Q2 2020 Grocery Outlet Holding Corp Earnings Call
Greetings and welcome to grocery all its fiscal second quarter 2020 earnings results Conference call.
At this time, all participants are in listen only mode.
Of course in an exercise and will follow the formal presentation.
So what's your require operator assistance during the conference with Star Zero other telephone keypad.
As a reminder, this conference is being recorded.
It's now my pleasure to introduce your host Joseph Stalin Vice President Investor Relations like you you made again. Thank you. Good afternoon, everyone and thank you for joining us on today's call to discuss grocery outlet second quarter financial results.
Participants on this call will make forward looking statements, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements.
Any such items, including our outlook for fiscal 2020.
And future performance.
Be considered forward looking statements within the meaning of the private Securities Litigation Reform Act that 1995.
A description of these factors can be found in this afternoon's press release, well within our latest prospectus periodic reports, we file with the FCC all of which we may be found on our website that investors dot grocery <unk> dot com.
On a DC dot Gov.
We undertake no obligation to revise or update any forward looking statements or information.
During our call would may reference certain non-GAAP financial information, including adjusted items.
Reconciliations of GAAP to non-GAAP measures as well the description limitations and rationale for using each measure maybe found in the supplemental financial tables included in this afternoon's press release, and our 60 filings and to the investors tab of our web site.
We reference non-GAAP measures and some of our financial discussions as we believe they more accurately represent the true operational performance and underlying results of our business.
As I think on today's call will be growth for our Chief Executive Officer, Eric When Burke.
President R.J.C.D. and Chief Financial Officer, Charles broker.
Following our prepared remarks, well open the call for questions with that I'll turn it over to Eric.
Thanks, Joe.
Good afternoon, everyone Hope you and your family's remain safe and well.
Actually one year ago today, we conducted our first earnings call as a public company. We're very pleased to have delivered strong and consistent financial performance since our IPO.
We're equally proud.
Our ability to navigate the unprecedented challenges and opportunities presented by Kobin Nike in recent months.
I'm also extremely proud of our hard work dedication community support that has been demonstrated across organization.
This includes our I O is in their store associates, who worked tirelessly on the front mines to serve our customers our communities.
Our distribution center teams, who went above and beyond to help us key product flowing.
Purchasing teams, who leveraged our strong relationships the source, both opportunistic and everyday products, enabling us to deliver great values for customers and.
So so grateful for all their commitment.
Looking or second quarter results or performance reflects the strong execution across organization.
Revenue growth of 24.5% was driven by 16.7% increase in comparable store sales and sales from 32, New store open openings since June of last year.
Adjusted EBITDA grew 34.7%, reflecting gross margin expansion slightly offset by modest SGN, a de leverage due to higher cost related to protecting our employees and our customers during cobot 19.
As we move forward, we'll continue to reinvest productivity savings and leverage our flexible business model to drive long term term growth.
Consistent with that philosophy, we're accelerating our investments in people and capabilities across three areas.
First advancing how we buy as we further develop our infrastructure to drive a wider gap in our leadership position in secondary market.
Second advancing how we sell by improving our ability to attract the very best operator candidates and prepare them for success and by making our extraordinary network of bio is even better.
Third continuing to scale, our business to support 10% annual unit growth.
Our Jay will speak in a moment about the first Jerry reinvestment, how we buy my discussion today, we'll begin with the second area, how we so which is centered all around our ideas.
We continue to expand our network of field based educators to more effectively support our existing ipos as well as train and develop our new operators.
In terms of recruiting our new operators to the system, we're utilizing our digital marketing capabilities to more effectively targeting recruit new operator candidates.
While early we're pleased to see the quality and the strength of incoming inquiries, we receive from both those with traditional retail experience as well as other relevant background such as hospitality in foodservice.
As we look for new operators, we know that candidates must have both the right mindset and the right skill set to succeed as iOS, we aggressively search and screen for entrepreneurs, who are smart independent hungry and humble.
Well, we love to find candidates with existing grocery management experience equally important to us are vital skills, such as customer service labor management marketing leadership.
Once the Densified. These candidates go through an intensive training program.
Part of which is in in store immersion experience with a seasoned operator.
In order to make our training program more consistent scalable efficient you are evolving our training approach to leverage the best of our operator field and corporate teams to create a virtual learning environment.
We believe the kids consistency and rigor provided by virtual training workshops and simulations being effective supplement to the in store training environment.
We expect this hybrid approach will help improve the readiness and effectiveness of new operators. They began managing their new store. We also believe that will provide a more consistent and scalable training experience as we continue to grow or shore base.
Training doesn't stop once the Io first opens their store our operators are aggressive and hungry entrepreneurs, we're always looking to develop their skills and grow their businesses to support that we provide operational and analytical resources to our field management teams corporate staff as well as various data and business intelligence tools.
To build upon this support we're developing new educational content designed to help them further grow and develop their skills.
For example, sharing of best practices is always played a very important role in our culture.
And the emphasis on virtual learning will make it easier for subject matter experts to work with operators across all geographies and easily share video content.
As their business grows we will continue to leverage scalable technologies to enhance or our ability to support operators.
Turning now to new store growth, our retail expansion strategy remains a significant investment priority.
Opened seven new stores in the second quarter and now expect opened 30 to 32 new stores for the year.
We remain pleased with the performance of our new stores, which like our broader store base are benefiting from the elevated customer demand looking forward. We remain excited about the availability of attractive real estate sites as we continue to build our store pipeline to support 10% annual growth.
In summary, the strong financial results, we delivered in the first half of 2020 set us up to accelerate investments and our business to support our long term growth objectives. We look forward to updating you on that progress.
Now before I turn it over the call the RJ I want to discuss the topic of great importance to us as we've shared with you in the past our mission of touching wise for the better is deeply rooted in the foundation of grocery outlet.
