Grocery Outlet - Earnings Call - Q3 2019
November 11, 2019
Transcript
Speaker 0
Greetings and welcome to the Grocery Outlets Fiscal Third Quarter twenty nineteen Earnings Results Conference Call. At this time, participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Joseph Pillen, Vice President, Investor Relations.
Please go ahead.
Speaker 1
Thank you. Good afternoon, everyone, and thank you for joining us on today's call to discuss Grocery Outlet's third quarter twenty nineteen 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 twenty nineteen and future performance should be considered forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. A description of these factors can be found in this afternoon's press release as well as in our registration statement and quarterly reports on Form 10 Q filings with the SEC, all of which can be found on our website at investors.groceryoutlet.com.
We undertake no obligation to revise or update any forward looking statements or information. During our call, we may 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 can be found in the supplemental financial tables included in this afternoon's press release and in our filings. We use non GAAP measures as a lead in some of our financial discussions as we believe they more accurately represent the true operational performance and underlying results of our business. Presenting on today's call will be Grocery Outlet's Chief Executive Officer, Eric Lindberg Vice Chairman, MacGregor Reed President, RJ Sheedy and Chief Financial Officer, Charles Brocker.
Following our prepared remarks, we will open the call for questions. With that, I'll turn it over to Eric.
Speaker 2
Thank you, Joe. Good afternoon, everyone. Thank you for joining us today. MacGregor, RJ and I will share highlights from our third quarter as well as an update on our growth strategies. Charles will then review financial results and provide details on a revised outlook for fiscal twenty nineteen.
We're extremely pleased to see continued momentum in our business through the third quarter with strong financial results across the board. Outstanding performance over the last three quarters is a direct result of hard work, dedication from our entire staff and family of independent operators. I want to say thank you to all of them for their efforts. As reflected in our October second press release announcing our preliminary results, we delivered top line growth of 13.1% in the third quarter, driven by new store openings and a 5.8% increase in comp store sales. Our strong top line performance was complemented by gross margin expansion and lower than projected expenses, allowing us to exceed our expectations for adjusted EBITDA, which increased 13.2% to $44,200,000 Notably, this increase was burdened by an estimated $1,800,000 in public company costs, which we did not incur in the same period last year.
Our objective remains to deliver consistent gross margin performance and reinvest in our business to support our long term growth objectives. That said, based on our better than expected year to date performance, we are raising our full year guidance, which Charles will discuss in more detail. Now I'd like to turn over to some highlights from the quarter. Beginning with our comp growth, the strength was once again broad based across product categories, regions and store vintages as we continue to deliver across our three primary growth drivers. First and foremost, we are committed to providing our customers deep value and unique treasure hunt shopping experiences in the stores.
We continue to strengthen our relationships with our current suppliers as well as seeking out and developing new relationships to procure brand name products at amazing values. The pipeline of opportunistic product remains very strong and we continue to generate excitement for our customers. Second, we remain committed to supporting the independent operators in delivering the Wow! In store shopping experience. One example of this commitment is a round of regional meetings that we held with our IOs in early October.
Our leadership team visited nine cities in five days to share recent updates, provide opportunities for the IOs to share their best practices, and to respond to their questions. Key component of our success is derived from our efforts of our IOs. We wanna always ensure that we are providing the right level of ongoing support and engagement. We were thrilled with the broad participation from 95% of our independent operators and the enthusiasm throughout these meetings as it reinforces that this is time well spent by both management team and our IOs. Third, we leverage marketing to increase brand awareness and engagement at both the corporate and the local level.
Our Bargain Bliss marketing campaign continues to be very well received by customers. This corporate marketing is supported by local events and other advertising led by IOs within their individual communities. RJ will talk about some of these advances we made across these growth drivers. Moving to our store expansion strategy. We remain pleased with the performance of our new stores.
During the quarter, we opened eight new sites, bringing the year to date total to 24 new locations. These new stores are a balance of existing mature markets and developing markets, and they continue to perform in line with our expectations. Mac will talk about our expansion strategy in more detail shortly. We remain focused on the execution of our differentiated business model. It's the combination of the opportunistic sourcing and the local independent operator that allows us to out local the chains and out chain the locals.
We believe that this is the formula behind the consistency in our comp stores growth and our history of strong, stable financial performance. Looking forward, we remain excited about the opportunities ahead and we remain committed to delivering measured and consistent growth while operating our business for long term success. To reiterate our long term growth objectives, we expect to deliver consistent long term comp store sales growth of 1% to 3% annually, primarily through the three drivers I mentioned earlier. We remain on track to grow our store base 10% annually with a healthy balance of openings across mature markets. We have a high level of brand recognition in developing markets where we're building brand awareness.
To that end, we are extremely pleased to have filled our newly created leadership position for the Executive Vice President of our East Region as we look to develop our growth plans in the Mid Atlantic market. Lastly, as I stated earlier, we will continue to strategically reinvest our productivity savings back into the business to support future growth. With that, I'll turn over the call to RJ who will provide more details on our recent initiatives.
