Grocery Outlet Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 10 speakers on the call.

Operator

Greetings, and welcome to Grocery Outlet Third Quarter 2023 Earnings Results Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. We ask that all callers limit themselves to one question and one follow-up. As a reminder, this conference is being recorded.

Operator

It is now my pleasure to introduce your host, Christine Chin, Vice President of Investor Relations. Please proceed.

Speaker 1

Good afternoon, and welcome to Grocery Outlets' call to discuss financial results for the Q3 for the period Ending September 30, 2023. Speaking from management on today's call will be RJ Sheedy, President and Chief Executive Officer and Charles Following prepared remarks from RJ and Charles, we will open the call for questions. Please note that this conference call is being webcast Live and recording will be available via telephone playback and on the Investor Relations section of the company's website. Participants on this call may make forward looking statements within the meaning of federal All statements that address future operating, financial or business performance or the company's strategies or expectations are forward looking statements. These forward looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from these statements.

Speaker 1

A description of these factors can be found in this afternoon's press release as well as the company's periodic reports filed with the SEC, all which may be found on the Investor Relations section of the company's website or on sec.gov. The company undertakes no obligation to Certain non GAAP financial information, including adjusted items, reconciliations of GAAP to non GAAP measures as well as the description, limitations and rationale for using each measure may be found in the supplemental financial tables included in this afternoon's press release and the company's SEC filings. And with that, I would now like to turn the call over to RJ.

Speaker 2

Good afternoon, everyone, and thank you for joining us. We are pleased with our Q3 performance and the underlying trends in our business. We continue to drive industry leading sales growth due to our differentiated value proposition, and we are delivering on our mission of touching lives for the better. Customers are increasingly seeking value in their everyday lives, and we provide unbeatable value and access to affordable quality food. Our 3rd quarter sales increased 9%, driven by a 6.4% increase in comparable store sales.

Speaker 2

Transaction count remains strong in the quarter, increasing 9%, which is consistent with the prior two quarters. Traffic increases continue to be a combination of more new customers in our stores and existing customers shopping with us more frequently. Gross margin was also very strong in the quarter, up 80 basis points to 31.4%. This, together with sales growth, Drove a 20% increase in adjusted EBITDA to $68,000,000 Adjusted EPS grew 24% to $0.31 per diluted share. While pleased with our Q3 performance, we experienced Operational disruptions as we transition to upgraded systems.

Speaker 2

On prior calls, we have discussed our approach and history of investing in modernizing systems to improve capabilities and drive efficiency. We began to implement our most recent enhancements in late August, which includes upgrades to product, inventory, financial and reporting platforms. One important component of this upgrade is that will provide operators with improved data to make better purchasing, merchandising and marketing decisions. We are excited for the improved functionality, scalability and data analytics that this and other enhancements will provide. The transition to these new systems has resulted in ordering and inventory disruptions that have impacted 3rd and 4th quarter results.

Speaker 2

We have been partnering closely with our independent operators to minimize the impact to customers and sales. We have also elected to provide commission support to our operators as we continue to make steady progress adapting to the new systems. We anticipate the transitional impacts to be largely behind us by the end of the year. Charles will provide more details in his commentary. While food inflation has been moderating, consumers are still challenged with higher food prices and other financial burdens.

Speaker 2

Our 40% average basket savings compared to conventional grocers saves customers money at a time when they need it most. We also continue to wow customers with an ever changing treasure hunt assortment that includes savings on many items of up to 70% or more. This unique value proposition has been driving new shoppers to our stores throughout the year, resulting in ongoing increases in market share. A recent customer survey shows that increased trip frequency is resulting in higher spend. Our consistently low prices and unexpected great deals are driving high customer satisfaction as value remains the most important criteria for store visits.

Speaker 2

And our overall brand awareness continues to increase with customers intending to spend more with us in the next 12 months. In terms of products, we are pleased with continued strength and opportunistic supply and the solid execution of our purchasing team. The closeout market remains strong and our growing size and scale provide increasing access to products. We remain highly selective with our opportunistic purchases and we continue to buy only the best deals that are presented to us. We look forward to becoming a more valuable partner to suppliers as we grow and expand our geographic reach.

Speaker 2

As one of the largest buyers of consumable closeouts, we quickly buy and sell through large volumes of product, which helps our suppliers manage their excess inventory. Suppliers have increased their manufacturing capacities over the past several years and more recently have been rapidly adjusting and innovating their product assortments. These dynamics create more opportunities for our purchasing team as we work in close partnership with our suppliers to help them with their surplus inventory situations. We continue to strengthen our long standing partnerships with large CPG suppliers. We maintain strategic relationships throughout these organizations and we manage the partnerships for long term mutually beneficial sales and profit growth.

Speaker 2

New supplier acquisition and development remains another Many smaller suppliers rely on us to not only assist them with surplus inventory, but to also help them scale more quickly. We help them fill production lines and we provide a unique opportunity to grow their brands more easily than through other distribution channels. These partnerships allow us to offer our customers more brands, Items and value, particularly within our fast growing natural, organic, specialty and healthy categories. Our NASH product offering appeals to a broad customer base and further strengthens the treasure hunt shopping experience that drives a bigger basket, more frequent visits and new customer acquisition. Turning to operator support, We continue to work collaboratively with operators to build programs and initiatives that support and enhance their business.