And as part of this each July for the last 10 years, we have run our independence from hunger campaign to address critical food and security needs across our communities.
We're excited to share this was a record breaking year for us a $3 million raised across our network grocery outlet also donated an additional $1 billion, bringing the total raised a $4 million.
This brings our total money raised and donated to local communities since it campaigns inception, 10 years ago to over $11 million.
As proud as we are this accomplishment recent events have pushed us as well as many other organizations to ask ourselves whether theres more than we can be doing to address inequality across our society, specifically, how can we be more effectively supporting diversity equity and inclusion.
Well, we've always serve diverse communities and fostered an inclusive workplace. We know there's more we can do and there's more we will do.
We spent considerable time internally discussing steps, we can take to improve going forward and our efforts will span across our employee base network of iOS and other partners that includes an assessment of our diversity performance and establishing scorecards, a measurable goals for the future.
We're also gathering information through surveys and rolling out listening sessions again, a deeper understanding of our teams perspectives.
Lastly, providing education modules and resource guidelines increase awareness insensitivity across our corporate teams as well as radios.
With that I'll turn it over to RJ.
Thanks, Eric and good afternoon, everyone.
We remain incredibly thankful to our independent operators are buying and distribution team and our valued partners for their outstanding efforts and dedication and helping us to support community since it started with pandemic.
Our combination of extreme value unexpected deals localized assortment and friendly service resonates with customers now more than ever.
Over the last several months, we have leaned on our flexible operations to adapt quickly to industry changes.
Our inventory management capabilities and supply chain execution enabled us to consistently meet increased consumer demand throughout this period.
Our inventory levels remain healthy yeah. The value remains strong and we continue to offer an exciting treasure hunt of Wow deals for customer shopping our stores.
Our execution in the first half of this year with made stronger by prior investments made in strategic business initiatives.
For example, consistent reinvestments in purchasing through people processing systems have enabled us to further strengthen our leadership position in the secondary market and scale our business for growth.
These investments help deepen relationships and improved partnerships with existing suppliers.
It also helps to support new and better ways, a pursuing partnerships with both traditional and non traditional suppliers.
We've talked before about greater specialization in our buying organization.
Opportunistic supply remains plentiful.
Specialized approach is helping to capture even more of this product.
Our buying team continues to develop and strengthen supplier partnerships ranging from our largest strategic suppliers bounce it smaller high growth company.
We also continue to deploy new strategies to identify establish and develop relationships with new suppliers.
Our relationships with many of our largest suppliers go back decades, and we consider them to be an extension of the Geo family.
He'd partnerships or strategic which means they are broad long term relationships that reach well beyond any individual opportunistic deal.
Our buyers use a personalized high touch approach to engage with each supplier.
We interact with each of them at senior levels and communicate regularly to identify a wide range of mutually beneficial opportunities.
Excess packaging innovation planning and reconditioning opportunities or just a few examples of ways, we partner with major suppliers.
We also look at the total business both opportunistic in every day and managed to shared sales and profit goals.
We are equally excited about our potential with smaller high growth suppliers.
These are a combination of suppliers in high growth categories and those that are on a strong growth trajectory due to their own brand and product positioning.
Our objective is to be a valuable solution provider for these partners as well as to help them grow.
In some cases, our partnership helps them elder business by reducing manufacturing cost.
In other instances, we help them by driving new customer trial, which increases brand awareness and loyalty.
We provide an easy go to market retail option for them to grow their business.
As with our strategic suppliers, we follow it customized approach and partner with them on long term mutually beneficial strategies.
We also continue to invest more time and resources in establishing and developing new opportunistic relationships.
We are further increasing buyer specialization they focus on new supplier acquisition.
This positions us well to efficiently identify and develop new relationships with suppliers of all sizes.
In many cases, new partnerships to begin with a smaller initial purchase order.
Many initial purchase this represents an opportunity to develop new high growth long lasting supplier partnerships and we work to nurture these relationships with this mine.
Disruption from the pandemic continues to present, a number of these new supplier opportunities, including non traditional suppliers similar to what we shared last quarter.
In addition to investments in opportunistic buying we're also enhancing our approach to everyday items in category management.
This is a combined effort between buying inventory management and our strategy teams.
Benefits here include more relevant items higher sales productivity and better seasonal plant.
One recent example is improvements made to our relatively new seafood category, we optimized and focused our assortment. According to a customer demand, which drove higher sales and margin, while also streamlining store ordering and execution.
Extreme value on quality branded product resonates with customers now more than ever.
We continue to see strong engagement from existing customers and a healthy flow of new customer shopping grocery outlet.
New customers, representing makes it different shopping behaviors and patterns consistent with our overall customer base.
We are the primary store for some and secondary or tertiary stores with others.
We continue to target bargain minded customers with value.
This approach has served us well and offers ample opportunity for growth.
Our marketing strategy, they're focused on attracting new customers as well as thing top of mind to drive repeat visits with those that already shop.
We continue to evolve our media mix and messaging to capture the attention of our target customer.
Our shift from print to digital provides the flexibility to communicate real time store specific information on our ever changing Wow deals.
It also helps us address more recent changes in customer behavior and communication preferences.
Another initiative within marketing is personalization.
Investments made in our email database have enabled the launch of our welcome series email campaign.
Customers that sign up to receive email now received a welcome message followed by a customized program with additional emails and videos that serve as an introduction and education on the unique attributes of grocery outlet.
We supplement this brand marketing with regular while alerts that communicate the best deals currently available.
This is just one part of communicating the Wow beyond the four walls of the store.
That's must have responded very well to this outreach and we plan to further increase engagement as we advance our personalization strategies.
In conclusion, we are extremely pleased with our progress Im confident.