Speaker 3
Thanks, Eric and good afternoon everyone. We were very pleased with our broad based comp and margin results in the third quarter. Our customer value proposition remains strong and we continue to make it even stronger. Our philosophy is to always reinvest in our business and comp growth strategies. These efforts have and will continue to support our current and long term growth objectives.
I will start by reiterating that opportunistic buying remains strong in the third quarter. Opportunistic products, which represent about half of our assortment, deliver deep value and drive the treasure hunt shopping experience. Standout results in our nosh and wine categories represent the impact of delivering brand name products to our customers at unbeatable values. We've continued to enhance our buying efforts this year with a more specialized approach with some buyers now focused solely on either opportunistic or everyday products in their respective categories. This has led to improvements in both opportunistic and everyday sourcing as well as improvements in category management.
Our planning team, which provides inventory management and analytical expertise, is another critical factor to our continued success across all categories. Let me talk next about how we improve the ways we support IOs in delivering a Wow shopping experience. We continue to enhance the tools we provide IOs, which helps them operate more efficiently while also making smarter decisions to drive their business. As you may recall, IOs select approximately 75% of their assortment and have autonomy to create unique merchandising displays highlighting their Wow deals. This strengthens the local feel of each store.
Our real time order guide is one example of a critical business tool that we continue to invest in. It is a custom developed proprietary system that optimally manages the flow of products between the warehouses and stores. Recent enhancements to this ordering platform provide greater visibility to product availability, product information, and relevant selling statistics for smarter and faster decision making. By investing in ordering technology and supply chain improvements, we can better equip DIOs to optimize their inventory while continuing to strengthen the Wow shopping experience for their customers. Our third comp growth strategy is to increase customer awareness and engagement through local and store level marketing.
We continue to find more relevant and engaging ways to communicate with consumers. We expanded our digital marketing efforts, leveraging social media, email, streaming radio, connected TV, and third party media distribution channels. We have a highly engaged and growing email subscriber base that receives our daily Wow alerts and regular digital ads. Our digital marketing efforts allow us to dynamically highlight the best products in the customer's local store. This takes the treasure hunt experience beyond the four walls of our stores, communicating the Wow externally to our customers.
In the future, we see an opportunity to further personalize our digital communications to increase engagement with existing customers and to introduce new customers to our stores. We are committed to reinvesting productivity gains back into sourcing and distribution, IO support and marketing initiatives. This is part of our ongoing effort to further strengthen our compelling value proposition. One example of this is a network optimization study that we have recently begun. We are partnering with an outside firm to assist in the long term strategic evaluation of our supply chain network, which will help us plan for the next decade of successful growth.
Now, I'll turn it over to MacGregor.
Speaker 4
Thanks RJ and good afternoon everyone. I'm extremely pleased to see the continued progress we are making across our retail expansion strategy. During the third quarter, we opened eight new stores and closed one at the end of its lease term, bringing our total to 24 openings year to date and three thirty seven stores in total at the end of the third quarter. As Eric said, we're pleased with the performance across our new store base as we maintain a balanced approach to real estate expansion. Our business model has proven to be highly portable, and we have seen our stores succeed across a variety of geographies, urbanicities, and income levels.
Performance at our recently opened stores demonstrates this wide demographic appeal and continued consumer shift towards value. We're very focused on continuing to balance store openings in existing mature markets where we are well established, and developing markets such as Southern California, and longer term, the Mid Atlantic where we are continuing to build our brand awareness. I'm pleased to share that we have begun building the corporate structure needed to support our long term growth objectives in the Mid Atlantic region. To that end, we hired Heather Mayo for the newly created leadership role of Executive Vice President of our East Region. Heather brings twenty three years of experience in the retail club channel and will lead our efforts to expand our existing Mid Atlantic store base and future expansion.
We look forward to leveraging her operational and merchandising expertise as we develop our long term plans for this market. Looking ahead, we expect to open an additional nine stores in fiscal twenty nineteen. We also have a high level of visibility into our 2020 lease opportunities and are on track to deliver approximately 10% unit growth with a strong pipeline of future real estate locations. Before I turn it over to Charles, I wanna share an example of how our IOs create a unique community feel and generate awareness within their individual stores. As you have heard us speak about in the past, our IOs are constantly finding creative ways to engage with the community, whether it be through in store events, contests, or other attention grabbing activities.
This is an important part of building brand awareness at the local level, as well as deepening customer engagement. We often like to highlight some of these new and imaginative ideas across our IO community. One of the more unconventional examples of this came to us just recently in San Luis Obispo, where a couple who first met in our local store asked our IO if they can hold their marriage ceremony in the same aisle where they first met. The couple exchanged marriage vows in the candy aisle, no less. The store team who came to know the happy newlyweds were thrilled to be a part of their special day.
The wedding brought new meaning to our campaign tagline, falling in love on every aisle, and was picked up in the local papers and on social media. These types of stories are truly key differentiators that contribute to the success of our business model and are representative of the entrepreneurial spirit of the independent operator community. And with that, I'll turn it over to Charles.
