Sprouts Farmers Market, inc (SFM) Q2 2021 Earnings Call Transcript

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Sprouts Farmers Market, inc (SFM 1.09%)
Q2 2021 Earnings Call
Aug 5, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day and thank you for standing by. Welcome to Sprouts Second Quarter 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. [Operator Instructions] Please be advised that today's conference is being recorded, [Operator Instructions]

I would now like to hand the conference over to your speaker today, Susannah Livingston, Vice President, Investor Relations and Treasury. Please go ahead.

Susannah Livingston -- Vice President of Investor Relations & Treasury

Thank you and good afternoon everyone. We are pleased you have taken the time to join Sprouts on our second quarter 2021 Earnings Call. Jack Sinclair, Chief Executive Officer; and Denise Paulonis, Chief Financial Officer are with me today. The earnings release announcing our second quarter 2021 results, the webcast of this call and quarterly slides can be accessed through the 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 2021 and beyond. These statements involve a number of risks 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 the second quarter of 2020 were significantly impacted by the COVID-19 pandemic, this presentation will also include certain comparisons to results in the second quarter of 2019.

With that, let me hand it over to Jack.

Jack Sinclair -- Chief Executive Officer

Thank you, Susannah, and good afternoon everyone. Thank you for joining our call today. In early 2020, we embarked on a new strategy that led to a positive step change in our financial performance, which is strong and sustainable. While, we have plenty of work ahead, I'm excited about the progress we have made and the continuation of our strong profitability this year.

Due to the pandemic, results are down compared to last year. Our year-to-date 2021 sales are up 9.5% and our profit is up 56% compared to the pre-pandemic same period in 2019. We have made great strides in executing against many of our strategic priorities. We have a differentiated model and a great team in our stores, which gives me great confidence for the future. The creation of innovation centers through dedicated merchandising displays, an increase of seasonal and local produce, the opening of two new fresh distribution centers and the opening of our first new format store in July among many changes that are driving our strategy forward. Plans are now in place to rollout our innovation centers to all our new stores and many of our existing stores in the back half of this year. Each month these displays will showcase new to market attribute driven items like Vegan's robot butter popcorn, plant-based foods and Grassroots Organic [Phonetic]. And thankfully, the country is in a place where we can start an active sampling program, which is a new endeavor for Sprouts and will prompt education trial and purchase. We're leaning into why customers love Sprouts produce, Our produce pricing remains ultra-competitive with prices significantly lower than the marketplace.

We just went through a great cherry season, which showcased more than five different varieties from unique family owned farms like Orondo Ruby Cherries and the Skylar Ray Cherries with distinctively different flavor profiles than the common red cherries. We excel at great purchase buying and we are only getting better with our two new DCs added this year.

Our organic produce is up to 35% of department sales, which we believe is one of the highest penetration rates in the industry. Our organic produce prices are very competitive and we are now focused on getting some of our organic produce prices in line with conventionally priced items making it a clear differentiator for Sprouts. On the supply side, our Aurora, Colorado DC is running strong and the Florida DC just opened in June getting us back to our farmers market heritage. We now have more than 85% of our stores within 250 miles of our DCs. As Sprouts are sourcing practices paired with our strong relationships with our local growers are a part of how we bring the freshest products to our customers all year along. With the addition of the Colorado DC. We have already noticed an uptick in produce sales in this region as fresher produce and larger local selections are being recognized by our customers. Specifically, our ripening rooms for bananas and avocados in Florida and Colorado have contributed to significant improvement and sales for these products in these regions.

Produce is in peak summer season in Colorado and our local buying has increased substantially and will gradually increase through the growing season up to 20% of the department or a 300% increase versus our past assortment in previous years, and with the addition of our Florida DC we will be able to provide an even larger range of affordable organics and locally grown items during the fall growing season in this region. Creating this advantaged fresh supply chain has provided benefits this year, which will ramp overtime as we cycle the regional growing seasons and expand our business. All in all this leg of the strategy is in very good shape as we head into the back half of the year and we begin to leverage the close proximity of our DCs to our stores.

Our 35,000 team members in our stores continue to do a great job. We've restructured our store leadership to reduce the span of control and in stores we've restructured to ensure our team members can spend more of their time taking care of the customers. As planned, we opened one store in the second quarter in Reno, Nevada and continuing with our plan, we have opened two more in the third quarter to date and remodeled one of our California stores, two of those stores were in the new format. These new format will make it easier for our health-minded and food-centric customers to explore the markets unique and attribute driven product. Enhancements include all new signage [Phonetic] featuring Sprouts new branding and expanded frozen department offering easy innovative meal solutions with more than 115 additional new items including meat alternatives and an expanded refrigerated section highlighting the latest plant-based foods. As a reminder, this new format will have a smaller footprint, but more selling space per square foot similar to many of our original Southern California stores.

The smaller size is very efficient and keeps produce at the heart of the store, while maintaining our familial open layout and treasure hunt shopping experience. They also cost 20% less to build and we expect to have similar sales to our boxes that we have to date, resulted in expected higher returns. Our plan is to open three more of these new format stores across the country this year. With all this said, sales were slower than we expected in the second quarter while April experienced strong results both top and bottom line, we were disappointed with May and June. Customers are enjoying travel and dining out again and against this backdrop, marketing did not drive as much traffic as we would have expected. To be clear, our brand campaign has reached more target customers, increased awareness, anti-purchase intent, which is a very important first step, but more will be needed. We're making necessary changes going forward as we continue to update our marketing mix with a test and learn approach. The intent is to convert awareness into increased traffic,, given the strength of our basket one that we need to margins increase in customers to fulfill our long-term strategic goals.

