Albertsons Companies, Inc. (ACI) Q4 2021 Earnings Call Transcript

Ladies and gentlemen, welcome to the Albertsons Companies Fourth Quarter 2020 Conference Call. Thank you for your patience. This call is being recorded. If you have any objections, please disconnect now. I will now hand the call over to Melissa Plaisance, GVP of Treasury and Investor Relations. Thank you. You may begin.

Good morning, and thank you for joining us for the Albertsons Companies Fourth Quarter 2020 Earnings Conference Call. With me today from the company are Vivek Sankaran, our President and CEO; and Bob Dimond, our CFO. Today, Vivek will share insight into our fourth quarter and fiscal 2020 year-end results as well as review our progress against our strategic priorities. Bob will then provide the financial details of our fourth quarter and full year 2020 as well as our full year 2021 outlook before handing it back over to Vivek for some closing remarks. After management's comments, we will conduct a question-and-answer session. I'd like to remind you that management may make statements during this call that include forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are not limited to historical facts but contain information about future operating or financial performance. Forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. These risks and uncertainties include those related to the COVID-19 pandemic. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are and will be contained from time to time in our SEC filings, including Form 10-Q, 10-K and 8-K. Any forward-looking statements we make today are only as of today's date, and we undertake no obligation to update or revise any such statements as a result of new information, future events or otherwise. Please keep in mind that included in the financial statements and management's prepared remarks are certain non-GAAP measures. And historical financial information includes a reconciliation of net income to adjusted net income and adjusted EBITDA. And with that, I will hand the call over to Vivek.

