Greetings. And welcome to Grocery Outlet Full-Year 2023 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation. Please note participants are restricted to one question at a time. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Christine Chen, Head of Investor Relations. Please go ahead, ma'am.

Good afternoon. And welcome to Grocery Outlet’s call to discuss financial results for the fourth quarter and fiscal year for the period ending December 30, 2023. Speaking from management on today’s call will be RJ Sheedy, President and Chief Executive Officer; and Charles Bracher, Chief Financial Officer. Following prepared remarks from RJ and Charles, we will open the call for questions. Please note that this conference call is being webcast live and a recording will be available via telephone playback and on the Investor Relations section of the company’s website. Participants on this call may make forward-looking statements within the meaning of federal securities laws. All statements that address future operating, financial or business performance or the company’s strategies or expectations are forward-looking statements. These forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from these statements. A description of these factors can be found in this afternoon’s press release, as well as the company’s periodic reports filed with the SEC, all of which may be found on the Investor Relations section of the company’s website or at SEC.gov.

Good afternoon, everyone, and thank you for joining us. We are happy to be speaking to you today about our business results, acquisition of United Grocery Outlet and outlook for 2024. Let me start by providing some commentary on business performance and notable growth initiatives over the next few years. First, our fourth quarter results were slightly ahead of our expectations and traffic and customer acquisition remains strong. We continue to deliver unbeatable value with an exciting treasure hunt experience and our underlying business fundamentals remain healthy. Second, we are excited to be acquiring United Grocery Outlet, which adds 40 stores to our network. This is an ideal strategic fit given our similar business models, customer value propositions and shared mission of serving and helping others. This acquisition provides Grocery Outlet with scale in a new geography as well as a platform for future expansion in the Southeast. We are thrilled to welcome the United Grocery Outlet team into the Grocery Outlet family and we look forward to working together on the many growth opportunities ahead. Third, we are making good progress on a number of strategic initiatives that we believe will strengthen our value proposition and contribute to future growth. Our personalization app is now rolling out to all stores and we will soon begin to invest in marketing to drive downloads and adoption. We are also looking forward to the launch of our new private label program later this year. Finally, we are excited to welcome Ramesh Chikkala to Grocery Outlet in the new role of Chief Operations Officer. I have known Ramesh for a number of years and he is familiar with our business through previous consulting work. Ramesh is leading our business technology and supply chain teams to help us scale and improve our capabilities to support growth. Let me now expand on each of these with more details. Fourth quarter sales increased 6.3% driven by a 2.7% increase in comparable store sales, which was ahead of our expectations. Transaction count remains strong at 7.5%, increasing throughout the quarter. While food inflation has been moderating, consumers still face higher food prices and other financial burdens. Our compelling savings and ever-changing assortment of high quality wow items continue to drive healthy traffic increases and market share gains. Fourth quarter gross margin was also ahead of our expectations at 30.2%. The closeout market remains strong in our growing size and scale provide increasing access to products with strong customer value and healthy margin. We opened 13 new stores in the fourth quarter, including our first store in Ohio, ending the year with 468 locations. Recent vintages continue to ramp well and we are pleased with new store performance. We have made steady progress with our systems implementation work, though data integration efforts are taking longer than expected and are still impacting our business results. The largest remaining issues are related to warehouse product expiry data and store level reporting for IOs. We expect these to be resolved soon after which the P&L impact will be behind us. Despite the systems disruption, business fundamentals are healthy and our new applications are supporting daily operations well. We are proud to have delivered strong results during 2023 growing sales by 11% to a record $4 billion. This was driven by comp store sales growth of 7.5% and a customer count increase of 8.3%. We also leveraged gross profit by 76 basis points and grew adjusted EBITDA by 18%. Now let's turn to the acquisition. United Grocery Outlet is a healthy, profitable and growing business. Their opportunistic buying model, similar company values and adjacent geographic footprint