Sprouts Farmers Market, Inc. Q4 FY2021 Earnings Call

Good day and thank you for joining us. Welcome to the Sprouts Farmers Market Fourth Quarter and Full Year 2021 Earnings Conference Call. Please note that today's call is being recorded. I would now like to turn the call over to Susannah Livingston, Vice President of Investor Relations and Treasury. Please proceed.

Thank you and good afternoon, everyone. We are pleased you have taken the time to join Sprouts on our fourth quarter and full year 2021 earnings call. Jack Sinclair, Chief Executive Officer; and Chip Molloy, Chief Financial Officer, are with me today. The earnings release announcing our fourth quarter and full year 2021 results, the webcast of this call and quarterly slides can be accessed through our Investor Relations section of our website at investors.sprouts.com. During this call, management may make certain forward-looking statements, including statements regarding our expectations for 2022 and beyond. These statements involve a number of risk factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. For more information, please refer to the risk factors discussed in our SEC filings along with the commentary on forward-looking statements at the end of our earnings release issued today. Our remarks today include references to non-GAAP measures. For a reconciliation of our non-GAAP measures to the GAAP figures, please see the tables in our earnings release. In addition, because our results for 2020 were impacted by the COVID-19 pandemic, this presentation will also include certain comparisons to results in 2019. As a reminder, to account for the 53rd week in fiscal 2020, we shifted each week back one week, thereby ignoring the first week of fiscal 2020 to better align holidays for comparison purposes. Because of this, the two-year stack comp will not be the simple addition of two periods. More information can be found at our investors.sprouts.com under Additional Reports if needed. With that, let me hand it over to Jack.

Thank you, Susannah and good afternoon, everyone. We're pleased to report that our results for the fourth quarter were better than we anticipated for both sales and earnings. And we're encouraged by the fact that our quarterly comp transactions turned positive. 2021 was a year of meaningful accomplishments for the Sprouts team. While at the same time, we successfully navigated a very challenging retail environment. During the year, we opened 12 new stores, remodeled one and relocated one of which four were in our smaller store format and are encouraged by their initial results. We made significant progress towards filling our pipeline of future store openings, opened two new distribution centers, launched over 5,700 new products and issued a fulsome ESG report which resulted in a AAA rating from MSCI, just to name a few. I'm excited about the platform we're building and where we can take it in 2022 and beyond. Going forward, creating more meaningful messaging about our customer proposition, densifying our store base in established markets and extending our reach to new customers in new markets will help us to continue to profitably grow. To that end, I'm thrilled to announce that Nick Konat will join our team in March as President and COO. I'm looking forward to Nick's leadership over the areas of marketing, merchandising and operations. Nick brings a wealth of experience in these areas with deep, deep retail knowledge from industry-leading companies such as Target and Petco. As we enter our 20th year as a specialty grocer, the bolstering of our team allows us to move our strategy forward and fulfill our mission of providing healthy living options for less to more people. Before providing more details relating to the quarter's activities and strategic performance, I'd like to turn it over to Chip, who will review our financial results for the quarter and full year as well as provide our 2022 outlook. Chip?