Thank you, Melissa. Good morning, everyone, and thank you so much for joining us today. I want to start today by thanking our associates for their unwavering commitment to take care of our customers, our communities and each other during every twist and turn of the pandemic over the last year. 2020 was a difficult year for all of us, and our hearts go out to all those directly impacted by the virus. 2020 was also a transformational year for Albertsons Companies. We deepened our relationships with customers and added many new ones through our execution in stores and through online channels. We accelerated digital transformation across our company. Almost every critical capability in our company is now enhanced with or enabled by technology. We delivered our planned productivity target, and we added to it. We further strengthened our culture, learning how to sustain the flexibility and speed that comes with being locally great, while at the same time leveraging the scale benefit that comes to being nationally strong. As I've mentioned throughout the year, our strategy is focused on building deep relationships with our customers. We support this strategy with our differentiated product offerings, anchored in fresh and Own Brands, our breadth of assortment so they can complete their shop with us, everyday execution excellence in every store and the suite of omnichannel capabilities that allow customers to conduct their shopping with us in any way they want. Our enhanced loyalty program is also resonating with customers as we provide them with personalized offerings and drive repeat shopping occasions. As a result of our team's execution, we delivered strong performance in the fourth quarter and record results for the year. Our full year results exceeded our outlook across all key metrics, with ID sales up 16.9%, adjusted EBITDA up over 60% to $4.5 billion and adjusted EPS growing 212% to $3.24. In Q4, ID sales were 11.8%, with continued market share gains in both dollars and units. Importantly, growth in Q4 remained strong across our geographies regardless of the level of COVID restrictions in place, giving us confidence in the sustainability of our competitiveness in the future. Our digital initiatives were a key catalyst for growth. In Q4, digital sales growth accelerated to 282%, with growth of 258% for the full year. Membership in our just for U loyalty program continued to accelerate sequentially and has been up over 20% year-over-year each quarter and is now at 25.4 million members with a 93.1% retention rate. These members have been a key driver of share gains as they spend 2.6 times more than non-registered customers. We've also increased the number of actively engaged customers almost 10%, who spend nearly 5 times more than a non-active customer. We know our retention rate is 34% greater when a household is actively engaged in our loyalty program. We closed 2020 with almost 11 million more identified households shopping our stores than in 2019, allowing us to understand which categories they are purchasing with us for the first time, how often they're coming back to repurchase, how they're progressing up the loyalty ladder and their incremental spend levels as they migrate from in-store to omnichannel engagement with us. We ended fiscal 2020 with 3 times the number of omnichannel households compared to fiscal year-end 2019. These households spend more with us and are more profitable. We also saw that as customers moved into omnichannel, they increased their spend in our stores with a net growth of 20% per household and a total spend rate double that of an exclusively in-store shopper. We saw even our most loyal households early last year purchased 2 times the number of categories in our stores than the prior year, for example, in paper goods. And we're able to quickly reward these new category buyers with personalized deals to retain that category spend in our stores. At the start of the fiscal 2020, I shared with you 4 strategic priorities that we are focused on: in-store excellence, accelerating our digital and omnichannel capabilities, driving productivity and strengthening our talent and culture. Regarding in-store excellence, our ability to create a one-stop shopping experience for our customers has remained a key differentiator for us, supported by the quality, variety and depth of our fresh and Own Brands offerings that give us a competitive advantage. In fresh, we continued to see ID sales outpace center store by 300 basis points. Standouts during the quarter were seafood, meat, and floral, as customers continued to spend more time at home. This trend continues as we see customers supplementing their weekly stock-up shop, filling in with fresh items in smaller trips during the week. Our Own Brands portfolio also continues to gain traction driven by the introduction of new innovative products as well as our focus on Albertsons legacy divisions that were historically underpenetrated. Much of the disruption of the supply chain at the start of the year has abated, and penetration continued to improve in Q4 and is now exceeding 25%. We continue to expect Own Brands penetration to reach 30% in the next few years. With gross margins approximately 1,000 basis points higher than national brands, this should increase our flexibility to grow the business going forward. We are continuing to innovate and expand our portfolio of brands, moving quickly to meet evolving consumer preferences. As a result, we launched over 1,200 items in fiscal 2020, well above our stated goal of 800-plus new items for the full year. We're also working on some exciting changes to our meals program that will give us significant growth opportunities. We're expanding the rollout of our ready meals program in our United division to other divisions, where we make ready-to-eat, ready-to-heat and ready-to-cook meals in our stores. Finally, we continue to invest in our stores. We opened 9 new stores and completed 409 upgrades and remodel projects during fiscal 2020. Moving on to our second priority, the acceleration of our digital and omnichannel capabilities. Digital continues to be a key growth driver for us as we achieved over 200% digital sales growth in each quarter this year, demonstrating the strength of our digital offerings to capture consumer demand for more convenient shopping experiences. Drive Up & Go grew over 1,000% in Q4 and 865% during fiscal year 2020. We launched 343 new DUG locations in Q4, and DUG is now available in 1,420 stores. This puts us ahead of schedule, and we now expect to have DUG in approximately 2,000 stores with 98% coverage by the end of fiscal year ‘21, above our prior target of over 1,800 stores. We're also extremely pleased about the profit curve in our digital business, particularly in Drive Up & Go. We are seeing our incremental DUG sales driving flow-through in the mid to high single digits. And we expect that to continue improving as our DUG business continues to scale. In 2020, we saw significant acceleration in consumer preferences towards digital, and we drove a step change in our digital offerings to meet this demand. During the year, we invested over $300 million to accelerate our offerings and launch new capabilities. To enhance the customer experience, we've improved our on-time fulfillment and delivery to 95%, enabling consistent on-time delivery and DUG pickups. We leveraged our loyalty program to provide exclusive events like virtual cook-alongs with celebrity chefs. We began a trial of an automated electric delivery robot powered by Tortoise and continued to pilot a number of walk-up and go options, including walk-up counters, pickup lockers, and stand-alone kiosks. And we're testing in-market an integrated loyalty and e-commerce app, offering an effortless ordering experience to a single interface. And to improve the profitability of the business, we shifted delivery at many of our locations to third-party logistics providers to improve speed and lower costs. We improved our picking software, optimizing and standardizing the picking process to drive cost reduction through increased picks per hour and improved auto prioritization. From our 2 MFC installations, as in-stock commissions have improved, we have learned that the labor cost per order can be dramatically reduced without compromising the breadth of assortment and the customization a customer can get from our store. We're opening our third MFC this week and have plans for an additional 6 before the end of our fiscal year, bringing our total to 9 MFCs. Our third strategic priority is driving productivity to support reinvestment in the business and help offset inflation. We achieved approximately $500 million in gross productivity savings in fiscal 2020 as a result of our actions with large contributions from indirect spend, labor productivity, and shrink reduction. Given our progress to date and the incremental opportunities we see ahead, we now expect to exceed our goal of $1 billion in gross savings by the end of fiscal year '22 and have increased our cumulative target to $1.5 billion. The additional $500 million in savings is principally driven by new projects related to the transformation of our supply chain and additional cost-reduction programs and further optimization of our promotional spend. Our fourth priority is strengthening our talent and culture and supporting the communities we serve. We are committed to adding talent in key areas and recently announced that we have hired a new Chief Data Officer to lead efforts in translating data into an enhanced customer experience. In addition, I would like to call out the contributions of our pharmacy teams to our communities. Partnering with the Department of Health and Human Services and local authorities, they have administered 3.1 million COVID vaccine doses as of Friday last week. We are very proud of how nimble our pharmacy teams have been to support this effort, delivering the service in our stores and in several offsite locations, enabling easy scheduling through our app, executing with high throughput, and emphasizing equitable distribution and dispensing of vaccines. We are now providing access to vaccines to 100% of our locations. In total, we have hired 1,000 new associates and trained 2,000 pharmacy technicians to support this effort and invested in technology solutions, including handheld devices to make it easier for our associates to facilitate these transactions outside our stores. During fiscal 2020, we also supported our communities with food and charitable donations totaling $260 million. For example, through our Albertsons Foundation, Nourishing Neighbors program, we provided $95 million in support to the communities in which we operate and reached 13 million individuals and over 3,000 organizations. We assisted our neighbors in Texas following the unprecedented winter storm there, matching the first $250,000 raised in our stores. These actions are all part of our ongoing focus on ESG. We recently completed a new materiality assessment, which will be the foundation for our ESG strategy and initiatives going forward as our efforts here continue to evolve. We've already identified high priority areas, and you can expect to hear more from us on topics such as diversity, equity and inclusion, energy and emissions, product and consumer packaging, food waste, and community stewardship. And last week, we announced our commitment to setting a science-based target to reduce carbon emissions. And now I would like to ask Bob to cover the details of our fourth quarter financial results.

