Q3 2023 Grocery Outlet Holding Corp Earnings Call
Greetings and welcome to grocery Outlet's third quarter 2023 earnings results Conference call.
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A question and answer session will follow the formal presentation.
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It is now my pleasure to introduce your host Christine Chen Vice President of Investor Relations. Please proceed.
Afternoon, and welcome to grocery outlet's call to discuss financial results for the third quarter.
For the period ending September 30th 2023 speaking from management on today's call will be RJ, Sheedy, President and Chief Executive Officer, and Charles Clarke, Our Chief Financial Officer. Following prepared remarks from our Jean Charles will open the call for questions. Please note that this conference call is being webcast live and a recording will be available.
Via telephone play back 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 Securities laws, all statements that address future operating financial or business performance or the companys 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 a description of these factors can be found in this afternoon's press release as well as the Companys periodic reports filed with the SEC all of which may be found on the Investor Relations section of the company's website or an FCC dot Gov. The company undertakes no obligation to revise or update any forward looking statements or information.
These statements are estimates only and not a guarantee of future performance. During today's call. The company will also reference 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 maybe found in the supplemental financial tables included in this afternoon's press release and the company.
<unk> SEC filings.
That I would now like to turn the call over to RJ.
Good afternoon, everyone and thank you for joining us.
We are pleased with our third quarter 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 third quarter sales increased 9% driven by a six 4% increase in comparable store sales.
Transaction count remained strong in the quarter, increasing 9%, which is consistent with the prior two quarters.
Rapid increases continued to be a combination of more new customers in our stores in 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 million.
Adjusted EPS grew 24% to 31 cents per diluted share.
While pleased with our third quarter performance, we experienced operational disruptions as we transition to upgraded systems.
On prior calls we have discussed her 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 a new store portal 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 third and fourth quarter results.
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 for our operators as we continue to make steady progress adapting to the new systems.
We anticipate the transitional impact 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 as consumers are still challenged with higher food prices and other financial burdens.
Our 40% average basket savings compared to conventional grocers saves customers money at a time when they need it most.
We also continue to allow 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 and value remains the most important criteria for store visits.
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 in the 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.
I was one of the largest buyers of consumable closeouts, we quickly buy and sell through large volumes of product, which helps our suppliers manage their access 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 maintained strategic relationships throughout these organizations and we manage the partnerships for long term mutually beneficial sales and profit growth.
New supply our acquisition and development remains another important buying focus.
Many smaller suppliers rely on us to not only assist them a 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 in value, particularly within our fast growing natural organic specialty and healthy categories.
Our nosh 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 the operators to build programs and initiatives that support and enhance their business.
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 Io has previously bought on their own.
Our scale and distribution network allow us to say the operators money on many items they use to run their business.
The new store portal is another example of investments we make to help address.
This new system will help them more efficiently receive inventory manage the assortment and access data to improve their operations.
Look forward, you're 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 third 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 eight stores during the third quarter, including our 458 store, which was also our first store in Las Vegas.
We ended the quarter with 455 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 first Ohio store before the end of the year. In addition to stores and 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.
Our white space remains huge with the potential to operate over 4000 stores across the U S.
Finally, we are extremely proud to have recently published our first 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 been core to the business from the start and fulfilling this purpose has resulted in positive environmental and social impact throughout our 77 year history.
Ah report highlights seven key impact areas.
The first three areas positively impact our communities.
First we save customers a tremendous amount of money.
Over the past five years, we have saved customers over $10 billion compared to conventional grocers and we aim to provide customers $3 billion in annual savings in 2024.
Second we provide access to affordable quality food.
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.
Since its founding in 2011, our independence from hunger drive has raised over $16 million to fight food and security and our local communities.
The next two highlighted areas positively impact our people fared.
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 product and providing outstanding service to their customers every day.
We provide support to help them achieve the American dream.
Second 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 E D and I initiatives helped strengthen our culture and business overall.
Our final two highlighted areas had a positive impact on our planet.
Our opportunistic sourcing model reduces food waste by creating value from products that may otherwise be discarded.
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 you'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 at grocery outlet has on our communities our people and our planet.
In closing.
<unk> I want to thank our amazing iOS for their partnership and service.
I also want to thank the entire D O 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, Roger and good afternoon, everyone. Our third 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 nine 3% to $1 billion, primarily due to a six 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 are running in the high single digits before the transition transaction growth remained strong increasing eight 6% slightly offset by a one 9% decline in our average basket.