Speaker 5
Thanks, Mac, and good afternoon, everyone. I will begin with a review of our third quarter financial results followed by an update on our outlook for fiscal twenty nineteen before opening the call for Q and A. Our third quarter performance reflects continued strength across all of our financial metrics. Sales for the third quarter increased 13.1% to $652,500,000 compared to the same period last year. This growth was the result of a 5.8% increase in comparable store sales on top of a 4.2% comp increase in the prior year period, as well as the sales contribution from 30 net new stores opened over the past twelve months.
The growth in comparable store sales was broad based and driven by contributions from both customer traffic and average ticket with strong performance across store regions and vintages. We opened eight new stores during the quarter with a balance of openings in mature and developing markets. As MacGregor stated, we remain very pleased with the performance of our recent vintages along with the productivity of our entire store base. With respect to margin performance, third quarter gross margin dollars rose to $201,100,000 a 14.5% increase compared to the third quarter of fiscal twenty eighteen. Gross margin rate expanded 40 basis points to 30.8%, in line with our expectations.
This increase was the result of strong opportunistic purchasing as well as increased efficiencies in product delivery and inventory management. SG and A expense increased 15.1 to $161,000,000 largely attributable to increased commissions resulting from gross margin dollar growth due to new unit expansion and strong comparable store performance. As a reminder, our business has a highly variable cost structure due to our gross profit share with IOs, which flexes with sales and margin rate performance. Other factors impacting third quarter SG and A included incremental occupancy costs associated with new store growth and the impact of $1,800,000 of public company costs, which we did not incur last year. In addition, third quarter SG and A growth also includes roughly $600,000 of secondary offering costs that were expensed because the company did not raise primary proceeds in the October 3 stock offering.
In total, however, SG and A expenses were lower than anticipated due to timing shifts into the fourth quarter. Stock based compensation expense for the third quarter was $2,900,000 Roughly half of this reflects ongoing expense associated with stock options and restricted stock units granted at the IPO. The other half was due to vesting of time based stock options associated with our October 2014 equity plan. Versus the third quarter last year, interest expense decreased by approximately $6,000,000 or 45.7% to $7,300,000 as a result of our IPO related debt pay down and subsequent repricing. We recorded income tax expense of 3,700,000 representing an effective tax rate of 23% in the quarter.
The lower tax rate reflects a tax benefit associated with the exercise of employee options during the quarter. GAAP net income for the quarter was $12,400,000 or $0.13 per diluted share compared to net income of $7,700,000 or $0.11 per diluted share in the prior year. In order to better illustrate the underlying performance of the business, we also report adjusted EBITDA and adjusted net income, which excludes certain expenses, including those related to our IPO, secondary offering and prior financing transactions. In the third quarter, dollars 600,000 of SG and A expense related to our secondary stock offering was added back to adjusted EBITDA and adjusted net income. Note, however, that we do not add back ongoing public company costs such as the $1,800,000 in expense we incurred in the third quarter.
A reconciliation of our adjusted EBITDA and adjusted net income to GAAP results can be found in our earnings release and 10 Q. For the quarter, adjusted EBITDA grew 13.2 to $44,200,000 from $39,000,000 last year. This result exceeded our preliminary estimate of 42,000,000 to $43,000,000 largely due to the expense timing shifts I mentioned. Adjusted net income increased 58.8% to 20,600,000 or $0.22 per diluted share based on an average of 93,200,000.0 diluted shares in the quarter. This compares to $13,000,000 or $0.19 per diluted share on 68,500,000.0 diluted shares in the prior year.
Now let's turn to our balance sheet. As of quarter end, we had cash and cash equivalents of $44,000,000 Inventory was $206,400,000 as compared to $185,600,000 in the same period last year. As a reminder, due to the opportunistic nature of our business, inventory levels can and will fluctuate from quarter to quarter as we take advantage of buying opportunities that become available. Over the long term, we expect working capital to grow roughly in line with sales. Regarding our capital structure, we ended the third quarter with $475,000,000 in gross debt, reflecting a 2.6 times adjusted EBITDA net leverage ratio.
Subsequent to quarter end, we prepaid $15,000,000 on our first lien term loan in late October. Now let me move on to guidance. We have raised our full year 2019 earnings guidance to account for a strong year to date performance through the third quarter and our expectations for the balance of the year. We now expect net sales for fiscal twenty nineteen to be slightly above 2,550,000,000 This assumes comparable store sales growth of approximately 4.9% for the full year and the addition of 33 new stores in full year 2019 along with three closures resulting in three forty six stores at year end. We continue to expect our Q4 gross margin rate will increase over last year consistent with the year to date gross margin improvement we've delivered.
Keep in mind that fourth quarter gross margin rates are typically lower than other quarters due to the impact of holiday product and mix. With regard to SG and A, we expect to see accelerated SG and A growth in the fourth quarter driven by number one, ramping public company costs, including cost to comply with Sarbanes Oxley, incremental accounting and legal expense and directors and officers insurance costs. Number two, shifts in expense timing from prior quarters into Q4, including self insurance and personnel related costs. And number three, various business and technology reinvestments to support our long term growth strategies. With respect to adjusted EBITDA, we are increasing our full year guidance to be in the range of $167,000,000 to $168,000,000 up from our previous range of $162,000,000 to $165,500,000 We've assumed a tax rate of approximately 28% and approximately 94,500,000.0 weighted average fully diluted shares outstanding in the fourth quarter.