make it an ideal strategic fit. Founded 50 years ago, United Grocery Outlet offers customers tremendous savings within a treasure hunt shopping environment. Strong partnerships with national and regional brands enable it to provide quality food at unbeatable prices to its loyal customer base. United Grocery Outlet also operates as a local business with a mission of giving back and making a positive impact on their community. Their stores averaged 17,000 square feet and have seen healthy same-store sales growth in recent years driven by both transaction count and ring. This acquisition provides Grocery Outlet a great entry point into the Southeast region with 40 stores across the six states of Tennessee, North Carolina, Georgia, Alabama, Kentucky and Virginia. United Grocery Outlet also operates a distribution center, which can support additional new store growth in the broader Southeast region. This is an exciting addition as we pursue our white space opportunity of over 4,000 stores across the U.S. Distribution center infrastructure in this region also provides us with better access to opportunistic products that can benefit all Grocery Outlet stores. We have many levers to accelerate sales growth in partnership with the United Grocery Outlet team. Some of these opportunities include assortment expansion, additional store fixtures and improvements, and technology and marketing investments. We also see our independent operator model as another lever for growth. It is an important differentiator for us and we believe that it can have a positive impact in this region as well. We look forward to updating you on integration progress as we go. In addition to the United Grocery Outlet stores, we plan to open 15 to 20 stores for a total of 55 to 60 net new stores this year. Our real estate pipeline is healthy with approved sites for 2025 in good position to deliver our 10% annual growth goal. Given this, most of our recent real estate efforts have been focused on building the 2026 pipeline. This will add to what is currently over 100 approved sites for 2025 and 2026 combined. We continue to pursue organic growth combined with additional real estate opportunities that align with our long-term geographic expansion and store growth strategies. We are expanding strategic relationships with large property owners, evaluating opportunistic real estate listings, and exploring additional strategic regional acquisitions. The combination of these activities will help us deliver on our tremendous long-term store growth and geographic expansion opportunities. Let's turn now to other strategic initiatives. Our personalization app is on track to be active in all stores by the end of the first quarter. This app will allow us to communicate our weekly deals to customers and customize their treasure hunt experience. This will increase customer engagement with Grocery Outlet and help drive trip frequency and share of wallet. We are also looking forward to launching our first new private label products later in the second half of the year with a goal of 100 SKUs by year-end. Our assortment will initially focus on everyday value commodity categories that deliver better value and margin and complete the full shop. These items will help us capture larger baskets and create a stickier customer relationship. Our private label strategy will also include NOSH categories and unique items that will serve as another differentiator, enhancing the customer shopping experience. Next, for people update, we welcomed Ramesh Chikkala last month in the new role of Chief Operations Officer. Ramesh's experience in retail and operations organizations includes 14 years at Walmart, where as SVP, he led its global supply chain and food manufacturing operations, as well as its global technology organization. Most recently, Ramesh has been a Senior Advisor to Kearney in their operations, supply chain technology and consumer industry and retail practices. I look forward to working with him to further optimize our supply chain and technology infrastructure to support our long-term growth. We are in the process of searching for a new CFO and I'm happy to have Lindsay Gray, our SVP of Accounting and Principal Accounting Officer stepping into the role of Interim CFO effective March 1. Lindsay has been with Grocery Outlet for the last eight years leading our accounting team. She is an experienced financial executive with deep knowledge of Grocery Outlet's business and over 14 years of leadership in finance. She is also well connected throughout the business and a strong supporter of the IO model. In closing, I would like to thank the Grocery Outlet team and our IOs for their dedication and many contributions. The entrepreneurial spirit of our IOs combined with the buying power of our team creates a powerful and unique customer experience, which positions us well to continue to grow our market share. I also want to thank Charles for his invaluable contributions to Grocery Outlet. Thank you, Charles for all that you've done over the past 12 years. You'll be greatly missed by everyone and we wish you the best of luck in the next chapter of your career. And with that, I'll turn it over to Charles.