Thanks, Vivek, and hello, everyone. I'm pleased to provide details on our strong fourth quarter and record fiscal 2020 results. For the quarter, total sales were $15.8 billion, driven by our 11.8% increase in identical sales. Our gross profit margin increased to 28.9% during the fourth quarter of 2020 compared to 28.6% in Q4 2019. Excluding the impact of fuel, our gross profit margin increased 10 basis points primarily driven by improvements in shrink expense and sales leverage, partially offset by investments related to our growth in digital and strategic investments in price. We continued to see significant sales leverage on expenses in the fourth quarter. Excluding fuel and one-time pension charges, our selling and administrative expenses decreased 80 basis points compared to the fourth quarter last year. Incremental COVID costs during Q4 totaled approximately $110 million. Interest expense declined $28 million to $113 million during the fourth quarter of 2020 compared to $141 million during the same quarter last year, primarily driven by lower average interest rates as a result of our refinancing transactions and lower outstanding borrowings. Adjusted EBITDA was $917 million compared to $756 million or $702 million excluding the extra week during the fourth quarter of fiscal 2019. The 30% growth in adjusted EBITDA represents a strong flow-through of approximately 15%. Adjusted net income was $347 million, or $0.60 per fully diluted share, compared to $194 million, or $0.33 per diluted share during the fourth quarter last year. Turning to the full year, we delivered strong results that were above the outlook we provided last quarter. Identical sales finished the year at 16.9%, above our expectation of approximately 16.5%. Adjusted EBITDA finished the year at $4.5 billion, driven by strong sales leverage, both in gross margin and in selling and administrative expenses that translated to strong flow-through. Adjusted EPS finished the year at $3.24, which was $0.09 per share above the top end of the range of our outlook we provided during the third quarter call. Our strong results have generated very robust operating free cash flow of $2.3 billion in fiscal 2020. Our capital allocation priorities remain unchanged and include reinvestment to drive profitable growth, continued deleveraging, and returns to shareholders through our $0.40 per share annual dividend and opportunistic share repurchases. Capital expenditures were approximately $1.63 billion during the year, and we completed 409 remodels. We also accelerated technology-related investments, including those in digital. As we've outlined, these high-return projects included both in-store and productivity initiatives in manufacturing and supply chain and in merchandising to expand our meals program, as well as in digital, including incremental DUG rollouts and various technology initiatives intended to drive efficiencies and future productivity. But at the same time, we generated asset sale proceeds of approximately $161 million as we continue to actively manage and selectively monetize our real estate portfolio. We made significant progress in delevering the balance sheet and reduced our debt during the year by $400 million and refinanced debt at very attractive rates. These actions will save the company approximately $77 million in interest expense on an annualized basis. Given these actions and the strength of our cash flows, our net debt-to-adjusted EBITDA ratio is now 1.5 times on an LTM basis. Finally, we completed stock repurchases of $119 million under the company's $300 million authorization in fiscal year 2020. Turning to the outlook we provided this morning on fiscal year 2021. I'd like to provide some details and color. As you know, because of the way 2020 played out with some of the pantry loading we saw early in fiscal 2020, we think it's appropriate to provide guidance through a 2-year lens against 2019 to show the step-change improvement in our business. We expect identical sales on a 2-year stacked basis to be in the range of approximately 9.5% to 11%. We expect adjusted EPS in the range of $1.95 to $2.05 per share, which represents over 37% compound annual growth compared to 2019. We expect adjusted EBITDA in the range of $3.5 billion to $3.6 billion, representing compound annual growth of 13% at the midpoint of our range compared to 2019. We also expect to spend $1.9 billion to $2 billion in capital expenditures, which includes incremental capital for high-ROI projects that include in-store remodels that will have near-term paybacks as well as our continued acceleration of digital and technology investments. The implied growth in sales and related flow-through to EBITDA on a 2-year basis on this guidance continues to be industry-leading even as we continue to make investments designed to drive long-term sustainable growth. As you think about the year, we want to point out a couple of items that will impact the cadence of the annual guidance within fiscal 2021. As you know, fuel margins spiked significantly during the onset of COVID-19, and as such, we expect fuel to be a headwind during the first quarter of approximately $50 million. In addition, the incremental productivity savings that Vivek mentioned will be ramping up and more heavily weighted to the second half of fiscal '21, enhancing our confidence in achieving our EBITDA and EPS goals. Before I turn it back to Vivek, I want to spend a brief moment to discuss the impact of the American Rescue Plan Act on our multi-employer pension plans, in which $86 billion were earmarked for underfunded multi-employer pension plans. The net effect of this legislation safeguards and protects benefits of the retirees in these plans for at least the next 30 years. In terms of the impact on Albertsons Companies, the multi-employer plans that are classified as critical or critical and declining are likely to be eligible for some level of relief under the special financial assistance through ARPA. While the amount of financial assistance received will vary by plan, we currently estimate that these plans represent over 90% of our estimated share of the $4.7 billion total underfunding of all the multi-employer plans to which we contribute. Pending details on how the program will work, we expect the financial assistance program will provide the necessary funding for the multi-employer plans to which we contribute to remain solvent through at least 2051. It also ensures the help of the PBGC, which is the guarantor of participant benefits for these multi-employer plans. We do not anticipate that our cash contributions to these plans will change in the near term as we continue to fund what we always have based upon collective bargaining agreements. And as we have consistently indicated, the legislation confirms that the underfunded liability related to these plans is not an obligation of the company.

