Sprouts Farmers Market, Inc.

Good day, and thank you for standing by. Welcome to the Sprouts Farmer's Market's fourth quarter and full year 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Susanna Livingston, Vice President, Investor Relations and Treasury. Please go ahead.

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 Malloy, 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 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 stat comp will not be the simple addition of two periods. For 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 with their initial results. We made significant progress towards filling our pipeline of future store openings, opened two new distribution centres, 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 Conant 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 fulfil 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 continued 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 percent. 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. SGA 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 2 million shares. For fiscal year 2021, total sales declined 4% to $6.1 billion. This 6.7% decrease in comparable store sales growth 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, or 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 costs, 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 2022 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 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 and $4 million. For the first quarter, we expect comparable store sales growth of 0 to 2%, and adjusted diluted earnings per share between 69 and 73 cents. 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 serving 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 speciality 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 sous vide keto-friendly Atlantic salmon with poblano crema, and a whole line of pasta 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 experience 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 Jarrow's quercetin. The top-trending mushroom brand, OM, created Immune Multi-Boost, which hit all the key attributes and 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 were our Sprouts-branded dark cocoa kettle corn and Siete's mini bueneros, 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 chili and lime rolled tortilla 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 Sprouse. 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 recognised in the marketplace as our vendors increasingly look to us as the destination for all new ideas. Organics continue to be a driver of differentiation for Sprouse. 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 organics, 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 centres, reducing our miles on the road by 3 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, 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 lower in cost to build, it continues to show sales strength with the addition of more grab-and-grow options and prepared foods, even after taking out more labour-intensive items like salad bars. Most all the new stores this year will be in the new format, except for the seven stores we've 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 speciality 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 storytellings. inside and outside the store to break the inertia of the non-sprout shoppers. We're optimistic these changes are starting to make a difference, ending the year on a good note with slightly positive traffic. Directly related to our fourth quarter improvement, we delivered a holiday catalogue, which through storytelling emphasised all the attribute-driven holiday items like organic free-range turkeys, gluten-free ingredients, and healthy sides like Kevin's Paleo Mashed Sweet Potatoes and Tattooed Chef Riced Cauliflower Stuffing. It includes digital-based actions, marrying up storytelling with QR codes to join our app, melding together a growing customer base which stays informed and gets access to all the deals. Customers now know that all our best deals are automatically loaded in the Sprouts app with discounts given at checkout. no more clipping necessary. For 2021, these efforts helped grow our loyalty scans up more than 700%. Our active email addresses grew over 25% to approximately 3.8 million customers, which equates to a 90% growth since 2019. Our SMS text group grew over 75%, led by a quick enroll program nationwide. In total, we can now reach over 5 million customers through our different channels. As it relates to ESG, while our 2021 report won't be out for a few months, it would be remiss if I didn't mention the accolades Sprouts has received this past year from the progress we've made and the updated disclosures. This past fall, we received a triple A ratings from MSCI, a marked improvement from the respectable triple B rating last year. As well, just recently, we were honoured by the Corporate Knights as one of the global 100 most sustainable corporations in the world. Both highlight the excellent work of our company and foundation has done in improving our disclosures and making a positive impact on the environment, a positive impact on our team members and the communities we serve. For 2022, our focus remains on providing our customers our unique and differentiated product assortment aligned with their shopping needs. Our customers will be able to see and taste even more creations from Sprouts and our vendors as we launch our innovation centres to 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 right-sides 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 labour shortages in the fields and warehouses, as well as a shortage of drivers, our team remain hedged down, finding new places to source products and passing through increased cost 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?

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. We ask that you please limit yourself to one question and one follow-up. 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?

Yeah, we're very encouraged by Frozen, Ken, and we're in the place where maybe we should have mentioned it specifically if I'm honest with you, because it's something that's been really strong for us over the last two or three years. We've reinvented the products that we're selling. A lot of innovative vegetarian, vegan, plant-based, keto, paleo. So we're really encouraged by it. And if you look at our new stores, we're giving a lot more space to frozen in our new stores going forward. So we're investing in it. We're encouraged by it. And we think it's something that You know, a few years ago, Frozen was seen as a kind of poor relation against Fresh, but it's been a place where we've been able to generate a lot of innovation, and the team are chasing this hard. So that was probably a missing out part, Ken, but it's doing well for us.