At the investments we continue to make in talent infrastructure and operational enhancements will further advance our strategic growth initiatives.
I'll now turn the call over to Charles.
Thanks, RJ good afternoon, everyone.
Our second quarter results reflect the strength of our business model and the outstanding efforts by our team and our independent operators is we continued to operate through this pandemic.
Sales for the second quarter increased 24.5% to $803.4 million compared with the same period last year.
This growth was driven by 16.7% increase in comparable store sales as well as the sales contribution from 32 net additional stores since the end of the second quarter last year.
Our comp growth in the quarter was a result, as an increase in average transaction size, partially offset by a decline in traffic.
Comp performance was once again broad based strength across all regions and vintages.
We opened seven new stores in the quarter ending with 362 locations.
We remain pleased with the performance of our newer stores, which consistent with our established stores are benefiting from elevated food at home spending.
Second quarter gross profit increased 27.7% from prior year to $253.8 million its gross margin performance exceeded our expectations going into the core.
Our gross margin rate was exceptionally strong increasing approximately 80 basis points from prior year to 31.6%.
Largely due to reduced markdowns and throwaways is result of faster inventory turnover.
This improvement in inventory efficiency more than offset distribution costs de leverage resulting from enhance safety measures in higher personnel expense warehouses related to cope at night chain.
SGN a expense grew 25.6% to $198 million with the increased largely attributable to higher variable commission to independent operators, resulting from gross margin dollar growth.
Higher store occupancy duty unit expansion continued personnel and infrastructure investments to support the growth of our business.
In addition, we incurred incremental cobot related store in corporate costs as well as public company costs and transaction expenses related to our April secondary offering.
These factors resulted in SGN, a increasing as a percentage of sales to 24.6% grew 24.4% in the same period last year.
Stock based compensation expense for the second quarter was $10.2 million largely driven by the full that's in 2014 performance based stock options in conjunction with our April 2nd secondary offering.
As a result of the tax benefit associated with employee option exercises during the second quarter, we incurred a 2.2 million dollar tax benefit, resulting in an effective tax rate of negative 8.3%.
Relative to our normalized tax rate this option related tax benefit increased net income by $9.6 million in the quarter or 10 cents per diluted share.
As a result, GAAP net income for the quarter increased to $29.3 million worth 30 cents per diluted share compared to a net loss $10.6 million or 15 cents per diluted share in the prior year.
For the quarter, adjusted EBITDA increased 34.7% to $60.6 million from $45 million last year.
Adjusted net income increased 189% to $41.8 million or 42 cents per diluted share based on an average of 90 98.6 million diluted shares in the quarter.
Turning to our balance sheet liquidity due to the sustained momentum in our business and our strong cash flow generation, we elected to repay our $90 million revolver draw in late May.
As a result, we ended the second quarter was $79.8 million a cash. It's RJ mentioned, we remain pleased where the quantity and composition of our inventory, which increased 13.1% person in the prior year to $229.3 million.
Total debt decreased from the first quarter to $460.1 million as a result of our revolver pay down.
While we remain confident in our liquidity position, we continue to take the conservative approach a building cash on the balance sheet given kobin related uncertainty.
For the quarter, we generated $22.2 million, an operating cash flow, it's our strong operating performance more than offset our rebuilding inventory from our March low point.
We invested $21.8 million in Capex and the second quarter as we continued to build new stores and invest back into the existing fleet.
Turning to current trends and our outlook for the back half the year.
Comp sales growth stands at 10% for the third quarter to date.
We continue to see growth and basket size, partially offset by lower traffic as customers continue to consolidate their trips we anticipate that our comp growth will continue to moderate the economy reopens.
With respect to gross margin, we expected our margin rate in the back half will be roughly in line. Prior year quarterly results that expectation is driven by a moderating shrink benefit its inventory turnover normalizes margin headwinds from commodity cost increases and the fourth quarter margin death, we typically experience as Rick.
Built at holiday product mix.
With respect to expenses, we continued to prioritize making the right health and safety investments on behalf of our employees customers independent operators.
As such we expect to continue to incur incremental cost in the back half of the year associated with cope at 19, such as cleaning and safety cost cost for protective equipment and supplies and higher personnel expense.
Well it depends AMAK has been challenging to navigate this provided a unique opportunity to bolster talent and infrastructure. It's we continued to execute against our long term growth objective.
As such we have increased investments in people process and tools to better position us to capitalize on the significant white space in front of us.
Those accelerated investments began in the second quarter, but we'll work more meaningfully in the third and fourth quarters. The same can be set for public company costs, which we believe we'll continue to build as we become fully Sox compliance.
Taking all of those sales margin and expense expectations into account, we believe adjusted EBITDA margins for the second half a 2020 well be modestly below prior year levels.
In terms of other items on the P. now with respect to stock based compensation, we have now incurred substantially all of the expense associated with our time based performance based 2014 employee option.
[laughter] quarter, we implemented new long term incentive plan to attract and retain talent.
They target level. So that she meant you expected stock based comp expense associated with this new plan will ramp over three years to an annualized run rate of approximately $25 million.
Following the repayment of our revolver, we expect interest expense to be roughly $6 million on a quarterly basis.
We continue to expect the normalized tax rate of approximately 28%, which excludes discreet items.
And we expect weighted average diluted share count for the year to be approximately 100 million shares.
Based on our current projection of 30 to 32, new store openings in 2020, we now expect the Capex for the year, we'll be in the range of $95 million to $105 million.
We do not expect any store closures in 2020 beyond the two we had in the first quarter.
In closing, we're incredibly proud of the performance of our team an iOS an exceptional results we delivered in the first half a 2020.
Despite the continued uncertainty surrounding kind of it we remain as excited as ever about our unique positioning in the marketplace and our long runway for growth, we remain committed to managing the business for the long term and making smart investments and pursue those objectives.