We opened eight new stores during the quarter ending with 455 locations.
Our new stores are performing well and building in line with our expectations.
Third quarter gross margin increased 80 basis points to 31, 4% and gross profit increased 12, 5% to $315 $7 million healthy.
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 impacted gross margin by approximately 50 basis points.
SG&A expense increased eight 7% to $278 $1 million compared to the third quarter of 2022.
The increase was driven by higher commission payments to iOS store occupancy cost due to new unit growth and higher incentive compensation expense, reflecting our strong performance, partially offset by a vendor receivable.
Higher Commission expense reflects strong gross profit growth together with support we elected to provide to our iOS in connection with our system upgrades.
As a percentage of sales SG&A decreased by 20 basis points to 27, 7%.
Net interest expense decreased 11, 9% to $4.2 million 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 third quarter increased 55, 1% to $27 $1 million or 27 cents per diluted share.
Adjusted net income increased 23, 4% to $31 million or <unk> 31 cents per diluted share.
Adjusted EBITDA increased 20% to $68 1 million for the quarter.
As a percentage of sales adjusted EBITDA increased 60 basis points from the prior year to six 8%.
Turning to the balance sheet, we ended the quarter with $155 $7 million of cash slightly above normalized levels as we experienced longer payable processing times as a result of the system transition.
We ended the third quarter with $308 $6 million of inventory.
Gross debt was $296 $3 million at the end of the third quarter with net leverage less than one times adjusted EBITDA.
During the quarter, we generated $119 $1 million of operating cash flow and invested $42 $7 million in Capex net of tenant improvement allowances, primarily for new store growth upgrades to our existing fleet and technology and infrastructure investments.
Now, let me provide some commentary on our expectations for the fourth quarter and update our outlook for the full year, while our underlying business remains strong we do expect the system transition to significantly impact financial results in the fourth quarter and to a greater degree than the third quarter given the additional month.
[noise] affected.
With respect to the top line, we expect fourth 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 of 7% to seven 5%.
In terms of unit growth, we expect to open 13, new stores in the fourth quarter and 27 net new stores for the year.
We continue to expect fiscal 2023 net sales of approximately $3 $95 billion.
We expect fourth quarter gross margin to be approximately 30%, reflecting normal holiday seasonality, along with approximately 150 basis points of impact due to the system transition.
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 fourth 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 million to $252 million.
At the midpoint, our guidance represents a healthy bottom line leverage and approximately 16% adjusted EBITDA growth versus last year.
Moving down the P&L, we continue to expect net interest expense of approximately $21 million for the year, which reflects projected forward interest rates on our outstanding debt.
For adjusted net income purposes, we project, our full year tax rate of approximately 30%.
Long with average diluted shares outstanding of approximately $101 million.
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 million for the full year net of tenant improvement allowances, reflecting 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're making important investments to further strengthen our value proposition and position us for long term growth.
Now open the call up to your questions operator.
Uh huh.
Operator.
Okay.
Thank you we will now conduct a question and answer session.
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While we poll for our first question.
Our first question comes from Lee of Jordan <unk> with Goldman Sachs. Please proceed.
Good afternoon. Thank you for taking my question.
Just wanted to start off with a couple of questions around the new platforms you implemented this quarter.
What has been the biggest challenge related to the ordering is it just learning the new program 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 costs that we should think about Annualizing and then also you mentioned that it would bring better data analytics. Just curious how quickly you think you can implement those learnings or have you any <unk>.
Sure and just the first few months.
Highly yeah I'll take the first a couple of parts of 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 included replacement of our I guess 400 system, which was our legacy ERP system with S. P along with other third party.
D plus some new proprietary applications for buying in store operations. So that 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 eight to 10 years and consistent with the approach that we've talked about in making ongoing investments in modernizing our systems to build the 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 that these new platforms will provide them they will give us new capabilities.
For how we manage the business they'll drive efficiencies through better data and analytics that.
That will support us with better decision, making and that will be an improvement enhancement.
For both the operator community as well for our grocery outlet in total in terms of the challenges and the disruption that we face as we transition to the new systems, 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 <unk>.
Packed throughout the business and the the P&L and notably as mentioned in our comments tough topline sales were impacted by a later inventory levels slightly lower variety and we had some pressure on margin as it relates to inventory inefficiencies and then SG&A was higher as wells, we elected to pre.
<unk> operators with support I'll say that we did expect some disruption during this transition 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 in 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.
<unk> levels and flow throughout the system. 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 some.