Thanks, Jack and good afternoon, everyone. Before I get started, I'd like to reiterate the fact that fiscal year 2020 was a 53-week year and year-over-year and quarter-over-quarter comparisons will be 52 to 52 and 13 to 13 weeks, respectively. For reference purposes, the extra week in 2020 included $122 million in sales, $29 million in SG&A, $16 million in earnings before interest and tax and $0.10 in earnings per share. Fourth quarter total sales were $1.49 billion, up $12 million from the same period in 2020. Comparable store sales were down 1.1%, resulting in a positive 2.7% two-year comp. As Jack mentioned, comp transactions for the quarter were slightly positive. It was the first quarter with positive comp transactions since 2018. Average retail prices were up primarily due to inflationary cost pressures passed on to the consumer, while our units per basket were down as we continue to cycle the larger baskets that occurred during the first 12 months of the pandemic. Encouraging is the fact that our units per basket for the quarter were still higher than they were during the same period in 2019 even with higher prices. E-commerce sales were 10.4% of total sales, settling to what appears to be a relatively stable run rate. Fourth quarter gross margin dollars totaled $533 million and gross margin rate was 35.7%. The margin decline of approximately 100 basis points was driven predominantly by a slight lag in price increases relative to the pace of cost increases. That gap has been narrowing as we've moved into the first quarter of this year. SG&A for the quarter totaled $449 million or $14 million higher when compared to the same 13-week period last year. SG&A increases were predominantly driven by new stores, offset by lower COVID response and incentive compensation costs. For the quarter, our earnings before interest and taxes were $51 million. Interest expense was $3 million and our effective tax rate was 25%. Fourth quarter diluted earnings per share were $0.32. During the quarter, we opened eight new stores, spent $28 million in capital expenditures net of landlord reimbursements and repurchased two million shares. For fiscal year 2021, total sales declined 4% to $6.1 billion. The 6.7% decrease in comparable store sales growth which was primarily from cycling the demand from the COVID pandemic in 2020. Our gross margin for the year was 36.2%, down approximately 55 basis points. Merch margins were down approximately 40 basis points and the remaining 15 basis points was a result of warehouse and distribution deleverage during the first half of the year. Our gross margin was slightly better than we projected at the beginning of the year and up approximately 260 basis points when compared to 2019. SG&A expenses for the year decreased $86 million on a 52-week basis to $1.75 billion or 28.7% of sales. Increases in SG&A from opening new stores were more than offset by significantly lower expenses associated with COVID response costs and lower incentive compensation. For the year, our earnings before interest and taxes were $334 million. Our interest expense was $12 million. Our effective tax rate was 24% and our diluted earnings per share were $2.10. During the year, we opened 12 new stores, ending with 374 stores across 23 states and invested $81 million in capital expenditures net of landlord reimbursements, funded by our strong cash flow from operations of $365 million. For the year, we repurchased 7.4 million shares of common stock for a total investment of $188 million, ending the year with $112 million remaining under our current $300 million share repurchase authorization. Turning to the balance sheet highlights. We ended the year with $245 million in cash and cash equivalents, $250 million outstanding on our revolver and $28 million of outstanding letters of credit and a net debt-to-EBITDA ratio of nearly zero. As we move into 2022, we are cautiously optimistic. We're encouraged by our fourth quarter results and believe many of our strategic initiatives have laid the foundation for ongoing and more consistent growth in revenue, profits and free cash flow. Navigating inflationary pressures on cost, both product and expenses as well as some lingering COVID dynamics will be important to our success in the near term. For 2022, we expect total sales growth between 4% and 6% with comparable store sales growth of 0% to 2%. We now expect to open 15 to 20 new stores, less than our previous communication of 25 to 30 and our strategic goal of 10% growth per year due to the ongoing permitting and supply chain challenges associated with sourcing materials and equipment. Several of our new stores in '22 were scheduled to open in December and are now shifting to the first quarter of 2023. Our real estate team continues to work diligently, building a quality pipeline of new locations. And we believe by 2023, we can be closer to our 10% goal. Today, we have more than 80 approved sites and more than 50 signed leases in the pipeline. For the year, we're expecting our gross margin rate to be relatively flat when compared to 2021 and SG&A to grow approximately 4% to 6%. We expect adjusted earnings before interest and taxes to be between $330 million and $345 million, interest expense of $11 million, an effective tax rate of 25% and adjusted earnings per share of $2.14 to $2.24 assuming no additional share repurchases. That said, we do expect to continue to repurchase shares opportunistically. Capital expenditures, net of landlord reimbursements, should total between $150 million and $170 million which includes the potential relocation of one of our distribution centers to a larger facility. Our guidance for the year does not include the temporary costs associated with California's recent passage of their 2022 supplemental sick leave bill that provides paid leave time off for COVID issues through September 1. The estimated incremental cost is between $2 million and $4 million. For the first quarter, we expect comparable store sales growth of 0% to 2% and adjusted diluted earnings per share between $0.69 and $0.73. With that, I'll turn it over to Jack.