Thank you, Bob. Before we turn to Q&A, I want to share a few closing remarks. Fiscal 2020 was a transformational year for Albertsons Companies, and we believe the changes we have made to our business have enhanced our ability to retain our customers, continue to drive share growth and grow from a higher baseline relative to our pre-pandemic trajectory. We have learned a lot from the pandemic, both in terms of customer behavior and how to operate the business more efficiently. We are emerging from this crisis more digitally focused, both in-store and online, and elevating the service our customers expect, while at the same time, being more productive and doing so delivering more profitable growth. We further strengthened our financial position. We've generated strong free cash flow, allowing us to accelerate investments in initiatives that will support future growth, reduce debt, pay our dividend, and repurchase shares. And through debt reduction and refinancings, we have truly transformed the balance sheet, and we are approaching the future from a much stronger position. And we are continuing to develop and execute our ESG agenda, enhancing the sustainability of our operations, supporting the communities in which we operate, and investing in people with an unwavering commitment to diversity and inclusion across the organization. As I reflect on some recent topics of interest in our industry, I would like to share some insights on the first 7 weeks of fiscal year '21. I realize this is unusual, but we live in unusual times, and you will ask us these questions anyway. So here goes. Our sales momentum continues with growth in market share in food and on a 2-year basis in MULO. When looking at our average weekly sales dollars, sales are trending at approximately the same levels that we exited the fourth quarter on a seasonally adjusted basis, taking into account holidays in spite of significant business reopenings across the country. We are seeing continued strength in sales of items that have been elevated throughout the pandemic such as meat, seafood, produce, eggs, breakfast cereal, and high-end wines that provide evidence that some important food and beverage categories that shifted from food away from home are still being consumed at home. But we've also seen, as we expected, some categories falling below pandemic levels such as soup, pasta, and pasta sauce. While food-at-home inflation is still at recent high levels and could be sustained at these levels for some time, we have planned our business assuming inflation of 1% to 2% this fiscal year. And we expect a rational competitive environment to prevail driven by relatively tight supply, sophistication and promotion management, and more digital promotions. With all this as a backdrop, we are confident in our ability to continue to produce strong results. I want to reiterate my thanks to our entire team of approximately 300,000 associates. I'm so proud of what they have done to serve our customers and communities over the last 13 months. And we'll now take your questions.

Our first question today is from Edward Kelly at Wells Fargo.

Vivek, I just wanted to first just clarify one thing that you said about quarter-to-date trends. I think you said in line with the exit of Q4. So I guess at the end of the day, are you talking about quarter-to-date trends that are above the high end, that 11% number that you talked about for the 2-year stack expectation for 2021?

No, Ed. The way to think of it is that we've tried to model the business based on weekly dollar sales. We assumed that these weekly dollar sales would remain similar to how we closed out last year, with seasonal adjustments. That's what we're observing. Bob, do you have anything to add to that?

Yes. From a stack standpoint, there will be some differences by quarter. But we think the right way to try to make sure that we forecast the quarter is as Vivek suggested, which is taking a look at the absolute sales dollars and trend those forward. And that's what we've done to begin the year, and we're tracking along that very closely.