With that we can turn it back to the operator to begin kubernetes.
Thank you ladies and gentlemen at this time, we will be conducting a question and answer session.
We'd like to ask your question you May press Star one on your telephone keypad a confirmation total indicate your line is then the question Q.
You May press star to if he would like to remove your question from the Q.
For participants using speaker equipment, and maybe necessary to pick up your handset before pressing the star cake.
Our first question comes from the line of Paul Trussell with Deutsche Bank. Please proceed with your question.
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Yes, good afternoon, congrats on another good quarter.
To start maybe we could touch on the availability.
Oh good.
As well as the performance kind of breaking down between everyday items.
As well as opportunistic items.
[laughter].
Hi, Paul its R.J. I can I can take that one or two questions I'll start with availability of opportunistic supply.
We continue to see ample supply from our partners as mentioned in our comments on we're pleased with the health of the inventory and the overall assortment and I'd I'd point to the great work done by or buying inventory management teams and maintaining inventory levels that we have we're in a unique situation for sure.
But yeah, we've been we've been out this business for a long time and we've been through lots of different cycle.
They were we keep in very close contact with all of our suppliers, we understand supplier dynamics very well.
Whether its changes to assortments being made or innovation or where product may still be on allocation.
I'd point to our success rate now being resolved at the same method and approach that really we've followed over many many years, we haven't changed the way that we conduct business even in this unique situation.
We continue to benefit from doing business with with lots of different suppliers, we plan to the diversified supplier base of the strength on previous calls supply does cycle by item in supplier and so to be able to balance that across many supplier partnerships helps at all times and important remember here that.
Yeah, that's just contribute to the treasure hunt experience in the stores and that customers are used to changes in items and and you know they get excited by new and different items shown up with great value on a regular basis.
I always come back to the partnerships, we have with suppliers strong long lasting partnerships where solutions provider to them. We partner strategically on long term goals, we call a customized approach we were creatively all of these things you know their long term in nature. So they helped you know during any short term fluctuations.
We see and that again has been true throughout our history.
And then it also point to focus on new supplier acquisition as a real strength in pre covert times with United change in the supplier landscape, but certainly certainly now.
As a benefit of both with traditional and non traditional suppliers.
And we've mentioned previously on the non traditional side, you'll continue to see opportunities from foodservice.
Hospitality more recently cruises in hotels, and fitness centers and you know other opportunities that have come our way.
Maybe last point I'll make on an opportunistic supply I continue to be bullish on a long term opportunity here.
Manufacturers have increased production on they don't want to get caught again like what happened back in March and April I'll say, we've already seen some opportunities that have come our way from over production, we expect more.
<unk> to come in the future, we continue to benefit from retail closures and slower Reopenings and you know that at that time will time will tell you how quickly others opened but we've been able to help out some suppliers and type situations, there and anytime there changes in assortments.
Whether its ski related or category related packaging related we see those opportunities.
And ultimately any type of supply chain and balance.
Thanks, Ross so.
All of those things will continue to be true as we look forward and then just quickly in terms of mix. You don't have we I think your question was have we seen any material change in mix.
Yes, what I'd say here as we don't we don't manage our business to mix, we manage to value and mix continues just to be the result of where demand is what we're able to purchase and ultimately where we can do to deliver value. As a reminder, customers don't know the difference between everyday and opportunistic that's all internal speak but they do right.
Nice value. So we continue to orient around that.
With.
That said everyday has tracked a bit higher in terms of mix as some of the higher demand items in categories do skew more to the everyday side. So.
That's bumped that up a little bit, but yeah, but we're used to short term changes in mix its demand and supply fluctuate and you always come back to our flexible buying and merchandise model that allows us to adjust that we don't have that skews or hierarchy or any volume commitments. There so perfectly comfortable man.
During these fluctuations in mass next always maintaining.
Healthy valued to drive both sales and margin.
That's really helpful color. Thank you and just as a follow up is there any metrics or color you can share on what you're seeing from.
New customer count standpoint, or just overall brand awareness and while food at home is obviously benefiting you know all stores. You know trials is there a way that you kind of strip that out and kind of gauge new store productivity, but you can speak to thank you.
Yes, Paul I'll take the first part and then Charles can pick up on the second I I'd say in regard to new customers. We're pleased with the number of new customers.
That continue to come into our stores.
New customer levels are tracking it very very healthy levels, particularly in our developing markets, specifically, Los Angeles, and Pennsylvania, So seeing really nice new customer account growth. There. We you know in terms of metrics, we conduct regular surveys I would say.
Yeah, we look at profile of the customer we look at shopping behaviors, we look at satisfaction with grocery outlet.
Say, a couple of things one new customers or a mix of those that shop is primary secondary tertiary very consistent with what we've seen in the past and consistent with the overall mix.
And they're having a great experience. So satisfaction is is high.
Very satisfied with the store experience, we believe there is incredible stickiness.
To that experience and we're seeing it in the metrics from our survey.
The treasure hunt resonates with them value can be into a small shop, the operator the connection to community.
Health and safety of course is critically important to customers now and and they're satisfied with the things that are operators are doing around health and safety and cleaning and so they're coming in and they're having a good experience and we think that bodes well for us looking forward Charles.
Yeah, Paul just just to add RJ comments on new store productivity, we're really pleased to see outperformance and new stores again, the rising tide is lifting all boats and so.
We've seen new stores opened this year as well is the ramping vintages for the past several years continue to benefit and importantly, as is our Jay mentioned, a big part of that is new customer acquisition. So feel really good about where we are it's important metric for us and one that we we track very closely.
Our next question comes from the line of Randy Konik with Jefferies. Please proceed with your question.
Hey, guys. How are you can you can you hear me.