Thanks, RJ, and good afternoon, everyone. Our fourth quarter results slightly exceeded our expectations reflecting continued strength in transaction growth which improved throughout the quarter. For fiscal 2023 in total, we delivered strong top-line growth with comp sales increasing 7.5% yielding $4 billion in total sales. We also drove healthy bottom-line growth with adjusted EBITDA up 17.7% and adjusted net income increasing 15.2%. For the quarter, net sales increased 6.3% to $989.8 million due to a 2.7% increase in comparable store sales and the impact of new stores opened over the past 12 months. Comp transaction growth of 7.5% was partially offset by a 4.5% decline in our average basket. We estimate the system transition impacted comp sales by approximately 200 basis points for the quarter. We opened 13 new stores during the quarter, including seven in the East and one in Southern California, ending the year with 468 locations. We remain pleased with the performance of our new stores that are ramping in line with our expectations. Gross profit increased 6.3% to $298.9 million, representing a 30.2% gross margin rate, slightly better than our expectations. We continue to experience healthy deal flow, which helped offset the margin impact of our system integration, which we estimate was approximately 130 basis points in the quarter. Turning to expenses, fourth quarter SG&A increased 8.8% to $279.9 million. As a percentage of sales, SG&A increased 65 basis points. The increase was driven by higher commission payments to IOs, store occupancy due to new unit growth and D&A expense. This was partially offset by lower incentive and stock-based compensation accruals. The higher commission expense reflects gross profit growth along with additional commission support we elected to provide our IOs in connection with our system transition. Net interest expense decreased 74.2% to $1.5 million in the quarter. This reflects a reduction in net borrowing versus the prior year, partially offset by higher average rates. In addition, we recorded a reduction of approximately $2 million in the quarter to reflect full year capitalized interest costs related to store construction and other capital projects. Our effective GAAP tax rate during the quarter was 19.3%. For non-GAAP purposes, our normalized tax rate was approximately 31% in the quarter, which reflects a 30% rate for the full fiscal year. As a result of these factors, GAAP net income for the fourth quarter was $14.1 million or $0.14 per diluted share. For the fourth quarter, adjusted EBITDA was $50.9 million or 5.1% of sales, slightly better than expected. Adjusted net income was $18.2 million for the quarter or $0.18 per diluted share. Turning to our balance sheet, we ended the quarter with $115 million of cash. Our inventory position improved throughout the quarter ending at $350 million. Total debt was $292.7 million at the end of the fourth quarter with net leverage less than 1x adjusted EBITDA. For fiscal 2023, we generated $303.5 million of operating cash flow and we invested $175.6 million in CapEx net of tenant improvement allowances. This was higher than initially planned due to the timing of payments for new stores and costs related to our systems implementation. Now let me provide you with some commentary on our fiscal 2024 guidance, which includes the impacts of the United Grocery Outlet acquisition and the system transition. We expect the acquisition to close at the beginning of the second quarter. Our first quarter guidance assumes no financial impact from the acquisition and our full year guidance assumes nine months of financial results from United Grocery Outlet. As a result, our fiscal 2024 guidance assumes incremental sales of approximately $125 million adjusted EBITDA of $7 million and a modest benefit to adjusted EPS. With respect to our system transition, while we have made progress, the data integration efforts have taken longer than anticipated. Because of this, we expect we'll continue to experience P&L impacts during the first quarter. With that as background, let me provide you with our expectations for fiscal 2024. For the full year, we are projecting comp sales growth in the range of 3% to 4%. We expect comp growth in the first quarter to be approximately 2%, which includes an estimated 50 basis point impact from the system transition. We expect to add a total of 55 to 60 net new stores this year. This includes the 40 newly acquired United Grocery Outlet stores as well as 15 to 20 new stores on our existing markets evenly split by quarter. In total, we project fiscal 2024 net sales of $4.3 billion to $4.35 billion. For the full fiscal year, we project gross margin of approximately 31.3%. We expect gross margin for the first quarter of approximately 30.4%, which includes an estimated 100 basis point impact from the system transition. We expect sequential improvement in gross margins into the back half of the year. For the full fiscal year, we expect adjusted EBITDA to be in the range of $275 million to $283 million. We expect first quarter adjusted EBITDA margin of approximately 5% reflecting lower gross margin and higher IO commission support. For the year, we expect G&A to grow in the mid-teens on a percentage basis reflecting the impact of store growth, the United Grocery Outlet acquisition and infrastructure reinvestments. We expect stock-based compensation of approximately $32 million for the year. Net-interest expense is anticipated to be approximately $17 million. We forecast a normalized tax rate of 30% and average diluted shares outstanding of approximately $102 million. We expect CapEx net of tenant improvement allowances of approximately $170 million reflecting new store growth, upgrades to our existing fleet including approximately $15 million of anticipated United Grocery Outlet store capital improvements as well as ongoing investments in technology, supply chain and infrastructure. We expect resulting full year adjusted EPS to be in the range of $1.14 to $1.20 per diluted share. In closing, I want to thank the Grocery Outlet team and operator community for an incredible past 12 years. Grocery Outlet is truly a unique company and I will miss being part of this organization. I'm incredibly proud of all that we have accomplished and I want to thank RJ, the Board and the leadership team for their fantastic partnership along the way. We will now open the call up to your questions.