Speaker 2

Our relationship with our IOs is a true partnership, and we are continuously reinvesting to upgrade fixtures, implement new technology and processes and deliver efficiencies that help them grow sales and profits. For example, we recently consolidated the purchasing of many store supplies that IOs previously bought on their own. Our scale and distribution network allow us to save operators money on many items they use to run their business. The new store portal is another example of investments we make to help IOs. This new system will help them more efficiently receive inventory, managing the assortment and access data to improve their operations.

Speaker 2

We look forward to realizing these benefits as we move past our initial transition period challenges. Average store operator income continues to grow, driven by the sales and gross profit growth that we split with our IOs in the form of commission. In the 3rd quarter, Operator commission payments increased by low double digits on a comparable store basis versus the prior year. Commission growth has been very healthy this year and we look forward to helping IOs with future efficiency and business enhancements. We opened 8 stores during the Q3, including our 400 and fiftieth store, which was also our 1st store in Las Vegas.

Speaker 2

We ended the quarter with 4 55 stores and we are on track to open 27 net new stores for the full year. We continue to be pleased with our new store performance, including those in our Southern California and East Coast markets. We also look forward to opening our 1st Ohio store before the end of the year in addition to stores in other new communities within our existing supply chain reach. Our new store growth efforts for 2024 and beyond remain focused on organic growth together with new real estate opportunities that align with our long term geographic expansion and store growth strategies. Complementary growth opportunities include expanding strategic relationships with large property owners, evaluating opportunistic real estate lists and exploring strategic regional acquisitions.

Speaker 2

Our white space remains huge with the potential to operate over 4,000 stores across the U. S. Finally, we are extremely proud to have recently published our 1st annual ESG report. This report showcases the positive impact that we have on our communities, our people and our planet. Our mission of touching lives for the better has core to the business from the start and fulfilling this purpose has resulted in positive environmental and social impact throughout our 77 year history.

Speaker 2

Our report highlights 7 key impact areas. The first three areas positively impact our communities. First, we save customers a tremendous amount of money. Over the past 5 years, we have saved customers over $10,000,000,000 Compared to conventional grocers, and we aim to provide customers $3,000,000,000 in annual savings in 2024. 2nd, we provide access to affordable quality food.

Speaker 2

About 10% of the U. S. Population is food insecure. We increased food access in our communities by providing customers with affordable quality food from trusted name brand suppliers. And third, we give back to our communities.

Speaker 2

Since its founding in 2011, our independence from hunger drive has Over $16,000,000 to fight food insecurity in our local communities. The next two highlighted areas positively impact our people. First, our highly differentiated model creates unique opportunities for our IOs to become local business owners and entrepreneurs. Operators enjoy the autonomy of running their own businesses, selecting localized products and providing outstanding service to their customers every day. We provide support to help them achieve the American dream.

Speaker 2

2nd is that we also create exciting opportunities for our employees. We continue to hire great talent to support growth and we continually reinvest in development and career advancement opportunities for our best in class team. In addition, our focus on our core values and ED and I initiatives help strengthen our culture and business overall. Our final two highlighted areas have a positive impact on our planet. Our opportunistic sourcing model reduces food waste by creating value from products that may otherwise be discarded.

Speaker 2

Our partnership with suppliers keeps food out of landfills, Reducing methane emissions while providing accessible nutrition to communities that need it. Lastly, we are focused on improving operational efficiency in our business and we partner with IOs to manage energy use in stores. These investments are good for both grocery outlet and IO profit growth as well as for the environment. We are proud of the positive impact we've had throughout our history. As we continue to grow our business, We remain committed to exploring new and innovative ways to further enhance the positive impact that Grocery Outlet has on our communities, our people and our planet.

Speaker 2

In closing, I want to thank our amazing IOs for their partnership and service. I also want to thank the entire GEO team for all that they do, which enables us to support our IO partners and deliver outstanding service and value to our customers. We see tremendous opportunities ahead of us and believe that the investments we are making today will position us for long term growth and increased profitability. I will now turn the call over to Charles to discuss our financials. Thanks, RJ, and good afternoon, everyone.

Speaker 2

Our 3rd quarter results reflect the continued momentum we are seeing in our business, which drove strong comparable store sales growth and margin expansion. For the quarter, net sales increased 9.3% to $1,000,000,000 primarily due to a 6.4% increase in comparable store sales and the impact of new stores opened over the past 12 months. Our system upgrades impacted comparable store sales by an estimated 150 basis points As comps were running in the high single digits before the transition, transaction growth remains strong increasing 8.6% slightly offset by a 1.9% decline in our average basket. We opened 8 new stores during the quarter Ending with 455 locations. Our new stores are performing well and building in line with our expectations.

