that being said, it feels like the price increases that have happened, it may slow down the pace -- taking the Ukraine aside for a second, the pace may slow down, but the absolute number probably will hold. That's our perspective.

That makes sense. I guess another pressure that we're seeing really across the grocery space is wages. And so number of your grocery and even mass merchant competitors have been making some pretty public wage hike announcements. How are you thinking about the overall wage market outlook over the next few years? And has your outlook on store level wages really changed much versus when you guys were laying out your initial strategy a few years back?

So labor's been a real tale over the last 1.5 years, how that labor thing could go. The COVID environment has certainly changed the dynamic of labor. I actually think people working in grocery stores have got a higher, kind of -- are being regarded higher than they've ever been before, because for a long period of time, in an uncertain world, they were in the front line providing food to people. And I think it's brought a lot of pride for a lot of people working in the industry, which I think is a good thing. I feel very, kind of, nice -- it's nice to feel that they feel so much -- so important to the communities that they serve. So that's been something and we want to take care of the people that are taking care of our customers. And I think that's even accentuated it for management and people running companies to think much more carefully about that going forward. That it's not just a commodity that you can bring in and send out and bring in and send out. Having said all of that, we operate our own world. We pay bonuses every quarter, which not many -- a lot of other people do. We pay -- each store can get its own bonus. Every person in the store can earn a bonus every quarter and at the moment, that's been working pretty well for us. We've been giving special one-off bonuses on top of that. So if you look at the numbers we've been paying out on bonuses, they're fairly substantial. And we like to do it in that way where we can be very direct with people. Our average wage tends to be higher than other people because we've got a kind of skill base that's different. We've got butchers and vitamin people and people that have got some expertise that means their hourly pays tends to be a bit higher. So we operate a couple of bucks more than most in the space because of that mix being different. And as we go forward in labor, clearly, the macro environment for labor is going to get more challenging going forward. And I think that's something that's not necessarily a bad thing, but it will force us -- we've got a lot of inefficiency in our business. And this isn't about not wanting the people, but we've got inefficiencies in our business. So we're investing a lot in self-checkouts, which we had none. We're now at 150 stores, potentially getting more than that going forward. We're investing a lot in taking the tag -- the work of putting tags into the store, more efficient and different. That's a big cost for us. We can see some benefits in labor costs going forward. The cost of replenishing the store from the back door to the shelf. Those are the 3 big buckets of money where we are actually relatively inefficient against a lot of other people. So we'll be working on that, if you like, to mitigate the number of labor hours that we need to operate the store. Within that context, the labor hours that we're using, we want to take care of the people that are working for us and create that kind of loyalty. It's interesting because what's happened over the last few months is at the end of the year when Omicron hit, we had some real challenges just keeping the stores running. We had 1,900 people out from COVID. And the people that were left were really left holding the baby, to be honest with you, really having to work to make it all come alive and keep the stores going. So we were very pleased with those people and we tried to reward them in the appropriate way. But it's interesting, January, February, it's just, kind of, changing a little bit back. We're getting more applications, we're getting the stores back in where we need them to get. We were struggling to recruit people in November, December to fill the gaps that we had. That's getting a little bit better in January, February. And I think that the context of that is probably people needing to get back to work and get paid and feeling a little bit more comfortable in the COVID environment. So labor's got a bit better. The long-term challenge for us is how do we get the costs down, but we want to take care of our people.

So in terms of, it sounds like a lot of progress on the labor front and the stores. How is it looking in the supply chain?

Yes, I think drivers have been a problem for us in terms of the operations from the fresh distribution supply has been -- that's created some problems. We've got -- certain locations in the country have been harder than others in our distribution because we've got 8 distribution centers. We've had more challenges in certain places than others, but transportation's probably the biggest one, drivers and getting drivers and being able to work that again. Getting a little better in the last few weeks, but that was a tough time through November, December, particularly in that.