Let me share a bit of what we have underway. In the third quarter we're focused on refining our marketing to drive profit with targeted offers, unique partnerships and continuing to push brand awareness. We're connecting with those customers who know us with more touchpoints to foster more loyalty with mailed goodness guides, which highlight our seasonal produce offerings as well as new offerings like our 100% profit and stakes and promote those find a new favorite items, many of which are exclusive to Sprouts. We continue to offer weekly specials online through a digital lot, supported by extensive media both paid and owned, and we're expanding our full-size digital coupon freebies program for Sprouts account holders to encourage trial of new products, drive traffic and grow our database. We're building an innovation network by cultivating partnerships with up and coming vendors in the food industry, for example, our GloSlim SpiceFruit drove immediate customer interest in traffic to the vitamin department after being featured on the front cover of Women's World and we're collaborating with many other vendor teams becoming the destination for the products like [indecipherable].

Before I hand it off to Denise, I want to acknowledge that credible work the teams at our stores, DCs, and in the support office continue to do week after week, As we expand our business in markets across the country. our strategic initiatives are laying the foundation to solidify our position as a highly profitable specialty grocer with a strong unit growth story, making me confident we are well on our way to delivering the growth and returns presented in our five-year strategy.

Denise Paulonis -- Chief Financial Officer

Good afternoon, everyone. For the second quarter, we generated adjusted diluted earnings per share of $0.52 compared to $0.59 in 2020. Compared to the second quarter of 2019, earnings per share was up 73% as we continue to maintain our improved margin structure and make decisions rooted in positioning Sprouts for long-term profitable health.

For the second quarter, net sales decreased 7% to $1.5 billion and comparable store sales were down 10% compared to the same period last year. On a two-year basis, our net sales were up 7% compared to the second quarter of 2019 and our two-year comp stack was nearly flat at down 0.6%. As a reminder, to account for the 53rd week in our 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 will not be the simple addition of the two periods. More information can be found at investor.sprouts.com under additional reports if needed.

April sales started off strong in line with our expectations and posting positive traffic. May and June experienced more challenges. As Jeff mentioned, we believe the reopening of restaurants, travel and people going back to the office contributed to the slowdown. Having said this, our basket remains strong trending down only modestly since the first quarter of 2021, primarily due to lower eCommerce penetration. Our daily sales were strong this quarter partially driven by less time trends, which nearly doubled and speaks to customers being back at work as well as an increase in prepared meal solutions like One Pan meal. Vitamins experienced a marked improvement from the first quarter, as our customers got back to basics with added proteins and sports nutrition.

The benefit in ease of online shopping has remained relevant for a portion of our customers. For the quarter, eCommerce was 10.1% of sales, settling in the 9.5% range toward the end of the quarter. Compared to the second quarter of 2019, eCommerce sales have increased more than 350%. We've been absorbing the additional costs associated with the services for over a year now. Importantly for orders placed through the Instacart website, we're seeing about 50% of the transactions are for customers who have opted in to share their data with us. When combined with our own shop.sprouts.com, we are collecting meaningful customer data on around two-third of those who shop online. We're also working more closely with Instacart on analytics to support both our eCommerce and brick and mortar businesses. We believe the higher use of eCommerce for grocery isn't the only customer habit for this changed during the pandemic, to make sure we're driving business decisions on recent trends, we're currently performing new state survey work to evaluate customers' habits in this post-COVID environment.

For the second quarter, gross profit was $550 million and our gross margin was 36.1%, a decrease of 115 basis points versus the second quarter of 2020 in line with our expectations. This decrease was predominantly related to lapping opportunistic produce buys, an exceptionally low shrink from elevated demand last year. Our efficient promotions, attractive everyday pricing, and differentiated assortment continue to result in superior margins, which were up 330 basis points compared to the second quarter of 2019. SG&A costs decreased $52 million to $436 million or 28.7% of sales leveraging 108 basis points compared to the same period last year. The majority of this leverage was attributed to lower COVID pandemic response costs mainly incentive compensation, as well as lower eCommerce expense. This was partially offset by sales deleverage. Compared to the same period in 2019, SG&A increased 14%.

For the quarter, our adjusted earnings before interest and taxes were $84 million compared to $96 million in 2020. Compared to the second quarter of 2019. Adjusted EBIT increased to 63% continuing with the positive step change in financial performance. Our interest expense was $3 million and our effective tax rate was 24%. Even with some sales deleverage, we realized an adjusted EBIT margin of 5.5%, trending well ahead of our 3.6% margin in the second quarter of 2019. We continue to generate strong cash flow from operations, $177 million year-to-date to fund future expansion and sales initiatives. In the quarter, we invested $27 million in capital expenditures, net of landlord reimbursement, primarily for new stores. Additionally, we repurchased approximately $87 million in stock by the end of the second quarter. We ended the quarter with $250 million outstanding on our revolver, $39 million of outstanding letters of credit, $221 million in cash and cash equivalents, and $213 million available under our current $300 million share repurchase authorization.

Subsequent to the end of the quarter, we repurchased an additional $25 million in stock for year-to-date total of $112 million, reflective of a strong balance sheet, we continue to maintain a low debt position, ending the quarter with a net debt to EBITDA ratio of nearly zero.