Great, thank you. 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 the range. The street's 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.

Great. Thank you.

Thank you. Our next question comes from Martin with UBS. Your line is open.

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 comp guidance anymore? Is it simply a desire to build in some conservatism, something else?

Thanks. This is Chip. There's a couple things going on there. One is just a balance of traffic. units going in the basket and AUR. And so you just look at the trends and where we are. We've had units in the baskets have been down year over year, and that'll still continue to be down as you're going through the first quarter and part of the second quarter as we're comparing to 2021. And then traffic will be, you know, we're hoping to have traffic in the positive range throughout the year and we'll the AUR will start to subside as the units in the basket start to build again. So net-net, it all kind of comes out together in that 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 inflation to play out?

The market seems pretty rational to me, Mark, in terms of how people are passing it on. But with the level of inflation, it's a pretty volatile situation. I'm old enough to remember kind of what happens when you get high, when you get teen inflation. And the context of how you manage that, the timing on it is always kind of, there's always lags and then you get ahead of it and you get behind it a little bit as you try and manage it. I'm not seeing any major activity from anybody that would say that there's not rationality going on in the kind of promotional space on this. But there is some timing in terms of how fast you can move pricing when you get cost inflation. And probably in Q4, we were kind of a little bit slower than we might have been. And as we go forward, we're seeing that coming in line.

Yeah, and I would add, Mark, if you go back, It 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. Great. Thanks so much, guys, and good luck. Thank you.

Our next question comes from Scott with R5 Capital. Your line is open.

Hey, guys. Thanks for taking my questions. So a couple 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 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 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 you know in many ways um 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.

Perfect. Then just kind of two quick housekeeping items. I just want to make sure I heard something right, and then I wanted to go back to the last question around comps. So the $2 million to $4 million I think you guys pulled out as far as the change in the California law, I think you said it's excluded from guidance, and I'm just Curious why, since you know what the number would be, and it sounds like it's ongoing. And then the second thing with comp would be, you know, the zero to two in the first quarter with inflation running as hot as it is, it would be suggestive that volumes are down fairly sharply. And I just, I mean, I heard the explanation. I guess I'm just not sure I understand it completely.

Yeah, a couple things. So the California piece, that actually stops in September. So the law was set up in September. We weren't sure, actually, when we started quantifying it, because we just, you know, the law just got passed just recently, and it's a $2 million to $4 million number, and we just felt like we wanted to call it out because it's a temporary sort of one-time cost. As it relates to the zero to two, you got to almost go all the way back to when the pandemic started in the second quarter of 2020. And you think about four quarters. Unfortunately, it didn't happen at the beginning of the year, so it's kind of the next four quarters. And what happened were the units in the basket went way up in the second quarter of 2020. So when you cycled that this past year, they went way down, and they've been staying down. So we've got another quarter of that where they're still going to be comp units per basket are going to be pretty far down. And then that will start to catch up in anniversary, and it should be – going into the second to third quarter, unless something else happens from another variant, who knows? But beyond that, it should start to all come together and stabilize with small relative positive traffic. Transactions should be positive. Units per basket should be a little bit positive. And AUR should be a little bit positive as we start to cycle the big inflation of last year.

Okay, guys, thanks. I'll yield. Appreciate the answers. Thanks.

Our next question comes from Rupesh Parikh with Oppenheimer. Your line is open.

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

Hey, Rupesh. Yeah, that would, you know, normally this company hasn't given guidance for the current quarter in the past, but we've done that this time. So And we will going forward. So the guidance we've given is in line with where we expect to be for the end of the year, end of the quarter.

Okay, great. And then second, just on private label. So a lot of innovation 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.

Well, exactly what happened to the penetration, I'm not sure about. I think as I've said in the past in a lot of these conversations, Our private label mix at the moment, I think it's about 14%, 15%, something like that. 16% as we sit at the moment. Some of that 16% is commoditized that we don't really kind of feel is the right direction for private label. But some of it is real innovative product. And the progress that we've made in the holiday, I was very encouraged by. There's a new team in place. We're doing a really nice job. And we've got some really innovative products coming through. So I'm excited about the new designs and the new products that are coming into the businesses. through the course of this year, exactly what the penetration will be. It's not something we're ambitious. We're not saying it's got to be 20 or it's got to be where I was at Tesco all those years ago. It doesn't need to be a particular number. The important thing for us is that it's bringing that differentiation to our customer and we're bringing innovative products into the space. And that's something that I'm very excited about going forward. But the exact number, I'm not quite sure where it will play out.

