Grocery Outlet - Earnings Call - Q3 2025

Transcript

Operator (participant)

Greetings and welcome to the Grocery Outlet's Third Quarter 2025 Earnings Results Conference Call. At this time, all participants are in a Listen-Only Mode. Q&A session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ian Ferry, Vice President of Treasury and Investor Relations. Thank you. You may begin.

Ian Ferry (VP of Treasury and Investor Relations)

Good afternoon and welcome to Grocery Outlet's Call to discuss financial results for the third quarter ended September 27th, 2025. Speaking for management on today's call will be Jason Potter, President and Chief Executive Officer, and Chris Miller, Chief Financial Officer. Following prepared remarks from Jason and Chris, we will open the call for questions. Please note that this conference call is being webcast live, and a recording will be available via 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.

Description of these factors can be found in this afternoon's press release as well as in 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. These statements are estimates only and not a guarantee of future performance. Additionally, during today's call, the company will 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 on the Investor Relations section of the company's website under News and Releases and in the company's SEC filings. Now I would like to turn it over to Jason.

Jason Potter (President and CEO)

Thanks, Ian, and thank you all for joining today's call. In the third quarter, we continue to advance our strategy while executing to deliver strong bottom-line results. We grew net sales 5.4% to $1.17 billion, with sales in comparable stores up 1.2%, which I'll discuss in greater detail in a moment. In the quarter, we also added 11 net new stores. Importantly, in Q3, we began to roll out our store refresh concept to an initial wave of independently operated stores. We are seeing encouraging results with the pilot stores that are participating in this program, and we're planning to accelerate the expansion of the program throughout the rest of the year and into 2026. On the execution front, we continue to operate with discipline to achieve healthy profitability. We reported a gross margin of 30.4%.

Consistent with our outlook, while carefully managing spending allowed us to deliver an adjusted EBITDA of $67 million at the top of our outlook range and adjusted EPS of $0.21, which exceeded guidance due to favorable taxes. While Q3 results were broadly consistent with our expectations, comp store sales of 1.2% came in below our outlook range. Leading into the final weeks of the quarter, we were pacing to our 1.5%-2% outlook, with traffic up roughly 2% over that time frame. However, during those final weeks, we experimented with promotional activity as well as marketing mix that was, we believe, net negative. Testing is a key part of the work we're doing to drive sustainable growth and will continue to eliminate things that don't contribute and double down on what does.

In this case, we've course corrected, and over the last couple of weeks, we've seen a return to weekly comp growth. While recent comps have been positive, given the slow start to Q4, we now expect same-store sales growth to come in between flat and up 1% for the quarter. Chris will detail the impact to our annual guidance in just a few minutes. Since joining the company nine months ago, I've spoken about four key strategic imperatives: tackling new store performance, securing top talent, addressing execution gaps, and improving execution at scale. These remain our key focus areas and will be going forward. On the new store front, our strategy continues to progress in the manner I outlined on our previous call, and the performance of our 2025 cohort remains ahead of plan.

In addition, we continue to secure talent at the company with two recent hires that I'll comment on later. However, given the current situation with softer comps than we'd all like, I'm going to focus on most of my comments on this call on the latter two pillars that address execution at the company. First, on execution gaps. We've made significant progress on restoring systems functionality to enhance our IO's ability to deliver a higher level of in-stock performance with better inventory visibility. The second is now scaling execution through our model store refresh program, which will deliver a much stronger in-store experience for our customers. I'll now share how the systems and support work we're doing on behalf of IOs, which we expect to yield a meaningful impact in 2026, will enable our operators to drive comps and build momentum.

