Grocery Outlet Holding Corp

We are a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold primarily through a network of independently operated stores. Our flexible buying model allows us to offer quality, name-brand opportunistic products at prices generally 40% to 70% below those of conventional retailers. Our stores are primarily run by entrepreneurial independent operators ("IOs") who create a neighborhood feel through personalized customer service and a localized product offering. As of June 29, 2024, we had 524 stores in California, Washington, Oregon, Pennsylvania, Tennessee, Idaho, Nevada, North Carolina, Maryland, New Jersey, Georgia, Ohio, Alabama, Delaware, Kentucky and Virginia.

Macroeconomic Conditions and Recent Developments

Over the past several years, and to a lesser extent recently, our business has been and continues to be impacted by macroeconomic conditions including supply chain and labor challenges, inflation and subsequent disinflation, and changes in consumer behavior, and our IOs have been impacted by staffing challenges and increased labor costs and utility costs within their businesses. Furthermore, planned construction and opening of new stores has been, and may continue to be, negatively impacted due to both increased lead times to acquire materials, obtain permits and licenses, hook up utilities as well as higher construction and development related costs. Additionally, we have recently experienced increases in promotional and pricing activities from key competitors, putting further pressure on our relative value. In turn, we have been actively negotiating costs and adjusting prices to sharpen our value proposition. The extent of the continuing impact of these factors on our operational and financial performance will depend on many factors, including certain factors outside of our control.

Our new store growth efforts for fiscal 2024 and beyond are focused on organic growth and new real estate opportunities that align with our long-term geographic expansion and store growth strategies. Complementary growth opportunities may include expanding strategic relationships with large property owners, evaluating acquisitions of opportunistic real estate that become available through consolidation in the retail sector, and exploring strategic regional acquisitions of operating businesses. On April, 1 2024, we acquired United Grocery Outlet, which included 40 stores in six adjacent states we did not operate in as of such date (Tennessee, North Carolina, Georgia, Alabama, Kentucky and Virginia) and a company-operated distribution center. Our near-term integration focus is expanding the assortment, investing in store refreshes and new fixtures and introducing some of our marketing programs to the Southeast region. In addition to the newly acquired United Grocery Outlet stores, we plan to open approximately 22 to 24 stores in fiscal 2024, for a planned total of 62 to 64 net new stores in fiscal 2024. Excluding the United Grocery Outlet transaction, we opened 17 new stores and closed one store in the first half of fiscal 2024.

In late August 2023, we replaced components of our enterprise resource planning system, including our financial ledger, inventory management platform and product data warehouse system. The implementation of these system upgrades resulted in disruption to our business operations, including ordering and inventory disruptions, as well as payment processing, which adversely impacted our results of operations in fiscal 2023 as well as the first half of fiscal 2024, as more fully described below in "Comparison of the 13 and 26 weeks ended June 29, 2024 and July 1, 2023." We have since improved the data visibility to help us manage and forecast the business and we do not expect any further disruptions that would result in material negative impacts on our results of operations in the second half of fiscal 2024.

Beginning in the third quarter of fiscal 2024, we will be introducing our private label program to stores. In addition to providing better value and inventory consistency for our customers, our private label products are expected to deliver better margin for us and our IOs. We currently anticipate introducing approximately 100 new private-label SKUs by the end of fiscal 2024.

Key Factors and Measures We Use to Evaluate Our Business

We consider a variety of financial and operating measures in assessing the performance of our business. The key generally accepted accounting principles ("GAAP") financial measures we use are net sales, gross profit and gross margin, selling, general and administrative expenses ("SG&A") and operating income. The key operational metrics and non-GAAP financial measures we use are number of new stores, comparable store sales, EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share.

Second Quarter of Fiscal 2024 Overview

Key financial and operating performance results for the second quarter of fiscal 2024 compared to the second quarter of fiscal 2023 were as follows:

•Net sales increased 11.7% to $1.13 billion from $1.01 billion in the second quarter of fiscal 2023.

•Comparable store sales increased by 2.9%, driven by a 5.1% increase in the number of transactions, partially offset by a 2.1% decrease in average transaction size.

•In addition to the 40 stores acquired as part of the United Grocery Outlet acquisition on April 1, 2024, we opened 11 new stores and closed one store, ending the second quarter of fiscal 2024 with 524 stores in 16 states.

•Gross margin decreased by 140 basis points to 30.9%, compared to gross margin of 32.3% in the second quarter of fiscal 2023. As previously disclosed, we experienced disruptions as a result of the implementation of new technology platforms in late August 2023. Such disruptions are estimated to have negatively impacted gross margin by 100 basis points in the second quarter of fiscal 2024 and 150 basis points in the first half of fiscal 2024.