So we're offsetting -- so on the supply chain front, we opened up 2 new DCs this year earlier in the year. So those 2 new DCs took up to 3 million miles off the road. So taking that mileage off the road has helped to offset the wage pressure that we see with the drivers. And we'll continue to see that going into this year and because we're growing in the Mid-Atlantic, we'll probably be looking at a DC in the Mid-Atlantic. So those are ways that we can work through that piece of it. And then back to the stores, a couple other elements to think about is back when they cut corporate taxes down to the 25% rate, we gave some of that back -- Jack wasn't here then, but it's just a few years ago. We tried to get ahead of the curve. We increased wages across the board in the stores to try to get ahead of that. Thank goodness we did. That was a good move on our part. And then secondly, because we're one of few growing retailers, because we are putting square footage in the ground, the job opportunities to advance in our company as a retailer is much better than most any other retailer. We promote -- 25% of our associates get promoted each and every year. So there's a really good reason to come and work for Sprouts.

Actually, I've got a timely one coming from the audience related to the distribution center questions. How much room is there for automation at Sprouts? Is that really as possible as we can see with some more conventional retailers? Your mix is pretty different. You obviously have more produce. How do you think about that?

I think it's a -- all of our -- at the moment, of our total business, the only thing we're self-distributing is our produce business. Produce doesn't lend itself -- I think that's implied in the question -- to the level of automation, although we are going -- we've moved to 100% voice pick, which it, kind of, doesn't sound like that dramatically different to where the innovative places are, but that was a big step for us. So that's -- so there's elements of technology that we can bring into our self-distribution. The piece going forward is how far do we want to go beyond fresh produce as a self-distribution? Do we want to take more control of our destiny in a lot of other categories? And we're going through some specific work on that. Again, it's implied in it, the technology that's very prevalent in distribution centers and evolving and developing is less relevant for us today. It might become more relevant in the future as we go forward. And the 2 distribution centers that Chip were talking about, we've created space in those to do more. And if we did more, it would then require a little more automation than maybe what we've been working to so far. Produce is just a different game from an automation point of view.

I can see that. So in terms of, Jack, remember when you first joined, one of the pain points that you noticed initially was Sprouts' distribution center network overall and just, it wasn't big enough to handle the growth trajectory that the company was on. You guys have obviously opened a few distribution centers recently. It's been a huge area of investment. How close do you think Sprouts is today to having what you would consider to be the right number of stores for your existing footprint and for your near-term growth plans?

We're certainly closer than we were. One of the things that we were doing was building stores in very geographically challenged places. It took me a little while to figure out it's a long way from San Francisco to Seattle, it's a long way from Atlanta to Naples. And when you've got that dynamic, it's not an ideal way to distribute fresh foods. And if you want to be really good at fresh foods, you want to try and be as local as you can and as short a distribution channel as you possibly can. So that was the premise behind the Colorado facility, which took all the -- which was being shipped from Arizona. That was the premise behind the Orlando facility, which took a lot of the [ fresh ] which was being shipped from Atlanta. We still have a problem in our Mid-Atlantic stores where we haven't quite got the critical mass to put the distribution center in today, but we will have. That's something that's right in the middle of our wheelhouse at the moment, which is where do we -- how do we cope with the challenge of Atlanta to places like Philadelphia and Baltimore. So we're going to fix that one over the next little while. So we've probably got a fair number of stores in that area that we have to get better in terms of distribution. We've also got capacity constraints coming our way in Southern California, where we've got a really big store opportunity. Customer base really knows us in Southern California and we've identified a lot of sites in LA, Orange County and the Inland Empire that we call it. So that whole area there, we can see an opportunity. So we will need a new facility in Southern California in the course of the next year or 2. So you'll see that evolving and developing with us. The principle we're operating to is we want stores within 250 miles of a distribution center. And at the moment we're not building it. We're not planning any stores that are outside of that thing, that dynamic, but beyond the Mid-Atlantic, we will have one. And the stores that we're looking out for, for the next 2 or 3 years, will be in that premise. So 250 miles is the premise. We've probably got -- we've got a lot less stores that are outside 250 miles today than we did then. And we're left with a handful that we'll have to think about and whether we need distribution facilities to accommodate them, or do we do something different going forward. So that's what we're in the middle of, but we're close.