We began this year with the goal of delivering meaningful improvements in inventory visibility and availability for our IOs. We started by building upon the strengthened technology foundation of our systems integration, rolling out our real-time order guide. And in October, we began introducing our new arrival order guide. Both initiatives have given our IOs greater visibility to inventory. And the capability to sharpen merchandising in their stores. I recently spent time with IOs around the country and heard resoundingly that the greater upstream inventory visibility has enhanced their ability to execute. This is exactly what we mean by making Grocery Outlet a great selling organization. By year-end, we expect IOs to have regained all order guide systems functionality that existed prior to the SAP implementation, which will allow us to shift our focus from fixing integrated-related issues to driving growth.

To build on the strength of our order guide implementation, we're now enhancing these tools with forecasting capabilities for fresh meat and produce. We're supporting these updates with training to help our IOs manage inventory even more efficiently. Creating proficiency in matching forecasting and demand is foundational for improving the execution needed to drive a sustained sales performance. With that in mind, these new enhancements combine three essential components that IOs can implement to deliver on that objective. Number one, resetting the retail display areas for fresh products to prioritize top-selling items. Second, implementing operational SOPs that support accurate inventory counts, higher turns, while improving the quality of our fresh offering. And three, implementing training to execute these new systems, methods, and procedures on this forecasting system so stores can deliver a consistent in-stock position just in time.

Each part of this system supports the others, and we believe this holistic approach will improve our operators' ability to execute consistently. We believe this will be one of the most important and impactful initiatives implemented across the company. We expect in the coming months, we'll have this capability embedded into our proprietary order guide, making it easier for IOs to operate their businesses. Through enhancements we're making to our order guide, operators will not only have better visibility of supply, but they will be better equipped to forecast and meet demand, which will improve the customer experience. Delivering a stronger in-store experience has been our top priority, and the results of our store refresh give us confidence in our ability to meaningfully accelerate our comp growth going forward. Let me start with some background.

We've spent much of this year engaging with customers and our IOs to discern where we could drive a better in-store experience. Feedback from the survey work indicated that our customers felt a lack of consistency in their store visit experience. While customers appreciate the value we offer and enjoy the treasure hunt aspect of shopping in our stores, they indicated that the experience was challenging to shop and that a lack of consistent availability of various key items hurt their trust in us. We want our customers to see us as the place where they can shop every day confidently, creating an experience that delivers value. To address this feedback and strengthen our performance, we focused on three critical areas within the pilot stores. First, improving the store layout. Second, expanding and standardizing our core assortment, and third, elevating our in-store value messaging. Customer receptivity has been outstanding.

These three initiatives have driven mid-single-digit comp lift in our two pilot stores with a full quarter reporting, and we have several more stores in various stages of completion. While we learn more about the sales lift potential as we touch additional stores, based on the promising early results we've seen so far, we plan on meaningfully scaling the store refresh. We believe that this initiative and the retail fundamentals it's based on can be rolled out to the vast majority of our store base. We expect to end the year with approximately 20 stores completed. We also expect to complete at least another 150 stores by the end of 2026 and complete the balance of addressable stores in 2027. We believe this work, combined with the system stabilization, improved IO tools, should position us to drive future sustainable comp growth.

I'll share some details around those changes to give you a sense of their impact. Starting with improving the store layout and the merchandising changes we made. In our pilot stores, we've improved the layout to create a more inviting and more intuitive shopping experience. When shoppers now enter our store, they enter with a clear sightline to understand the layout. We've removed the forced flow and have logically grouped categories throughout the store and ensured that the fresh departments are merchandised together. We improved the store flow by relocating produce to the front of the store, co-locating meat and fish, and moving general merchandise and health and beauty towards the back of the store. Now, these may sound like modest changes, but they're delivering big results.

Bringing produce up front and center and expanding our offerings of high-quality fruit and vegetables has driven double-digit comp lift in meat and produce within our test group. And to illustrate the impact for customers, our independent operator at Roanoke Park, California, shared the following feedback. "I'm really excited about the freshness, openness, and clarity the changes bring to the store, and that is exactly what customers are telling us." We've implemented these changes informed by our customer feedback and getting input from our IOs. We look forward to working with our IOs across the business this year to demonstrate the meaningful impact our refresh will have for their customers and their stores. Getting fresh right is a big part of helping us earn the opportunity to grow basket with our customers. Now, turning to core assortment.

