Good afternoon, and welcome to Grocery Outlet's call to discuss financial results for the second quarter ending July 1, 2023. Speaking from management on today's call will be RJ Sheedy, President and Chief Executive Officer; and Charles Bracher, Chief Financial Officer. Following prepared remarks from RJ and Charles, we will open the call for questions. Please note that this conference call is being webcast live, and a recording will be available via telephone playback on the Investor Relations section of the company's website. Participants on this call may make forward-looking statements within the meaning of the federal securities laws. All statements that address future operating, financial or business performance or the company's strategies or expectations are forward-looking statements. These forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from these statements. A description of these factors can be found in this afternoon's press release as well as the company's periodic reports filed with the SEC, all of which may be found on the Investor Relations section of the company's website or on sec.gov. The company undertakes no obligation to revise or update any forward-looking statements or information except as required by law. 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. Reconciliation of GAAP to non-GAAP measures as well as the description, limitations and rationale for using each measure may be found in the supplemental financial tables included in this afternoon's press release and the company's SEC filings. With that out of the way, I would now like to turn the call over to RJ.

Good afternoon, everyone, and thank you for joining us. We are very pleased with our second quarter results and the continued momentum in our business. Our differentiated model and strong value proposition are driving industry-leading sales growth, and we are fulfilling our mission of touching lives for the better. More customers are shopping with us for the first time, existing customers are spending more with us, and overall customer satisfaction continues to increase. Second quarter sales grew 13%, driven by a 9% increase in comparable store sales and total quarterly sales reached a new record of over $1 billion. Traffic remained very strong in the quarter, increasing 9% and average basket remained high and consistent with last year. Gross margin was also very strong in the quarter, up 120 basis points to 32.3%. This, together with sales growth, drove a 23% increase in adjusted EBITDA to $71 million. At the end of the second quarter, we operated 447 stores across 8 states. We remain pleased with the performance of our newer stores, with sales levels and growth in line with our historical performance and underwriting model. We continue to see positive momentum in our newer markets particularly in the East, where we are increasing awareness in our customer base through targeted marketing investments, strong execution, and expanding store count. Our strong performance is driven by our differentiated model and compelling value proposition. We save customers an average of 40% compared to conventional grocery retailers with our best WOW! items saving customers 70% or more. Shopping at Grocery Outlet combines a fun treasure hunt experience with the convenience of a small box format. And our independent operators provide a localized assortment and personalized customer service while giving back to the communities in which they live and operate. We are a unique, high-growth specialty discount retailer. We have delivered strong and consistent performance with an average annual same-store sales increase of 5% over the past 20 years. As a result, we have steadily increased our market share and touched countless lives for the better. Our model is unique in 2 distinct ways: opportunistic purchasing and independent operators...

Thanks, RJ, and good afternoon, everyone. Our second quarter came in ahead of our expectations, driven by strong same-store sales growth and margin expansion. As RJ mentioned, we achieved quarterly sales over $1 billion for the first time in our history. We are all proud of this achievement, and I want to thank our employees and our independent operators for their contribution in achieving this significant milestone. For the quarter, net sales increased 12.5% to $1.01 billion, primarily due to a 9.2% increase in comparable store sales, along with the impact of new stores opened since the second quarter of last year. Strong transaction growth drove our comparable sales while our average transaction size remained high and flat to last year. We opened 4 new stores and closed 1 store during the quarter, ending with 447 locations. We remain pleased with our new store initial sales volumes, and recent vintages are ramping in line with our expectations. Second quarter gross margin increased 120 basis points to 32.3% and gross profit increased 16.9% to $326.6 million. Our buyers are doing a fantastic job partnering with suppliers, and we are seeing healthy deal flow across categories. Strong execution, combined with the favorable buying environment drove the better-than-expected margin result. SG&A expense increased 14.9% to $290.1 million compared to the second quarter of 2022. The increase was driven by higher commission payments to independent operators, reflecting gross profit growth, store occupancy costs due to new unit growth, and incentive compensation expense based on our strong first half results....

As we look to the back half, do you expect for the basket to also be flat? What should we know about disinflation or deflation in terms of what you're seeing? Also, you commented on the great buying environment. Do you expect that to continue? It was quite favorable to your gross margins. And finally, a lot of great comments on developing markets and targeted marketing. What have been some of the key learnings in terms of making progress there?