Yes. We're close.

Good stuff. So key element of your new operating model is ramping up to 10% store growth, again, annually. This is a similar pace to what the company used to run a few years back before it pulled back due the execution headwinds and the distribution center supply chain issues that we just talked about. What gives you the confidence that the company is ready to achieve this rate once again, in addition to the distribution network? I mean, is it the simpler store models? Is it a more effective distribution network? Is there something else that really just gives you guys the confidence that it's the right time to accelerate?

Well, I think a couple things. One, the stores were getting bigger and more expensive to build. And at the same time, the marketplace had changed as conventionals had gotten into organic and upped their game in produce. So it was, kind of, the perfect storm back in '15, '16, '17, and our margins started to decline and our stores were getting bigger, which really wasn't what we should have been doing. So when we made the decision to go smaller, we made the decision to go smaller because we felt like we could do the same volumes in a smaller store. We had stores in Southern California that were 18,000, 19,000, 20,000 square feet that were pumping out a lot higher volumes than we were seeing in our 30,000 square foot boxes that we were building that were not just bigger, but just more complicated, more expensive. So we made that strategic shift and on paper, our assumption was we could do the same sales. That is materializing. In fact, that's what we're seeing. And they cost less to build, significantly less to operate. And so we feel good about it. I'm glad we didn't ramp up store growth at a 30,000 [ K ] box, but now with a smaller box, with better returns, we feel like -- and the white space is there for us. We did a lot of work on white space and where it was. We feel like we can go get it. Whether we can achieve it into -- we are challenged right now as trying to get those stores built. Not because we can't find great sites, we've got great sites. We've got -- anybody heard on the earnings call, we've got more than 80 in the pipeline. We've got 55 signed leases and we're trying to crank them out. It's really just supply chain challenges and permitting challenges that's slowing us down right now. We feel good about it. And quite honestly, we need to get the stores -- we need to create density with this brand to really have it hunt. And we're beginning to see that now in Florida, which is incredibly encouraging as we're starting to get density in some of those markets. We have density in Arizona and California. We don't in the Mid-Atlantic. It takes time for brand awareness. And if we don't be aggressive about getting new customers through brick and mortar, we won't get the density and so we need that. It's a chicken and egg.

Yes. I think a question that's come in just in terms of -- for people that are a bit newer to the story, maybe you could highlight some of the biggest differences between the old store model versus the new store model. We talked about the size difference, but other…

So first of all, the size difference, we're going from 32,000 square feet to 23,000 square feet. A lot of the space that we've taken out has been back-end space, not consumer-facing space. So we've redesigned the back-end. So the deli prep area, the meat prep area, the bakery prep area, which isn't directly in front of the customer, has been contracted, which has allowed us to keep the SKU count pretty much the same, which gives us some confidence that we can hold the sales. Big differences in the stores is we've gone from two doors to one door. So you've only got one door going in, which is -- that's a significant change from where the business has been. We've changed the positioning of meat, which is fairly controversial in the grocery space. We've put meat and plant-based upfront, which is center of plate. And that whole principle of how do you get the center of plate working, that -- so we've flipped -- meat used to be behind deli. We've flipped meat and deli. We've significantly changed the investment in deli equipment and decor and the whole way it feels and looks. And it looked really good in the 32,000 square feet, but it cost $140,000 to put a big thing above the deli. So we kind of cut back on a lot of things that we thought were actually not helping the consumer. And so that change in deli was fairly significant. We repositioned bakery from front of the store to back of store. We doubled down on frozen foods where we've created a lot more space for frozen. Frozen that not long ago was the kind of ugly stepchild of the grocery industry where people, kind of, thought, oh, it's all the bad stuff that goes in there. We've, kind of, turned that on its head. And I would say 90% of what we sell, you won't find in an Albertsons or a Kroger or somewhere like that. And we're seeing real success in the product innovation and development in frozen. And that's something we'd like to find a way of doubling down on our existing store base. It's expensive, but we're looking at finding ways of doing that. So very significant increase in frozen, significant increase in our -- a big change in the positioning of our meat business. Cut back a little bit on bulk, relative to that space. Frozen remains the important center piece of the store. And we spent a little bit of time trying to get the lighting right, which the great -- some of the great things I'm pleased about is the consumer reaction when they walk in. They say, "Well, this is just as big as it's always been." And part of that's lighting and how we've made that come alive. And so we've made quite a lot of changes and we're encouraged by both the feedback and the numbers that's coming from it.