Thanks, Chip. I would like to speak more about our current business and ongoing strategic initiatives. First, I want to give a heartfelt thanks to all the team members at Sprouts for their service. Our team members remain critical to Sprouts and taking care of them is our top priority. We'll continue cultivating the community within Sprouts, reinforcing the positive culture inherent in our DNA. We're also expanding access to development opportunities, helping ensure our amazing team members reap the rewards of their hard work and are able to grow within Sprouts. It's not been an easy two years for them, yet they never stopped working to serve our customers, make lasting positive changes to the company and improving access to healthy foods across the country. Our focus on product innovation and differentiation in partnership with our vendors is the lifeblood of our success and what makes us a specialty grocer. This focus helped drive our sales in the fourth quarter. And we were especially pleased with our sales performance in deli, bakery, vitamins, and grocery. Deli continues to show strength in our prepared deli meals, grab-and-go, vegan options and sushi. Even our sushi department is getting into plant-based offerings. And in Prepared Foods, we released some new meals created by our in-house chef which really brought the program to life. They included Suvi, keto-friendly Atlantic salmon with Poblano Crema and a whole line of faster meals using NEA chicken, grass-fed beef, and other attribute-driven proteins. Bakery continues to grow year-on-year, supported by ongoing innovation and seasonal events. Fourth quarter saw strength in holiday items, up double digit from last year. This category continues to grow in artisan breads and gluten-free items. And keto bread sales are now larger than conventional bread sales which speaks to our experienced seeker customer. Vitamins benefited from immunity products, partnerships, and innovative new items. The year ended with a return to a normal cold and flu season. And when coupled with elevated COVID cases, it led to a sales increase in our immunity categories like Jaros Cureton, the top trending Mushroom brand OEM created immune multiboost which had all the key attributes on trending ingredients to support immune health and everyday wellness which we released in the fourth quarter to great fanfare. In October, we hosted an interactive wellness live stream with industry experts to discuss natural remedies for anxiety, inflammation and immune health. Grocery benefited again from a strong holiday program and innovation. Holiday sales started early and remained strong through the fourth quarter, especially in private label. Some favorites driving the strength for our Sprouts branded Dark Cocoa kettle corn and Citi's Mini Bonello, our full innovation centers rolled out in our new format stores. And we converted nearly 250 bulk tables into innovation tables in our existing stores, creating halo and trial each week as bi-monthly, we highlighted new innovative items. This treasure hunt destination displays trending private label and branded items such as our Chilean line rolled top-tier chips and new organic Sprouts branded teas. These premium teas are harvested from small farms around the world with complete traceability and include fully compostable and biodegradable tea bags and strings. As it relates to strategy, we moved the needle on many fronts in 2021. Our merchandising team made tremendous progress by highlighting even more of our differentiation and innovation which remains our strength at Sprouts. We ended the year with over 70% of our products being attribute-driven like keto, paleo, plant-based or, of course, organic which is much different than other grocers. And this strength is being recognized in the marketplace as our vendors increasingly look to us as the destination for all new ideas. Organics continued to be a driver of differentiation for Sprouts. In total, they represented 24% of our sales in 2021. In produce, our contribution of organic sales to total department sales grew by nearly 600 basis points. In dairy, our organic sales penetration was 60% higher than conventional grocers. And in meat, which is new to organic, performed better than we expected. Overall, 2021 brought the addition of more than 5,700 new branded and private label items, of which more than 400 were private label releases. They include many plant-based and organic products like our whole wheat spaghetti and organic extra-virgin olive oil as well as vegan protein powders and our new health and beauty line. Our supply chain was boosted in 2021 with the opening of two new distribution centers, reducing our miles on the road by three million, improving strength and bringing fresher and more local products to the shelf. In Colorado, we increased our local SKU count by 200% in season, resulting in sales penetration of local produce in the mid-teens. For Florida, while we're still in season, we have already partnered with many local growers. These partnerships are already resulting in increased local produce sales penetration into the mid-teens which should continue to increase as we hit peak season. In 2021, we also planned and opened a smaller, more profitable new format store. Our SKU count is very similar to older vintages with a slight change in departmental mix, resulting in similar opening sales. In total, we had four of those stores in 2021, including one relocation and one remodel. Produce remains the cornerstone of the new format stores highlighted by prominent position in store, new varietals and of course, a focus on best quality at everyday great prices. We expanded the frozen department and put a greater emphasis on plant-based items, both of which are showing stronger sales in the new vintage. And despite the deli being smaller in scale and lowering cost to build, it continues to show sales strength with the addition of more grab-and-go options and prepared foods, even after taking out more labor-intensive items like salad bars. Most all the new stores this year will be in the new format, except for the seven stores we pushed from 2021 due to supply chain challenges in getting equipment. And finally, I want to speak to marketing. Our marketing approach has gone through an evolution in the past year. We began 2021 with a new campaign which strengthened our awareness as a specialty grocer. It highlighted our strength in fresh quality produce and that perception remains very high in the industry. However, we found it didn't include enough call to action to drive more footsteps to the door. Those that shopped us understood we had great prices but that fell short in the market overall. In the back half of 2021, we began to change a few tactics by reinforcing the value message, compelling reasons to visit the store and product differentiation in all our storytelling inside and outside the store to break the inertia of the non-Sprout shoppers. We are hopeful that these changes are starting to show results, allowing us to end the year positively with a slight increase in traffic. Our fourth quarter improvement was directly tied to the holiday catalog we delivered, which, through storytelling, highlighted various attribute-driven holiday items such as organic free-range turkeys, gluten-free ingredients, and healthy sides like Kevin's paleo mashed sweet potatoes and Tattooed Chef riced cauliflower stuffing. We incorporated digital strategies that combined storytelling with QR codes to promote our app, creating a growing customer base that stays informed and has access to all deals. Customers are aware that all our best offers are automatically available in the Sprouts app with discounts applied at checkout, eliminating the need for clipping. These initiatives led to a more than 700% increase in our loyalty scans for 2021. Our active email list grew over 25% to around 3.8 million customers, representing a 90% increase since 2019. Our SMS text group saw over a 75% increase, driven by a rapid enrollment program nationwide. In total, we can now engage over five million customers through various channels. Regarding ESG, while our 2021 report is still a few months away, I must acknowledge the accolades Sprouts has earned this past year for our progress and updated disclosures. Last fall, we received a AAA rating from MSCI, a significant improvement from last year's BBB rating. Recently, we were also recognized by Corporate Knights as one of the Global 100 most sustainable corporations in the world. Both accolades reflect the excellent work our company and foundation have done to enhance our disclosures and positively impact the environment, our team members, and the communities we serve. Looking ahead to 2022, we will continue to focus on offering our customers a unique and differentiated product assortment that aligns with their shopping needs. Customers will be able to experience even more creations from Sprouts and our vendors as we launch our innovation centers at approximately 120 new and existing stores. As for new stores, our unit growth story remains one of the best out there for retail. Though our growth in 2022 is less than 10%, our pipeline remains very strong with more than 80 stores to be opened in the next few years. As Chip pointed out, once the supply chain and city approval process rightsized from the pandemic, we expect to be back on track to our high-growth model. As for marketing, we will mine our customer data to get them engaged with broader and more inclusive media messaging, highlighting value, differentiated categories and supported by our vendors, partners, and influencers. The live stream we did this past fall was so successful, we're exploring additional events this year as well as innovative partnerships with industry experts. While we do expect supply chain challenges to linger due to labor shortages in the fields and warehouses as well as a shortage of drivers, our team remains heads down, finding new places to source products and passing through increased costs in most cases. We believe the focus on health and wellness is here to stay which bodes well for our differentiated offering. We're optimistic that the positive fourth quarter traffic is beginning to validate our strategic changes. Our focus remains on delivering great products and great prices to our customers and coupled with unit growth expansion will drive our top line. And our internal focus on efficient operations and the right promotions will maintain the change in our margin structure. I'm encouraged with the progress we have made against our strategy and I'm confident this success will only grow in 2022 and beyond. At this time, we're happy to take your questions. Operator?