Note that the share count excludes the potential future impact of 5,800,000.0 unvested performance options associated with pre IPO grants. Accordingly, we are raising our full year guidance for adjusted earnings per diluted share, which we now expect will be zero seven three dollars to $0.74 compared to $0.68 to $0.71 previously. Finally, expenditures net of approximately $10,000,000 in landlord allowances are now expected to be between 90,000,000 and $95,000,000 for the full year, which reflects the additional new store in the fourth quarter and the timing of first quarter openings. In summary, we remain very pleased with the broad based strength in our business as we continue to execute on our long term growth strategies. Now we'd like to open the line for questions.
Speaker 0
Thank you. At this time, we'll be conducting a question and answer ask to answer questions. You may press star two if you'd like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions.
Your first question comes from the line of Randy Konik with Jefferies. Please proceed with your question.
Speaker 6
Yes. Thanks a lot. Good afternoon, guys. I guess my question first question would be for RJ. The theme of the company seems to be one of a focus on continuous improvement.
And you gave us some broad strokes about the independent operator dashboard and the enhancements you've kinda made there. Maybe give us some perspective on, you know, where you've where the business has come from, you know, a few years ago, how the, dash dashboard has improved productivity in in in a measured way. And then how do we think about, you know, areas of focus for the dashboard to continue to enhance productivity across the ordering process and, I I guess, supply chain over the next few years going forward? Thanks.
Speaker 3
Yes, sure. Hi, Randy. Yes, so let me cover a couple of things on that question. First, from a systems investment standpoint, 've really made a significant effort, I'll say, over the past six years or so to enhance some of our core operating systems. A lot of this is custom developed, specific to our business and the way that we operate.
And we talk about things like the real time order guide, mentioned that in my comments, related to that distribution system, the order guide that is used for direct store delivery products, all of those custom built. And then in addition to that, a number of what we believe to be best in class third party software platforms that have helped us bring better business intelligence to the company. We have a new WMS system, relatively new WMS system over the past several years, a platform through which we better communicate with operators and manage processes internally. There are several others there as well. Specifically to when you talk about the operator dashboard, I would point to two specific things.
One is the real time order guide. Again, that is the primary tool for transferring product from the warehouse to the stores. The vast majority of which is pulled into the stores by the operators, they're making the decisions on that, which really creates the localized assortment, that we enjoy specific to that market and those customers and how the operator can best provide those products to their customers. And within that tool, there is a lot of information and increasingly more information and tools to manage that as best we can. So giving them the best information, making it as efficient as possible and then allowing them to order the right products in the right quantities, again, for their local customer and their needs, which is the way they then take in merchandise within the store.
So a lot of information and it's a tool to transfer product, but it's also a dashboard and it has that information to help them make smarter decisions. We also provide, on the business intelligence side, a couple of dashboards, really several that one, help them manage their business as far as comp goes and margin goes and customer service and it brings all the operating information, benchmark information to a very detailed level to help them understand where their business is trending and some of the things that they might do to capture opportunities. And those have proven to be very helpful again for them in the decision making specific to their stores. So those are just some examples of recent investments. We'll continue to enhance those specific systems.
And then as we talk about, continue to look for new systems and tools that we can bring to the business to improve the way that we do things.
Speaker 6
Thanks. And then just one quick follow-up, maybe perhaps, for Eric or Mac. You know, if you think about the the dual prongs of, marketing around, awareness and engagement, and you think about how you, you know, grew awareness outside of California in the other states, and then built then engagement, how do you how do you guys think about distorting your marketing messaging of Bargain Bliss and then specifics around engagement versus awareness as you think about growing into new states? Just kinda getting a perspective of what you did in the past to kind of build into the new states to give us some perspective on how you're thinking about approaching marketing, going into additional states going forward would be helpful. Thanks.
Speaker 2
Yes. Hey, Randy, nice to talk to We didn't market a whole lot in our early years at Grocery Outlet. It was more experience coming into the store and finding the bargains. We have a fundamental belief that if we can tell that story and continue to repeat that story, we're going to win. We know the values are unbeatable.
We measure them. You guys have measured them. So what you really have now is more the methodology that we're going to tell that story. And so years and years ago, was TV and radio and quite literally print ads every week for retailers. And today, those tools that we're using are just a little bit more modern.
We're pushing down the continuum of trying to get the information that's most relevant to the consumer that's individual to get that message. And then I'd say the second piece is the operators are getting a lot more sophisticated at local marketing. And so they're picking up on the queues in their neighborhoods and their communities. They're responding directly to customers in front of them in their stores. And they're using the order guide, the merchandising and they're using their community involvement to go very, very deep in community.
And I would say that on a continuum, since Mac and I have been at Grocery Outlet, we've just gotten better and better systematically every year at using the tools and developing a little deeper understanding of how the consumer wants to talk to us and be talked to. So that hopefully answers your question.
Speaker 0
Your next question comes from the line of Robbie Omos with Bank of America. Please proceed with your question.