Now, let me provide an update on our 2021 outlook. As a reminder, I'm giving these comparisons on a 52 to 52-week basis as fiscal 2020 was a 53rd week year. The COVID backdrop is resulting in an ongoing flux in customer spending habits and continued consumer hesitation for doing multiple shops. While out basket has remained healthy this year, we haven't realized the growth in transactions that we originally planned. Because of this, we are reducing our top line expectations, we expect net sales to be down low-single digits versus 2020 with comparable store sales down 5% to 7%. Our 20 new store openings for 2021, while in ten signed may not be completed by year-end due to difficulties in securing certain equipment from third parties, because of supply chain delays that have been complicated by the pandemic. At this time, we've about seven store openings that may be delayed to 2022, although we continues for options to open these stores by the end of the year.

The good news is that our real estate pipeline remains strong and we continue to work toward our 10% unit growth goal in 2022. Similar to 2021, we expect our 2022 new store openings to be weighted more to the back half of the year. With the potential store delays, we now expect 2021 capital expenditures, net of landlord reimbursement to decrease to the range of $110 million to $125 million. We continue to expect our corporate tax rate to be approximately 25%. Our scenario based planning, which contemplated potential outsized sales volatility has served us well resulting in our EBIT range remaining in line with our prior guidance of $305 million to $325 million.

Due largely to shares repurchased in the second quarter, we are increasing our adjusted diluted earnings per share to be in the range of $1.90, to $2.02. We continue to expect to maintain a majority of the gross margin rate improvement we realized in 2020 with the next few quarters being slightly pressured as we cycled some COVID benefits we don't expect to repeat.

In closing, we continue to remain confident in the strategic changes we began last year, which has structurally changed our financial algorithm for the long term.

At this time. we're happy to take your questions, operator?

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Krisztina Katai with Deutsche Bank. Your line is open.

Krisztina Katai -- Deutsche Bank -- Analyst

Hi, good afternoon and thank you for taking the question. So I just wanted to start with the top line. I know you guys have a very different sales mix and the customer profile that you were targeting, but you know your two year just turned negative for the first time, but industry data remains strong. So I'm just curious if you could just talk about your level of confidence in the strategy that you are indeed targeting the right customers in the right way, and then I also wanted to get your thoughts, I believe, Jack, you talked about just fine tuning your customer communication. So if you could just talk about what it is that you're trying to do to really drive customer traffic?

Jack Sinclair -- Chief Executive Officer

Yeah, Kristin, where we're not at the moment as we're feeling -- we're feeling very strong about the strategy in terms of the way it's been is flowing through in terms of what we've been -- what we've been doing and holding to make it work. The encouraging thing a little better is our basket, which we expected to decline a little bit more hasn't declined, but our traffic hasn't growing, but make it be really clear that traffic is stable through the pandemic and there's

A lot of noise in the pandemic. If you take it back to 2019 and take it today to 2021 on the Q2, our traffic went down through the pandemic as you'd expect, our traffic went down as you'd expect, because of the change in our promotional position and how we -- how we went to market, we expected to lose some of those if we'd said pre-pandemic we expected that. Since the last couple of quarters, we've seen a pretty static customer base, so it's not like we're losing customers, but we're not gaining them as fast as we would like them to do, and that leads on to your second kind of point, which is what are we doing to stimulate that demand and stimulate that traffic, and we're doing a variety of probably more call to action promotions as opposed to the genetic brand building that we had, we did. We're very pleased with it, it's giving us good awareness scores, which is always a problem, which always has been a problem for this business and it's also giving us good intent to purchase scores. But what is not doing is translating itself into more people coming in which we would have expected to have happened by now and Kristin, we don't need that many more customers for the equation of this to work and the good thing, from my point of view is we look at different tactics and different call to actions to drive that traffic.

We've got -- We've got because of the financial strength of our model now, we've got a lot of them if you like orders in our quiver that are able to we can deploy them and we're doing a number of things, testing number of things in a number of different places, both regionally and different category approaches and that's what we're encouraged about going forward that we've got room to play and we've got some options that we're working on that I'm feeling pretty confident that the base that we've built in terms of the merchandising changes we've made, the supply chain changes that we've made, the real estate changes that we've made going forward, places in a strong position to position ourselves with the target customers and as we've said often on these calls there's enough of those customers, we don't need, many of them for this thing to look very dramatically and a really dramatic way the returns that we can get -- if we can get a few more customers and this really are exceptional. So thanks for the question.

Krisztina Katai -- Deutsche Bank -- Analyst

Thank you. And just -- if I could just squeeze in a quick follow-up, maybe if you could share what your performance is in recent weeks as we're looking at the third quarter, and your guidance assumes that reacceleration on the two-year stacks. So how should we think about the cadence between the third and the fourth quarter there, and we're starting to see some companies delaying the return back to office, some of them are into 2022, which in theory could help you guys, so I wonder if you could just talk about some of your thoughts there?

Jack Sinclair -- Chief Executive Officer

Yeah, we cannot talk specifically about where we've got, you can have a look back and see the comparisons change a little bit. So I guess some of the comparison triggers made, there is a slightly different number going forward relative to where we've been in Q2, but we can't talk specifically about where we're at and that's kind of dynamic.