Our first question comes from Ken Goldman with JPMorgan. Your line is open.

Hi, thank you. Good afternoon. When you were listing the departments that you were particularly proud of, I didn't think I heard frozen and correct me if I'm wrong there. So number one, was that an intentional omission, if I did hear it correctly? And number two, can you walk us through a little bit how the frozen business is doing for you at the current time?

Yes, we're very encouraged by the frozen category. We may not have highlighted it specifically, and if I'm honest, that's something we've been strong in for the last two or three years. We've reinvented our product offerings to include many innovative vegetarian, vegan, plant-based, keto, and paleo options. We're giving more space to frozen products in our new stores moving forward, which shows our investment in this area. A few years ago, frozen items were considered inferior to fresh, but we have been able to drive a lot of innovation here. Our team is actively pursuing this opportunity. So, while that may have been an oversight on our part, the frozen category is performing well for us.

Great. And then quick follow-up. I know you don't give specific gross margin guidance all the time. Just wanted to get a sense of a range. The Street is at about 36% for '22. Is that far off from where your model might be expecting at this time?

Ken, this is Chip. No, that's not far off. We said relatively flat for this year. So it's going to be relatively flat and some of the margin degradation in Q4 is starting to subside into Q1.

Good afternoon. Thanks a lot for taking my questions. My first question is on the comp guidance. I know low single digits is what you're targeting over the long term. That said, given the degree of inflation that we're seeing in the marketplace and your relatively easy comparisons, why not bring up 2022 guidance anymore? Is it simply a desire to build in some conservatism? Something else?

This is Chip. There are a few factors at play. Firstly, we're seeing changes in traffic, units added to carts, and average unit retail (AUR). If we analyze the trends, we've noticed that units in shopping baskets have declined year-over-year, and this trend is expected to continue into the first quarter and part of the second quarter when we compare it to 2021. On the other hand, we are optimistic that traffic will remain positive throughout the year, and as units in baskets begin to increase again, the AUR will start to stabilize. Overall, it seems to balance out in the zero to two range.