Speaker 2

3rd quarter gross margin increased 80 basis points to 31.4% and gross profit increased 12.5% to $315,700,000 Healthy deal flow and a favorable buying environment drove margin expansion and more than offset inventory inefficiencies related to our system transition, which we estimate to have impacted gross margin by approximately 50 basis points. SG and A expense increased 8.7 percent to $278,100,000 compared to the Q3 of 2022. The increase was driven by higher commission payments to IOs, Store occupancy costs due to new unit growth and higher incentive compensation expense, reflecting our strong performance, partially offset by vendor receivable. Higher commission expense reflects strong gross profit growth together with We elected to provide to our IOs in connection with our system upgrades. As a percentage of sales, SG and A decreased by 20 basis points to 27.7 percent.

Speaker 2

Net interest expense decreased 11.9 percent to $4,200,000 due to a reduction in long term debt versus the prior year and higher interest income, partially offset by the impact of higher effective borrowing rates. With respect to the bottom line, GAAP net income for the 3rd quarter increased 55.1 percent to $27,100,000 or $0.27 per diluted share. Adjusted net income increased 23.4 percent to $31,000,000 or $0.31 per diluted share. Adjusted EBITDA increased 20% to $68,100,000 for the quarter. As a percentage of sales, adjusted EBITDA increased 60 basis points from the prior year to 6.8%.

Speaker 2

Turning to the balance sheet, we ended the quarter with $155,700,000 of cash, Slightly above normalized levels as we experienced longer payable processing times as a result of the system transition. We ended the Q3 with $308,600,000 of inventory. Gross debt was $296,300,000 at the end of the 3rd quarter with net leverage less than 1x adjusted EBITDA. During the quarter, we generated $119,100,000 of operating cash flow and invested $42,700,000 in CapEx, net of tenant improvement allowances, primarily for new store growth, Upgrades to our existing fleet in technology and infrastructure investments. Now let me provide some on our expectations for the Q4 and update our outlook for the full year.

Speaker 2

While our underlying business remains strong, We do expect the system transition to significantly impact financial results in the Q4 and to a greater degree than the Q3 given the additional months affected. With respect to the top line, we expect 4th quarter comp growth to be approximately 2%, which assumes a 300 basis point headwind from the system transition. For the full year, we now expect our comp sales growth to be in the range 7% to 7.5%. In terms of unit growth, we expect to open 13 new stores in the 4th quarter And 27 net new stores for the year. We continue to expect fiscal 2023 net sales of approximately $3,950,000,000 We expect 4th quarter gross margin to be approximately 30%, reflecting normal holiday seasonality along with approximately 150 basis points of impact due to the system transition.

Speaker 2

For the full year, we now expect gross margin of approximately 31.2%, a 70 basis point improvement over last year. With respect to the bottom line, we project 4th quarter adjusted EBITDA margin of approximately 5% of sales, reflecting the previously mentioned system transition impacts along with commission support that we are electing to provide operators. For the full year, we now expect adjusted EBITDA to be in the range of $248,000,000 to $252,000,000 At the midpoint, our guidance represents healthy bottom line leverage and approximately 16% adjusted EBITDA growth versus last year. Moving down the P and L, we continue to expect net interest expense of approximately $21,000,000 for the year, which reflects Projected forward interest rates on our outstanding debt. For adjusted net income purposes, we project A full year tax rate of approximately 30% along with average diluted shares outstanding of approximately 101,000,000.

Speaker 2

Based on these expectations, we now expect full year adjusted EPS to be in the range of $1.04 to $1.06 per diluted share. Regarding CapEx, we continue to project approximately $155,000,000 for the full year Net attendant improvement allowances reflect a new store growth and ongoing investments in our store base and business infrastructure. In closing, I would like to take a moment to thank our incredible team of independent operators and employees for continuing to execute at a high level on behalf of our customers. Our underlying business remains strong and we are making important investments to further strengthen our value proposition and position us for long term growth. We will now open the call up to your questions.

Speaker 2

Operator? Operator?

Operator

Thank you. We will now conduct a question and answer session. Our first question comes from Leah Jordan with Goldman Sachs. Please proceed.

Speaker 3

Good afternoon. Thank you for taking my question. I just wanted to start off with a couple of questions around the new Florence, you implemented this quarter. What has been the biggest challenge related to the ordering? Is it just learning the new program?

Speaker 3

Is there anything specific About the functionality that surprised you. And then you also said the disruption would be largely behind us by year end. But how should we think about any impact into the first half of next year, especially any cost that we should think about annualizing? And then also you mentioned that would bring better data analytics. Just curious how quickly you think you can implement those learnings Or have you any insights to share in just the 1st few months?

Speaker 2

Hi, Leah. I'll take the first There are a couple of parts to that question, and then I'll turn it over to Charles to address your question around impact into 2024. First, just some more information on what I shared in my comments. We did upgrade a number of systems at the end of August, Inclusive of product inventory, financial and reporting platforms. These upgrades include a replacement of our AS400 system, Which was our legacy ERP system with SAP along with other third party plus some new proprietary applications for buying in store operations.