I think with regard to return to office, what we saw as people go back to office, we certainly got a benefit in our daily business from that in terms of people being around and going in and buying those kinds of things is as Denise alluded to in some of the remarks and what's going to happen, it's certainly an uncertain time for us all in terms of our own business, what are we going to do with the office, we had everybody coming back in September, but now we're --we think that's what we're going to do and I think that's the way the market is going to be, if it's delayed then I think there will be a dynamic change in terms of how the customer drove us back to some of the behaviors that happened in the pandemic or we are trying our best to not talk about the pandemic going forward we're trying to talk about now the COVID is over and we're going to get ourselves into Q3, Q4 in terms of really getting back to drive in the traffic within the strategy that we've outlined.

So I don't know what's going to happen with regards to the offices and whether people are going to go back or not. If the office is closed down again, then it will make a difference in terms of how traffic and basket plays into our stores.

Operator

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

Scott Mushkin -- R5 Capital -- Analyst

Hey guys, thanks. for -- thanks for taking my questions. So I guess the first one, obviously, everyone's going to poke at the sales issue, because it's the elephant in the room. Wanted to -- wanted to talk about the differences if there are differences where you have more density, Jack, like Southern California and Phoenix, where the brand is really well known like I think you have obviously on the popular following and compare that to less than series. Is there a difference?

Jack Sinclair -- Chief Executive Officer

In absolute terms no and in relative terms no, there's not a huge difference across the different marketplace been. In absolute terms, where you're starting from is different in different marketplaces, as you alluded to, Scott, Southern California, Denver, some of the other markets where we're more established in Los Angeles and beyond. We're seeing, as I've said the encouraging thing for us is the baskets holding up in those places or the basket is not going down by as much as we would have expected it to do and the traffic dynamic this happened in those areas isn't really a surprise to us when they went down, because in 2019., we were pretty clear pre in Q2 2019 that the traffic was there, a lot of that traffic was coming in response to the weekly promotional cadence that we had very aggressive pricing on the low margin and changing that we did see a reduction in traffic that then gets all confused by the noise of COVID, which probably took it down further. We would have expected our traffic to have bounced back about harder in those places, and that's back to what is it, we need to do in terms of building the clarity of our messaging and then the call to action -- the immediacy of the call to action that we need, and that's the things we're testing out at the moment, but to the crux of your question, we're not seeing a significant difference across the different marketplaces.

Denise Paulonis -- Chief Financial Officer

And I'd just add the point, it's what we -- what we do know as we just started a different water level. So some of our California stores are just much higher volumes starting stores and perhaps our Florida stores, but to Jack's point that the relative change is not materially different across the regions.

Scott Mushkin -- R5 Capital -- Analyst

As a follow-up questions. And when you say, call it to action Jack, it's just getting a little bit more promotional, or how do we think about it. And then, any thoughts on how this test and store is doing so far. I know it's only been a month or so, but love to understand how the new format, even though it is remodel performing?

Jack Sinclair -- Chief Executive Officer

Yeah. You're right, Tucson was a little bit of a remodel, Scott. As you know with the new one that we've opened in Phoenix, which we're very excited about. We opened 10 days ago or something like that. So it's early days, but, so, and we're very encouraged by the customer reaction to the changes that we made in Tucson and we've got a lot of positivity. The encouraging thing for me with regard to that is the way customers are saying, well I thought you were mail building smaller stores, but it feels bigger and that's definitely the feedback from the Phoenix store, which we built at 23,000 square foot and the people that people in Phoenix know that know our business well, and they're actually think the stores, they got. So that's encouraging. In terms of going, That's too early to say in terms of the absolute level of the numbers, call to action. The call to action will be more of less about very direct product and price, high, low depth drivers will be much more about if you like, dragging people to the offer and the proposition that we have whether it'd be plant-based, whether it be our new meat assortment in terms of our grass fed beef [Phonetic] assortment whether it will be toward our key tool business. It will be much more about how do you tell the story and give a value against our vitamins and how that business give a value to our bout as we relaunch our bout it will be more about category, I'm very unaggressive in some ways as I said, we've got some resources to do that. So it will be aggressive and not be what it won't be as a return to 10 per $1 corn.

Scott Mushkin -- R5 Capital -- Analyst

Perfect. Thanks guys I appreciate it.

Jack Sinclair -- Chief Executive Officer

Right.

Operator

Our next question comes from Ken Goldman with JP Morgan. Your line is open.

Tom Palmer -- JPMorgan -- Analyst

Hi, it's Tom Palmer on for Ken. Thanks for the question. I just wanted to follow up on the promotional discussion. Do you think, if you chose to you could drive traffic with heavier promotions, just in the current environment our promotions is effective than they've been in more normal period. Just trying to understand how you think about that potential lever as you reach out to customers?

Jack Sinclair -- Chief Executive Officer

Yeah, I think it's a good question about what're the dynamics of change. I think there are certainly a -- I think the holidays our competitors that's how we'd want to call them, the main line groceries are certainly going back to more aggressive promotions around the holidays on products that we do want sell. So I think there may be some evidence that that can drive some traffic in the post-COVID world, although ending of the COVID world.