In terms of iterations, have you guys had to make many tweaks, just given you rolled out the strategy right before the pandemic? You talked about some of the changes.

You mean in the new format?

In the new format, yes.

In the new format, yes. I think this is -- format is always an iterative thing. You're always, kind of, trying to work it right. I'm not -- we've done really good work on the assortment of wine, but I'm not happy where we've positioned it in the store. It looks a bit too much like a grocery store, to be honest. So I think we can improve on that a little bit. I think we can improve on our presentation of prepared meals in our store. So that's a thing that maybe we've not -- we've done a bit, but not as much as I would like us to do. So those would be the 2 big areas that we're still -- we're focusing in on. And maybe the positioning of our dairy business is a little bit cramped at the back end of the store. So there's always learnings you've got to do on that and we'll iterate as we go on this.

Great. In terms of, when you're just thinking about where to put a new Sprouts store, what are the key factors that you look at in different locations and how has it changed for your new store model versus your old store model?

Well, our target customer, we did a lot of work on target customers. So we start there, where do our target customers live? Of course, density of people is important. Who's in the trade area; what the competition looks like in the trade area; how we define competition. Those are all factors, kind of, typical. We model it out. We do, sort of a -- now -- we're using now, or transitioning to a third-party model, what we've used internal regression before. And so we're getting better at predicting the sales in the locations. But it's combination of, Jack said earlier today, some of the things that you wouldn't think would make sense, like being in the same center with a Trader Joe's actually works, it works really well. And some of the other co-tenants work really well that you wouldn't think. Being across the street from a conventional works really well. They get the volume and we're the secondary shop, they're going to come to us for either the great produce or the unique products that they can't get across the street. So high traffic is important.

So the target customers, the driver to -- it's the driver to real estate, it's the driver to merchandising, it's the driver to marketing. How are we talking to these people, what products are we're putting in front of them and where are we building the stores? And if there's not enough target customers. And we're improving our technology to understand that. As you narrow your focus, it's about being really clever about not being even too narrow. You could -- it's this balance that we've got to find going forward. But at the moment, if it's not within 250 miles, we don't build it, no matter how many customers are there. And then we got to try and find the right enough customers to do it. And then it's about what other specialties are around us. We work well in Florida. We're next to a Publix, I'd love to be next to a Publix in Florida. Love being a complementary retailer. So it's about then picking the right site within the context of the -- and as Chip said, we're developing, I think, a better -- even better way of understanding the technology to really narrow down on where the opportunity is for us.

And in terms of -- Chip touched on white space earlier. Historically Sprouts has been pretty aggressive with M&A, but that's really ramped down quite a bit in recent years. How do you think about balancing organic growth with M&A?

Well, we're committed to organic growth. You can tell we've got that process in place and whatever happens in M&A, we're committed to organic growth. We'll tell a look at opportunities when they come, but we'll be opportunistic in that context. I mean you're not like -- there might be something along the way in the future, but just at the moment, we're focusing on organic growth.