•SG&A expenses increased by 11.4% to $323.1 million, or 28.6% of net sales. This included $3.8 million of commission support we elected to provide our operators in connection with our system upgrades in the second quarter of fiscal 2024 and totaled $16.2 million in the first half of fiscal 2024.

•Net income was $14.0 million, or $0.14 per diluted share, compared to net income of $24.5 million, or $0.24 per diluted share, in the second quarter of fiscal 2023.

•Adjusted EBITDA(1) decreased 3.7% to $67.9 million compared to $70.5 million in the second quarter of fiscal 2023.

•Adjusted net income(1)decreased 21.4% to $25.1 million, or $0.25 per adjusted diluted share(1), compared to $31.9 million, or $0.32 per adjusted diluted share, in the second quarter of fiscal 2023.

(1)Adjusted EBITDA, adjusted net income and adjusted diluted earnings per share are non-GAAP financial measures, which exclude the impact of certain special items. Please note that our non-GAAP financial measures should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. See the "Operating Metrics and Non-GAAP Financial Measures" section below for additional information about these items, including their definitions, how the non-GAAP measures provide useful information to investors and how management utilizes them, and reconciliations of the non-GAAP measures and the most directly comparable GAAP measures.

Key Components of Results of Operations

Net Sales

We recognize revenues from the sale of products at the point of sale, net of any taxes or deposits collected and remitted to governmental authorities. Discounts provided to customers by us are recognized at the time of sale as a reduction in net sales as the products are sold. Discounts that are funded solely by IOs are not recognized as a reduction in net sales as the IO bears the incidental costs arising from the discount. We do not accept manufacturer coupons. Net sales consist of net sales from comparable stores, described below under "Operating Metrics and Non-GAAP Financial Measures - Comparable Store Sales," and non-comparable stores. Growth of our net sales is generally driven by expansion of our store base in existing and new markets as well as comparable store sales growth. Net sales are impacted by the spending habits of our customers, product mix and supply, as well as promotional and competitive activities. Our ever-changing selection of offerings across diverse product categories supports growth in net sales by attracting new customers and encouraging repeat visits from our existing customers. The spending habits of our customers are affected by changes in macroeconomic conditions, governmental benefit programs such as the Supplemental Nutrition Assistance Program and discretionary income. Our customers' discretionary income is impacted by wages, fuel and other cost-of-living increases including food-at-home inflation, as well as consumer trends and preferences, which fluctuate depending on the environment. Because we offer a broad selection of merchandise at extreme values, historically our business has benefited from periods of economic uncertainty.

Cost of Sales, Gross Profit and Gross Margin

Cost of sales includes, among other things, merchandise costs, inventory markdowns, inventory losses, transportation costs and distribution and warehousing costs, including depreciation. Gross profit is equal to our net sales less our cost of sales. Gross margin is gross profit as a percentage of our net sales. Gross margin is a measure used by management to indicate whether we are selling merchandise at an appropriate gross profit. Gross margin is impacted by product mix and availability, as some products generally provide higher gross margins, and by our merchandise costs, which can vary. Gross margin is also impacted by the costs of distributing and transporting product to our stores, which can vary. Our gross profit is variable in nature and generally follows changes in net sales. While our disciplined buying approach has produced consistent gross margins throughout economic cycles, which we believe has helped to mitigate adverse impacts on gross profit and results of operations, changes in consumer demand as a result of macroeconomic conditions, including inflationary cost increases for goods, labor and transportation, supply chain constraints and changes in discretionary income, have resulted and could continue to result in higher variability to our gross margins. The components of our cost of sales, as well as our gross profit and gross margin, may not be comparable to the same or similar measures of our competitors and other retailers.

Selling, General and Administrative Expenses

SG&A are comprised of both store-related expenses and corporate expenses. Our store-related expenses include commissions paid to IOs, occupancy and our portion of maintenance costs, depreciation and amortization of store-related assets and the cost of opening new IO stores. Company-operated store-related expenses also include payroll, benefits, supplies and utilities. Corporate expenses include payroll and benefits for corporate and field support, share-based compensation, marketing and advertising, insurance and professional services, depreciation and amortization of corporate assets and operator recruiting and training costs. We continue to closely manage our expenses and monitor SG&A as a percentage of net sales. SG&A generally increases as we grow our store base and invest in our corporate infrastructure. SG&A related to commissions paid to IOs are variable in nature and generally increase as gross profits rise and decrease as gross profits decline. We expect that our SG&A will continue to increase in future periods as we continue to grow our net sales and gross profits. The components of our SG&A may not be comparable to the components of similar measures of our competitors and other retailers.

Operating Income

Operating income is gross profit less SG&A. Operating income excludes interest expense, net, loss on debt extinguishment and modification and income tax expense. We use operating income as an indicator of the productivity of our business and our ability to manage expenses.