Great. Thank you.

Thank you. Our next question comes from Sarah Kosky with North Coast Research. Your line is open.

Good afternoon, everyone. Jack, I was wondering, and Chip, I was wondering if you could discuss some of the best benefits thus far of clustering stores or having more stores in clusters, how it's helping with sales growth, distribution efficiency, and cost reductions.

Well, specifically, when we open stores in markets where we've got a significant penetration, we do better than when we open in markets where we don't. So simply speaking, when people know who we are, we've got a real chance of it hitting the ground a little bit faster. What we're finding in the Mid-Atlantic and Florida, we've got great customers in that space. We've got great opportunities on it. But as we build the density, we're starting to get better strength in that. But it takes a little bit of time in these markets where people literally don't know who we are. And that's a marketing challenge and it's a communication challenge. And it becomes much easier when you've got density in the marketplace to do that. So very simply, when we've got decent strength of market share in California, Arizona, Vegas, we do better than when we get on day one, we do better than when we launch in the Mid-Atlantic or in Florida marketplace. So I suppose that makes a lot of sense. But we're very encouraged that the distribution centers is allowing us to be much more effective locally. So we put two new distribution centers on the ground. We're probably going to have another one at some point during the next 18 months or so. And that's going to allow us to source product more locally. So when you're a farmer's market in Florida, the fact that we've now got an Orlando distribution center and we're not shipping from Atlanta, Georgia, all the way down to Naples, We've actually got ourselves in a place where we're working much better with the local farming community, the local agriculture community, and selling more local product. And I'd like us to, we'll be encouraging the teams to do much more of that. We've been recruiting a lot of people. So this combination of getting product, getting more stores in a dense area, providing more local product through our distribution network, which will evolve and develop, I think sets us pretty well for the future.

Is that what you want to add to that, Chip? Yeah, the other things 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?

Yeah, it's a great question. It's something we talk about a lot. Actually, almost maybe contrary to the question, I actually think when you're only sourcing products that you sell yourself, your destiny is in your own hands. The reality of the CPG world over the last two months or so is you've had all the conventional grocers battling with Walmart and battling with Target for product. And when I go into those stores over the last few weeks, I see pretty significant out of stocks. Now, we've got some challenges, but nothing like the challenges I'm seeing in some of our some of those more conventional grocers. And I think the fact that we're not battling for inventory with other people in the context of the supply chain challenges and labour challenges that exist across the marketplace, we're able to work pretty closely with our vendor base and our distribution partners. And it's only us. We either get it right or get it wrong. And I think in many ways, in January in particular, I think we're in a better place than most of the other guys. Although we weren't by no means where we want to be, But I think we were better than most.

All right. Thank you. Thanks.

Our next question comes from Kelly Bonillo with BMO Capital. Your line is open.

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 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?

Yeah. So, Kelly, let's take the two separate questions. Let's start with the traffic question. Maybe, Chip, you could pick up on the first question that was asked here. With regard to traffic, there's a lot of things happened that we're feeling good about in terms of how our marketing worked in Q4. We did a little bit better, I think, in terms of telling the story digitally around the strength of our fresh pricing, particularly our produce pricing versus the marketplace. As I kind of mentioned in my remarks, how do we get clarity, particularly in our new markets where people don't quite understand the value that we have in our produce business? And I think that the digital messaging behind that we think has helped us a little bit going forward. I also think that the fact that in the context of the COVID environment that kind of accelerated at the end of Q4, people were not as nervous. At the start of the pandemic, people were nervous shopping. The number of times people were going to do grocery shopping went down from four or five times a week to one or two times a week. That didn't happen in December for us. We saw that some of our customers were feeling more comfortable coming in. So I think the combination of sending the message out getting some bounce back communication to customers to encourage them to come back from the holidays. So I was pleased with some of the marketing that worked at the end of Q4. And I think the context of the marketplace helped us a little bit as well. So, and again, it's very early days, but we're kind of cautiously optimistic about the progress that we've made on getting this traffic, which has clearly been a conversation that we've had with you guys over the last little while. We're cautiously optimistic that The work we've done on marketing is helping a little bit, and there's some macro factors that are probably helping a bit as well.