Got it. That's helpful. And then how is cost inflation trended coming out of the quarter? Are you passing on any more or less than you may have at the start of this inflationary wave? Are competitors still rational? And how are you expecting to play out?

The market appears quite rational in how people are responding. However, due to the level of inflation, it has become a volatile situation. I remember the effects of high inflation from the past. Managing this situation always has its timing challenges, leading to periods where you may be ahead or behind in your approach. I'm not observing any significant actions indicating irrationality in the promotional space. Yet, the speed of adjusting prices in response to cost inflation is an issue. In the fourth quarter, we may have been a bit slower to adapt than we could have been, but moving forward, we're seeing that balance improving.

Yes. And I would add, Mark, if you go back was probably Q2 this year where the cost got ahead of the prices a little bit and that's flowed through and it's starting to catch up. And once again, I think we're catching up to that by Q1 of next year. By Q2, for sure and it's starting to narrow in Q1.

Hey guys, thanks for taking my questions. So, a couple of things. Number one is the hire of a COO. Why did you do it? What are you expecting from that person? What do you think he brings?

Well, I think as we grow our business, we need to widen our bandwidth and the capabilities that we have in the organization to generate and stimulate the growth that we want going forward. This is quite a kind of immature business in many ways. So bringing more talent and more people on board who can drive that; so we're very excited about Nick. He brings a wealth of experience and a real passion for our proposition and what we do. And the fact that he's got the kind of background that he's got, I think he's going to add a lot of value to our business and bring a lot of discipline to our merchandising, marketing and operations side of things which in many ways, it's part of the process of us growing and developing as a business. And I'm very excited about the role he's going to play for us.

I have a couple of quick housekeeping items. First, I want to clarify something I heard, and then I’d like to revisit the previous question about comparables. Regarding the change in the California law, I believe you mentioned the $2 million to $4 million is excluded from guidance. I’m curious about the reasoning behind that, especially since the figures are known and seem to be ongoing. Second, about the comp expectations of zero to two for the first quarter, considering inflation is quite high, it suggests a significant drop in volumes. I've heard the explanation, but I'm not entirely sure I grasp it completely.

Yes. There are a few points to discuss. The California aspect ends in September. The law was established then, and we were uncertain about the quantification since it was recently enacted, and it represents a $2 million to $4 million cost. We wanted to highlight it as it's a temporary, one-time expense. Regarding the zero to two, you need to look back to when the pandemic began in the second quarter of 2020 and consider the following four quarters. Unfortunately, the issues didn’t arise at the beginning of the year, but instead in the next four quarters. The units in the basket significantly increased in the second quarter of 2020, so when comparing this past year, they decreased considerably and have remained low. We will have another quarter with comp units per basket still considerably down. Soon, we expect things to start to recover and stabilize with relatively small positive traffic. Transaction levels should show positive signs, units per basket should slightly improve, and average unit retail should also be a bit positive as we begin to compare against last year’s high inflation.

Okay guys, thanks. I'll yield. I appreciate the answers.

Good afternoon. Thanks for taking my question. So the first question I have is just on quarter-to-date trends. Is there anything you can share in terms of what you're seeing quarter-to-date?

Rupesh, yes, this company hasn't provided guidance for the current quarter in the past, but we have done so this time and will continue to do so going forward. The guidance we've provided aligns with our expectations for the end of the quarter.

Okay, great. And then second, just on private label. So a lot of innovations routes on the private label side. Curious where your private label penetration is today and where you guys expect it to go by the end of the year.

I'm not exactly sure what happened with the penetration. As I mentioned before, our private label mix is currently around 14% to 16%. Some of that 16% includes commoditized items which we don't feel align with the direction we want for private label, but there's also some truly innovative products. I was very encouraged by our progress over the holiday season. We have a new team in place that's doing great work, and we have some exciting new products coming this year. I'm looking forward to these new designs and products entering the business. We’re not aiming for a specific penetration number; it's not about reaching a target like it was during my time at Tesco. What matters to us is that we bring differentiation to our customers and innovate within this space. I'm excited about what's ahead, but I'm not certain what the exact penetration number will be.

Good afternoon, everyone. Jack and Chip, could you discuss some of the best benefits of clustering stores or having more stores in clusters, particularly how it's contributing to sales growth, distribution efficiency, and cost reduction?