Yeah Yeah.
Yes, sorry.
So I guess my personal maybe maybe that's a RJ to kind of a lot of a follow up on the first question. There. So can you give us a little bit more background, you talked about expanding the supplier base during the pandemic cruise lines hotels et cetera, but could you maybe frame out.
Little bit more quantitative mean, just how the supplier base has grown maybe in the past six months all pass.
Five years in Paris, and there's just no reason I'm asking is.
During the great recession, we saw TJX had a similar all thing happens and then where their supplier base exploded during the great recession and kind of led to a really kind of.
Yes, expansive partnership network.
Then the other thing that happened with that particular company, what's the nature of the relationship or the dynamic relationship with those suppliers also change it and then I'm hearing your comments on the script a witness script all with the call. It sounds like the dynamic up <unk> relationship with these suppliers is deepening even further meaning.
You're getting even more preferential treatment seen a your best stress preferred partner getting more maidens made full product for something yarn, just opportunistic close out kind of stuff, maybe just give us some perspective on quantifying that supplier base, and then kind of giving us little bit more need around the dynamic of the relationship with the supplier base and.
Now that's been changing over the past.
Three months in the past few years.
Yeah. Thanks for the question Randy.
What you just said there is true and what we've experienced over the years and certainly growth in terms of number of suppliers. We've we've expanded our supplier base as the assortment has evolved so you think about categories and we talk a lot about nosh, but I'd point to natural again in specialty healthy as I'm seeing tremendous growth.
And the establishment of new supplier partnerships, that's in part because of how we've evolved assortment and of course.
It's happening within the supplier landscape with.
New upstarts suppliers and higher gross suppliers coming into the industry and we've been able to establish those relationships and and grow with them.
Teach your comment about the with the types of relationships you know and how that's evolves we talk a lot about strategic partnerships and you know in the comments there what that means to us as its it it is much more than a transactional type of relationship it's much more than an individual op.
Opportunistic deals so we partner with them together for the long term and so.
We treat the relationship accordingly so.
Think about things like creative solutions to instances, where they're stuck certainly as we think about cost and margin and value inadequate and it's over a longer period of time, we you I'd say, we've evolved into more of a hybrid opportunistic in everyday mix with many of our larger suppliers.
And that's proven to be mutually beneficial we're a high growth channel for them and.
We continue to access more and more of their opportunistic.
Specialization within our team is a part of managing these relationships better. So we think about strategic suppliers in an approach that works well there we think about smaller high growth suppliers and tailoring our approach needed. There and then just continued focus on new supplier acquisition and development.
Something that allows us to be more more focused.
We do believe that we are preferred partner, we ask suppliers all the time, what more we can do to to be a better partner and and we've gotten better as a result, so we have that type of relationship and communication.
And and for US it it's about finding new and helpful ways to partner with them and so we're constantly working with our point of contact broadening our reach throughout the organization and exploring opportunities to help them, whether it's specific to innovation or supply chain.
Situations that they're in or for the on the smaller side and helping them scale to grow and so you know all of these approaches I'd say have been part of a longer term evolution.
The company's grow and as we've invested in people and systems to be able to do things better and I think both we and our supplier partners has benefited as a result, and then just lastly, I think on your question relates non traditional suppliers.
Yeah, we think of those no different than any other new supplier partnership and that we want to cultivate that relationship and and grow with them.
It has been a smaller part of the mix in terms of PEO volume or sales volume, but as with most new supplier partnerships. If it starts with an initial T O and then develops into longer bigger partnerships from there. So we expect many of those opportunities to play out the same way on the non traditional side.
Very helpful. I, just real quick follow up just maybe it's a progress report on younger market progress will say like Pennsylvania.
Or southern California, and how that compares to mature market performance, just so we get a labor for how.
The younger markets and so as they are doing relative to the historical markets. Thanks. Thanks, guys.
Hey, Randy it's Eric good to talk to you you know we've said it before that.
The east business is still a very young business.
Super Super excited have Heather back there she started really in earnest in February and.
I'd say great progress this year in terms of you know comps and sort of her leadership in the market in sort of getting a set up for for growth.
Transfer out to southern California, and that market is done really really well you know we really started opening stores are sort of 2014 2015, and it's taken us a while to get up to what I think is going to be around you know 85 to 90 store count by the end of this year and ER.
Market shares are still fairly small, but we're doing really well down there I think the brand is growing.
Concentrated a lot on supply chain, the last few years and making sure we're buying product putting it in L.A. and distributing from there. We've also focus our recruiting locally for placement locally and so everything sort of clicking together and obviously as we build that market share.
And build that position.
Things will continue to get even better so we're really pleased with both of.
Super helpful. Thanks, guys I appreciate it.
Our next question comes on the line of Robby Ohmes with Bank of America. Please proceed with your question.
Oh, Hey, guys great quarter in thanks for taking my question actually just two quick questions. The first was just on the the sequential slowdown to the 10% comps any color on whether this slowdown is more traffic or ticket driven you know sort of you know maybe just smart more color on the slowdown and maybe it are there.
Any category things that are you know any categories slowing sequentially more than others and then my.
My other question is just on the incremental Kobin 19 cost can you remind me what the Io cost structure is you know in terms of how how how much of that covert 19. How are you guys, helping them with a store level cobot 19 costs or are your incremental costs all.
Outside of the business. Thanks.
Hey, Robbie its Charles let me tackle both of those so first with respect to the comp flow I would say get it that the trend the enduring trend that we're seeing is that safety is really top of mind for customers. So.
Beginning the second quarter and continuing now they continue to consolidate their trips into the store in so that overall traffic trend has been steady and I think that's true across across our markets. A it's really been the average basket size that while it remains elevated that's starting to moderate as the economy.