Let me start with the basket, and we'll try to take these questions in order. But really pleased with the basket trends that we're seeing in the second quarter. We are, as expected, seeing moderating inflation, and so average unit retail, while still up, came down from the first quarter. Recall that for us, the impact of inflation is more muted because of our buying model. Units in the basket is down modestly versus the prior year, which we would expect to see given the higher frequency and traffic that we're driving. And again, for us, it's not directly comparable given the nature of the buy and the fact that it's an ever-changing mix and assortment within the store. But units overall still slightly ahead of pre-pandemic levels, which we feel really good about. So as we look towards the balance of the year, we really think that the same trends continue. Traffic will be the larger driver of comparable sales as customers continue to seek out value, and then bring, again, with moderating inflation should continue to moderate as those trips increase.

Regarding the buying environment, Oliver, we continue to be encouraged by the pipeline of opportunistic product. It continues to be broad-based across categories. The positive momentum all the way back from the beginning of the year and through Q2 is carried forward to this quarter as well. We continue to see really healthy inventory positions and variety available to both operators and to customers, contributing to the great value in treasure hunting and the positive experience customers are having shopping our stores. So a lot of positive trends there that we like. In regards to marketing, we continue to see nice returns from our targeted marketing efforts. We do still continue to invest more in certain areas, and we're always following a test-and-learn approach as we deploy, try, learn from new marketing activities, certainly very active in the digital space, as you're well aware, and always trying new activities there. We'll be even more targeted once we fully roll out and do a full launch behind our personalized program, the app that we have out there, in some of our stores. And so we're excited for that and the additional benefit that it will provide.

Two follow-ups to Oliver's questions. The first, just can you give a little more on the gross margin increase? I understand the buying could be better, but also, I think you in the independent operators price usually to a certain gross margin. And you also mentioned execution as part of the gross margin benefit. Can you give an example of what you mean by that? Is that less clearance, less shrink? And maybe how should we think about gross margin for next year versus these really strong gross margins you're putting up now? Is this the new sustainable gross margin we should be thinking about for you guys? That would be my first question on gross margin.

Yes, Robby, it's Charles. Thanks for the question. Yes, we're really proud of the margin performance that we delivered. In the second quarter, it clearly was ahead of our expectations as we went into the quarter. And really a few factors at play as we look at it. Number one, we always talk about normal with our model to see the quarterly fluctuations just because of the nature of the buy and the ever-changing assortment. So I would describe the second quarter performance as naturally at the higher end of that. Number two, yes, it is a favorable buying environment for us right now. We're seeing healthy deal flow across departments, which feels really good. And then lastly, strong execution from the team that you can think about this as really end to end the way we manage inventory from the buy through supply chain, through allocations to stores. And importantly, everything the operators do at store level to efficiently manage inventory and minimize shrink. So each of those players has an important part to contribute to overall margin management. And I'd say they're just executing really well, which we feel great about. And so as we look forward, I think you see this in our guidance for the back half of the year, we do expect that some of these things continue in terms of purchasing. The backdrop continues to look really positive.

Congrats, RJ and Erik, on the great results. I had a similar question, just to follow up on the gross margin, right? Just wanted to ask about the sort of the healthy buying environment. Is there anything that would tell you that maybe the buying environment is becoming permanently more favorable for Grocery Outlet as you are bigger, you have more importance with your vendors? And therefore, Grocery Outlet can essentially sustain structurally higher margins, and it wouldn't really have to go back to the pre-pandemic levels that you were managing to before?

Yes. Thanks, Krisztina. I'll take that one. Yes, I already mentioned, really pleased with the buying environment, but it's also the activities that we're always involved in the investment we make. Our objective is always to be an even better partner to the suppliers that we work with. And just as a reminder, some of these relationships go back decades. As we grow, we do become a stronger partner. We do gain even better access to product. Part of the growth story for us has been, as we expand geographically, we open up opportunities for other distribution centers in areas where product is held that we can then take advantage of. So yes, there is structural benefit improvement that comes from growth, and we're always looking to get better. And we're certainly benefiting from that in the partnerships that we have and the access to product that it gives us and then the value that we're able then in turn to provide to our customers.

In quarter, I guess, what are you guys seeing in terms of the health of the consumer? It sounds like you're seeing a lot more frequency. The basket is holding up. I guess I'm curious if you're just seeing customers trading down like more affluent customers shopping more often or maybe buying differently within categories at all. Just anything about the health of the consumer would be great.

Thank you for the question, Joe. We feel encouraged by the trends we are observing in consumer and shopping behaviors. The positive patterns we highlighted in our last call are still in place, and we see strong engagement across various income levels. Different customer types continue to shop with us, and we are witnessing a rise in new customers visiting our stores, which is excellent news. Our operators are actively engaging with these customers, helping them understand our model, and this is contributing to the increase in same-store transaction counts we've experienced throughout the year. Our survey data indicates a growing number of middle to higher-income customers shopping with us, implying a shift in their behaviors. Additionally, we’ve noticed an uptick in trip frequency and overall spending from our existing customer base, as our values resonate well with them and we have gained a larger share of their spending. Customer satisfaction remains high, and their intent to shop more in the future is strong. Beyond a supportive backdrop, the initiatives we are implementing are further reinforcing these positive trends.