At this time, we will be conducting a question-and-answer session. The first question that we have today is from Oliver Chen from TD Cowen.

The United Grocery Outlet deal sounds quite synergistic. I would love your thoughts on what the characteristics were most attractive? How might the integration phases go? And then what should we know about the ramp to maturity of these stores and why you like the Southeast? A housekeeping item too, you mentioned that the deal will modestly benefit adjusted EPS. Are there any details on how this will be financed or anything else it should be on looking at the EPS accretion dilution?

I'll take the first part of that and then kick it over to Charles for the second part of your question. Yes, we're really excited about this acquisition. A lot of things that we like about it. First, I would say that the companies are a great match. We have a shared mission of touching lives and serving customers. We have similar business models, store sizes, and shared customer value propositions around unbeatable value and the treasure hunt experience, all supported by opportunistic sourcing and localized assortment. So, just a lot of similarities between the two businesses. This is a growth acquisition and there are many benefits related to growth. United Grocery Outlet is already a healthy growing business across the six states in the Southeast where they operate. In addition to just continuing growth of that business, we believe that we have several levers by which we can accelerate growth in the United Grocery Outlet stores. Just a few examples here: one, expanding the assortment; two, enhancing the store experience through investments in fixtures and signage and technology; and also looking to make additional investments in marketing to continue to drive traffic and growth in that region. I mentioned in my comments that we also believe that there are benefits to introducing the operator model to this region as well. So, a lot there to be excited about and we think can help the Grocery Outlet business. They have a bigger fresh meat assortment, so that's something for us to learn from. They have relationships with regional suppliers that we think we can take advantage of along with some other unique operating practices that we look forward to learning from. Another benefit that I mentioned is the infrastructure that comes with the deal. It provides us infrastructure in an adjacent region to our current East footprint. It's a great entry point for us into the Southeast. It is great infrastructure to support future growth as we continue to pursue this tremendous white space opportunity that we have. When you think about the infrastructure that comes with this deal together with the platform that we already have up in the mid-Atlantic region, we now have a lot of the Eastern U.S. covered in terms of infrastructure for supporting future growth.

Yes, Oliver, it's Charles. Just quickly on how we're approaching the financing and sort of EPS impact of the acquisition with respect to 2024. So, we do anticipate using cash on hand upon closing to finance the deal. In our guidance, we talked about the EBITDA impact from the deal, which we estimate to be roughly $7 million prorated for 2024. Think of that as really steady state performance of the business as it currently stands. Further down the P&L because of the financing with cash, we have factored into our interest expense the impact of really lost interest income into our guidance there. Likewise, in D&A, our mid-teens guidance reflects the impact of depreciation and amortization related to United Grocery Outlet. All that comes together to deliver modest EPS accretion in 2024.

The next question we have comes from Krisztina Katai of Deutsche Bank.

I just had a question about the Southern States and how you're thinking about the store expansion potential there now that you will have 40 stores in the region. So one, is there a profitability differential? How do you view the profitability potential in the region? And how it compares relative to the rest of the geo network? Are these included in your 2025 and 2026 store plans? Just anything that you can share in terms of if you started to look for IOs in the region? And just lastly, the acquired DC; you've talked about that it can support further growth. Just wondering how many stores it can fully support?

I'll take the first part and then Charles can touch on part of your question as well. Yes, as I mentioned, we are excited about the infrastructure here. United Grocery Outlet operates a multi-temperature DC, and we think this will serve us well both supporting growth in existing stores and also to your question, as we think about future new store growth. Our immediate focus right now is on integration. So we don't have immediate plans to accelerate growth beyond what the United Grocery Outlet team already had planned. We'll do the work together with the UGO team to proceed on that integration plan. As we look forward, the Southeast region holds a lot of potential for growth. The existing DC can support growth for the next several years in terms of new store growth. And similar to how we manage across the entire network and across all of our points of distribution center and infrastructure, we'll make the necessary investments in that to support future store growth. But again, we love the volume that it provides us, love the scale that it provides us, and love the entry point into this region of the country, which will support a lot of future stores.