You think about our customer proposition and what we're doing. That's our strategy, is to present that customer proposition that we have today. The great -- the farmer's feel, the great produce at great prices, having unique, healthy products, that customer proposition, that's -- if there are opportunities to purchase companies that might be a complement to that or a bolt-on or fill in a geographic area that would help us do that that would make some sense. If it's a multi-banner and it's a totally different customer proposition, it becomes a lot more challenging for us to think about that one.

Okay. And in terms of, when you're thinking about your expansion plans, just in terms of geographically, regions that you would go into, are there any regions of the country that you guys would maybe avoid targeting? I know that, for instance, in the Midwest, you guys have a -- there's a competitor that offers -- operates a pretty similar model. Does that make you -- I mean, is it more attractive to create more density in the markets where you guys really excel at?

Well, in the short term, it makes more sense to drive density in the markets that we've got, but the work that we did at the outset, the strategy identified, I think it was 12 -- I can't remember the exact number, but 1,100, 1,200 sites around the nation. So we could probably open a store in Billings, Montana, but it probably wouldn't make a lot of sense just at the moment because it's too far away from anywhere. And there's -- but there's certain markets, you look at Chicago, you look at Boston, you look at where we're at, you look at -- there's definitely opportunities, but we're not going to go there until we've got distribution capacity to do that. So it wouldn't be -- somebody being there wouldn't put me off or somebody not being there wouldn't encourage me, kind of thing. I think we've got to be really clear about who our target customer is and chase after that.

And we feel like we can -- at least the white space work we've done, we can double our store base with the smile of the US, if you take the smile. So that's distribution attacking that smile. And as you said, there is somebody in the Midwest that's a player there. So let's do the smile and we'll figure that out later.

I've never heard you say the smile before. Is that what it is, the smile?

I smile all the time.

It's a good analogy.

I like it, I get it. I get it. I've just never heard him say it before.

I'm a smiley kind of guy.

Yes, of course you are. Sometimes, Chip.

I think a lot of people would like that distribution capacity in the Northeast, Boston, New York, get some more local…

That's the tip of the smile. Yes.

So in terms of e-commerce, another thing that we talked about briefly early on, really took off for Sprouts over the course of the pandemic, going from a low single-digit rate to now 10% of the company's sales. You've added delivery, you've added Click & Collect. How do you think about the next leg of growth in the channel and what changes -- we talked about some of the changes to the new store prototype earlier. Any specific to just the increased e-commerce volume that you...

I should have mentioned that when we were talking -- we specifically -- because we've got down to one door from two doors, the other bit where a door would've been is now the way that our e-commerce delivery people or our e-commerce Click & Collect -- pick-up people act, they scan it through and go out a separate door so they're not getting in the way, to be honest, with the operational side of our registers. So that's been a very specific change. We're going to let -- e-commerce is going to be what it's going to be for us. And we're going to provide -- we're going to let the customer take us there. We're not going to try and force something, one way or the other. We would -- we need people in our stores. And I think I'm expecting the dynamic to be come to store sometimes, and you come -- you get delivery other times. And that's, kind of, the way this is evolving. And if you've got a business that's very -- fresh foods is very important, you want frequency in the store. And when you've got innovative curation and you're trying to bring products in, you want people to experience it. E-comm's harder to make those kind of new products come alive. So our intent is not to make e-comm bigger or even force it smaller, where it'll be what it's going to be. And the context of our business on that, we work very closely with Instacart on that. The data, there's more and more we can use that data to help us going forward, it can help us in being in stock and put -- the delivery guys, what could they get, what can they not get, we're getting a lot of feedback on that. We can get a lot more information about customers from that information and linking that to credit card data and linking it to different ways of understanding our customers. So there's a lot we can do with e-comm that's not about e-comm, if you see what I mean, it's actually helps us run our business and helps us understand our customer. And I think we'll get better at that over the next couple of years going forward. So it's not a strategic intent for us to drive e-comm. We're going to be -- it's going to be what it's going to be. And my gut feel is it'll drift a little bit down from the 10% when things settle down, but not much, it'll, kind of, stay at that level going forward.