And then on the units, Kelly, they go back to – you've got to go back almost two years because you look back, and we had dramatic – and I mean dramatic – increases in units per basket beginning second quarter 2020 – And then, of course, when you cycle that and you go into 2021, those were negative and will continue to be negative year over year through all of this past year and have another quarter to go. So that should settle out by the second quarter of this year. Net-net, if you looked at units per basket on a two-year perspective, we've been up 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 in detail about the 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.

Well, the cost of the new store formats, we've talked a lot about the fact that we've put less into the stores and we're making them smaller. So, The economics of the store in terms of rent, in terms of the size, because the size is smaller, then we're clearly spending less to build them. Having said that, there are some cost pressures on the other side with regard to supply chain, construction, steel, a lot of the equipment. So there's some pressures coming that's pushing it in the other direction. But relatively to what we would have had to spend... in the bigger stores that we've had, they're moving directly in line with what our expectations were. So just to be clear, the costs might be creeping up a little bit, but they're significantly lower than they were, and they're in line with our expectations. So in terms of the way the flow through is working, our new store margins are coming through exactly the way we expected them to do. Some of our older stores, we've got this nomenclature of, V1s, V2s, V3s. Our V6s are coming through the way we want them to. Our older stores that are high volume are the very profitable stores, and that's kind of what we're trying to capture with the new format stores, make them smaller, make them more higher sales per square foot, and deliver better returns from them. When I look back at the smaller stores that we've got in San Diego and some of the areas of California, those are the ones that are making the most money for us.

Thank you. Our next question is from Robbie Ohms with Bank of America. Your line is open.

Hi, this is Kendall Toscano on for Robbie. Thanks for taking my question. 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?

Well, our promotional cadence and the investment in price is exactly what we've been saying for the last two and a bit years in terms of the change in approach. We're not going loss leaders. We're not chasing after. And our promotion mix has gone down fairly substantially over the last couple of years. So we're not investing in price. Some of the margin stuff's a little bit to do with the lag in pricing in terms of how fast are we moving our retails in the context of a high-cost inflation environment. And that will smooth out through time. So the simple answer is we're not investing anything in our margin and the margin expectations that we have going forward are in line with the expectations that Chip went through in his presentation. So we're feeling pretty comfortable about where we're at and that provided there's no other major shocks in the marketplace, that we're pretty comfortable that our margin is in a good place going forward and we've reset our margins so that we're in a good place with our investments going forward.

Chip, do you want to add to that? 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, yeah, sometimes we're being a little bit more aggressive on price or a little bit more aggressive on the deal, but it's a much narrower selection that that's being applied to.

And I've been very pleased with the way the marketing teams have, you know, we've got a lot more people engaging in our in our digital space, so we've got our scans are up. We've got about five million people now from two and a bit million not that long ago who are actually engaging and getting these promotions digitally, and they're not crazy promotions, and we think it's helping to stimulate some of the demand.

Thank you. Our next question comes from Christina Katai with Deutsche Bank. Your line is open.

Hi, good afternoon. Just as we think about the last two years and the impact of trip consolidation, you know, can you just talk a bit more about your strategy of focusing on more value-added promotions or, you know, your 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 to essentially conventional grocers and now even the largest retailer in the country is raising prices?