Is slowly reopening so really hard to say how traffic and basket are going to trend as we move into the fall and winter, but I think broadly speaking. This this trend that overall moderating comps is one that we would expect is markets continue to reopen so.
That's that's comp slowed secondly, or your question on cobot cost, yes. So we are absorbing some costs in helping support the operators in cost that would normally fall onto their TNL.
Thanks about things like supply cost in the store for personal protective equipment and safety related cost cleaning costs again, it's not for the letter the operator agreement it wouldn't be a cost required that we think it's the right thing to do and so we've been we've absorbed those costs in the second quarter and we would anticipate continue.
Turning to absorb those costs.
As we as we move through the balance of the are here.
That's great that makes a lot of sense in a really helpful. Thanks guys.
Our next question comes from the line of Michael Lasser wouldn't you be US. Please proceed with your question.
Good afternoon. Thank for taking my question. If you look at the customer base by shopping behavior. So the whole shops versus those who are just doing a film, which I think you had some some nomenclature and how you referred to the different buckets earlier and recall.
How are those do baskets doing quarter to date persons, where they were doing in the first two quarters. The year. So my question is basically are you seeing a slowdown in those filling shop shoppers or the slowdown referring more and those who are doing their mean shop at grocery outlet.
Yeah, Hi, Michael Yeah, I'd say across different shopping.
Behaviors or groups. If you will we talk about primary secondary tertiary.
Yeah, we've seen we've seen consistent trend so no no particular trend specific to one versus the other.
And for those customers, who you are able who you've been able to attract new into the fold.
We've been able to treat them up from from being tertiary a secondary into a primary shopper.
How do you do that.
Yes, so we as I said, we had been a healthy mix. There are there new worse. So there isn't a ton of history. There for movement. If you will.
And then beyond that a you know we don't necessarily think of all tertiary says as potential for secondary or secondary to primary all the way up.
Customer customer shop us in different ways, they fit us into shopping patterns specific to their needs and how that works for them.
So yes, certainly to the extent that were they have the propensity to become primary as we continue to offer great value and a great shopping experience.
Move there.
But we don't really think of our business.
So much in that way in terms of customer migration as you described it just given the unique nature of our store and how we appealed to different customers in different ways.
Okay. Thank you very much and good luck.
Thank you.
Our next question comes from the line of Oliver Chen with Cowen. Please proceed with your question.
Hi, Thank you inventory management was tightly managed this quarter as we look ahead should we expect inventory growth to underpin sales growth in the back half as well do you expect that trend to continue also your your comments on buyer specialization I'm wireless now the right time for that to happen then what do you.
See happening in terms of timing of impact of that decision.
Hey, Oliver This is Charles let me, let me take the first part and then I'll send it over to RJ, but with respect to inventory yeah really pleased with the current composition and level of inventory that we habit of course, you saw a nice.
Rebuild for on the ended the first quarter. So as we look towards the back half of the year I would think in general it's going to trend roughly in line with with sales growth course, given the nature of our business and the opportunistic purchasing it can it can fluctuate a bit more.
Then the traditional retail but.
I think that that general rule of thumb of inline with sales growth is pretty safe.
And in regards to specialization we've been talking about that for a number of years I'd say the first piece was when we introduced inventory management back in 2013. Those were those were tasks handled by the buying team previously so that you. The first piece there and then more recently really two years.
They go started the planning and moving people into.
Every day and opportunistic and I'm really just a reflection of.
You know being able to better manage the business recognizing that opportunistic and everyday our unique parts to buying and and you know with the change we've been able to go deeper so on the everyday side still growing into better category management and everything involved with that and then on the opportunistic side.
You know it's been hugely beneficial to have on your percent focus from that team as we think about your different tiers in Texas suppliers as well as new supplier acquisition.
Thank you and as you do look ahead of curbside pickup and delivery what are your thoughts about how that may be a factor in near future and what your customers one.
While the special Nestle the treasure Hunt may or may not relate to those digital option.
Yeah, our long term position on E commerce hasn't changed to it you have a long runway for growth with.
It through both our existing stores as well as new store growth.
And ultimately your customers enjoy the in store Wow shopping experience the treasure Honda value the personal engagement.
So I'm still hard to replicate online and we don't want to sacrifice value for that so.
Well continue to evaluate ecommerce relative to other long term priorities and in the meantime, we continue to look to a lot by way of digital marketing.
Things like personalization, and social media and growth of email database I mean, all those things have been impactful for us and yeah. We think that helps us quite a lot in terms of new customers and share wallet gross okay, and lastly on that point, you're making about digital marketing and marketing spend how are you.
Thinking about the incremental dollar and spending at what medium and customer acquisition cost as you look at different options online and you also allocate your dollars from print media.
Yeah, it's really been a shift so we've become more efficient with our marketing spend in analogic lot of digital has come as we've shifted away from Prince and you know traditional conventional marketing media codes print and still very prominent and we've just shifted those dollars more efficiently and more effectively.
You know I've always said it it it's better for this business real time store specific items digital.
Portside in the way that print never could in so it's been beneficial both from an efficiency standpoint, but also from an effectiveness standpoint, and fitting with our model as well.
Our next question comes from the line of John.
Hi, Michael with Guggenheim. Please proceed with your question.
And maybe for RJ I know a lot of the stuff you've done with the procurement department is that.
The internal folks.
And it have you expanded that group here or intend to the part of the investment.
Well, it's not that and then secondarily, where do you think you sort of end up here on the private brand journey.
Particularly a you know we're in a downturn and it made me last for oil.
Yes, so we have expanded the groups. So one of the one of the best bet investments. We make is in people and so that the group has grown as the business has grown.
Part of that related to Specialisation part of that just related to a growing business. So we'll continue to invest in people and you would expect.