Within our improved store flow, we're ensuring that our stores are in stock on core basket-building items. This allows customers to do more of their shopping during their trips to Grocery Outlet and ultimately make Grocery Outlet their primary shopping destination. To address this opportunity, we defined 400 core items that all stores will carry going forward and be consistently in stock on. These items include well-known name brands like Heinz ketchup, Daisy Sour Cream, and Eggo waffles, along with many of our private label staples that are on our customers' regular shopping list. Our refresh store ensures that our stores are easy to shop by merchandising categories in a logical, intuitive way, with a consistent product location and assortment on shelf while still leaving plenty of room for our opportunistic buys and treasure hunt experience.

Improving the experience overall by being more consistent and easier to shop are key areas of friction that will support sustainable momentum in our comp sales. Now, on elevating in-store messaging, we feel it's important to make our messaging work harder. In these refreshed locations, we have created a kit that clearly communicates a feeling of value throughout the store. This signage helps shoppers see the tremendous value they're getting while ensuring they're benefiting from the improved core assortments and the unique opportunistic offerings we carry. Greeting shoppers with great merchandising supported by strong messaging is cementing our value prop with customers that come to our stores. Our business offers tremendous value, and improving our marketing, our branding, and communication will all contribute positively to telling our unique and differentiated story.

As we roll out our store refresh, we'll continue to operate with discipline with the goal of driving improved returns on capital, another important priority for the company. These investments come at manageable, incremental investment, and their execution is relatively straightforward. We estimate that our payback period on these investments is roughly three and a half years, and accordingly, we expect these initiatives to yield attractive returns while improving our IO incomes. Our refreshed store is also focused on ensuring that our new stores achieve the 20%-plus return target by creating sustainable comp growth. Going forward, our new stores will launch in our refreshed format. We've rolled this new approach already in one of our new locations late in Q3 with early and favorable results.

A key focus for the upcoming year's rollout is delivering on these merchandising standards, and part of becoming a great selling organization is continuing to improve our ability to localize our stores. Supporting localization has the power to drive store productivity, and we're approaching this theme of localization in new ways. For example, in Southern California, we're testing a model store with a more demographically relevant assortment with supporting marketing and promotion designed to serve the large and growing Hispanic population in the region. While our tests are early, we're seeing encouraging results from this test, and we see an opportunity to deploy this widely through the region. Finally, and critically, we've prioritized securing top talent for this business to propel our work in our stores. We recently welcomed two strong leaders to our team.

Our new Chief Stores Operations Officer, Frank Kerr, brings a wealth of operations and consumer experience to Grocery Outlet. He joins us from Lidl, where he was instrumental in the company's US expansion, leading store operations, supply chain, logistics, and merchandising as senior VP ops and its Chief Customer Officer, also responsible for marketing, consumer insight, digital commerce, and promotional planning and strategy. Early in Frank's career, he served as vice president of retail operations at Save A Lot, where he led retail and wholesale of over 900 stores in 32 states. Frank's leadership across large grocery fleets and experience scaling IO models is invaluable to us in our next chapter of development. Our new Chief Supply Chain Officer, Scott Premont, brings deep insight to Grocery Outlet from a decorated 18-year career at Target, where he most recently served as vice president of global transportation, trade, and logistics.

Scott's deep knowledge of supply chain logistics and management strengthened this critical area of our business as we update and evaluate our centralized distribution network to deliver improved levels of execution for our IOs, and we're very excited to welcome Scott to the team and work with him to unlock the tremendous potential in our business. In closing, while we're dissatisfied with our current comp performance, we're making significant sustainable progress against our strategy, setting the company up to deliver stronger comp performance in 2026 and beyond. As we roll out our refreshed stores, we'll continue to focus on execution and improving returns on capital. And finally, we expect to enter the upcoming year with our systems implementation work substantially complete, allowing us to be laser-focused on delivering consistent growth and capturing the large opportunity in front of us.