Speaker 2

So that was the enhancement that was implemented back a couple of months ago. It's The continuation of prior ERP upgrades that we've implemented over the past 8 to 10 years and consistent with the approach We've talked about in making ongoing investments in modernizing our systems to build foundation for future growth and scalability of the business model. As far as benefits, you asked about data and analytics, really look forward to the enhancements These new platforms will provide. They will give us new capabilities for how we manage the business. They'll drive efficiencies Through better data and analytics, that will support us with better decision making and that will be an improvement enhancement For both the operator community as well for grocery outlet in total.

Speaker 2

In terms of the challenges and the disruption that we face as we transition to the new We were challenged with inventory visibility and the impact here was on ordering and inventory management in general. And unfortunately, this disruption did have an impact throughout the business and the P and L. And notably, as mentioned In our comments, top line sales were impacted by lighter inventory levels, slightly lower variety. We had some pressure on margin as it relates to inventory inefficiencies and then SG and A was higher as well as we elected to provide Operator, with support. I'll say that we did expect some disruption during this transition.

Speaker 2

It was factored into our previous guidance, just not to the degree that we've been experiencing it. And of course, we're very disappointed with the magnitude of it and we own it. We own where we are. And at this point, we have addressed the inventory visibility issues along with other issues we experienced Earlier on, so we've made very good progress there. We've also recently returned to more normalized Store ordering practices, we have much healthier warehouse inventory levels and flow throughout the system.

Speaker 2

So we're feeling good About all of that, I'll also say that we are still adapting to other parts of the new systems. We were working through levels and margin management and therefore, the impact that we anticipate throughout the 4th Nevertheless, we are making good daily progress. And as I mentioned, we do anticipate the transitional impacts to be largely behind us as we get To the end of the year. And I'll kick it over to Charles now to comment on 2024. Yes.

Speaker 2

Leah, this is Charles. Just a bit more color on costs and sort of The cadence as you think about the quarterly impact going into next year. So as it relates to the Q3, again, think of this as being 1 month Of impact to the fiscal quarter. And so as RJ mentioned, we felt both the top line and a margin impact In Q3, along with elective commission support, you see the same impacts in the 4th quarter just to a greater degree as we're feeling the Got a full 3 month impact, if you will, in the Q4. We do expect that as we over the course of the Q4, all of those Impacts moderate and as disappointed as we are with the magnitude of the impact in the Q4, we do expect and believe that it will be Largely behind us by the end of the year.

Speaker 2

And so our view at this point is we will enter the New Year without any lingering Cost impacts or otherwise related to the transition.

Speaker 3

Okay. Thank you. That's very helpful. So for my follow-up, I just wanted to ask about new store growth for next year. I know you're not giving formal guidance yet, but any color around how the pipeline is building, what you're seeing in the construction and permitting environment Or how maybe the progress around discussions for potential M and A to get to 10% for next year?

Speaker 3

Thanks.

Speaker 2

Yes, yes. We are feeling good about future store growth opportunities. White space remains massive. You continue to Think about that 4,000 plus number across the U. S, so plenty of opportunities out there for us.

Speaker 2

If I were to go back earlier in the year from prior calls, first Goal is to get back to 10% growth rate this year and we're happy to be tracking to this now with 8 new stores that we opened in the 3rd quarter and on track For 13 more in the Q4 that'll get us the net 27 new stores for the year. So tracking well there. Regarding 2024 and the out years as we are actively working the pipeline right now for 2025 and 2026 as well, Continue to see great opportunities and the efforts underway continue to include Organic growth together with consideration of opportunistic real estate lists as well as smaller Regional acquisition opportunities and same as what we've talked about before, we think about all of those activities coming together to represent Future store growth. We do try to stay close to that 10% target as we think about the moving pieces here. There are a lot of Certainly as it relates to dispossessed real estate and lists that are available that we're evaluating.

Speaker 2

And then more recently from the past call, past several months, opportunities around Acquisitions, those are interesting for us to explore and how it might complement the other activities that we Have underway. So feeling good about the number of things in the pipeline and we'll provide further update More specifically on 2024 store count on our February Q4 call.

Speaker 3

Great. Thank you.

Speaker 4

Thank you. Thanks.

Operator

Our next question comes from Oliver Chen with C. D. Cowen. Please proceed.

Speaker 4

Hi, RJ and Charles. Regarding your comp guidance, is your expectation that traffic continues to be Very positive offset by average unit retail. What should we think about in terms of average unit retail near and longer term? And then as we appreciate a lot of the good changes on the new store portal, the issues you had, just what gives you confidence That they'll be largely behind by end of the year. And then a follow-up, as we think about new regions, It sounded like store productivity was in line with your expectations.

Speaker 4

We just love your thoughts on your supply chain footprint. You gave more color on how you approach M and A, But that framework would be interesting to hear more about as well. Thank you very much.

Speaker 2

Great. Oliver, it's Charles. Let me The first part of your question, then I'll kick it over to RJ. So with respect to comp composition, yes, really pleased with the health of Comp that we're driving, as you can see, continues to come from strong transaction growth. Customers clearly responding to the values in Treasure Hunt I love that we're seeing both increased visits from existing and new customers with high satisfaction.