So one of the challenges I imagine with e-commerce is for Sprouts, it's so experience driven, just the treasure hunt aspect of that. How do you replicate -- can you fully replicate it there?

Well, you see it in our Click & Collect. So Click & Collect is 20% of the 10%. So it's 2%, it's different than the other -- because the consumer, if they are -- if they make the effort to get to the parking lot, they want to come in our stores. We want that because it's unique, it's differentiated. It's a different experience.

And it's a...

They want the treasure hunt. They want to walk around. They want to see the colors of the produce and the low profile. And so the customer's going to drive that, as Jack said, we're not going to force the customer against them coming to our stores. And when you think about our opportunities versus some of the others who are putting so much effort there, we still haven't had our brand across the country. Like, there's still ways to get our brand in markets where we aren't, through stores and density of stores. Not to sound old school, but it's a little bit old school-ish as it relates to our opportunity is the opportunity the Home Depot had in the beginning, or Lowe's had in the beginning, or you name it. We can name the laundry list that went from the Pacific to the Atlantic or vice versa. We still have that opportunity. One of the few retailers that do, I think.

That's great. Another one that's come in, in terms of the margin profile, and this is one that we get asked a lot, is that Sprouts has actually been able to bring up its gross margin. Some structural differences there. A lot of other grocers, some that are more commoditized. You have the pressure from potentially a shift back to food away from home as COVID winds down. There's been a lot of additional sales brought into the channel. What makes Sprouts different and how is Sprouts able to sustain its margin trajectory when a lot of other food retailers might run in some challenges here?

I'll maybe take how -- why we're different and Chip, you can build on the specific margin conversation. So what makes us different? We sell a lot of vitamins and supplements that nobody else sells. We sell a lot of bulk that nobody else sells. We sell a much bigger proportion of fresh produce than anyone else sells. And the reason our margins were coming under pressure to 2019 was very much about the level of high/low pricing. And as we've changed the profile of doing very deep cut product and price on a Wednesday ad, when we were sending 21 million paper ads out, we were, kind of, edging towards investing margin to drive -- not just edging towards, going fully fledged into driving customers from high/low promotions in the anticipation that they would buy a lot of other things. What was actually happening is those coupon clippers were fundamentally buying the deals and not buying anything else. And that was the strategy that we embarked on pre pandemic, which would've said, we can get our margins up by getting more loyal customers, but we're going to have a tough time for a little while as we lose those promiscuous shoppers. And that's what we said. Then on top of that, you got COVID which changed the dynamic of how many people shop. So the question now is why would -- why is our margin sustainable going forward and I'll let Chip build on it a little bit, but fundamentally, not going back to doing high/low promotions is something that doesn't make any sense for us to do, because we aren't going to win a price battle on promotions and we don't sell the things that other people sell. So how's that going to work for us? So my confidence in the margin profile is, we're going to build innovative products in our business. We can invest in our -- we've got a great price position in produce because of the mix that we've got. And that mix of other things that we sell that aren't directly comparable with the conventional grocers, as I said, vitamins, bulk, keto, paleo, specific innovative products in our grocery business, allows us to have confidence that our model is different and our business is different, too.

Yes. And to reinforce that, I think if you ask -- if the question is, how do you get back to the traffic levels that you had before, you can't do that without taking margin out. Or if you're trying to take share from the conventionals, can you do that without burning the margins down? Maybe not. But if the goal is you want to have some incremental traffic because you're becoming more aware, people understand your proposition. You're new to them. They like what they see. They like the innovative product. If the goal is to drive just a little bit of comp traffic every year, a little bit of AUR every year and via mix and maybe the extra item, if that's our goal, we can make a lot of money and grow both top line and bottom line a lot from this point going forward. We believe that. Our goal was to not compete with conventionals, it's not our goal. Because if we did, you're right, we couldn't do that without driving down the margin.