Some of these new processes and working our way back to what I would describe as more optimal inventory levels and margin management and therefore the.
The impact that we anticipate throughout the throughout the fourth quarter here.
Otherwise, 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, yeah.
This is Charles just a bit more color on cost and sort of the cadence as you think about the quarterly impact going into next year.
So as it relates to the third quarter again think of this as being one month of impact to the fiscal quarter and so it's RJ mentioned, we felt that at both the top line and a margin impact in Q3, along with elective Commission support you see the same impact in the fourth.
Quarter, just to a greater degree is we're fueling the kind of.
A full three months impact if you will in the fourth quarter. We do expect that is we over the course of the fourth quarter all of those impacts moderate and as disappointed as we are with the magnitude of the impact in the fourth quarter, we do expect and believe that it will be largely behind us by the end of the year.
Year.
And so our view at this point is that we will enter the new year without any lingering cost impacts or otherwise related to the transition.
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 youre seeing in the construction and permanent environment or how maybe the progress around discussion.
<unk> for potential M&A.
To get to 10% for next year. Thanks.
Yeah, Yeah, we are feeling good about future store growth opportunities.
Space remains massive you continue to think about that 4000, plus number across the U S. So plenty of opportunities out there for us.
If I were to go back earlier in the year from prior calls first goal was to get back to 10% growth rate. This year and we're happy to be tracking to this now with eight new stores that we opened in the third quarter and on track for 13 more in the fourth quarter 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 25 and 26 as well continue to see great opportunities and the efforts underway continue to include organic growth together with consideration of.
Mystic 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 opportunities.
Certainly as it relates to dispossess real estate analyst that are available that we're evaluating 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 will provide further update more specifically on 2024 store count on our February Q4 call.
Great. Thank you.
Thank you thanks.
Yeah.
Our next question comes from Oliver Chen with TD Cowen. Please proceed.
But our game Charles.
Regarding your comp guidance is your expectation that traffic continues to be very positive offset by average unit retail what what should we think about in terms of.
Unit retails, you know near and longer term.
As we I appreciate a lot of the changes on the new store portal.
But the issues you had just what gives you confidence that there'll be a largely behind by end of year.
And then a follow up as we think about new regions. It sounded like store productivity was in line with your expectations would just love your thoughts on your supply chain footprint. You gave more color on how you approach M&A, but that framework would be interesting to hear more about as well. Thank you very much.
Great Oliver It's Charles let me tackle the first part of your question then I'll kick it over to RJ. So with respect to comp composition, Yes, we're really pleased with the health of the comp that we're driving as you can see continues to come from strong transaction growth.
Customer is clearly responding to the values and treasure Hunt.
And loved that we're seeing both.
Increased visits from existing and new customers with high satisfaction.
It relates to the comp headwind as a result of the system transition that really did impact ticket. So rainy as you saw was down.
A little less than 2% for for the quarter really coming from from lower units and that's both as a result of higher frequency, but yes lighter inventory levels and variety as a result of the system transition AUR is still positive, but moderating very much.
As we expected as we're lapping higher year over year inflation levels and so yeah 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 it's more muted because of.
Because of our buying model and then that AUR units in the basket dynamics isn't necessarily directly comparable due to the changing nature of our assortment.
And on the your question around the systems upgrades Oliver Yes, as I mentioned before.
We have addressed the bigger issues that we faced earlier on around inventory issues around inventory visibility issues as well as <unk>.
Product flow challenges in both into the warehouse and also from the warehouse to the stores. So that progress feels really good 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.
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 adapting to other parts of the new systems and 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 in operations included.
Given the progress that we've made in the daily progress that we continue to make we do feel confident in being able to resolve these.
These outstanding issues to the point, where.
The impact is that largely behind us by the end of the year and then to your to your third question around new store performance fees.
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 its through organic growth or or opportunistic lists or perhaps acquisitions of course infrastructure is a really important part of supporting that growth and we've always.
Those investments ahead of the store count that that follows or that is part of our longer term growth plans, so wouldn't be any different as.
As we think about those opportunities and you're back to my comments around wanting to.
Center around this 10% annual growth numbers because of infrastructure investments.
That we wanted to make to make sure that we're growing at a healthy rate.
Thank you best regards.
Thanks Al.
Once again, we ask that all callers. Please ask one question at this time. Our next question comes from Robbie <unk> with Bank of America. Please proceed.
Oh, Hey, thanks for taking my question.