Could we drive traffic by going back to aggressive pricing probably would it be the wrong people coming into the stores, probably would it help us probably not, so can -- out of the whole business is about driving the traffic of the target customer base and winning dollars and market share from that target customer base and that's a call to action that we're putting in place. The last thing we want to do is drive in very low profitable customers. So just come in for the deals, which is -- where we come in a couple of years ago and that's why the comparison to 2019 Q2 and the Q2 in 2021 works for me. In terms of understanding our business. We've reshaped the whole proposition of the business and we reshaped it to target against specific customers who appreciate the differentiation that we have. So that we're not going head to head with anybody on pricing our promotions and we don't actually have to win a trip from anyone, we just need to win some dollars to drive the transactions. So, I think to answer your question we probably could get traffic back-end in terms of the wrong traffic, but it does feel like that would be the right place, because we go back to making a lot less money as well.

Tom Palmer -- JPMorgan -- Analyst

Okay, understood. And then just on the store delays. So with some of the 2021 openings get pushed to 2022, you indicated that 2022 could be back-end loaded. Could we expect some of these stores to then just get pushed into 2023 given the bandwidth constraints or sure if those stores get pushed should we think about 2022 being 10% unit growth plus whichever portion of the seven stores get delayed.

Denise Paulonis -- Chief Financial Officer

Great. Great, great question. And we actually keep the two pieces separate. So I'd say we continue to be optimistic about our core 2022 pipeline in terms of deals that we have in the works and getting to that 10% new store growth that we wanted. Any impact that happens with up to these seven stores from 2021 is a separate outcome than what would be in 2022. So if some of them push that would make the 2022 number bigger, not really be a replacement and then I belief that 2022 would push out. Just opposed to understand of the delay in the stores that we have is really tied to some of the refrigeration equipment and some of the inputs that go into how those get installed into stores, working hard to find alternatives to just some supply chain constraints in some of that product inputs, being able to come through. So we don't expect that this is going to be a long-term sustainable issue that we have about our own capacity to build the stores. It is just a near-term supply chain constraints.

Jack Sinclair -- Chief Executive Officer

On some of these I think we could have done differently if we've known, so was not given up on those seven stores yet, so we'll see where that plays out over the next few weeks.

Tom Palmer -- JPMorgan -- Analyst

Thanks.

Jack Sinclair -- Chief Executive Officer

Okay.

Operator

Your next question comes from Robbie Ohmes with Bank of America. Your line is open.

Analyst

Hi, this is [indecipherable] on for Robi. Thanks for taking my question. I wonder if you guys could give us any color on how SG&A performed during the quarter versus maybe what you were expecting. I guess as a percent of sales, were you expecting it to be down as much as it was and or should and or should we still be thinking about a flat rate of sales for the year?

Denise Paulonis -- Chief Financial Officer

Yeah, so in reverse order there, we are still expecting to have a flattish rate of sales for SG&A for the year and as we have expected throughout the year and the quarter did come in as we expected. The two main drivers of the health in the quarter were the lapping of a number of the COVID-related compensation and incentive items that were in place last year that we knew would come away and come out of the model this year, and then secondarily, as we were expecting. We saw a little bit of a triple down in eCommerce penetration, which then reduced some of the eCommerce fees in the model as well. So I'm very much in line with expectations and do expect the full year to be flattish as we look to the close of 2021.

Analyst

Got it. That's helpful, thanks. And then just as a follow-up on the two-year same-store sales trends. Apologize if I missed this, but should we still be thinking about an improvement on a two-year stack each quarter, moving past 2Q?

Denise Paulonis -- Chief Financial Officer

Yeah, I would say the way that we really are thinking about it right now is what we gave in the minus 5 to minus 7 comp. We're going to -- we're going to come up on an easier comparison to last year as we work through Q3 and Q4. And so that's really what's factored into the baseline that gets us for the minus 5 to minus 7 for the year.

Analyst

Okay, great. Thank you.

Operator

Our next question comes from Greg Badishkanian with Wolfe Research. Your line is open.

Spencer Hanus -- Wolfe Research -- Analyst

Hi, this is Spencer Hanus on for Greg. Can you just comment on personal basket shopping and when do you think that's going to get back to pre-COVID levels and you guys aren't the only retailers that's experienced some loss of shoppers as people consolidating trips. Walmart is comes to mind is another big one that faced some challenges there. What do you think is a strategy of the industry uses to sort of get know shoppers back, is it price driven, is it more focused on advertising. Just how are you thinking about that. And then in terms of your value scores with your core customers, how has that sort of changed over the last few quarters?

Jack Sinclair -- Chief Executive Officer

Yeah, that's a good both good questions. In terms of I think ultimately what happens will be driven by COVID in the customer behavior that customer behavior, I'm not sure retailers will be able to influence that because really over the pandemic it is not really been the retailers behavior that's influenced a lot of what's happened. It's been the customer behavior and how they do view the context that we're in which evidence coming out.

It's clearly we had expected even a few weeks ago, we have expected to be in a different place today relative to where we were then. And now, who knows how people are going to play out with it now what will the retailer due to try and attract traffic within that environment. I think probably it will be more about trying to invest, if they need to invest in some kind of promotional techniques to try and get people by probably using loyalty and data information more effectively than we've had and more than that's certainly something we are thinking about how best we can communicate directly with our target customers and really give them a rationale to come back and probably get you some calls to action as I just outlined and talk about.

The second part of the question I've lost mine.

Denise Paulonis -- Chief Financial Officer

Oh, just how customers looking at value?