Speaker 7
Hey guys, thanks for taking my question. I'm going to make it too really brief. Just on the long term comp guidance of 1% to 3%, you're obviously doing much better than that. Can you remind us why you can't keep doing much better than 1% to 3% going forward? And then similarly, your gross margin is coming in as you expected, but up nicely year over year.
Can you remind us why you couldn't continue to grow the gross margin going forward? Thanks.
Speaker 5
Hey Robbie, it's Charles. Yes, let me tackle the comp question and I'll turn it over to RJ to talk about gross margin. But with respect to comp sales, again as we've talked about, feel really good about the health of the business and broad based strength that we've seen over the course of the year. And as you can see in our implied guidance, the Q4 we're guiding in essence above the high end of our long term comp range of that the 1% to 3% that you referenced. And we do think about that 1% to 3% is really the essence of the way that we manage and plan the business over the long term.
We're of course happy when outperform that, but we think that the discipline of sticking to that 1% to 3% range, and the way that we manage behind that is really a key reason behind the consistency of the financials that we've delivered over time. Let me turn
Speaker 4
it to Arjun to talk about margins.
Speaker 3
Sure. Yes. So on margin, we've been very pleased with the performance that we've seen this year. I would point to it being the results of a number of improvements on the purchasing side, lot of work done there to negotiate cost on the everyday side of the business, always point to strength of opportunistic and deal flow and that really comes from the strong partnerships we have with our suppliers, always working to be better partners to them and strengthening those relationships further. We've seen nice productivity enhancements from a supply chain standpoint.
And then there's a lot that we've done that we've seen the benefit of this year, by way of inventory management and that's specific to allocations and distribution logic, and again the systems that we use to manage that. So I'm really, really pleased with the results that we've seen there. In terms of, how we think about margin looking forward, as we've said, expect that to be consistent, with the levels that we've delivered this year. For us always the balance of delivering first and foremost value to the customer, the customer excitement and the Wow! Shopping experience and then, maintaining a healthy margin as well.
And so we feel like we have the right balance. Again, with the improvements that we've seen this year, but expect that margin to be pretty stable looking forward.
Speaker 0
Your next question comes from the line of Simeon Gutman with Morgan Stanley.
Speaker 8
My question, somewhat of a follow-up to the prior couple. You
Speaker 2
have
Speaker 8
all this extra top line growth relative to your plan and gross margin, as was mentioned, is doing better. So what I guess, where are you investing all these incremental gross profit dollars? I know you gave us some examples, but thinking on a near term basis, where you're able to spend it? Is it advertising? Can you point to some other items?
And then just to clarify, it sounds like there's going to be some SG and A moving to the fourth quarter. It seems like the math would be about 100 basis points of deleverage in Q4 to get to your EBITDA guide to confirm that?
Speaker 3
Simeon. It's RJ. I'll take the first part of your question and then maybe Charles will want to cover the second part. In terms of reinvestment opportunities, I'd say there's a healthy list of things that we continue to reinvest in to support long term growth, is how we orient in the way that we think about how we manage our investment dollars.
I mentioned a few in my comments, maybe a little bit more color on some of those because I think they're good examples. One being this more recent specialization around opportunistic and every day. And think of that as both a current and future investment in people, process, systems and other related expenses to manage these different halves of the assortment. So that's a new one from the beginning of this year and that orientation and investment that goes along with it will carry forward. There's a lot on the system side, real time order guide, distribution system.
As we look forward, there'll be other enhancements to follow. Those are investments, again, both current and future in the development of course, but also oftentimes processes and ways that we operate the business to better support growth on the top line, whether that's supply chain or purchasing again, inventory management or some other part of the business. And so all those things tie together. The network optimization study that I mentioned, again, another example, that one is looking well out into the future at infrastructure and really everything around supply chain, how we can best support future growth as we look out over the next five, ten, fifteen, twenty plus years. And so, there's a longer list of other things that we continue to invest in and we see the results, in years like this one on both top line and from a margin standpoint.
Speaker 5
Hey Simeon, it's Charles. And with respect to as we think about EBITDA margins for the fourth quarter, so again just a few things to keep in mind as you're looking sequentially. Number one, our fourth quarter gross margins, are generally lower, over the course of the year due to the impact of holiday product and mix. So again, we're seeing nice, year to date gross margin improvement of about 32 bps and we would expect to see that carry forward into fourth quarter. So the real key is SG and A and again as we think about changes relative to last year, the key factors are the impact of public company costs which is really ramping.
We continue to think that the $8,000,000 that we've circled up as annualized public company cost is accurate, but we are seeing heavier we expect to see heavier spend in the fourth quarter of this year continuing into the first half of twenty twenty, largely as a result of being right in the thick of SOX implementation over that time period. Secondly, as we talked about the timing shifts in SG and A expense out of Qs two and Q3, into Q4, has an impact that has to do with things such as self insurance expense as well as other personnel related costs. And then lastly, the reinvestments that RJ spoke to. So in total, those are the key drivers. I think the number that you referenced is probably a little bit high, but those are the factors.
Speaker 8
Thank you.
Speaker 0
Your next question comes from the line of Oliver Chen with Cowen and Company. Please proceed with your question. Hi, thank you very much. Congrats. Regarding supply chain, what do you see on the road ahead for the major needs near and longer term?