And Krisztina, it's Charles, just a bit more color on the store productivity and comparisons versus our Geo stores. Yes, we're excited about the potential here as RJ said. Looking at store productivity, the average sales volumes for the new Geo store are about half of our current stores. The basket really similar traffic is a big opportunity for us. We think there is a significant opportunity to drive that higher through a combination of expanding the assortment, driving trips, and making investments into store CapEx and technology, as well as on the marketing side. In terms of the margin profile, I'd say no real structural margin challenges as we look at the business. Gross margins are a little bit higher than our own stores due to mix differences in the more limited everyday assortment they have. Store expenses are a bit higher than what IOs currently operate, but all of that nets down to a very similar EBITDA profile.

Our next question is coming from the line of Robby Ohmes with Bank of America.

Just a clarification, the UGO stores that you're acquiring, are they currently in the IO model?

They are not, no.

Are you planning to convert them to the IO model?

We do. We do think, of course, the IO model is super important to our business and an important part of our value proposition. We think those benefits will all apply to the Southeast region as well. We are still getting to know the business, the individual stores. We're putting integration plans in place as we speak. We just announced the deal a little over a week ago. So we're now working together with the United Grocery Outlet team on those plans. But yes, we do think about introducing the operator model to these stores as well.

RJ, to clarify, I understand you are planning to open 55 stores in 2024, with 15 to 20 of those being organic and not part of the acquisition. However, I recall you were initially aiming for 10% organic growth, which would translate to approximately 47 organic stores. Did you adjust your timeline for opening stores, or were you on track to fall short of the 47 organic stores when you decided to pursue this acquisition? Could you help me understand the organic growth outlook?

Sure. Yes. We've been focused on delivering the 10% annual store growth this year. We've talked about that throughout. And in the past few calls, we've also talked about pursuing this growth across several fronts, right? Organic growth, of course, but also consideration of opportunistic real estate. We have some new exciting strategic relationships we've built and then these regional acquisition opportunities that we've been considering as well. All of these activities combined would represent 10%. As we started to see progress on the United Grocery Outlet acquisition, we were able to manage and moderate some of the other activities with this 10% goal in mind. Keep in mind that real estate is just one part of successfully opening new stores, right? We were super mindful of the infrastructure needed to support them. Of course, there's operator recruiting readiness, marketing, and a lot of other things that go into opening stores successfully. We've been able to make those modifications and we love where we're at. We've got 55 to 60 new stores planned this year. It's a little bit ahead of the 10% growth, but given the work that we've done and the plans in place, we're excited about the integration work with the 40 as well as the 15 to 20 that we will open organically.

The next question we have comes from Joe Feldman of Telsey Advisory Group.

I wanted to go back on the private label, if you could share a little more color there. I know it's not coming until the second half. But just curious what if you could dive in a little more in categories. You mentioned NOSH, but are there other everyday categories that you're looking to fill with these products? And how might that impact the relationship with any of the vendors or suppliers that you have?

We're excited to be getting to the point here where we will be introducing these new items and brands later this year. As you know, we've been spending a lot of time building capabilities and setting the strategy and foundation this past year. So it is exciting for us to be at this point soon, where we'll have new items being introduced to the store. These items will enhance our everyday assortment, provide better value for customers, a better shopping experience, better baskets, and also better margin for the business. We have this goal of 100 new items by the end of the year. The initial focus will be in more commodity categories where we have a nice opportunity to offer better value and margin on some of the items that we're currently carrying. I will just give you a few examples where you may start to see some of these initial items; water will be one of the first ones, and we have good opportunities lined up within the baking category, pasta category, and cheese as well. We have others on the list that will be part of the 100 items. Additionally, we plan to introduce more differentiated items where NOSH is a great opportunity, further strengthening the treasure hunt experience and further differentiating us, creating another point of destination for customers that are shopping our stores. So there’s a lot there for us to like, and this is just the beginning. This is going to be a longer journey, but at least we are excited to be taking this first big step in getting this initial wave of products out to the stores and to our customers.