When we open stores in areas where we already have a strong presence, our performance is better compared to markets where we are less known. Essentially, when people are familiar with our brand, we see quicker success. In regions like the mid-Atlantic and Florida, we have established a solid customer base and promising opportunities. However, building market presence takes time in areas where people are not acquainted with us, presenting both a marketing and communication challenge. Having more stores in a concentrated area makes it easier to overcome this. For example, we experience stronger market performance in California, Arizona, and Vegas right from the start, compared to the mid-Atlantic or Florida. We're also optimistic that our new distribution centers will enhance our effectiveness at a local level. We've recently opened two new centers and plan to add another in the next 18 months, allowing us to source products more locally. With the Orlando distribution center, we're now able to work directly with local farmers instead of shipping products from far away. We aim to promote local sourcing even more. We've been actively recruiting, and this blend of local product sourcing, increased store density, and an evolving distribution network positions us well for the future. Chip, do you have anything to add?

Yes. The other thing that I would add to it is just from a talent perspective, you start to get some brand awareness. It's easier to hire talent as you promote people from within the boxes. It's easier to promote and move them to other boxes and they know we're not bringing in people that don't know who Sprouts are in a new market. And then on top of that, of course, you get leverage off of your media spend as well.

Got it. Can you quantify at all what amount of sales you might have left on the table due to out-of-stocks? And is Sprouts more vulnerable to out-of-stocks due to the unique nature of many of your products versus run-of-the-mill CPG products in a typical supermarket?

Yes, that's a great question. It's something we discuss frequently. In fact, I believe that when you're only selling products that you provide, you have complete control over your outcomes. Over the past couple of months in the consumer packaged goods world, I've noticed conventional grocers competing with Walmart and Target for products. During my visits to those stores recently, I've seen a significant number of items out of stock. While we do face some challenges, they are not nearly as severe as what I'm observing with those conventional grocers. Because we aren't competing for inventory with others amid the current supply chain and labor challenges, we can collaborate effectively with our vendors and distribution partners. It's solely our responsibility, and we either succeed or fail. I believe that as we move into January, we are in a stronger position than many of our competitors. Although we still have a long way to go, I think we are performing better than most. All right. Thank you.

Hi, thanks for taking our questions. I wanted to just dig in a little bit more on the traffic and ticket drivers. And I guess a couple of questions there. The decline in units per basket, is that across all of your customer types? Or is there any differences in trends between your different customer types there? And then the traffic momentum that you have, are you able to tie that back to your marketing campaign and new customers? Or just any ways you can track how that marketing campaign is working to drive traffic?

Yes. Kelly, let me address the two questions separately. First, regarding traffic, I believe Chip can elaborate on the initial inquiry. We experienced positive developments in our marketing efforts in Q4. We conveyed our message more effectively digitally, highlighting the strength of our fresh pricing, especially in produce relative to competitors. As I mentioned earlier, it’s crucial to clarify our value in the produce sector, particularly in new markets. We believe our digital outreach has contributed positively to this. Additionally, in the context of the COVID environment, which saw increased comfort levels by the end of Q4, we noticed customers returning to stores. Historically, grocery shopping frequency had decreased from four or five times a week to one or two, but December showed improvement for us as customers felt more at ease returning. The combination of effective messaging and follow-up communications encouraged customers to visit us after the holidays. I'm pleased with our marketing effectiveness at the end of Q4, and I believe the broader marketplace conditions have supported our progress. It's still early, but we're cautiously optimistic about the improvements in traffic, a topic we've discussed with you, and we think our marketing initiatives, along with some external factors, have had a positive influence.

Regarding the units, you need to look back nearly two years. We saw significant increases in units per basket starting in the second quarter of 2020. However, when we compare that to 2021, those numbers were negative and will continue to be negative on a year-over-year basis through this past year, with another quarter to go. This trend should stabilize by the second quarter of this year. Overall, if we examine units per basket from a two-year perspective, we have seen growth every quarter.

Okay, that's very helpful. And then just also to ask on the stores and this might be too early. But curious if you can talk a little bit more about sales and the margins and how they're starting to track out between the old and the new format. And if the cost of the new store format is coming in line with your expectations.

We have discussed how our new store formats involve a smaller size and reduced investment in the stores. This leads to lower costs for rent and construction. However, we are experiencing some cost pressures related to supply chains, steel, and equipment, which are pushing some expenses higher. Despite this, the overall costs we are incurring are significantly lower than what we would have spent on our larger stores, and they align with our expectations. To clarify, while costs may be incrementally increasing, they remain well below past levels and match our projections. Our new store margins are performing exactly as anticipated. Regarding our older stores, which we categorize as V1s, V2s, and V3s, our V6s are performing as we hoped. The high-volume older stores are very profitable, and that's the strategy we are aiming to replicate with our new formats—making them smaller, focusing on higher sales per square foot, and achieving better returns. Notably, our smaller stores in San Diego and parts of California are among our top performers financially.