And one of the things that our survey really pointed to was a big opportunity in the mobile apployalty point of view in terms of customers wanting that as well as the opportunity to employ a lot of data and analytics and machine learning around customers using that. So, would love your thoughts on both. Thank you.
Speaker 3
Sure. Hi, Oliver. So, with regards to supply chain, I think we do a very nice job moving product into our system and through the stores. There's always room to improve and I think we've done a nice job of taking through some of those improvements this year. Mentioned some productivity enhancements and other changes that we've made to improve the flow of product in the most efficient way possible.
The study that I mentioned is more of a further look out when we get to higher store counts expand beyond geographies and, really covers all aspects of supply chain from transportation inbound, outbound, capacity planning, the systems that we deploy to manage that and everything for how products move through the system. And so that's just the way that we manage the business. Nothing immediate or specifically needed there other than taking a look at how to support that longer term growth expectation. In regards to marketing and digital and personalization, again, this is something that we continue to look at for the future. We don't have a loyalty program today.
We think there's an opportunity to be more specific. We love the improvements that we've made from a digital standpoint through social media and we're active in a number of platforms there increasingly through, streaming radio and connected TV. We think we've seen a nice lift, in both awareness in more newer markets, but then also engagement and trips in more mature markets and leveraging this database that we have that is store and item specific. We think it's very compelling in a way that brings those deals outside of the four walls of the stores. We think that goes a long way to driving trips.
And then of course they find many great deals around that, which leads to basket. We're going to spend a lot more time over the next year or so looking at the opportunity from a personalization standpoint. Think to the extent that that proves favorable, we'll then get to that next level of communication being more specific to the customer, not just at the store and item level.
Speaker 0
Thank you. Very helpful. Best regards. Happy holidays as well.
Speaker 3
Thank you. You too.
Speaker 0
Your next question comes from the line of Michael Lasser with UBS. Please proceed with your question.
Speaker 9
Good evening. Thanks for taking my question. I have three questions actually. First on your comp guidance for the fourth quarter, it implies a 3.9% comp, which is very specific and would represent your lowest two and three year stacks of the year. Is there anything that's going on that would drive the slowdown?
And then two more quick ones.
Speaker 5
Hey, Michael, it's Charles. Just on the comp guidance, no, it really has to do with the way that we manage the business for the long term. I wouldn't say there's anything specific to the fourth quarter, but we just think this is the prudent way to think about the business. Happy that the business, is at this point, firing on virtually all cylinders through the third quarter. But knowing what we know now, the way we think about the fourth quarter.
Speaker 9
Charles, other question is, even if we take out the $1,800,000 of public company costs in the third quarter and given the fact that there were some expenses that flowed out of 3Q into 4Q, it looks like there still would have been some deleverage on the expense side despite a very healthy comp. What comp do you think you need to lever the operating expenses of the business at this point?
Speaker 5
Yeah, we think about a two comp, levering our fixed costs.
Speaker 9
Okay. And then my last question is, there was a mention in the transcript that you've reorganized some of the buying positions such that the buyers are solely focused on opportunistic buys. Is that allowing you to get better opportunistic buys and also help the gross margin? And is it also a recognition that the business is very dependent on these really good opportunistic buys in order to drive the types of comps that have been produced recently?
Speaker 3
Yeah, would say the reorganization there was to manage the complete assortment better. So nothing so specific to opportunistic or to the everyday side. Prior within these departments that have recently specialized, a buyer was managing both sides of the assortment within the categories that he or she managed. And so, by specializing, we think we can manage both for those that are focused on that, both the everyday side of the business better because it is a different process, it's a different type of relationship, it's a different cadence, a different approach to itemization and managing categories. So we think we get benefits there.
And then also on the opportunistic side, again, unique and different in the way that you work and partner with suppliers and manage items think about that. All of those or both of those, excuse me, of course tie together through how we manage inventory from an open to buy standpoint and then how we manage health of inventory within each specific category. So that's the thinking behind it. I would describe it as just the most current state or progress as it relates to specialization. Prior example was when we introduced the planning function, back in 2013.
We've great benefit from that in a lot of different areas and freed up time for people to do the things that they do best and this is really just another, slightly different iteration of that and we think, most of that benefit we've seen some this year but really most of that benefit is in front of us still.
Speaker 9
Thank you very much.
Speaker 0
Your next question comes from the line of Karen Short with Barclays. Please proceed with your question.
Speaker 10
Hi, thanks. A couple of questions. So just if you could give any color on the cadence of the comps in the quarter and then just generally what you're seeing on inflation?
Speaker 5
Hey Karen, it's Charles. We don't speak specifically to results within the quarter. As it relates to inflation, we continue to see inflation throughout the year being a modest tailwind. We would expect that that would continue. And then just a reminder relative to others, you know, it's a more muted impact for our business as a result of both the opportunistic buying model, as well as the gross profit share with operators.
So it more muted impact on both the way up and the way down.
Speaker 10
Okay. And then in terms of, just understanding a little bit more on the buyers, I just want to clarify. You're not adding another buyer for each category, correct? Because it sounded like you were saying that you have one buyer for opportunistic and one for more ADLP for each category. I just wanted to understand that better.