The next question now comes from Mark Carden from UBS.

So for the year ahead, you're expecting a gross margin that's north of 31% for the second straight year, even with the systems headwind, noticeably above your historical rate. It sounds like trends are expected to improve in the second half as well. Just what are the biggest factors driving this change?

Yes, Mark, it's Charles. I would say for us, we're just really pleased with the purchasing backdrop that we continue to experience. Yes, the technology implementation has had an impact, but the deal flow we're seeing, the backdrop from a buying perspective feels very good. Beyond that, we continue to see inflation moderate very much as we expected, and promotional activity looks to still remain very rational. So I feel great about the setup for the year. To your point, it's above our historical margin performance looking back over time, but I believe that some of those tailwinds will play to our strengths this year.

And then how is the overall product pipeline shaping up for 2024? Are you guys expecting to see much change in the pace of CPG innovation?

It's good. Yes, we continue to be encouraged by the pipeline of opportunistic product. It continues to be broad-based across categories. There was a lot of positive momentum throughout all of last year through to the end of the year and that's all carried forward through the first quarter so far, and we think it carries forward through this year. Forecasting continues to be hard, contributing to opportunistic supply. Yes, product innovation continues to be healthy and increase as suppliers introduce new items and extend brands; branded label changes and packaging changes are beneficial from the surplus inventory standpoint. Changes in assortment and products are favorable. So all those have us feeling pretty good about what we're seeing currently and what's in front of us here through the rest of the year.

The next question we have comes from Corey Tarlowe of Jefferies.

So I wanted to ask about the UGO acquisition. Thinking about this acquisition versus the one you made about a decade ago in Amelia's, when does the IO model make sense? Because I think RJ or Charles, you mentioned that the productivity or sales volumes are about half of the fleet currently. So when does it make sense to introduce the IO model? Is it a multi-quarter or multi-year phasing? How do you think about some of the similarities and differences between when you bought Amelia's and how that integrated into the enterprise versus buying UGO today?

I'm going to start with your second question, and then I'll come back to the first part of your question. The Amelia's acquisition was a long time ago. Many things have changed in our business since then. I will note some similarities between that acquisition and this one: similar business model, value propositions, shared values for how we operate in both cases. Both are providing us with infrastructure to support growth in a new region. In the case of Amelia's, it was really an entry point to the East Coast and here now a new region in the East Coast, but both coming with stores and distribution centers, local teams that we will continue operating the business. These are all very helpful for entry into a new geography. Additionally, providing better access to opportunistic supply was seen in a really positive way with Amelia's and we expect that to be the same for products that are local within the region in the case of United Grocery Outlet. A lot of similarities there. In terms of timing and integration, again, we are really just starting to work through integration planning together with the United Grocery Outlet team since it hasn't been that long since the deal was announced. First, I'd say it's a healthy growing business. So our top priority is to maintain current business momentum and be smart about how we begin to integrate and think about prioritizing and sequencing and timing for some of these growth opportunities. Getting to your question around the operator model, that would also apply to rebranding and other things that we might do. We want to ensure that we have a well-integrated plan and we're making these changes in the right cadence, not rushing relative to the ongoing business. We want to strike a healthy balance there. Think about the activation of many of these accelerated growth opportunities that are taking place over the next couple of years. These are things we would want to implement before any rebranding or conversion. Some near-term opportunities would focus on expanding the assortment and the investments we want to make into the stores. Once we establish a sound governance, we will consider sequencing the rebranding and the operator model opportunities. That wouldn't happen, at least regarding the operator opportunities, not in this first year. Think of it starting really in the second year and then following a period of time similar to Amelia's, during which we would look to introduce that on a store-specific basis.

Just a quick follow-up. What was ring up in 2023? And then within your guidance, what's the expectation for ticket or ring increase in '24?

Yes. So let me start with the latter there. So as we think about the components of comp for the balance of the year, we think that 2024 will continue to see comps driven by traffic, offset by lower basket. On the traffic side, yes, food inflation is moderating but, in absolute terms, remains high. The consumer is feeling pressure from that along with high interest rates and consumer credit. We believe all of that will serve as a tailwind for us from a traffic standpoint, as we've seen recently. From a basket standpoint, it will be lower due to the increased trip frequency and the resulting lower baskets due to moderated inflation. We are seeing changes within the basket, but as noted, it is slightly less comparable due to the changing nature of the assortment.