Jack Sinclair -- Chief Executive Officer

How the customer is looking at value. We're doing a lot of research on this, I think, Dennis alluded to in our remarks, we're doing a ton of research to understand our target customer and what the perspective is the ones that we are targeting are pretty much looking at as it's the same as it's always been at Sprouts, you know it's kind of good value on produce. I think people recognize that. I think they recognize the differentiation and they recognize the value behind it. We're not seeing significant -- we're not seeing any score changes in terms of value among our target customers and that's something we're looking at, because that's important to us. I think that's why we're again pretty static traffic at the moment. The question is how do we translate, how do we get to translate this awareness that we've got and this growing awareness into transactions and we think as COVID it dilutes and becomes less important, we think that's going to help us as we get these calls to action into the marketplace with our target customers.

Spencer Hanus -- Wolfe Research -- Analyst

Yeah, that's really helpful color and then I just wanted to ask on inflation, what was that running in the second quarter and, and how are you thinking about through the passing that through sort of over the next, in the back half and then into 2022? What do you think there is an acceleration, does it -- does it remain pretty sticky or is this more of a transitory inflationary environment that we're in today?

Jack Sinclair -- Chief Executive Officer

While looking to open as a transitory inflation environment, but let's wait and see. I think we'll manage as it goes. Produce has been pretty up and down, but pretty flat in terms of we're not seeing huge problems passing on our price, the pricing changes in produce, the protein side of things, salmon and beef and we have seen significant cost price increases, and we probably haven't been able to pass on quite as much as we'd like to, but we do see. Certainly we were planning on being transitory and that this thing will go back to normal in due course.

Denise Paulonis -- Chief Financial Officer

And it really was in the fresh side of the business, we've really not seen anything material on the non-perishable side of the business to date.

Operator

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

Mark Carden -- UBS -- Analyst

Good afternoon and thanks for taking my questions. So last quarter you noted that you're starting to see some customers trickle back in that may have been consolidating their trips with the Kroger's and Albertsons of the world during peak COVID. It sounds like some of this is stagnated a bit with a delta variant, does it become harder to get these customers back as it become more used to shopping for natural organic at the competitors, maybe [Phonetic] our loyalty programs, and does it change your strategy at all for getting them back? Thanks.

Jack Sinclair -- Chief Executive Officer

Yeah. I see. I don't think we've lost any of those customers who are interested in natural and organic and interested in our proposition and not the data, which suggest our traffic stayed pretty flat with that type of target customer, the customers that we lost, notwithstanding the consolidation part, the customers that we lost were, what we call the coupon clippers, the people that were particularly dynamically interested in our proposition, but they were interested in very low pricing on the fresh foods that we put in front of customers, whether it'd be chicken fillets or the corn or the tomatoes or whatever it might have been we were advertising aggressively.

So the challenge for us going forward is not so much can we get them back from Kroger is can we get a massive Joe on the call to action with those customers who have an affinity to who we are, but we haven't got them in the store. No if it's simply COVID this does not, I think that will happen automatically. It is not COVID has done it, I don't perceive that the challenge because the proposition If you go -- if you've gone to Kroger. I'm sorry, Kroger or anybody in terms of the context of consolidating your shop and you've gone and you sell they've got some natural and organic thing I promise you the scale of the differentiation between what we sell and custom all the pricing and produce, the differentiation from vitamins and harbor, the bulk of assortment that we've got, the attribute-based products, whether it be keto, paleo is so different. Our frozen food business 90% of what we sell in frozen foods is different to what I can walk around any supermarket. So it's differentiation, you cannot access it, and as the people who have not shopping with us because of COVID they will come back on the basis of the differentiation that we've got and we've got to give them a call to action to do that and I'm very confident that we've not got that underlying challenge that people have gone to the mainline supermarkets and thought I can get everything I need. I would have got at Sprouts it doesn't look like that in the data that we've analyzed.

Mark Carden -- UBS -- Analyst

Got it. That's really helpful. And then on your digital customers. What's the breakdown between delivery and curbside. Is it still skewing really primarily toward delivery any major differences in shopping habits between the two, what are you seeing and spend per customer and curious what you've seen on that front? Thanks.

Denise Paulonis -- Chief Financial Officer

Yeah, overall is still skews very heavily toward delivery. We just have a nature of a different product that comes in. So people aren't coming to us for curbside, for the convenience of not carrying out 24 packs of water and huge packs of toilet paper. So it seems to be delivery really does resonate better with our customers and we continue to have a nice portion of our business come through our owned website versus through the Instacart marketplace, and so we're pleased with that as well as that adoption continues. In terms of overall difference of the customer that eCommerce basket remained significantly higher than an in-store basket, which makes a lot of sense when people are paying for that delivery process they definitely want to take advantage of it and so that basket is almost double what an in-store basket would be so very healthy business there.

And overall we've really seen eCommerce stay pretty sticky. So as we talked about on the call, 10% for the quarter going to only trending down to about 9.5% by the end of the quarter. Now we'll watch the volatility that might come with the delta variant over the coming weeks and see if we see any change in trend, but seems to be well embedded into the shopping habits of our customers right now.

Operator

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

Erica Eiler -- Oppenheimer -- Analyst

Good afternoon, this is actually Erica Eiler on for Rupesh. Thanks a lot for taking our questions. So I wanted to switch back to, your new unit growth here. you know, clearly the team is very focused on opening new stores, but on the flip side of that comps clearly remain challenged. So can you talk a little bit about why yourself being fairly aggressive on the new store front, when the core business remains challenged, at what point do you say, hey, let's put on the brakes, maybe with our new store opening and focus on maybe a little bit more I I'm driving comps and turning around that core business?