Speaker 3
No. I'm describing just the team and roles and responsibilities there, and buyers are managing multiple categories.
Speaker 10
Okay. And then last question. Just in terms of the nine city tour that you did, maybe can you talk a little bit about what you're learning this year versus prior years, assuming you've done this in the past? Maybe just a little color there.
Speaker 2
Yeah, so I would say hey Karen, this is Eric. I would say just relative to operator health and our culture, this is how we get out and talk to operators. So once or twice a year, we're with them. I would say this year, it was a very positive engagement. They were engaged.
They were very curious. Half the meeting is dedicated to information sharing and half is dedicated to sort of Q and A. We asked them to help communicate their best practices that we think are fundamentally changing their business for the good and share those with other operators in the room. Generally, operators were very, very open and curious and asked lots of good questions. We use these events.
We pre survey them. They help us sort of modify our strategy. We seek the feedback on things that are working, things that aren't working. We confront the things that aren't working and we can sort of slightly course correct. I would say on their mind this year, they're fairly here and now type questions.
A lot about product, a lot about supply logistics, a lot about the tools rollout that we've been on for the last eighteen months, two years. So I would say those are probably the lion's share of the questions. It's a great way for us to be out with our larger team in front of the operators engaging and they're really seeing firsthand what's on their mind.
Speaker 0
Your next question comes from the line of Paul Trussell with Deutsche Bank. Please proceed with your question.
Speaker 11
Hey, good afternoon and good quarter. Just a few questions on the real estate side. First, maybe just talk a little bit more about what you're seeing in terms of new store productivity, both in California and into other states and markets you've expanded into. Also, you touched on the higher for the EVP Eastern Region. Maybe just help us to the extent you can now talk about how we should be thinking about the growth plans for the Mid Atlantic and what your expectations are for that area?
Thanks.
Speaker 5
Hey Paul, this is Charles. Let me start out with some of the specifics around new store performance and then I'll turn it over to Mac to talk about regional growth plans. But I think with respect to new stores, I'm very pleased with the performance we're seeing from new sites. They continue to perform in line with our underwriting expectations. We track each new store opening closely, but I think it's worth reiterating that our stores do have a meaningful sales ramp over the course of their first four years.
Cumulatively, that's about 25% top line growth. So we really take the long view and we also track the ramp of those vintages, to make sure that they're in line to hit their mature sales target. So we feel good both about new sites that are opening in the ramp of recent vintages. As it relates to performance across regions, I think the call out there is that we use an underwriting, we use a blended underwriting model knowing that we're going to have the mix of stores in newer markets, along with stores in more mature markets that have higher levels of brand awareness. So what we're seeing as expected would be that sales volumes typically track that level of brand awareness and we're seeing good progress, across all regions with all regions, reporting good results in the third quarter.
Speaker 12
Hi, Paul. It's McGregor. With respect to growth plans and newer geographies, I think very consistent with what we have said in the past and that is that we see both the opportunity to continue to infill in core mature markets and then also remain very focused on building out the Southern California market where again, we think we're about halfway there. And then really turning our attention to opening more stores in the Mid Atlantic and certainly hiring Heather is a great first step in that direction. We fully intend her to continue to build the infrastructure to support a higher growth rate as time goes on.
But you know, again, not to repeat myself, we really believe in sort of this crawl, walk, run approach. You'll see us open a few stores in 2020 in that region and then continue to build from there. So, I think over time, certainly the next three to five years, you'll continue to see a healthy number of stores opening in both core mature markets in Southern California and also in the Mid Atlantic.
Speaker 11
Thanks for the color there. Just one really quick follow-up. Just on the balance sheet, you mentioned in the release that you paid down some of that first lien term loan. Maybe just remind us of of leverage targets and timeline to get there.
Speaker 5
Sure. Again, is Charles. I would say we have not yet established a formal long term leverage target. But of course, as a result of the IPO, we we were able to cut our annualized debt service in half, which which is freed us some cash. That allowed us to make that $15,000,000 principal payment in late October.
But I'd say in terms of priorities, our first priority for cash is always to invest in growth. And then once we've done that, we can use cash to further delever. Again, having established a long term target, but over the near term, we'd expect to use cash in excess of growth capital to to delever.
Speaker 0
Your next question comes from the the line of John Heinbockel with Guggenheim Securities. Please proceed with your question.
Speaker 13
Hey, guys. Two things.
Speaker 14
Let me start supply chain, right? So the Ontario facility, when does that begin to make an impact? And I assume it's not material enough to move the gross margin dial. And beyond that, what do you still need to do on the West Coast?
Speaker 3
Hi, John. Yes, Ontario, pleased with that facility as it's been ramping up here. We're still flowing product through there and starting to distribute more locally than up from Modesto. But understand there's certainly benefit to the business, but there's also some offsets that we're managing as well and the business does become more complex. But we love it for the better service that will provide stores in Southern California market, get product to them sooner and then of course, local freight will enjoy that benefit as well.
And so with that, you talk about the West Coast market and as that continues to ramp, we've got our two primary facilities then servicing Southern California. We've got two primary facilities in the NorCal market and then two up in the Northwest. So we feel very well covered for the regions and as we continue to open stores in both infill and new markets, we think we're well positioned from a supply chain standpoint.