Got to continue to be a very positive return for US and then you have for private label. We haven't we haven't increased the priority on that it still remains on the left as far as future roadmap goes we continue to see plenty of supply from an opportunistic standpoint. So.
That's always preferred and you know, it's something that will keep on the list and we'll determine when or if it when or if it becomes a higher priority in terms of assortment strategy.
And then maybe just a quick follow up while alerts and the consolidate encrypt environment right. Alex I know there were very effective right and getting people and you know more frequently.
You know how effective or are they a in coated and then have you changed your approach and cobot.
Yeah. So so very effective John you for one it's a great way to communicate the customers what we have in the store. So if they're not sure about making a trip where they're trying to decide where to go we should we think it's a great even more relevant now than than ever great way to communicate that to customers.
And you know we think excited when we think about personalization, it's really about expanding wow alerts so to show them more of the store take it outside the four walls and make it more specific to the to the customer for the items of the categories that they're looking for so I'm really pleased that we have that and yeah, we expect that to be a important part of.
Digital marketing for Us ahead.
Thanks.
Our next question comes from the line of Karen short with Barclays. Please proceed with them question.
Hi, a couple of questions, where you maybe a little more housekeeping, but.
First would be can you give us a little bit of an update on the promotional environment and whether you know say problem. Your conventional is if you noticed an up tick in a promotional environment from them. The second as you called out commodity cost increases going forward. So can you just give a little color on what you're seeing on inflation and what your.
Expectations are and then I just had one question related to the <unk>.
Hey, Karen Eric.
Thanks for the question, Yeah, I would say nothing unique in the promotional environment.
Thank you all haven't seen in read about I think.
You paid attention to the.
I think albertsons and Safeway call. They just couldn't rely on suppliers inventory was down it's very difficult for most people are starting to get back into the fresh side, where controls a little bit is better, but we have not seen a whole lot different than what you all right and described.
We're not seeing any new competitive activity or any.
Gimmicks.
Many of the markets, but I'd say, it's pretty much status quo to to what we've read as well.
Karen. This is this is Charlie let me address the inflation question. So yeah, we didnt feel much inflationary cost pressure in the second quarter, but we are now starting to feel that across a number of categories, including meats and deli and produce so we do it.
Perfect that's going to be a bit of of gross margin headwind in the back half the year that we didnt see.
In the first half again, we love the fact that our model allows us to mitigate some of those inflationary pressures because we can we can buy and merchandise flexibly. It but we do think nonetheless, it will be somewhat of an impact in the back half.
Okay. Thanks, and then just one quick question on the iOS can you just give us an update if you did I Miss but on the interest rate relief that you had called out in one Q the iOS.
Yes, so that that's that continues to be the case, we've given.
We've given relief to the iOS, the tuna that 50% reduction in their interest rate and as I mentioned before it's it's one of its one of many coping related related costs that were absorbing and we would anticipate sad to continue to do so.
As we work our way through through the pandemic.
Our next question comes on the line of Simon Gutman with Morgan Stanley. Please proceed with your question.
Hey, guys Simeon. So my first question is a a modeling one with two parts.
The first part is in gross margins be up again in 2021 for any reason and then related to it is incremental margins in general for this business have been in the mid single digit range and that's with your normalized comps of let's say four to five or 6%.
When we start normalizing to those levels should the incremental margins follow and any reason why there should be stronger or weaker than those than those historical numbers.
Yeah. Simeon this is Charlie let me just trying to tackle both of those so first of all with respect to.
Your gross margin question, so you're really pleased with the performance we saw in the first half the year again shrink was a big benefit just because of the sustained momentum on the topline. So we some much lower markdowns and throw as a we you know we've always said that over the long term, we take the view of managing.
For stable margins and I'd say, that's true both with respect to the gross margin line as well as adjusted EBITDA margin lines. So <unk>. We're just starting our initial planning for 2021, we very much expect.
It will be a fluid environment, which will be operating but I can at what it what I can tell you is longer term.
We manage the business for stable margins and and again, both gross margins and adjusted EBITDA margins. The reason is because of the reinvestment that we've we've talked about you you'll definitely have quarters you can't have quarters like we had in Q2 were really up and down the PNM all stars aligned and we saw.
Some nice flow through.
But our objective would be to make sure that we're doing the right things to reinvest in talent and infrastructure to ensure our success as we continue to grow stores.
Okay, and then my follow up just with regard to the iOS and some of the training that was mentioned first I don't know a few you'd say this but what was the tone that they use this quarter in terms of the script around training was it with a little bit more urgency or iden importance and second of all if it was can you talk about.
The performance gap over the past two quarters among stores or use it widening and is there anything in terms of I O PNM thats different ring and so what what is the urgency or let's say to heighten importance on the training.
Yeah, Hey, Simeon Eric.
Thank you picked up on a correctly I think the urgency is all about scaling and just the reflection that we have you know 70 to 75 to 80 inbound who teas.
Per year that retraining and getting ready to go out into the system I'd say second you know if your your traditional grocery manager that is thinking about another opportunity. This is probably not the year that you're looking so.
We're dipping our toe into some other candidates from outside of the grocery arena. So.
It's an opportunity for us to upgrade the training and you know both from a forced to virtual training.
To combined with what we're doing in the stores and then two to train people on on the grocery business that may possess other skills entrepreneurial or customer service or you know back office. So I would say, it's all of those things and then you know I think you've heard themes throughout from us that.
You know if it's working well that's a good time for us to pick at it and see if we can improve it so just to a threat of continuous improvement would be probably the final.
Thanks, Eric.
Our next question comes on line of Joe Feldman with Telsey Advisory Group. Please proceed with your question.
Hi, guys. Thanks, taking my question I wanted to go back the RJ, you're talking about personalization in response to John is about it as well but.