Speaker 2

As it relates to the comp headwind as a result of the system transition that really did impact ticket. So ring, as you saw, was down a little less than 2% for the quarter, really coming from lower units. And that's both as a result of higher frequency, but yes, lighter inventory levels in variety As a result of the system transition. AUR is still positive, but moderating very As we expected, as we're lapping higher year over year inflation levels. And so Yes.

Speaker 2

Looking forward, from our perspective, it really is the same basket dynamics that we expect to continue. Just recall for us the impact of inflation, Deflation on the way down is more muted because of our buying model. And then that AUR units in the basket Dynamic isn't necessarily directly comparable due to the changing nature of our assortment. And on the your question around the systems upgrades, Oliver, as I mentioned before, We have addressed the bigger issues that we faced earlier on around inventory issue around inventory visibility issues as well as Product flow challenges, both into the warehouse and also from the warehouse to the stores. So that progress feels really good.

Speaker 2

And as a result, we have returned to more, I'll call them more normalized store ordering practices and then together with that Healthier warehouse and store inventory levels, at a really important time. So I'm feeling good about the progress that we've made In support of the holiday shopping period that we're in the middle of right now. We are still to other parts of the new systems, there are a lot of new processes, new functionality that comes with these new systems. And then together with that, working our way back to what we would consider to be optimized inventory levels along with How we manage the business in total margin and operations included. Given the progress that we've made and the daily progress that we continue to make, We do feel confident in being able to resolve these outstanding issues to the point where The impact is then largely behind us by the end of the year.

Speaker 2

And then to your third question around new store performance, Feeling good there, continue to see really nice performance from new stores across all geographies. And then, I think you were also asking about acquisitions and supply chain footprint as we continue to grow our stores, whether it's Through organic growth or opportunistic list or perhaps acquisitions, of course, infrastructure is a really important part of supporting that growth and we've always made those investments ahead of the store count that follows or that is Our longer term growth plan. So wouldn't be any different as we think about those opportunities. And back to my comments around wanting to Center around this 10% annual growth number because of infrastructure investments That we want to make to make sure that we're growing at a healthy rate.

Speaker 4

Thank you. Best regards. Thanks,

Operator

Our next question comes from Robbie Ohmes with Bank of America. Please proceed.

Speaker 5

Hey, thanks for taking my question. Is the system, the technology platform Does that change the timeline for e commerce initiatives like launching your app, I think the plan was for 2024?

Speaker 2

Yes. So we let me just update you on where we are with the app and in general, a more personalized approach to marketing. So we did just as a reminder, we have been successfully piloting the app in our Washington stores since the end of last year. So it's been out there in those markets For a while, more recently this year, we rolled out to Oregon and the East. California and Nevada stores don't have it yet.

Speaker 2

We had planned to introduce it by the end of the year. That has been delayed by the system upgrades and some of the things that we're still working through. Having said that, we do plan to introduce the app to these markets very soon. So think about a Q1 time frame. So just a little bit delayed there.

Speaker 2

And then from there, we would do more of a full on introduction and rollout. It's been a soft Launch to this point, as we've been learning about, how it operates and customer experience, which pleased to say has been Really positive. The customer adoption has been good. The feedback has been positive so far. We're seeing a nice percent of transactions On the app, through the app, so that all feels really good, despite not having really put any marketing muscle behind it.

Speaker 2

That's all in front of us still as an opportunity For 2024. That's helpful.

Speaker 5

And then my follow-up question is, how exactly does commission support work? How do you guys how does that work for the IO? And how do you determine how much commission support to give them in a situation like this?

Speaker 2

Yes, I'll start and then Charles, you can chime in here. In terms of impact to operators and the commission For the inventory visibility and ordering challenges that I mentioned, of course impacted the operators ability to manage The flow of product into their stores largely they are pulling product in through the order guide and when these challenges started back in September, beginning of September, that was very difficult for them to do. We've been in very close communication with them throughout and We've been navigating these challenges together and the partnership that we have with them. We talk a lot about the partnership and the relationship that we have with operators. It's been a really big part to minimizing the impact that this has had on customers and the business.

Speaker 2

We're not happy with the magnitude of impact on the business. But overall, the customer experience, there's not A huge impact on that, a little bit lighter in inventory, some lower variety accounts. But together with everything the operators have done, We have been able to minimize that impact. We did elect at the outset of the implementation to provide operators with commission support And the purpose for that was, well, 1, in spirit of the partnership that we have with them, and then 2, To help minimize the impact of this transition on their commission and income together with the work that we've been doing to minimize the impact on the customer and our P and Yes. Anything else, Charles?

Speaker 2

No, no. Just to add to that, Robbie, it's as RJ said, it really is a reflection of the spirit of partnership, The relationship we have with Ios and so we didn't disclose a specific dollar amount, but it is included of course in our SG and A for the Q3 and The estimated impact in the 4th quarter is included in our EBITDA guidance we provided.

Speaker 5

Got it. Thanks so much.

Speaker 2

Thanks. Thanks, Robbie.

Operator

Our next question comes from Christina Khattai with Deutsche Bank. Please proceed.