Hi, this is Kendall Toscano on for Robby. Thanks for taking my questions. I was just wondering on the gross margin and, I guess, the return to positive traffic. Were you guys investing in price to any extent during 4Q? And now that you've seen traffic turn positive, does that change the way you're thinking about maybe future price investment in 2022?

We are sticking to our promotional strategy and pricing investments as we've outlined over the past two years. We are not implementing loss leader pricing or aggressively pursuing promotions, and our promotional efforts have significantly decreased in recent years. Therefore, we are not investing in pricing. Some of the margin changes are partially due to the lag in adjusting our retail prices in a high-cost inflation environment, but this will stabilize over time. In short, we are not making any investments that affect our margins. The margin expectations we've set moving forward align with what Chip mentioned in his presentation. We feel confident about our current position, and as long as there are no significant surprises in the market, we believe our margins are well placed for the future and are aligned with our investment strategies. Chip, would you like to add anything?

The only thing I would add to that is we're being a lot more selective. So the breadth of the promotions are not nearly as wide. But the ones that we are doing, yes, sometimes, we've been a little bit more aggressive on price. We're a little bit more aggressive in the deal. But it's a much narrower selection that that's being applied to.

I am very pleased with how the marketing teams are performing; we've seen a significant increase in engagement in our digital space. Our scans have risen, and we now have around five million people participating in these digital promotions, up from two million not that long ago. They are not creating promotions themselves, but we believe this is helping to boost some of the demand.

Hi, good afternoon. Just as we think about the last two years and the impact of trip consolidation, can you just talk a bit more about your strategy of focusing on more value-added promotions or call to action to really drive traffic that you have been testing? And essentially some of the learnings and just how effective they have been. And then in terms of your value scores, has that changed at all over the last quarter or two, as essentially conventional grocers and now even the largest retailer in the country is raising prices?

Yes. Let me discuss our progress over the past couple of years. I’m pleased with the work we've done on loyalty. We began segmenting our customer base about 2.5 years ago, before the pandemic. We are sticking to that strategy, which gives me confidence. Our focus is on attracting customers who are enthusiastic about fresh, healthy foods, as well as those who appreciate innovation and are seeking new experiences. This is the demographic engaging with our loyalty initiatives, as they are using their phones in-store and responding to our loyalty communications. Early segmentation has been beneficial, and our marketing efforts seem to be gradually improving our core customer base. We’ve seen a departure of customers who weren't profitable for us, those we refer to as 'coupon clippers.' We're noticing some positive signs with certain customers reactivating, and these are the types of customers we want. We are not actively encouraging less desirable customers to return since we’re avoiding heavy discount promotions. Regarding store traffic, there is slight improvement as people are becoming more comfortable venturing out, which seems to help us since we aren’t their primary grocery choice. The initiatives to engage our loyal customers are leading to increased transactions, which we hope will continue throughout the year.

Krisztina, I want to mention a couple of points. First, we are now moving past the effects of the trip consolidation. Second, since we changed our strategy two years ago, the issues we faced with coupon clippers are behind us. Currently, the traffic we are experiencing feels much more stable. Additionally, concerning value, we are very competitive in our produce pricing, which has always been a key aspect of our business. We have opportunities, as noted in the last call, and we are actively working on them to improve our messaging, which we haven't effectively done in a couple of years.

Yes. And I think the value part linked to produce is the important thing for us. I think the customers are understanding that there's a volatility everywhere, as you alluded to, the conventionals and the other guys are having to put prices up at the moment. Within the context of that, we're sticking pretty rigidly to we need a discount, we need an advantage in our produce space which we have and will maintain. And the rest of the store which is not directly comparable, we're looking at elasticities and that and seeing what happens when prices change. And that's something that we're having to watch more diligently than we ever have before because of the level of inflation that's going up.

Hi, good evening. This is actually Renato Basanta on for Karen. Thanks for taking our questions. So just first, I was just wondering if you can talk a little bit about how you view sort of the company's overall growth algorithm on a more normal basis. Obviously, a lot of noise with inflation this year and some of the store growth challenges. But wondering how you think about sales growth in a more normal year, including the waterfall benefit to comp. And then generally, the relationship between sales and EBIT growth on a more sustainable basis.