How are you hearing the message on those while alert that's kinda, how I think about personalization or is it just like you're increasing the number of while alerts to people like what is actually happening now.
Yeah. So personalization, we're in the very early inning build Joe of of.
Planning, how we can come more customizing personalized mentioned in the comment.
Welcome series E Mail campaign that we put out to new customers. So it's specific to them. They are new to the model. So it is about introducing and educating them because it is a different kind of shopping we want customers to understand that the I'm. The Wow alerts are still now I'm not personalized to customers their specific as they've always been.
Specific specific to stores and items, so their local near real time and they reflect some of our best value highest velocity items. The next phase than with Wow alerts once we start tracking more customer specific information would be to have that specific to you Joe.
Someone else based on what you like what you buy other suggestions of things that you'd find interesting. We have we have super high engagement from these while or emails that go out customers look for them. They open them they react to them and we think we can engage we can increase engagement further still when it becomes even more relevant to you and your spin.
Civic needs.
Great. Thank you for that and then I guess Oh, a phone maybe also for U.R.J. was.
The opportunistic buys that you're seeing out there.
Are there any categories within the space, that's like really heavy and that's like there's too much of it.
You can't take all of it obviously, but.
Or is it pretty broad based like is it you know where you're seeing the opportunities.
Yes, it's really broad base and to the extent that they were ever our situations, where it's too heavy or or lighter so to speak I mean, I I'd I'd say those are those and from for long history.
This company operating with this model yeah, it's just part of normal fluctuations in cycles that happen and so but yes on the whole and over.
Reasonable period of time, its healthy and I know nothing specific to categories with ample it really across all and you know thing things move around but I'm not of any significance to point to that it would I'd call out one category versus another.
Oh last question comes from the line of Jeremy Hamblin with Dougherty and company. Please proceed with your question.
Thanks, and congrats on the strong results I wanted to start with a question on that store openings you increased your guidance by a couple of units.
In terms of as we look forward into 2021.
Can you provide any commentary on.
The quality of the real estate opportunities, you're seeing there quantity of real estate.
Opportunities and whether or not you know kind of what's transpired here in 2020 makes you think a little differently about the types of locations.
But you might look at going forward and that I had a follow up question.
Hey, Jeremy Eric I'll take the latter part of the question.
No change in direction in terms of the types of sites that were going to consider we're always looking for.
Great real estate, whether to dense market a rural market, we want to be sort of where people are in there used to shopping so I'd say that would be.
An overarching for us.
Relative to long term the target we think the 10% unit growth works really well on the pipeline for 2021 is very strong we've continued having a real estate meetings monthly improving sides getting leases signed we've continued to go out and look into markets and we're excited about both the.
Finish of this year and the prospects for next year I think relative to the big question that we've gotten from a number of people is what do we think is going to happen in years 21, and 22 relative to supply I would say the markets that we operate in for many years have been pretty competitive lots of people looking in the 15000 square feet.
The 30000 square feet, we've been able to be really flexibles split up boxes, like Kmart and Sears and other you know retailers that are that are giving up sites and get into 10000 square feet only up to 30 35000 square feet I think what is going to happen as this greater real estate markets.
For gives back square footage, we're gonna have more opportunities versus less than if we have more opportunities I think we'll have a good focus on quality, but at the same time I think there could be some opportunities relative to what we have to pay to get into those sites.
Okay. That's great and then just in terms of I wanted to ask a follow up question actually I'm on P.P.E. cost.
You know in terms of you know now we're you know many months into the pandemic. It seems as though there's been some efficiency gains.
Terms of managing a you know simply because we have better visibility on on what needs to be done on there's lots of a scramble in terms of getting people need to the team can you give a sense on whether or not but the impact of those costs.
Is that starting to diminish you know as it relates to the overall total cost of <unk> percent cost of sales.
But just any color you might be able to provide on that.
You know would be helpful.
Yeah. Jeremy This is Charlie let me trying to provide a little bit insight. There you know I would say I should emphasize everything we're seeing for covert cost for us given our model. It's it's across a number of areas. It's several different lines in the piano some of that's.
<unk> expense some of its capital, but everything from or distribution centers to costs in our corporate office for the the staff that remains at all the work from home costs.
Everything I talked about that we're doing that stores, both from a support standpoint for iOS as well as incremental capital that we put into the stores. So it is.
It's a number of things it was a significant impact to us in Q2, and really was one of the key drivers as to why we de Levered SG in a in the quarter I do think.
That you know while there maybe some efficiencies we're seeing it's going to continue to be significant cost for us until we get on the back side to covert so from a modeling standpoint, it's it's really one of the reasons why we're trying to Orient coax towards the back half of the year and adjusted EBITDA margins again being.
The lower than prior year.
Okay.
Great guys. One last question may be on on your debt and.
Kind of retreat or pulled that down in terms of thinking on a go forward basis, you're you're generating a lot of cash <unk> is that a priority to potentially reduce the overall.
Debt levels here as we move into 2021 or into 2022.
Yeah. The way, we're thinking about it Jeremy is that until we get again on the backside Cove. It let's just take the conservative approach and continue to put excess cash back into back on the balance sheet.
Feel great about liquidity position as you point out we've got plenty of internal cash flow to fund our investments in gross.
As result of how good we felt we did take the opportunity to repay the revolver in may.
But I think what we've done it decided the table the longer term discussion around what's the right leverage ratio ultimately for this business and then what do we want to do with excess cash after that I think that again that will be a conversation we can revisit once we get some more clarity around co that.
This concludes our joke question and answer session I'd like to hand, the call back to Eric Lindbergh for closing remarks.
Hey, Thanks, everyone for joining us appreciate all your questions and we look forward to catching up with the individually. After this call. Thanks, so much take care.
Ladies and gentlemen, this does conclude todays teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.
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