I have a couple of questions. First, could you provide some insight into the comparisons between the East Coast and the West Coast? Additionally, what is the current interest rate for independent operators compared to what you charge them, and how does that differ from the interest rate they would face as completely independent operators?

Yes. Karen, it's Charles. Let me take the first part. So regional performance, particularly in the East, we're really pleased with newer regions. I'd say both Southern California and Mid-Atlantic, both of those continue to post kind of company-leading comparable sales on both the current year basis and on a multi-year stack basis, which feels great. And so driving increased brand awareness and trial in the stores and continue to densify those regions, we're seeing kind of the momentum build, which we feel great about. And then as it relates to interest rates for the independent operators, the rate we charge IOs is fixed at 9.95%. So that number has not changed as variable interest rates have increased.

Yes. Yes. Regarding 2024 and how we are thinking about our future store count. As I just mentioned, the work includes organic growth, together with consideration for opportunistic real estate as well as smaller regional acquisition opportunities along with some additional new partnerships that complement our own internal activities. Some of the activities are new as it relates to opportunistic real estate and, of course, consideration of regional acquisitions. They're interesting for us, again, given the white space that we have. All of these activities are in progress right now. They're all interconnected. And we're in the process right now of evaluating it all together within the context of targeted growth over the next, call it, 12 to 36 months. And we'll plan to provide a further update with more specifics together with what would be full year 2024 guidance during our February Q4 call.

So obviously, you guys posted a really strong traffic number this quarter, and it sounds like you're doing well across all income levels. What are you seeing from some of the customers that you've acquired over the past few years? Are you holding on to more than you would have expected? How does your customer retention compare, I guess, to the prior cycles of elevated growth?

Yes. So Mark, thanks for the question. We don't track specific customer transactions. That will be a new capability that we have that will come with the personalization app. So we can't speak specifically to customer trends and how we're seeing the basket changing, etc. What I can say though is speaking more generally to retention and stickiness of the model. A lot of positive trends and data that we see in the customer survey. I already mentioned some of that around high satisfaction levels and intends to shop more....

I'm going to beat the gross margin horse a little bit further. What are you seeing with shrink and mix? And I'm curious, right, even during the best days of 2020, gross margin didn't perform this well. What do you think is different? Is there less competition for opportunistic purchases? Is it more disciplined right on how you're pricing that? I'm just curious what is different today, if anything, versus a couple of years ago?

Yes, John. It's Charles. Let me answer the point you referenced there on shrink and then I'll turn it over to RJ. As it relates to shrink, we have fortunately have not seen a significant change in our historical shrink rates. And probably a couple of factors at play when you think about our business, number one, of course, got lower value price points. But number two, and probably more importantly, is just the independent operator's control of the store and that customer local connection that they have. And the fact that they've got a shared gross margin management, inventory management incentive with them. So I think that really motivates them to keep a close eye on shrink. And as a result, we're seeing very consistent performance.

Yes. We're really excited about the portal, together with some other system enhancements that we will be implementing this quarter. So it's here being implemented very soon. And then yes, in terms of benefits for the operator, the first thing that comes to mind is just easier access to information and access to new information that they've not seen before, at least not in the format that it will be available. And then with that, comes better decision-making, faster, better decision-making around inventory, around ordering, around managing the mix, really in all aspects for how they manage their business. And that is a huge benefit, which will help grow sales and improve margins. The other benefit that I would mention is just efficiencies. So certainly, you've talked about rising costs, operating expenses, labor, etc., challenges that we, together with operators, have managed through for a long time now, but this new platform will allow them to operate even more efficiently.

You mentioned that the basket is increasing as more affluent customers come in and your average daily customers are also growing as well. Are you seeing an uptick in the share of wallets and even if they are spending decreasingly on a per visit basis? How do you view that?

Yes. Thank you, Oliver. Yes the combination of high income customers as well as the loyalty, and share of wallet of current customers, we feel really strong about. There are many initiatives we are implementing, including our newly launched customer loyalty program, which we expect will enhance that overall trend toward increasing customer spending.

Thank you, RJ. To wrap it up, we know that our strong performance would not be possible without the tireless efforts of our operators and the entire Grocery Outlet team. We appreciate all you do to make Grocery Outlet the company that it is today. Our brand momentum is strong, and we look forward to continued growth in the years ahead. Thank you all for joining us, and we will now open the call up to your questions.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.