Is the is the system the technology platform disruptions does that change the timeline for e-commerce initiatives like launching your App I think the plan was for 2024.
Yeah. So 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 we had plan to introduce it by the end of the year that has been delayed by the <unk> 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 timeframe. So just a little bit delayed there and then from there we would do more of a full on intra.
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 I'm pleased to say has been really positive the customer adoption has been good and the feedback has been positive. So far we're seeing a nice percentage of transactions on the app through the App.
So that all feels really good despite not having really put any marketing muscle behind it that's all in front of us still as an opportunity for 2024.
That's helpful. 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.
Yeah, I'll start and then Charles you can chime in here in terms of impact to operators and the commission's support the inventory visibility and ordering challenges that I mentioned of course impacted the operator's ability to manage the flow of product into their stores largely they are pulling product in through through the order guide.
And when it.
When these challenges started back in September 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.
We're not happy with the magnitude of impact on the business, but overall the customer experience, there's not been a huge impact on that a little bit later and inventories some lower variety accounts, but.
Gather with everything the operators have done.
Been able to minimize that impact we did have lacked at the outset of the implementation to provide operators with commission support and the purpose for that was well wine and spirit of the partnership that we have with them and then to to help minimize the impact of this transition on their commission income together.
With the work that we've been doing to minimize the impact on the customer and our P&L.
Charles just to add to that Robby, it's as RJ said, it really is a reflection of the spirit of partnership.
The relationship we have with ideas and so we didn't disclose the specific dollar amount, but it is included of course in our SG&A for the third quarter and the estimated impact in the fourth quarter is included in our EBITDA guidance, we provided.
Got it thanks, so much.
Thanks, Thanks Ravi.
Our next question comes from Cristina Cotai with Deutsche Bank. Please proceed.
Hey, guys. Thanks for the question so.
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 of that like one is that a fair characterization and then too.
Is it fair to say that this doesn't alter any of the margin structure into next year are the long term and you're essentially be able to fully recapture all of the margin pressures once you lap the third and the fourth quarters.
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 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 I'm certainly not to this degree or this magnitude. So I think you characterized it well and then in terms of impact looking forward I think similar to the earlier question.
As I said, we do expect the.
The transitional impact to be contained to this year from what we've already experienced in the third quarter.
And then and then largely behind US at the end of the year. So you should think about us reverting back to previous.
Performance in all the things that we've always talked about related to consumer trends topline sales and how we manage for both gross margin and bottom line profit.
Got it. Thank you and then a follow up I had a question on the I O pipeline, especially as Youre planning your 2024, and 25 mm unit expansion plan last quarter you provided some very helpful. Statistics on average Io net income, but just a question is do you have any concern.
And or any difficulty maybe attracting top talent in future years, especially just thinking if rates stayed higher for longer is that something that you're concerned about.
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 independents together with the support and scale that we provide they work with family to 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 now there are a lot of people out there.
And leads continue to be really healthy.
Annual leads we mentioned last time it was around 30000 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's and it goes both ways that needs to be the right fit for them as well.
But yes, no concerns about the Io pipeline to support future stores.
Great. Thank you so much.
Thank you.
Our next question comes from Joe Feldman with Telsey Advisory. Please proceed.
Hi, guys. Thanks for taking the question.
I guess, just one more on the systems.
Transition I guess.
Yeah.
Kind of curious about the staging of it you know you guys are always very methodical.
Even like the App you know take your time testing learning and I was curious as to.
Was there a reason behind needing to flip the switch on all of those systems at once.
Versus staging it a little bit more.
Well first we as you know Joe over the past 10 years, we have modernized and upgraded many of our enterprise systems inclusive of a warehouse management system. We were operating on a relatively new point of sale system with a new HR.
Our.
HR system and so the.
My point here is that this wasn't a 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 products platform inventory financial and reporting it did require us.
To do a a much bigger implementation across the functionality that previously existed on the S. 400 are legacy enterprise system, which is as I mentioned, replacing that with S. P. Together with other third party in some some new propel.
Terry systems, and so those are those that functionality all for the most part.
Previously it was on a is for 100. So it was a situation where we needed to do.
A bigger implementation.
Then then more piecemeal I think than what you are suggesting or asking about.
Got it. Thank you for explaining that I appreciate that and then just a quick follow up with some of the new customers that youre continuing to see yes, I was just curious.
The profile is any different maybe from the existing customers and how sticky. They are like are you retaining them.