Speaker 6

Hey, guys. Thanks for the question. So RJ, I just wanted to follow-up on the system upgrades. I mean, it does sound like you anticipated some disruption, but then it has actually come in well ahead some disruption, but then it has actually come in well ahead of that. Like, 1, is that a fair characterization?

Speaker 6

And then 2, Is it fair to say that this doesn't alter any of the margin structure into next year or the long term and you're essentially be able to fully recapture All of the margin pressures once you lap the 3rd and the 4th quarters?

Speaker 2

The yes, for your first question, that is a fair characterization. We did expect This is a big transition from a legacy platform that we've been operating on for the past several decades. So and it's something that we've been working on For a couple of years now, so we've always known how large it was and complex. We did expect As a result, some disruption, certainly not to this degree or this magnitude. So I think you characterized it well.

Speaker 2

And then in terms of impact, looking forward, I think similar to the earlier question, we as I said, we do expect The transitional impact to be contained to this year from what we've already experienced in the Q3 And then largely behind us at the end of the year, so you should think about us reverting back to previous Performance and all the things that we've always talked about related to consumer trends, top line sales and how we've managed For both gross margin and bottom line profit.

Speaker 6

Got it. Thank you. And just as a follow-up, Had a question on the IO pipeline, especially as you're planning your 2024 and 2025 unit expansion plan. Last quarter, you provided some very helpful statistics on average IO net income. But just the question is, do you have any concern in Or any difficulty maybe attracting top talent in future years, especially just thinking if rates stay higher for longer.

Speaker 6

Is that something that you're concerned about?

Speaker 2

No, no, we don't have any concerns about that. There are more than enough potential future operators. It's a really attractive model. They get to own and operate their own business. They've got the combination of independence together with the support and scale that we provide.

Speaker 2

They work with family. They have this opportunity to give back, unlimited financial upside. We've talked we talked on the last call about some of the Economics, favorable economics and average operator income. So no, there are a lot of people out there and the leads continue to be really healthy. Annual leads, we mentioned last time, is around 30,000.

Speaker 2

And so for us, The work is to make sure that we're finding the best candidates and the right fit. And so we do go through an extensive process and It goes both ways. It needs to be the right fit for them as well. But yes, no concerns about the IO pipeline to support future stores.

Speaker 6

Great. Thank you so much.

Speaker 2

Thank you.

Operator

The next question comes from Joe Feldman with Telsey Advisory. Please proceed.

Speaker 7

Hi, guys. Thanks for taking the question. I guess just one more on the systems transition. I guess Kind of curious about the staging of it. You guys are always very methodical, like even like the app, take your time, Testing, learning.

Speaker 7

And I was curious as to was there a reason behind needing to flip the switch on all those systems at once versus staging it a little bit more?

Speaker 2

Well, first, we as you know, Joe, Over the past 10 years, we have modernized and upgraded many of our enterprise systems, Inclusive of warehouse management system, we were operating on a relatively new point of sale system, we have a new HR system and so the my point here is that this wasn't full across the enterprise, every single operating system. So We have been more methodical in that regard. As it relates to these current upgrades for what we were replacing Product platform, inventory, financial and reporting, it did require us to do a much bigger implementation Crossed the functionality that previously existed on the AS400, our legacy enterprise system with, as I mentioned, Replacing that with SAP together with other third party and some new proprietary systems. And so those that functionality all For the most part, previously was on AS400. So it was a situation where we needed to do a bigger implementation Then more piecemeal, I think, than what you're suggesting or asking about.

Speaker 7

Got it. Thank you for explaining that. I appreciate that. And then just a quick follow-up. With some of the new customers that you're continuing to see, I'm just curious how The profile is any different maybe from the existing customers and how sticky they are?

Speaker 7

Like are you retaining them?

Speaker 2

Yes. The profile is pretty similar. I'd say the one notable difference consistent with My comments on prior calls is that we are seeing particular strength with middle income and higher income customers. Within the new customers that we're seeing, there are lower income customers there as well. We're over indexing on Middle to higher income where the need for value is more pronounced for that group or has become more pronounced Throughout the year as inflation has carried on.

Speaker 2

And so that would be the one notable difference. But overall, the profile is generally representative of our Current customer mix as we're quite broad, as you know. And then in terms of stickiness, we don't track Specific customers, so I can't speak to 1st trip, 2nd trip and then the stickiness. We do know, however, that Satisfaction levels are really high. This is from customer surveys that we do.

Speaker 2

We know that they like the savings and the products The assortment that they're seeing in the store and we also know that their intent to shop more in the future is high as well. And we see that For customers that have shopped us more recently and also true for customers that have been shopping us for a long time. So that to us is a good indication of stickiness and then A future, I'll call it new base for loyal customers as we look out into 2024 and beyond.

Speaker 7

Got it. That's great. Thanks for that and good luck this quarter. Thank you.

Speaker 2

Thank you.

Operator

Our next question comes from John Heitkenbako with Guggenheim Securities. Please proceed.

Speaker 8

Hey, guys. I'm going to try to do 2 quick here, 2 topics. Number 1, the impact On comp in the quarter on ticket, was that in stock? And then related to that, Has that now has the customer experience now begun to improve, let's say, October early November over September? Because I would imagine it's important, Right.