Jack Sinclair -- Chief Executive Officer

Well, I think we've been pretty clear about why we're in that place strategy-wise, what we had as a business, we've lost some traffic over the course of those two years on the back of the change in strategy, notwithstanding COVID, we've lost some traffic on the back of our promotional strategy and that's why you look at 2019 and you take it forward to 2021, you can see that and we've identified the target customer base that we need, and it's a pretty small number, and we've been pretty modest in our comp expectations going forward. We don't need crazy comps for the economics of this thing to work as we can -- as you can see from the earnings that we're delivering. So if you can deliver superior returns on a relatively modest comp base then the opportunity for us to grow comes with building a lot of stores in places where we don't exist and thus so many of those and we're trying to make sure that our distribution centers will support that program of growth and the opportunity for us and we've identified this is part of the new format that we've opened a couple of them in the last few weeks. We can build the stores much cheaper, we can get them in front of customers in a smaller footprint and we can drive pretty significant returns on that when we look at when I go through the pipeline of what we've got for 2022, 2023, all kinds of smaller stores relative to where we've been, and the returns that we can get on relatively modest top line gives us growth potential that I think is pretty unique.

So I'm not sure that going back to trying to chase the wrong customers to get comp in our existing store base and abandoning the program of new stores would generate that kind of returns or the kind of cash returns that we can get going forward and it's based on the premise of a couple of things, one is the customer is more interested in healthy options and healthy eating and focused diets than they been done and they will be more interested in that going forward than they will be less interested in that. We've got a unique proposition that nobody else can would even want to do, because we're narrow in what we do and not narrowness allows us to target and allows us to build stores smaller in the right places and the numbers we're looking at. I don't think the modules demonstrate now over the last few quarters even through the strange when we've been in, gives us a lot of confidence there is returns in a modest comp in our existing store base and our real opportunity for us to build 10% new stores, every year and deliver significant returns.

Erica Eiler -- Oppenheimer -- Analyst

Okay. I appreciate all that color. And then just on clearly a lot of pressure points out there on the cost side, can you maybe talk about some of the cost pressures you're seeing in your business right now. Labor, transportation and how you're thinking about the leverage you have to pull on to manage through them?

Jack Sinclair -- Chief Executive Officer

Yeah, I think it's a. First of all, let's talk about the labor and stores, I think one of the things I've said in previous calls year were relatively immature and our use of labor in the stores, so those things we are doing and have done that will mitigate some of the labor pressures. We start from a higher base than most any way in terms of wages, so we're in a good place. It's not going to go up quite as much, I don't think as some others, we've introduced self-checkouts and a lot of our stores are now rolling that out fast. We didn't have any of that, so that's significant given the labor hours associated with that. Our replenishment in terms of getting product from the back door-to-the-shelf, a lot of systems in place to reduce the costs that hours that we need to run our stores so filling the shelves and taking the money through the register, we're relatively inefficient in the hours that we use. So there's opportunities for us to mitigate some of the pressures that are coming on labor on that basis.

And with regards to transportation, I'm really pleased that we've built the distribution center in Colorado so we didn't have to drive from Arizona to Denver for the product. I'm really pleased with all our distribution center in Orlando. So the products driving from a Orlando to Naples rather than Atlanta to Naples, so our transportation pressures are clearly real, we've actually mitigated then by bringing them and we said all along, there is a bit less miles would save us some cost. So we're mitigated that, but those are real pressures and we think we're mitigating them pretty well. I don't think Denise will act it up.

Denise Paulonis -- Chief Financial Officer

No. I think you said it well, Jack, and I think for all those pressures coming forward, you can still see the profit that we're delivering through the company. So I think, the realization that we do have the cost saves to offset some of those pressures as is evident in the results.

Operator

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

Renato Basanta -- Barclays -- Analyst

Hi, good evening. This is actually Renato Basanta on for Karen. Thanks for taking my questions. So my first question is on gross margin. So far this year, it looks like you've been able to hold on to much of the increases, you saw in 2020 versus 2019, which is in line with what you've guided to, but in the second half, it looks like your guidance implies much less of an improvement on a two-year basis. So just wondering outside of losing some COVID benefits, wondering if there's anything unique to the second half in terms of pressure that you may be expecting, any color there would be helpful?

Denise Paulonis -- Chief Financial Officer

Yeah, I would reinforce that we do believe that we will hold the vast majority of the gross margin gains that we've had over the two-year cycle. The one thing that you might need to think about on the two-year basis is that remember at some of the improvements in margin actually started in the fourth quarter of 2019. So Jack joined us just before that at the beginning of the third quarter and started rolling some of the changes that we have today, and the fourth quarter was the first quarter where you would see some of the pull back of the very inefficient promotions. So that's why you will just see a little bit less of a full two year stack gain in the fourth quarter, then you see the balance of the year only because we actually captured it a quarter earlier. if that makes sense.

Operator

Thank you. And our next question comes from Chuck Cerankosky with Northcoast Research. Your line is open.

Chuck Cerankosky -- Northcoast Research -- Analyst

Good afternoon, everyone. First question, if we're taking a look at the customers who might have reduced their visits to Sprouts, do you see any demographic reasons, income reasons that they might be the same customers who were dining out more?