The next question we have comes from John Heinbockel of Guggenheim Securities.

I just wanted to start with when do you think, is it really the end of the first quarter when there's a complete normalization? And how the IOs are using the systems and financial impact? Is that fair? And then how do you forecast the recovery in the back half of the year? If you lost over 200 basis points of comp and over 100 basis points of gross. It looks like there is some recovery, but certainly nowhere near a complete recovery.

Yes, John, it's Charles. Let me give you a little bit of context on the impact of technology. It may be helpful to provide you with the impact on Q4 and then how we're thinking about the first quarter as well. Overall, the EBITDA impact from the technology transition and interruptions is impacting EBITDA by $20 million in the fourth quarter. About half of that comes from the elective IO commission support that we provided to operators. The balance is from a combination of the impact on the top line and gross margin rate, as we've disclosed. In the first quarter, those impacts continue but to a lesser degree. What had been a $20 million EBITDA impact in Q4 is down to what we estimate, and is implied in our guidance, to roughly $14 million impact in the first quarter. Again, half of that coming from the elective IO commission, and the balance from sales and margin impact. While we continue to provide that support during the impacted period, the monthly impact as we're tracking it continues to decline, which feels good to us. Our current guidance assumes that we resolve the remaining issues in front of us and are back to steady-state operations, concluding the elective commission support by the end of the first quarter.

One quick follow-up then. The food business is a little bit different, but have you seen any impact from the bad weather and rain in California? Is that would be separate from the 50 basis points, if any, but have you seen anything?

Yes, not significant. Nothing to call out for us.

The next question we have comes from Leah Jordan of Goldman Sachs.

I just wanted to touch on the 4Q comp a little bit. It looks like the headwind from the systems change came in about 100 basis points better than you initially guided, but less than that flowed through to the total comp. So I guess what surprised you versus your internal expectations for the core business? And can you talk about just the dynamics in ticket overall and how volumes trended as the ERP rollout improved?

Yes. Let me start first in terms of overall comp for us. We’re at 2.7% in the quarter, which was a bit better than we guided. It was a combination of slightly higher basket, which was aided by a quicker-than-expected recovery from inventory issues brought on by the system implementation. Traffic was also better. In terms of cadence throughout the quarter, we saw comps improve modestly as we progressed. More importantly, we're tracking the prior year comparisons closely, and they have been a little bit noisy now. We're looking at average weekly sales and seeing some nice improvement through the fourth quarter that has continued into the first quarter. I feel like the underlying trends in the business are healthy and improving as we can work our way through the system transition.

And for my follow-up, I just wanted to return to the gross margin discussion. Just curious if you've assumed any benefit from the private label rollout and any magnitude of that impact? And also on closeout, I guess, what have you assumed within guidance? Is it relatively stable throughout the year or any impact on a year-over-year basis there? And then longer-term, should we still think that margins stay relatively flat or has anything structurally changed in the business?

No impact from private label. We anticipate a small number of items rolling out later in the year, so not meaningful to margin. From an opportunistic standpoint, we expect stable trends, which are favorable. Those nice trends that I mentioned as they contributed in 2023, we expect to contribute similarly to gross margin in 2024. Looking longer-term, we aim to operate this business for stable margins, always focusing on delivering value and driving customer trips, both acquisition and retention and frequency. We're seeing some really nice trends in those areas. We like the balance we've established between the value that we're delivering and, of course, the margin that goes to the P&L.

The next question we have comes from Michael Baker of D.A. Davidson.

The EBITDA margins of the acquired company are approximately 5.5%, which is fairly close to your margins, though slightly below the 6.4% you achieved this year and with only half the sales volume. If you can increase those sales volumes closer to what your core stores achieve, what impact would that have on the margins from United Grocery Outlet? Would they significantly increase, or would you choose to reinvest that to maintain them in the mid-6% range? It’s interesting that their margins are not vastly different from yours despite lower sales.