I'll let Chip follow up a little bit but let's talk, first of all, about the store growth. We're very comfortable that from a top line store growth, we have the leases and the sites in line for us to deliver on the algorithm that we've talked about which is a 10% store growth. That's not going to happen this year, as we've said in the note, simply because the complications of trying to work our way through both the licensing and the construction side of things is very challenging. I'm really pleased with the way the team are working their way through this but it's challenging. But we're very comfortable that the real estate team have got all the sites that we need to more than deliver against the algorithms that we've talked about on new stores. And when we get the new store program up and running, as you know, there will be a flow-through into our comp sales as that naturally flows into our business. So we're pretty comfortable and I'll let Chip talk in more detail, that we can grow our bottom line faster than we can grow our top line marginally. And that's part of what we've talked about all the way along in this space.

Yes. I just want to emphasize the algorithm we've previously discussed. First, Jack has mentioned our store growth. We are optimistic about returning to double-digit growth in new store openings in 2023, barring any unforeseen circumstances. We are confident about this target. Additionally, we have projected a 0.2% increase in comparable sales for this year. Although there are fluctuations affecting basket size, average unit retail, and traffic, we feel positive about achieving that zero to two range this year. Looking ahead, as we ramp up store growth, we believe we can maintain consistent low single-digit comparable sales growth. We expect to continue expanding square footage in the double-digit range and anticipate growth in earnings before tax in the high single digits, possibly up to 10%, while also continuing to repurchase shares.

Hey Jack, two quick things. Number one, maybe talk to assortment. How happy are you with where you are, right? And sort of the benefit of breadth versus obviously some inefficiency, right, if you're overly assorted. And then secondly, when you go from ramping openings up to 40-plus or around 40 in '23, is there a temporary piece of dilution from those new stores? Or you think you've reengineered them enough where any dilution is minimal?

Sure. One thing I've learned in this role over the past few years is that our company needs a wide variety of products. In my retail experience, the common approach is to eliminate less popular items and focus on high-volume sales, which is typically the strategy for traditional grocers like Walmart and Tesco in the U.K. However, we need to take a different approach. The variety we are adding is specifically targeted at health-conscious customers who follow various diets such as keto, paleo, plant-based, dairy-free, or gluten-free. To genuinely resonate with these customers, we must offer a wide range of choices. This means we might stock items that don't sell as well individually, but it helps create an appealing environment for customers. This strategy will be a key part of our marketing for 2022 and 2023, highlighting our unique offerings, as many products we carry are not available elsewhere, which gives us a significant advantage as a distinct business.

Yes, that's a great question. When considering the increase from 5% to 10% in square footage, reaching a steady state can be challenging, especially with a comp of zero to two while also managing costs to achieve high single-digit or low double-digit growth in earnings. There will be a brief adjustment period, and we need to be very diligent during this phase. It’s crucial to manage both the costs of new stores and the overall corporate expenses to reach that steady state. The positive aspect is that if we can achieve a comp of two to four during this time, it significantly benefits us. We'll stay on top of it and navigate through the temporary phase of ramping from 4 to 5 to 10. We will manage through this.

Good afternoon. This is Spencer Hanus on for Greg. I just want to go back to the conversation on pricing. How are you guys thinking about the need to invest in prices consumers start to face impact from this rising inflation? And then when the supply chain eventually normalizes here, do you think the industry is going to remain as rational as it's been? Or do they start to deploy these trade dollars just more aggressively given they're going to be in a better in-stock position than they've been for the last 18-plus months?

Yes. Regarding supply chain normalization, I'm uncertain about the timeline for that. However, I believe that any changes in the conventional grocery space will not significantly impact us because we have a unique offering. The products we sell differ from what competitors offer. We're monitoring price elasticity closely, particularly with inflation, to understand how rising prices affect unit sales now compared to the past. This is not just a discussion about margin investment; it’s about how we can maximize our volume and individual SKU sales. The situation with produce is slightly different. We aim to maintain our price differentiation based on the perception of quality, which is very high compared to most competitors, and the data supports this. In markets where we're well-known, our pricing is established. In less familiar markets, despite our price advantage, we need to communicate that more effectively. So the context of the question, Spencer, is there going to be when we get supply chain normalization, is there going to be some kind of price activity across the marketplace. I doubt it. But if it did happen, I'm not thinking it's going to have a huge knock-on effect to us because our customers are very clear that they come to us for the stuff that we sell that they can't buy in other places. And when it comes to produce, I think it's unlikely that people will use produce is a key driver to bring people into the store because their mix depends on produce being on a high margin, not at a low margin, if that makes some sense. But I would love some supply chain normalization. That would be great if we can get there. I appreciate you taking the time to listen to our call today. We really appreciate the interest in our company and we're excited about what this company can do going forward. And I appreciate your support. So thanks ever so much to everybody and take care.

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