Okay. What are your thoughts on the timing of the IDs throughout the year? If we are looking at a 9.5% to 11% growth rate, I would expect some slowdown in the latter half. How do you see the timing of that playing out? Additionally, I have a follow-up regarding geographical differences, as you mentioned they have been relatively consistent. However, there appear to be variations, particularly in states with fewer restrictions.

Yes, Ed. As we've considered the business, we find that the further we look ahead, the more challenging it becomes to predict our revenue. This is why we've emphasized the importance of having strong productivity programs in place for the latter half of the year. If sales exceed our expectations, we anticipate a robust second half across various aspects. We've ensured we have a productivity buffer in place for that period. Regarding your second question about geographic differences, we didn't observe them in Q4. However, as we enter Q1, we are noticing significant variations in comparisons across regions. We are currently navigating a noisy environment regarding last year's performance versus this year's. Therefore, I won't assume that we won't see differences in reopenings this quarter. My earlier remarks were specifically about the previous quarter.

Okay. And then just last one for you. The incremental $500 million in cost savings, can you just provide a bit more color around where they came from? And then I assume some of this maybe gets reinvested in the business. How do we think about sort of like what's reinvested, what's not and the priorities there?

Yes. Let's begin with that philosophy. When we generate productivity, part of it is reinvested in the business to strengthen our capabilities, while some is saved for unexpected situations, which contributes to our bottom line. That's our approach. Now, regarding the $500 million, I would put it this way. One of our company's strengths is our local agility. We've gained valuable insights during this pandemic that highlight our ability to respond quickly. However, we've also recognized the importance of preserving this advantage. We have 13 divisions and supply chains, and adjustments in these areas will provide significant leverage in our operations. This will simplify processes for our supplier partners and enhance our procurement discussions. These are two substantial new initiatives we've launched that will continue over the next two years.

Our next question is coming from Ken Goldman from JPMorgan.

I wanted to follow up on Ed's question but not from this quarter, from last quarter when Ed asked, I think, about the gross margin. And Bob, I think at the time, you said it should be relatively flat. You weren't quantifying it necessarily, but I just wanted to see if there was any update there. Anything you could tell us about your gross margin ex fuel for 2021 with the benefit of a little more time.

Yes. First of all, I want to echo Vivek's earlier comments. Thanks to some of our productivity initiatives, we are seeing positive effects on our gross margin. Given this advantage, we are confident that our gross margin for fiscal 2021 will be similar to what we achieved in full year 2020. The quarterly performance may not follow the same pattern as before due to some fluctuations in the first two quarters, so it's important to account for seasonal variations typical of the year. Overall, we are optimistic about maintaining our gross margins at the full year level, which represents a significant improvement over our performance in 2019.

Yes, Ken, I want to share four significant initiatives. Firstly, we anticipate a strong recovery in Own Brands penetration, expecting a thousand basis points improvement on each item. Secondly, we are optimistic about our shrink initiatives, which have reinforced our confidence in their effectiveness. Additionally, we've introduced two major areas of focus: our supply chain and the overall cost of goods, which involves altering our purchasing strategies for mostly national items. These represent substantial sources of gross margin tailwinds. There are also some mix issues to consider. Overall, we see a lot of upside potential from these four initiatives.

Okay. That's helpful. Vivek, I wanted to follow up on the categories you mentioned that have continued to perform well since reopening, such as meat, seafood, cereal, and wine. You also pointed out some categories like soup and pasta, which seem to be lagging behind. Could you explain the differences among these center store categories, like cereal, pasta, and soup? What do you think accounts for the success of some compared to others that are not performing as well? Is it simply that people stocked up on items like soup and pasta previously, and now they're just reflecting that change?

That's it, Ken. You got it. So what you're seeing is that nobody is short on paper now. I think we're seeing things that have been loaded in the pantry. You've got that, and it's always there. But you're working more from home, eating more breakfast at home, and having more lunches at home, which is driving that fresh consumption. It's remarkable. We're continuing to see steady fresh consumption and the same frequency of purchases on fresh. People are feeling comfortable that they have enough in the pantry for some other products.

Our next question today is coming from Robby Ohmes from Bank of America Merrill Lynch.

Vivek, could you elaborate on the 1% to 2% food-at-home inflation assumptions you are considering for this year? Also, many CPG companies are discussing implementing significant price increases this year. How does that factor into your perspective? Additionally, you mentioned in the press release the strategic price investments made this quarter. What is your outlook on price investments this year? We've observed a resurgence of competitive promotions within the industry, as indicated by Nielsen data. Can you share your thoughts on the potential scenarios for how food inflation might unfold this year?