Yes, Mike, it's Charles. It's probably, I'd say, premature at this point, given again we haven't closed the transaction. The business, again, last year roughly $160 million in top line and EBITDA about $10 million. So really similar EBITDA margin profile to our business. We are excited about the long-term growth potential for this business, but we want to be really measured in our approach. It would just be premature for us to put a number to it. But again, the path we're taking is to integrate the business, make sure we protect what they have, combine the best of UGO and GO with the goal of continuing to operate the business really in steady state this year. We'll start to invest. Again, lots of ways we believe we can drive growth. We're going to learn a lot that will inform what exactly the P&L looks like in the future. But we do think there's a big opportunity for growth and again, taking the best of what we do and what UGO does. We're excited about it.

The final question we have comes from Jeremy Hamblin of Craig-Hallum.

Congratulations on the impressive results. I'd like to revisit the new unit development and understand your current progress in opening these stores, particularly in relation to your capital expenditures compared to a couple of years ago. Additionally, considering the investments you're making in the UGO deal, you've mentioned that you're planning an additional $15 million in capital improvements for the UGO locations. Can you discuss the returns on capital and whether you are seeing greater returns from your legacy business in comparison to the United deal?

Yes. Jeremy, it's Charles. Let me provide you a little context regarding returns for the acquisition. We do think this will generate healthy returns over time. We really looked at it through a few different lenses. First, what's the base business that we're buying? We believe we pay a fair multiple for the 40 stores that exist today plus the distribution center based on the last 12 months' performance. As we said, we think it will be modestly accretive to 2024 earnings, so that feels positive. Importantly, we view this acquisition as an opportunity to drive growth within the existing store base. As we integrate and invest in the stores, we see meaningful upside there to drive accelerated growth, higher productivity, and better bottom line returns. Lastly, this acquisition provides a platform for accelerated growth into a new region. RJ mentioned not only the real estate opportunity in total but also the advantageous supply chain perspective of the deal. This outlines how we interpreted the average multiples we received back from the deal versus the investments we made. We believe this is a great use of capital for us and we are pleased with how it bolsters our organic growth perspective.

Yes, you're exactly right. We are seeing higher CapEx costs today compared to before. The $2 million figure you mentioned ties back to when we brought the business public in 2019. The inflationary environment today is significantly different; consequently, we saw new store costs about 25% higher than when we were at that time. Additionally, we actively work to reduce costs regarding several levers, everything from value engineering the build-out to strategic sourcing for purchasing equipment. In examining the store model and returns, store volume and product profitability ultimately drive returns more than CapEx. Therefore, even though the recent vintages reflect higher construction costs, it doesn't significantly hurt our returns. Think of it as having about a 5-point impact on the mature year for return on invested capital. That's come down to 30% from 35%, but we still have healthy returns based on current construction costs.

The final question we have comes from Simeon Gutman of Morgan Stanley.

Everyone luckily, our airtime has not expired yet.

We don't know what happened with that one. We were just as appalled as you were. Apologies.

No worries. I want to go back to the ticket size. I know it's a bit of an enigma to look at same SKU inflation for your business. Is there a best guess on what that may be doing to the basket size versus we're putting fewer items in the basket or if there's some trade down happening? I’ll just put the follow-up in here, given the interest of time. Charles gave us some numbers on the fourth quarter and the first quarter commission sharing. I think you've disclosed the second and third or they're in the filings, but if you can just give us that one more time because there's going to be a pretty meaningful inflection in the composition of the P&L during the year.

Let me just start, Simeon, the basket. You can think within the basket, again, not directly comparable for us. We always talk about how our model mutes the inactive inflation on the way of deflation on the way down, but we are continuing to see slightly higher average unit retails. That's offset by fewer items in the basket as trip frequency increases, which influences the overall patterns. Regarding the commission impact for 2024 and 2021, for the fourth quarter, we estimate a total EBITDA impact roughly $20 million; about half of that from IO commission support, and for the first quarter, we expect the impact will be around $14 million. Again, half of that being from IO commission and the balance from sales and margin impact.

Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the call back to RJ Sheedy for closing remarks. Please go ahead, sir.

Thanks, everyone, for your time today, and we look forward to talking with you again on future calls. Appreciate it. Take care.

Thank you. Ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.