Jack Sinclair -- Chief Executive Officer

I don't think I really know the answer to that, if I'm honest chuck but clearly that's a possibility. I think the way we look at what's happened Chuck are, there has been two things, the consolidation from COVID and then there has been the reduction from less, I'm talking two years -- the two-year stack and in terms of traffic there has been those two things, consolidation plus less stimulus in terms of very aggressive promotions. With regard to restaurants. I think we saw a little bit of a peak at certain times up and down in this., but there are some behaviors of the customers of state kept going, which is I think, why the basket is held out when they do come in, whether it'd be a little bit of baking and a little bit cooking, a little bit of a meals, we're seeing our strength in our daily business which would suggest opposite to the question, but I don't know that really got the answer. Denise to that.

Denise Paulonis -- Chief Financial Officer

Yeah, you know, and the one thing that I would consider is knowing that we have seen some strength in April and that was the beginning of the reopening, but then May and June, I think we would all say whether we experienced it personally or in the public or press, truly restaurants becoming busy again, travel ticking up quite a bit. I have to believe that that's relevant for our customer base, more or less than someone else's customer base I don't know. But it feels as though it was real that people were making choices to get out of their homes and to take advantage of what felt like the COVID glory days for lack of a better way to put it before the delta variant really ramped up.

Chuck Cerankosky -- Northcoast Research -- Analyst

Great. and then when you're talking about calls to action or promotions, could you talk, tell us philosophically how that differs from attracting a new customer or lapsed customer into your stores versus getting an existing customer to spend a little bit more and increase their basket size?

Jack Sinclair -- Chief Executive Officer

Yeah, I think there is still, there are definitely two types of promotions that we're working on in terms of driving the basket in the store when the customer comes in, there is some very specific activity that we're putting in place a combination of bringing very exciting. a new varieties of product innovation centers where we've got products that people haven't seen before and that drives it through and I'm very and probably more assertive displays of our produce business, more assertive displays of local produce, which we've just kicked off in Colorado, right now, which I'm excited about.

So local seasonal innovation centers, there's a number of things that we're doing to drive to drive traffic -- to drive basket with the existing customer base. The secondary, the other side of that equation is how do we drive -- drive the traffic to the store and that tends to be more holistic promotions that would cover across. If you think what we've got to communicate we've got good everyday prices, we've got great produce prices, we've got unique promotions and we've got specific basket drive traffic driving events and that's what we're going through at the moment in terms of number of call to actions. For example, we run 25% all vitamins and half of promotion communicated it very effective for the direct customer that's the thing that can drive some traffic and drive some specific. So we're going to be running at 25% of both promotion, which again, other people on going to run about after and that allows us to communicate the differentiation of our business. Organic produce, we can use that very effectively, our organic produce makes it up to 35% of our sales. I don't know anyone that sell 35% of the produce business, that's organic. We're driving those messages in our digital way as opposed to using some of the techniques of, of being some mass media that we haven't used in the past, we're on TV, trying to do some of those things and some targeted markets. So it's both sides of the equation [indecipherable]. We're really pleased the way stores again behind the basket driving work as they can do a lot to help that and I'm pleased with the restructure. The way the stores are getting behind it. We're seeing some progress on that and then we are excited about the work that we're doing in terms of traffic building on the on those calls to action.

Operator

Thank you. Our next question comes from Kelly Bania with BMO Capital Markets. Your line is open.

Kelly Bania -- BMO Capital -- Analyst

Hi, thanks for taking our questions. First, I just wanted to be clear, and I apologize if I missed this, but just want to make sure we understand exactly what is coming in better on the margin front for you to maintain your EPS range despite the lower comp outlook? Just want to be clear on that.

Denise Paulonis -- Chief Financial Officer

When we play into the beginning of the year, we had, we have different levers that we would pull of you can look and say, which projects and how fast might they move, how fast can we move on and shrink, where can we drive efficiencies and labor in our stores, and how quickly can we adjust to those types of activities. So what we're really doing is we're really pulling those levers that were available to us. We're not stopping progress on anything that is core to the strategy, but what we're really doing is being prudent throughout the P&L in terms of maintaining the gross margin gains from last year and in the way that we wanted to do, managing distribution costs and taking advantage of the fact that we have the two new DCs and taking transportation cost off the road, and then really working on our in-store productivity initiatives to be able to realize the savings that we need to keep the P&L strong.

Operator

Thank you. And this concludes the question-and-answer session. I would now like to turn the call back over to Jack Sinclair for closing remarks.

Jack Sinclair -- Chief Executive Officer

Yeah. Thanks everybody for taking the time of listen to what we're excited about our business and we really appreciate you taking the time to spend some time [Phonetic].

Take care everybody. Appreciate your time.

Operator

[Operator Closing Remarks]

Duration: 59 minutes

Call participants:

Susannah Livingston -- Vice President of Investor Relations & Treasury

Jack Sinclair -- Chief Executive Officer

Denise Paulonis -- Chief Financial Officer

Krisztina Katai -- Deutsche Bank -- Analyst

Scott Mushkin -- R5 Capital -- Analyst

Tom Palmer -- JPMorgan -- Analyst

Analyst

Spencer Hanus -- Wolfe Research -- Analyst

Mark Carden -- UBS -- Analyst

Erica Eiler -- Oppenheimer -- Analyst

Renato Basanta -- Barclays -- Analyst

Chuck Cerankosky -- Northcoast Research -- Analyst

Kelly Bania -- BMO Capital -- Analyst

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