Yes, Robby, let me provide some context, and then I'll let Bob add his insights as well. The 1% to 2% is a planning assumption, which we prefer because we understand that with a 3% to 4% inflation rate, our business benefits more, resulting in a better outcome for our financials. We plan for the 1% to 2% range and then adjust from there. We are currently observing a 3% to 4% rate of inflation, as you've likely noticed. Although we are unsure about where inflation will ultimately settle, there are a few important factors to consider. First, demand continues to exceed supply in many categories. Second, while it's important not to generalize too much, overall, consumers appear to be in good shape financially and have disposable income. This suggests that if inflation is driven by strong demand, consumers will continue to purchase in these categories. However, if inflation exceeds 3% to 4%, we will need to engage in difficult discussions about how much we can absorb, as we will not be able to pass all costs onto consumers. Additionally, we may face tough conversations throughout the supply chain if inflation rises beyond the 3% to 4% threshold. Lastly, it's worth noting that while we hear a lot about inflation from consumer packaged goods companies, when it is planned and we have an understanding of how it may develop, it becomes more manageable. Our concern lies with unexpected spikes, but we are not currently seeing any of those emerging. That's the approach we've taken regarding inflation. Bob, do you have anything else to add?

I think you've covered it well. The 1% to 2% really is just our baseline planning process, and any upside from that typically will flow through either to the bottom line or we may choose to utilize that to drive the top line. But I think you've covered it well.

In terms of pricing, our investments continue to be strategic. We are consistently making changes each quarter across various markets. Regarding promotions, we aren't observing any significant increase in the market. We believe this is a reasonable approach as we are all moving more towards digital. Therefore, we don't anticipate a major change in the Wednesday flyer, such as an increase from 4 pages to 10 pages.

That's really helpful. And just a quick follow-up on DUG profitability. It sounds like you're feeling better about it going forward. Is that more about efficiencies you've figured out on executing that, that's made it a lot more profitable at the store level? Or are you seeing something on the MFCs working that makes you feel like you maybe figured something out there?

What happens with DUG is that as orders per store increase, labor costs decrease rapidly due to an exponential curve. When you reach a specific level of orders per store, labor costs improve, and we are beginning to see that in many of our stores. Additionally, we have launched new picking algorithms, and with increased scale, our picking efficiency improves, leading to lower costs. We have also implemented new picking software. Furthermore, as stock availability improves and we’re not sourcing from the MFC for store picks, we're witnessing greater efficiencies in the MFC itself. We are accumulating these factors and are optimistic that DUG can become a profitable part of our eCommerce offerings.

Our next question today is coming from Michael Kessler from Morgan Stanley.

This is actually Michael Kessler on for Simeon. First question, actually, on your guys kind of promotional strategies, and you've talked a lot about being more targeted and surgical with high level. And I would just love to get an update on the progress you guys have made. Are there any examples you can point to? And maybe I don't know if you have kind of an inning or kind of a roadmap for how that plays out? And also how does that kind of interplay with the price investments that you guys have spoke to and how that's trending?

We are working on two key initiatives. First, we have unified our promotions on a single platform that all our merchants can use. This technology integration allows our pricing team to analyze all promotions collectively, helping them understand market trends while still being responsive locally. This setup has proven to be very advantageous. Secondly, we now have 25.4 million users engaged with our platform, having added 1.1 million just last quarter. These users receive personalized promotions, which we can manage and deliver digitally. The success of these promotions is supported by our underlying technology. We've been utilizing this for a while and continue to refine our approach. As for our progress on the first initiative, if we liken it to a baseball game, we're probably in the third inning, with much more improvement and optimization ahead of us.

That's very helpful. I have a follow-up on Robby's question about Drive Up and its profitability. Bob, you mentioned a mid to high single digits flow-through. Is that figure based on EBIT? I would also appreciate insights into the assumptions you used regarding incrementality and how that plays into the number. Additionally, does that suggest that the incremental cost of delivery compared to Drive Up is maybe flat or even resulting in losses? How are you planning to improve that situation? Or is it simply a reality of the current business that you're willing to accept for the sake of sales?

Yes. Let me give you some context, and then I’ll have Bob discuss the flow-through and the EBIT aspect in more detail. You are correct that the delivery business is not profitable, whereas the DUG business is, mainly due to the difficulty in recovering delivery costs. We have shifted a lot of this to utilizing third-party services, and we are working to improve that aspect of the business. However, achieving profitability in that area will be more challenging over time. On another note, we are excited about the incremental revenue we are observing because we understand our customers. For instance, a customer who typically spends $100 with us is now spending $125, with the additional $25 coming from eCommerce. We are able to track this incremental growth. However, we recognize that a successful business cannot rely solely on incremental growth; it must also become profitable on a unit basis. Fortunately, we have some time, as there are other elements in our P&L driving productivity that enable us to make these investments. This is our current approach, and I have discussed some of our improvement initiatives in eCommerce. Bob, could you explain the flow-through statement?