Great. I think we got time for 2 more questions. Product innovation. It's another area where Sprouts has really looked to differentiate. What traits do you look for when determining which items you would like to offer through your innovation centers? How frequently do you cycle out the items and how frequently do they make it into the stores' more normalized mix?

Well, these innovation centers are very important to us. We put them in all our new stores and we're rapidly going through the fleet to put those innovation centers in them. And what we put on those is attribute-driven products. And we have this definition of it. If it's ACV, which judges how much distribution a product has, if it's above 0, I'm not really excited about it. Maybe, okay, if it's in 1% or something like that, if it's an [ error one ], maybe we'll be okay with putting it in. But if it's in any conventional retailer, we wouldn't be wanting anything to do with it in our innovation center. So that's -- and we're going to invest in people. And this whole concept that Whole Foods were so good at years ago, which is this forager concept where people are, kind of, always looking for new things, attribute based, that link to the kind of things that health enthusiasts and innovative seekers, we want that to be a destination as customers get in their minds, I can get healthy, innovative products in that space. So on that fixture, you won't find those products anywhere else and we'll run it for -- and it'll rotate a little bit and it won't hold. But every 2 weeks it'll rotate, some products will die and go away. Other products will then go back into the main fixture. And that process will be a kind of iterative process as things work. And what it does is, it gives opportunity for those innovative suppliers to create the -- they can get a chance to see whether something's working or not. And the vision we've got is that customer -- innovative vendors and innovative suppliers that are coming up with new ideas -- and there's a lot of really amazing young entrepreneurs coming up with ideas. We want to be the destination for those guys so that they can test it and we can get it in real quick. If they show us it, we'll have it in in 2 weeks, because we don't have to redesign a planogram, we don't -- we can get it into our innovation center straight away. And then the customers increasingly -- and I find, watching them walking around us, they really are intrigued. Customers like seeing new things. And that's, kind of, the problem with going around grocery shops, you, kind of, walk around and it's all the same old, same old. If you can find something [ different ], that's why people like Trader Joe's. You walk in, you wonder what they're going to have. I want customers coming into our stores, going, "I don't know what those guys are going to have this week, but it's going to be good," on top of the kind of fresh stuff that we've got. So to me, that's a really important part of the proposition going forward and we're going to double down on it and invest in it more around those innovation centers.

Great. And then really quickly because we're up on time, but marketing strategy, that's something that you guys have been talking about a lot in your recent calls. What changes have you made on this front? Do you think you're close to developing that optimal marketing message at this point?

Well, the messaging around marketing's going to be based on 2 fundamental things. One, we've got great produce at great produce prices. Freshest produce at the lowest prices. Some of the issues we've bumped into in this research is that customers don't think we're as good on price on produce as we actually are. So that's a messaging. And the second messaging around the innovation, we have got things you won't find anywhere else. Those are going to be the 2 fundamental messages. We're increasingly using different media channels, increasing -- we'll double down a little bit on big media. We'll cut back on -- as you know, we're not doing the kind of circulars with high/low on it. We will do some circulars around, kind of, telling the story of who we are. We'll do some multimedia work. Digital's been working well for us, but this is an iterative process. We learned a lot last year from this, as we tried to stimulate calls to action. I was pleased with the marketing message. I was pleased with how people were receiving it, but it wasn't creating the call to action that we want. We made a little bit of progress on that with bounce-backs and different ways of using digital communication. We'll double down on that behind those 2 messages going forward.

Awesome. Let's wrap here. Jack, Chip, thank you guys so much for joining us today.

Thanks so much. Appreciate you.

Thank you.