Speaker 8

When you think about the holidays, to have the experience getting a lot better, heading into Thanksgiving. So that's number 1. And then number 2, Maybe just talk about your thoughts on brand clustering and brand awareness on the East Coast. As you talked about Ohio, I know you're opening in Pittsburgh And you think about the western part of the territory versus Jersey and Baltimore, more important to cluster or do you just want to get to, Again, good locations get to the 70 locations on the East Coast, so the procurement kicks in.

Speaker 2

Hey, John, it's Charles. Let me tackle the first part with respect to your question around ticket and the basket. Yes. As I mentioned, really the comp headwind we saw in the Q3, it impacted ticket and specifically It was lower unit. So we are not having the normal sort of levels of inventory and stocks and variety As a result of the system transition, we believe the headwind there and would expect that continues to be the driver of the headwind in 4th quarter, as I mentioned, a bigger comp impact because you've got the full 3 months, but do anticipate that that improves Over the balance of the Q4.

Speaker 2

And that's related to the second part of your question. The customer experience has improved where We were a little bit lighter in inventory and variety impacting the basket that has since improved quite a bit. And so still a little bit To go, but we feel really good about the inventory levels and what's represented in the store now. And so the experience is even better and as you know an important time of year for us. And then as far as clustering goes, yes, that is our approach.

Speaker 2

We do try to cluster as best we can. Of course, you have real estate availability and timing that You can't do it exactly to how you might draw it up from a brand awareness and support standpoint. But we think pretty close Within the geographies that we're looking at, we have our first store in Western Pennsylvania recently opened. So that will Carry over now to Ohio, just across the border for our first store. And so very close markets there.

Speaker 2

And then we're building the brand awareness, whether it's in Maryland or New Jersey as we continue to infill there. And so while these are different It's still trying to stay more concentrated rather than opening a store in Florida or opening a store in Texas or where have you to be really, really spread far apart. So, we do try to follow that clustering strategy as part of our real estate growth strategy. All right. Thank you.

Speaker 2

Thanks, John. Thank you.

Operator

The next question comes from Mark Carden with UBS. Please proceed.

Speaker 2

Good afternoon. Thanks so much for taking the questions. So you guys talked about strength continuing in the closeout market. How is the product pipeline shaping up relative to what you've seen The past few quarters and then for how long would you expect the CPG innovation related opportunities to remain elevated going forward? The pipeline continues to be really strong, Mark.

Speaker 2

It has been the case throughout the year. I'd say Consistent where we are, well, Q3 and then where we are in the Q4 here, consistent with The strength that we've seen throughout the year, meaning it's broad across categories, it's broad across suppliers, there continues to be a lot of positive momentum In terms of the breadth and the depth of the lists that we're seeing. And you asked about innovation. Innovation is one of Several trends that continue to benefit surplus supply in our business. First, I'd say forecasting continues to be really hard.

Speaker 2

That's been true throughout. I think it continues to be a challenge for suppliers and anytime there are these imbalances that yield surplus inventory. Innovation, as you noted, that has increased new items, new brand extensions, brand label changes, As consumer preferences are changes, innovation goes along with that. I see that continuing Well, in front of us and so that's a positive trend for us. And then just changes in the assortment more generally, there's been a lot of that and anticipate that Continue as well.

Speaker 2

So, no reason for us to think we certainly haven't seen any signs of slowing down and we expect that strength to continue into next year.

Speaker 9

Great. Thanks so much. Good luck.

Speaker 2

Thanks, Mark.

Operator

The next question comes from Cory Tarlow with Jefferies. Please proceed.

Speaker 4

Great. Thanks. I was wondering if you could talk a little bit about your price gaps relative to the competition. So In recent months, I think some of your competitors have gotten a little bit more aggressive on pricing. Have you noticed As a result, a need to adjust your prices accordingly?

Speaker 4

And if so, how do those price gaps compare to what they have been in the past?

Speaker 2

The price gaps are very healthy. We always are managing value, we look at it a lot of different ways, and that's both for everyday pricing and promotional pricing. We've seen a little bit of a tick up in promotional activity. Nothing that concerns us. We've been At this business for a long time in all types of promotional environments and our value continues to Show a really nice spread and it's the reason why we've seen such healthy growth this year.

Speaker 2

We maintain The basket savings and the target there is 40% relative to conventional grocers that puts us at around a 20% basket savings The big discounters in our markets and in a time like this when inflation is really high For food and then for everything else, consumers are finding us as the place that offers the best value and access to affordable food compared to anyone else out there. So we'll continue to keep a close eye on that as the promotional environment changes, we'll adjust accordingly. No concerns with the slight increase there and feeling really good about the value that we're delivering customers and the trends that it's driving.

Speaker 4

Great. Thank you very much. Best of luck.

Speaker 2

Thank you.

Operator

The next question comes from Michael Baker with D. A. Davidson. Please proceed.

Speaker 9

Okay. Thanks. Curious about the what would your comp guidance have been with So I guess your comp guidance would have been 500 basis points or 300 basis points better without this, so sorry, it would have been about 5%. So Still a little bit of a slowdown from what you would have been at about 8% without this issue. Why the slowdown?