Yes, definitely. When we examine DUG, it was our fastest-growing segment of eCommerce last year. As a result, we are experiencing significant scale benefits that are becoming evident in our recent quarters. We anticipate mid- to high single-digit EBITDA growth in this segment, which is essentially equivalent to EBIT since there is little amortization involved. We look forward to further scaling this business while also considering future savings from MFCs, which should help improve that mid- to high single-digit rate.

Yes. I want to emphasize that we have made speed a priority in our delivery process. We understand that time is valuable, and customers will increasingly expect quicker delivery times. We are fully committed to this approach, and it aligns with our strategy for stores and micro-fulfillment centers. We intend to maintain this focus for the foreseeable future.

Next question today is coming from Karen Short from Barclays.

I just wanted to go back to this weekly sales commentary as it relates to 1Q. So if I take what the weekly sales look like they were doing in 4Q, I'm not doing average weekly sales per store, but just weekly sales. And I bring that forward to 1Q, I'm backing into kind of a negative comp in 1Q. And can you maybe just let me know if that's kind of directionally accurate? Because I think the way you described it was just a little nuanced.

Yes.

Go ahead, Bob.

I’ll begin and Vivek can add any details I might miss. First, we took the average weekly sales run rate from the fourth quarter, but we needed to adjust it seasonally for the first quarter. As you know, we experience stronger holidays in the fourth quarter, so we needed to normalize that. That’s the primary adjustment I’d highlight based on what I think you mentioned.

Yes. And I'd rather not comment on comps at this time, Karen, but we wanted to give you some sense for the momentum in the business by giving you that additional information for this Q1.

Yes. And the other thing that we feel really positive about is it's not only the continued momentum there, but we're also seeing the continuous momentum of market share gain.

Yes.

I wanted to clarify something. Based on my calculations, the total COVID costs included in the 2020 EBITDA figure was $875 million. Can you confirm that? I'm trying to understand how that relates to your midpoint guidance of $3.55 billion for 2021 compared to the $4.524 billion reported. I assume that the $875 million will not be an expense in 2021, meaning the net effect should be flat, correct?

Yes. I think you're directionally correct there. Remember that the first quarter had the biggest chunk of it, right? And we had announced that we had roughly $600 million in the first quarter. I think we added back a small portion of that, but that was directionally the number there. And then we had an additional just over $100 million per quarter after that.

Okay. And then sorry, 2 housekeeping questions. I don't know if you did give us fuel in terms of the impact in 1Q. Is there any way you could give us fuel for the year in terms of what you thought was outsized in dollars? And then the second question I had is just on this hero pay initiative in California broadly, how have you factored that into your guidance?

Yes. I'll first take the fuel piece. Our intention was not to provide quarterly guidance for fuel or any other lines other than we wanted to call out that fuel was going to be a headwind in the first quarter. I would say, for the year, it's directionally that amount of headwind for the full year. So the impact is really a first quarter primary event. There's certainly smaller impacts by quarter, but I prefer not to try to list what those are that kind of net out.

Yes. The hazard pay we're observing in certain regions of the country is expected to decrease as more people get vaccinated. While I wouldn't say it's insignificant, it is factored into our planning, and we intend to absorb it.

Next question is coming from Beth Reed from RBC Capital Markets.

I just had a couple of quick ones. On your ID sales guide, what are the embedded expectations for share gains in that? And then just wondering if you could comment on any potential impact from stimulus on quarter-to-date trends?

Yes. As far as your first question on market share gains, I mean, we would hope that we'll continue to see the trend that we're seeing now. That's kind of a hard one to predict as we move forward, though.

Yes. We had an outstanding year in 2020, which makes it challenging to assess share gains over just one year. It’s likely that on a one-year basis, the share could appear negative. However, when we examine a two-year period, there are significant share gains, and we’re seeing that trend continue into the early part of this quarter. Regarding the stimulus, when we analyze different shopper segments, particularly based on income, we have not noticed a significant change in consumption patterns among lower-income households that relates to the stimulus. We were performing well with them before the stimulus, and we are still doing well now. Therefore, I haven't observed a considerable impact from the stimulus on our performance.

Okay. That's helpful. And then just going back to the gross margin for a second. Can you talk a bit about some of the mix improvements that you've been seeing there and how you see those playing out over the course of the year?

Yes, improving our mix is a deliberate strategy for us. Historically, Albertsons Companies have focused on selling items like cut watermelon or cut asparagus rather than whole products. We are constantly seeking new ways to enhance these initiatives. The meal programs we are implementing are also designed to boost our gross margins. Additionally, our Own Brands contribute positively to our gross margins. Our strong performance in fresh products continues to enhance our gross margins, along with various productivity efforts we've discussed. Overall, we believe we have significant momentum in terms of gross margin.