Yeah. That's the profile is pretty similar I would say the one notable difference consistent with Mike.
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 are over indexing on middle to higher income where the need for value is more pronounced for that group has become more pronounced throughout the year as inflation has carried on and so that that'd be the one note.
<unk> difference, but overall.
The profile is generally representative of our current customer mix is where we're quite broad as you know and then in terms of stickiness. We don't we don't track specific customers. So I can't speak to first trip second trip and then the stickiness. We do know however that satisfaction levels are really high.
Hi, this is from customer surveys that we do we know that they're they like the savings and the products and the assortment that they're seeing in the store and we also know that they are intended to shop more in the future as high as well and we see that for four customers that have shopped us more recently and <unk>.
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 future I'll call. It new base for loyal customers as we look out into 2024 and beyond.
Got it that's great. Thanks for that and good luck this quarter. Thank you.
Thank you.
Once again as a reminder, we ask all callers to limit themselves to one question. Our next question comes from Jon <unk> with Guggenheim Securities. Please proceed.
Hey, guys, it's not going to try to do two quick here two topics number one the impact on on comp in the quarter on ticket.
Was that in stock.
And then related to that.
Does that now is the customer experience now begun to improve.
Let's say October and early November over September because I would imagine it's important right. When you think about the holidays.
Have you experienced getting a lot better.
Heading into Thanksgiving. So that's number one and then number two.
Maybe just talk about your thoughts on Brandon clustering and brand awareness on the East coast.
Talking about Ohio.
Opening in Pittsburgh, and you think about the western part of the territory versus Jersey in Baltimore, It's more important to cluster or do you just want to get too again, good locations get too.
The 70 locations on the East coast, So the procurement kicks in.
Hey, John It's Charlie let me tackle the first part with respect to your question around around ticket in the basket.
Yes, as I mentioned really the comp headwind, we saw in the third quarter it impacted ticket and specifically it was lower yet so you're not having the normal sort of levels of inventory in stocks and variety as a result of the system transition was really the headwind there and would expect that continues to be.
The driver of the headwind in the fourth quarter as I mentioned, a bigger comp impact because you've got the the.
The full three months, but do anticipate that that improves over the balance of the fourth quarter and that's related to the second part of your question. The customer experience has improved where we were a little bit lighter on inventory and variety impacting the basket that has since improved quite a bit and so still.
So a little bit.
To go but we feel really good about the.
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 and we do try to cluster as best we can of.
Of course, you have real estate availability and timing that you can't 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 that we're looking at we we have our first store in Western Pennsylvania recently opened.
And so that will carryover now to Ohio, just across the border for our first store in so.
Very close.
It gets there.
And then we're building the brand awareness, whether its in Maryland or for New Jersey, as we continue to infill there and so while these are different markets still trying to stay more concentrated.
Rather than opening a store in Florida are opening a store in Texas or where have you that would be really really spread far apart. So.
We do try to follow that clustering strategy as part of our real estate growth strategy.
Alright, thank you.
Thanks, John Thank you.
Our next question comes from Mark Carden with UBS. Please proceed.
Good afternoon. Thanks, so much for taking the question. So you guys talked about strength continuing in the closeout market. How is the product pipeline is 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 it.
Has been the case throughout the year I'd say consistent where we are well third quarter and then and then where we are in the fourth quarter 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 were 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.
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.
<unk> preferences or changes innovation goes along with that.
I see that continuing.
Well 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 to continue as well so.
No reason for us to think we certainly haven't seen any signs of it slowing down and we expect that strength to continue into next year.
Great. Thanks, so much good luck.
Thanks Mark.
The next question comes from Cory <unk> with Jefferies. Please proceed.
Okay.
Great. Thanks, I was wondering if you can 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 in the need to adjust your prices accordingly, and if so how do those price gaps compared to what they have been in the past.
The price gaps are.
Very healthy and we are always managing value, we look at 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.
We've been at this business for a long time, and all types of promotional environments and.
And our value continues to show a really nice spread and it's the reason why we've seen such health healthy growth. This year, we maintain the basket savings and the target there is 40% relative to conventional grocers that puts us at around a 20% basket savings too.
The big Discounters in our markets and in a time like this when inflation is really high for food and then for everything else. Our 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.
I on that as the promotional environment changes, we'll adjust accordingly.
No concerns with a slight increase there and feeling really good about the value that we're delivering customers and the trends that it's driving.
Great. Thank you very much best of luck.
Thank you.