Speaker 9

Is that just sort of being You guys always seem to guide conservatively or is there another reason why even adjusting the systems issue back to comps would slow?

Speaker 2

Yes. Mike, I think when you do the math and look at some of the stack comps, you'd see once you adjust for the system impact, you're going to see pretty steady Performance as it relates to the guide. And so it really is more of a reflection of just lapping higher numbers from prior year, both with respect to increases in traffic that we were driving last year As well as it's just higher inflation levels impacting the basket.

Speaker 9

Okay. That makes sense. And If I could ask sort of a follow-up, I guess, to that. It seemed like correct me if I'm wrong, but We sort of backed into your guidance back in the second quarter, you gave back half guidance and then you gave some color on the 3rd quarter. So you could back into the Q4 and it seems like you're planning on something close to about 2, 2.5 and that was before the systems issue.

Speaker 9

Now if you back out that systems issue, it seems like you're planning on something closer to a 5. So I guess my question is without the systems Would your Q4 outlook have been better than it was previously? In other words, is the underlying business actually even better than you had thought Excluding the systems issue.

Speaker 2

Yes. Again, just to clarify there, Mike. So we have not previously commented On 4th quarter comps, again, we provide kind of a range for the full year and then current quarter comp Commentary, if you will. So I can't reconcile the numbers you're speaking to other than to say, For us, again, as you normalize for the system transition impact, We're feeling really good about the underlying health of the business as it relates to comp and particularly the traffic that We're driving into the stores. As customers are really responding to the values we're offering and everyone continues.

Speaker 2

While inflation is moderating, Absolute price has remained really high and so consumers are seeking us out.

Speaker 9

Yes, understood. But understanding you didn't give 4th quarter guidance in the past, I understand that, but you gave full year guidance. We knew the first half and you gave 3rd quarter guidance. So one can back into the implied, if you will, Q4 outlook. I guess that's what I was referring to.

Speaker 9

But fair enough.

Speaker 2

Yes, we provide a full year range, but I get your point.

Speaker 9

Yes. Okay. Appreciate the color. Thank you.

Speaker 2

Thanks. Thank you.

Operator

The next question comes from Simeon Gutman with Morgan Stanley. Please proceed.

Speaker 2

Hey, guys. It's Michael Kessler on for Simeon. Thanks for taking us. My one question, just looking at Q4 related to a prior question, the Q4 outlook, looks like it's implying about 100 basis points of Lower margin lease versus the consensus set up and where we were thinking. As far as the kind of recapture potential for next year, The fact that it could be mostly resolved, does that kind of mean that we should be seeing some sort of like relatively comparable Bounce back next year as we move into 2024?

Speaker 2

Or is there also some sort of a component of higher run rate costs associated with the new systems that To kind of just speak to the evolution of your systems

Speaker 4

and the business as it scales.

Speaker 2

Yes. Michael, it's Charles. I'd say premature for us to provide specific guidance. I think R. J.

Speaker 2

Reference was with respect to the fact that we don't expect to see any lingering Margin impacts going into next year. But again, at this stage, we'll stick with our current cadence of providing Fiscal year guidance on the February call. But again, in terms of our orientation, we're feeling great about the underlying health of the business, Really looking forward to next year. Again, values resonating with customer, the buying environment is strong. And so we know We'll be well positioned for whatever the backdrop exactly is for fiscal 2024 and we'll provide all that color on the next call.

Speaker 2

Okay. Thank you.

Operator

The next question comes from Jeremy Hamblin with Craig Hallum. Please proceed.

Speaker 2

Thanks. Sorry, one more follow-up here on the commission support. Just in terms of dollars and cents, The commission support, is that going to be higher, I would assume, in Q4 because of the bigger impact to comps Then the total value in Q3. And then secondly, if we kind of back out the gross margin impact here, You've obviously had another strong year on comps, but it looks like your just your structural gross margin maybe is a little bit higher Then what it had been pre pandemic, but just wanted to see if you could comment on that and any Particular driver of that or is it just quality buying environment and still a little bit of inflationary pricing offset by costs coming down a little bit? Sure.

Speaker 2

So as it relates to the incremental commission support, yes, in the Q4, we do expect It will be a larger impact in the Q3, again, for the same reasons that we're seeing a larger impact to both comp and gross margin With the additional months in the Q4, that again is all reflected in the Q4 guidance that we provided. As it relates to sort of the normalized margin for 2023, yes, we feel again that it really is a reflection A variety of things, it is a favorable buying environment. Team continues to do a great job and we continue to see Great deals across the assortment. And so again, premature for us to say exactly what the environment will look like In the next year, but feel great about, the positioning as we enter fiscal 2024. Great.

Speaker 2

Thanks for taking the questions. Best of luck. Thank you.

Operator

Thank you. At this time, I would like to turn the floor back over to R. J. Sheedy for closing comments.

Speaker 2

Thanks, everyone, for joining us today. Appreciate your support and look forward to updating you on our next call. Have a great rest of the day. Thank you.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.

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Earnings Conference Call
Grocery Outlet Q3 2023
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