Our next question is coming from Scott Mushkin from R5 Capital.

I wanted to talk a little bit about the store environment as you grow pickup and delivery. How do you keep the store environment good for people to actually want to come into the store? And then you're probably rotating labor from customer-facing activities to picking activities. And I wanted to see how you guys are attacking that issue as well.

Scott, we are not sacrificing service in one part of the store to support another part. For the front-end, we use a different system to allocate labor based on historical and predicted demand, and we enforce that standard. We're increasing labor in the store for eCommerce, and this addition happens in block increments rather than fractions. As orders increase, we see an improvement in profitability. Additionally, we have a strong focus on fresh products. To excel in fresh, we need constant attention throughout the day, not just stocking in the morning and revisiting later. This labor model allows us to maintain freshness while customers are shopping. You'll notice staff working throughout the day to keep the store well-stocked, and so far, we haven't faced issues with stores being depleted or overcrowded for eCommerce.

Okay. And as a follow-up to this question, The Wall Street Journal had an article talking about the competition for labor. And given that you guys are growing these businesses where you're going to be adding labor, how should we look at kind of labor costs as the year progresses? Is it something you guys worry about? And what are you doing to control that line item?

Yes, a significant portion of our workforce is unionized, and we have contracts with our unions that are renewed periodically, usually for a duration of 3 to 5 years. This makes many of our wage expenses relatively predictable. Our main focus is on managing hours; we may increase hours in some areas while enhancing productivity elsewhere to offset those hours. We also have various initiatives, like our ordering program FaR and production scheduling programs, along with ongoing automation efforts, that help improve productivity in terms of labor hours. This is how we handle our labor cost management.

Our next question is coming from John Heinbockel from Guggenheim.

I know you guys added 4.5 million roughly loyalty customers this year. And I know omnichannel is up 3 times. How many actual omnichannel households did you add relative to that? I'm curious how many are coming as omnichannel? And then how big is the omnichannel customer base today as part of that 25.4 million?

Yes, John, let me put it this way. Our mix of eCommerce has improved dramatically, but we're still behind some others. That's why we will continue to invest in this business because we know it's resonating. We haven't shared those numbers you're asking about, but we are excited about the growth rate. We know who the key players are, and we will keep investing so that the eCommerce business becomes a larger part of our total mix. We still have a few points to catch up on in that area.

And I think you mentioned 11 million. That was total customers?

Yes, that's pretty good because we know who the 11 million identifiable customers are and what they're buying. We understand their engagement in eCommerce, which is what excites us.

That you added. The 4.5 million were loyalty, right?

That's right.

So you still have that 6.5 million that are identifiable but not loyalty.

That's right.

What is your strategy for converting these customers into loyal ones? How confident are you that you can achieve this?

Our loyalty team is now broadening their approach. Previously, our loyalty program mainly focused on financial incentives such as fuel rewards or pricing. Now, we are beginning to introduce additional features that will help engage the other 6 million customers in the loyalty program. We understand that pricing isn't the only factor; some customers prioritize convenience and experiences, and that is the direction we are heading towards.

Our next question is coming from Rupesh Parikh from Oppenheimer.

So going back to your CapEx guidance for this year, you indicated an increase in CapEx of $1.9 billion to $2 billion. As we look ahead, should we consider this as the new baseline for future years as well?

No, don't consider it the new base level. Remember, we were at approximately $1.5 billion in the past, and we plan to maintain that ratio at around 2.5% of sales as a long-term expectation. We're just being opportunistic here. When we have the cash, we're advancing initiatives that we know will provide clear returns on investment. We've done that, and within the $1.9 billion, you'll notice significant investments in our digital agenda, focusing on building digital capabilities across the company so we can monetize the 11 million additional customers I mentioned earlier.

Great. I have a follow-up question about free cash flow. I understand that this year there will be specific items, such as the payroll tax deferral, that may impact your cash flow. Bob, could you share any other specific items we need to consider regarding free cash flow for this year?

You're correct about the free cash flow. Regarding the CARES Act, we will need to repay just over $200 million in the fourth quarter of this year. Besides that, there is really nothing unusual.

We've reached the end of our question-and-answer session. I would like to turn the floor back over for any further or closing comments.

Very good. Thank you, everyone, for participating today. I wanted to point out that there is an infographic that has been made available on our website summarizing many of the statistics from this call today. And if there are any follow-up calls, Cody and I will be available over the course of the day and the rest of the week. Thank you so much.

Thank you, all.

Thanks.

Bye-bye.

Thank you. That does conclude today's teleconference and the webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.