Next question comes from Michael Baker with D. A Davidson. Please proceed.
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 three basis points better without the so sorry, it would've been about 5% so still a little bit of a slowdown from what you would've been at about 8% without this issue.
Why the slowdown is that just sort of you know being conservative you guys always seem to guide conservatively or is there. Another reason why even adjusting the systems issue back to comps.
Hello.
Yeah, Mike I think when you do the math and look at some of the stack comps you see once you adjust for the system impact youre going to see pretty steady.
<unk> 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 just higher inflation levels impact in the basket.
Okay.
That makes sense.
If I could ask sort of a follow up I guess to that.
It seems like.
Correct me, if I'm wrong, but we sort of backed into your guidance.
Back at the second quarter, you gave back half guidance and then you gave some color on the third quarter. So you could back into the fourth quarter and it seemed like you were planning on something closer to about two.
Two and a half and that was before the systems issue now if you back out the systems issue. It seems like you're pointing out something closer to five so.
I guess my question is without the systems issue would your fourth quarter outlook had been better than it was previously in other words is the underlying business better than you had thought excluding the systems issue.
Yeah again, just to clarify there Mike So we have not previously comment on fourth quarter comps again, we provide.
Kind of a range for the full year in the current quarter.
Commentary, if you will so I can't I can and cant reconcile the numbers youre speaking to other than to say.
For US again as you normalize for this system transition.
Impact.
We're feeling really good about the underlying health of the business as it relates to comp and particularly the.
The traffic that were driving into the stores as customers are really responding to the values were offered and everyone continues while more inflation is moderating absolute prices remains really high and so on.
Consumers Rishi.
Seeking us out.
Yeah understood, but I understand you didn't you didn't give fourth quarter guidance.
But you gave full year guidance, we knew the first half and you gave third quarter guidance. So.
One can back into the implied.
Implied if you will fourth quarter outlook I guess, that's what I was referring to but fair enough.
We provide a full year range back at your point.
Okay I appreciate the color. Thank you.
Thank you.
Our next question comes from Simeon Gutman with Morgan Stanley. Please proceed.
Hey, guys, it's Michael Kessler on for Simeon Thanks for taking us.
One question just looking at Q4 related to a prior question. The Q4 outlook. It looks like it's implying about a 100 basis points essentially lower margin lease versus the consensus setup.
Where we were thinking.
As far as the kind of that recapture potential for next year.
The fact that it could be mostly resolved does that mean that we should be seeing some sort of like you know relatively comparable bounce back next year as we move into 'twenty four or is there also some sort of a component of.
Higher run rate costs associated with the new systems.
Just speak to the evolution of your systems in the business as it scales.
Yeah, Michael It's Charles I'd say, it's premature for us to provide specific guidance.
I think RJ as 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 will stick with our current cadence of providing fiscal year guidance on the February 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, we can values resonated with customers. The buying environment is strong and so we know we'll be we'll be well positioned for whatever the backdrop exactly as for fiscal 2024, and we will provide all that color.
On the next call.
Okay. Thank you.
Okay.
The next question comes from Jeremy Hamblin with Craig Hallum. Please proceed.
Thanks, I'm, 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 than the total value in Q3.
And then secondly, if we you know kind of back out the gross margin impact here.
You've obviously had it.
Strong year on comp, but it looks like your you know your just your structural gross margin, maybe it's a little bit higher.
Than what it had been pre pandemic, but just wanted to see if you could comment.
On that and any you know.
A particular driver of that or is it just you know quality buying environment and still a little bit of inflationary pricing offset by <unk>.
Costs coming down a little bit.
Sure so as it relates to the incremental commission support yes in the fourth quarter, we do expect that it will be a larger impact in the third quarter again for the same reasons that were seeing a larger impact to both comp and gross margin.
With the additional months in the fourth quarter that again is all reflected.
In the fourth quarter guidance that we provided as it relates to sort of the normalized margin for 2023, yes, we feel again it really is a reflection a variety of things it is a favorable buying environment.
<unk> continues to do a great job and we're we continue to see great deals across the assortment and so again premature for us to say exactly what the environment will look like into next year.
You'll feel it feel great about the positioning as we enter fiscal 2024.
Great. Thanks for taking the question that's a lot.
Thank you.
Thank you at this time I would like to turn the floor back over to RJ Sheedy for closing comments.
Thanks, everyone for joining us today, we appreciate your support and look forward to updating you on our next call have a great rest of the day. Thank you.
Thank you. This does concludes 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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