Yeah, okay, so let's talk a little bit about how we've kind of been working this one through over the last little while. I've been encouraged by, as I said a minute ago, by the work that we've done around loyalty. We talked a lot about segmenting our customer base two years ago, maybe a bit more than that, I get mixed up, two and a half years ago when we embarked upon this strategy. And we embarked on this strategy before the pandemic kicked in And basically, we're following that strategy to the letter. I'm encouraged by that. But part of that was being very clear. We're narrowly focusing in on people who are excited about fresh foods and healthy food and people that are excited about innovation and the experience seekers. And those are the ones that are buying into the loyalty-based work that we're doing. Those are the ones that scan their phone when they go through the store. They get engaged in our loyalty communication. So I'm encouraged by that in terms of the focus that we put in early on to segment the market and the marketing activity that was put behind that appears to be gently and quietly improving our underlying customer base. We had a lot of customers who basically weren't making us, in fact, losing us a lot of money. So those coupon clippers that we call, they seem to have drifted away. What seems to be happening is there are some customers reactivating, coming back from where they were, but those are the customers that we want. And the customers that we don't want are not being encouraged to come in because we're not going on deep cut promotions. So if that makes some sense to you, as we look at the traffic, we're seeing a little bit of improvement. There's some macro things happening, people more comfortable. going to more places than they were before, which I think benefits us because we're not the primary shop. And the activity that we're doing to try and stimulate those customers who love us seems to be driving a bit more transactions with those customers. And that's something that we'd be hopeful about going forward for the rest of the year.

And Christina, I would just throw out a couple of things too. One is we're now getting beyond the lapping of the trip consolidation. Yep. Number one. Number two is when we did change the strategy two years ago or in 2019, the coupon clippers, as Jack points out, that were weeded out for all intents and purposes, that's behind us. So we're in a place where the traffic is really going forward as it feels much more stable. And then the other piece, when you talked about value, we are very price competitive when it comes to our produce pricing, which has always been the heritage of the business. we have opportunities, as we said on the last call, and we're working them diligently, we have opportunities to get that messaging out in a much better way that we haven't done for a couple of years, actually.

Yeah, 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 lot of volatility everywhere, as you alluded to, the conventionals and the other guys are having to put prices up at the moment. But within the context of that, we're sticking pretty rigidly to 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 on.

Thank you. Our next question comes from Karen Short with Barclays. Your line is open.

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. You know, obviously a lot of noise with inflation this year and some of the store growth challenges, but, you know, wondering how you think about sales growth in a more normal year, including, you know, 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 notes, simply because the 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. 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. Chip?

Yeah, I would just say that we want to give to the algorithm that we've kind of described before. Number one, Jack's already alluded to the store growth. So the square footage growth or store growth, you know, we're feeling, we're hopeful. I know hope is not a strategy, but we feel good about us getting back on track to the double-digit new store growth in 2020, what year is this, 22? Yeah, 23. So we should be able to get to 2023. unless something else happens. We feel good about that. And then, you know, we've got it to zero two on comps for this year. There is still noise moving around between all the basket size and AUR and inflation and traffic. We feel really good about the zero to two for this year. And then going forward, once we get the store growth going, you know, we're hopeful and we believe we can drive that low single digit comp consistently. We can continue to grow square footage up in the double-digit range. We can continue to grow earnings before tax somewhere in the high singles to call it 10, and we'll continue to buy back shares.

And I'm not sure we'll ever get – I don't know what normal looks like anymore. It's kind of with what I'm changing. There you go. Thanks for the question.

Thank you. Our next question is from John Heimbacher with Guggenheim. Your line is open.

Hey, Jack, two quick things. Number one, maybe talk to assortment. You know, 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, you know, when you go from – you ramp the openings up to 40-plus or around 40 and 23, is there a temporary – piece of dilution from those new stores or you think you've re-engineered them enough where any dilution is minimal?

Yeah, okay. John, let's start with assortment. One of the things I've learned in this job over the last couple of years is this company needs broad assortment. A lot of the discipline that I've had in my retail career would say you've got to cut out your tail and keep the high volume items and That would be the context of a lot of the work that's being done in conventional grocers and Walmart and Tesco back in the UK. That fundamental principle is something that's pretty much at the heart of being efficient. We have to be the opposite of that in many ways. And the assortment that we're adding is about trying to be very clear and very appealing to those health enthusiast customers. who are focused on a keto diet or a paleo diet or a plant-based diet or a dairy-free diet or a gluten-free diet. If you're going to be really relevant to those customers, those target customers that we have, you have to have a breadth of choice in that. So you end up having a lot of items that maybe don't sell as much on an individual store-by-store, item-by-item basis that you would want. But it allows us to create the dynamic of the attraction to the customer. And that's very much part of our marketing message going into 2022 and 2023, explaining the differentiation that we have. Because there's a load of products that we sell that nobody else would want to sell because of the, and that's one of the great advantages that we have of being a different business. So the question about does the assortment, we're always looking at our assortment. You can see we've added thousands and thousands of items this year, which I think in the context of 2021, was a pretty big achievement by the merchandising team to be able to motivate the vendor base to get that amount of product into the system over that period of time. And we have to develop our systems and our replenishment systems and our product flow work to make sure we're accommodating what the customer needs, not what maybe I would have done in a lot of other places. And that's been a real fascinating kind of, exercise, and I think the customers appreciate us when we get the bread to absorb in front of them to fulfill the kind of dietary needs.