Speaker 0
Your next question comes from the line of Chris Prykull with Goldman Sachs. Please proceed with your question.
Speaker 15
Good evening, guys. Thanks so much for taking the questions. Just a couple on my end. Maybe as a follow-up to Paul's question earlier, financial leverage probably below where you anticipated at this point. Any updated thoughts on share repurchase or dividend?
And then along that same line, would you consider accelerating store growth? What would be maybe a prohibiting factor from doing that? And any big capital expenditures that we need to be aware of on the horizon?
Speaker 12
Hi, Chris, it's MacGregor. I'll start with the latter part of your question. No, I think we continue to feel comfortable with 10% unit growth annually. I think consistent with what Charles said, relative to comp, we think it's the right way to think about it longer term for the business. And I just reiterate again that, as the absolute store count number continues to grow each year, it's a significant undertaking here from a variety of functional areas to continue to support that level of growth.
But we're comfortable in our ability to continue to do that.
Speaker 5
And then Chris, with respect to the numbers again, as it relates to share repurchases or or dividends, you know, I don't think we're we're ready at at this point to to make any comment there. Near term, continuing to focus on investing in the business and then delevering from there. We'll provide an update, likely next year with respect to a more specific, long term leverage target. And then as it relates to your next question around CapEx, again, first priority for us is investing in new stores. We love the return that our new store model offers.
Roughly two thirds of our spend of our CapEx spend historically has gone to fund new stores and then the remaining third, we're always looking at reinvesting back into the existing fleet. That includes, both sales and margin driving initiatives as well as just the regular maintenance cycle around store upgrades and repairs. And then, in addition to that, comprising that remaining one third would be everything that we do from a distribution, IT systems and corporate side to constantly be reinvesting back into the business to set ourselves up for long term success.
Speaker 15
Great. Thanks. And then I know I'm a quarter early, but as you look out to 2020 and think about guidance, any reason that that guidance would deviate either to the upside or downside from the long term algorithm that you laid out?
Speaker 5
Well, I would say we feel very good about where we are as we think about the three parallel pipelines in our business. Number one product, number two real estate, and number three new IOs. They all look healthy. So we feel great about that. We will be anniversarying strong results next year, but with respect to our long term growth algorithm, continue to feel like that is, that's right where we want to be and that's, consistent with the way that we manage the business.
And so on our next call, we'll provide more fulsome guidance with respect to 2020.
Speaker 0
Your final question comes from the line of Joseph Feldman with Telsey Advisory Group. Please proceed with your question.
Speaker 13
Yeah. Hi, guys. Thanks for taking my question. Wanted to ask about the IO pipeline, meaning just the people and the ability to get quality people and talented ones. I know in your core markets, you seem to have very good depth.
But the ability to get them to move to new markets like Southern California or even the Mid Atlantic, can you talk about that?
Speaker 2
Yeah. Hey, Joe, Eric. I think best practice for us, and we've tried it a lot of different ways over the years, as you might guess, is to get recruiting from market, in market. Being local carries a heavy weight with us. So take the Southern California market where we operate 70 plus stores.
We've gone into that market with a recruiting team, a training team and resources in market to make sure that we can find people that understand the local markets are
Speaker 9
going
Speaker 2
to live, not have to relocate. That's not to say we haven't tried it other ways, but that's generally the way we try and do it and think about it. Strength of the program remains very, very strong. I'd say a healthy mix of people coming from outside retailers and you can name the retailers in sort of the food retail business. We're getting all of them, a lot of them knocking on the door.
And then the other balance is coming from internal candidates. Takes a little bit longer to get up to speed, but we're finding a lot of success in both sides. And then we've built a kind of a team here from sort of start to finish. So from the time they enter the program to, getting assessed to putting together a specific training program to mentor him through training, to deploying him to stores, to handing him off to the DSM, there's a touch point along the way that is really driven to get them up to speed as quickly as possible and get them to sort of that full independent operator status.
Speaker 13
Great. And just one follow-up. I know you guys said you hired the new EVP, Heather Mayo, and had twenty three year background, I guess, in real estate. Just any more color you can share about maybe where she came from? Has she always been in that market?
Presumably she has, but other retailers she's worked for?
Speaker 2
Yeah. So Walmart and Sam's. She has a background in real estate, but really her specialty is in merchandising and operations, started in club stores in her early days, has operated regions in the Mid Atlantic, has operated on the West Coast, just a great executive all around. So we're really excited. She's brand new, started October 7.
So she's in sort of a three to four month immersion getting to know Grocery Outlet leadership practices, really getting to know the IOs across the company. So we couldn't be more excited to see sort of the progress we'll start making in 2020.
Speaker 0
Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Eric Lindberg for closing remarks.
Speaker 2
Don't have a lot to say, closing remarks. Just, want to say thanks for, being on the call with us. And, I know we have some follow-up to do with each one of you, but, appreciate all your questions. Thanks for being on, and we'll talk to you soon.
Speaker 0
Concludes today's conference. May disconnect your lines at this time. Thank you for your participation.