The dilution from new stores and how that works, maybe Chip will pick that one up. Yeah, I think it's a great question. You know, when you think about having to ramp up from 5% square footage to 10% square footage, there is, until you get to that steady state, it is difficult to do that on a zero to two comp and still you know, manage your cost to get that high single or low double digit growth on earnings. So there is that brief period. We just got to be really diligent as we go through that funnel, if you will. We have to be really diligent on the cost and make sure, you know, we're managing the cost, not only of the new stores, but managing the cost of the corporation so we can get to that steady state place. The beauty is if we can get to a two to four comp in that period, then that helps the world a lot. So, Once again, we'll manage it. We'll get there. There might be that brief period when you're ramping from 4 to 5 to 10 that we just got to make our way through, and we'll manage through that.

Thank you. Our next question comes from Greg Badashkanian with Wolf Research. Your line is open.

Good afternoon. This is Spencer Hennis 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 the 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?

Yeah, so with regard to supply chain normalization, I'm not sure when that's going to happen, but if and when it does, I can't I can't see whatever happens in the grocery conventional space is going to affect us too much because, as I keep saying in these calls, we have a very different proposition. So the products that we sell, and I'll talk about produce in a minute, which is the one that's directly comparable with everyone else, the products that we sell are not kind of in line with what anyone else sells. So we've got to watch elasticity, and we are watching that carefully. With inflation, as prices go up, what happens to the units in the basket? What happens to the units? What sells? And we've got to be very conscious of that. But that's not a margin investment conversation. That's a how do we figure it out in terms of maximizing our volume and maximizing our sales on individual SKUs. Produce is a slightly different scenario. And we're in the place where we're trying to make sure that the differentiation that we have on price and produce built on a quality perception. Our quality perception of produce is up there. It's as high as, it's way above most people, and the data is very encouraging on that. In our markets where we're known, our prices are known. In markets where we're not known, although we've got a price advantage, we need to talk about that more effectively. So the context of the question, Spencer, is, 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 as a key driver to bring people into the store because their mix depends on produce being at 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.

Spencer, I would add to just like we said earlier on the messaging about we do have great value on produce every day and get to that. But we also have, as Jack said, we have a lot of great products, very unique products. And part of our table stakes is to make sure that the world knows that we are unique. We are differentiated. We do have those unique products. So it's not the same kind of you know, battleground with the conventionals. And the more and more we can do that, which our merchandising team's doing a great job of continuing to add great products, which continually we have to let the consumer know how great they are. And we're doing that even through innovation centers in our stores or find this new product. You can walk in a lot of our stores today and we're going to launch those into virtually all of our stores by the end of this year. So we're, you know, We're driving the message that we are different and have different needs, fill different needs for the consumer other than just the normal conventional.

Got it. And then you mentioned that transactions turn positive in the quarter. Do you think that's a sign that the grocery basket has started to re-split again here, and maybe you guys will be added back into the rotation cycle? again, or is it really just the function of marketing and just refining that message like you talked about?

Actually, Spencer, I think it's a bit of both. I think there's less worry about going into stores this time around when the Omicron variant hit the market than there was when the first wave happened. So I think there will be more people shopping in more places, which I think is good for us going forward. And I also believe that our digital marketing and our communications has helped us a little bit as well. So we'll be watching both of those dynamics over the course of the next few quarters.

Great. Thank you.

Thanks.

Thank you. We'd now like to turn the call back over to Jack Sinclair for closing remarks.

Well, in a very volatile world, we 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. 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.