I'd like to thank the entire Grocery Outlet team, including and especially our IOs, for their continued dedication as we work together to deliver for our customers and position the company for sustainable growth and stronger profitability in years to come. One final note, as we observe the current situation unfolding related to the federal government shutdown and potential disruption to SNAP benefits, IOs will be working as they always have to have a positive impact in the communities they serve. Many of them will be raising money to support local food banks and other related support efforts. While the current situation remains uncertain, Grocery Outlet and our IOs are here to make our local communities better. And with that, I'll turn it over to Chris to take you through the numbers. Chris.

Chris Miller (CFO)

Thanks, Jason.

In the third quarter, we continue to make progress on our key strategic initiatives while delivering adjusted earnings per share that exceeded our outlook. I'll walk you through our Q3 results before sharing more detail about our outlook for the remainder of the year. Please note that the comparisons I will provide are on a year-over-year basis unless noted otherwise. Net sales increased 5.4% to $1.17 billion. Propelled by 11 net new stores and a 1.2% increase in comparable store sales. In the third quarter, we opened 13 new stores and closed two stores, enabling us to increase our targeted openings to 37 net new stores for the year. We ended the third quarter with 563 stores across 16 states.

Comp growth of 1.2% was driven by a 1.8% increase in the number of transactions, partially offset by a 60 basis points decrease in average transaction size, due primarily to a reduction in the number of units per transaction. As Jason noted, we believe the variance in comp relative to our outlook of 1.5%-2% for the quarter was due primarily to changes to our marketing mix and promotional timing. Over the last couple of weeks, we've seen a return to positive weekly comps. Gross profit increased 3% to $355.1 million, or 30.4% as a percentage of net sales, which was at the upper end of our outlook range. Gross margin was down 70 basis points compared to last year. However, it was consistent with the first-half average of 30.5% this year.

SG&A increased 8.7% to $331 million compared with Q3 last year, representing 28.3% of net sales, an increase of 80 basis points. The year-to-year increase in SG&A's percent of sales was driven primarily by costs attributed to new store growth, software amortization, and incentive compensation. As expected, we also incurred $1.3 million in restructuring charges related to our previously announced restructuring plan, which was substantially completed in the second quarter. Compared to the second quarter of this year, SG&A's percentage of net sales improved 20 basis points. Net interest expense was $6.7 million, up $266,000 year-over-year. The increase in net interest expense was driven primarily by higher average principal debt, partially offset by a decrease in average interest rates. Our effective tax rate for the quarter was 28% compared with 28.6% last year.

The change in our effective income tax rate was due primarily to the benefit of certain acquisition-related deductions, partially offset by a reduction in the tax benefit from share-based compensation. Net income was $11.6 million, or $0.12 per fully diluted share, compared to net income of $24.2 million, or $0.24 last year. Adjusted net income was $20.7 million, or $0.21 per adjusted diluted share, compared to $27.9 million, or $0.28. Adjusted EBITDA was $66.7 million for the quarter, compared to $72.3 million last year. Adjusted EBITDA margin was 5.7% of net sales, down 80 basis points from the prior year, but consistent with the second quarter of this year. Turning to cash flow and the balance sheet, our net cash provided by operating activities through the third quarter of 2025 was $149.8 million, compared with $72.5 million last year. The increase was driven primarily by improvements in working capital.

In addition to ending the quarter with $52.1 million in cash, we had $175 million in available capacity on our revolver. We remain committed to improving returns on invested capital as we prudently invest to accelerate growth. During the third quarter, we invested $39 million net of tenant allowances, primarily in new stores, supply chain projects, and information technology. We expect capital spending of approximately $210 million for 2025. For 2026, we expect a meaningful reduction in our CapEx spending, even with our large store refresh effort. Total debt net of issuance costs was $500.3 million at the end of the third quarter, up $22.8 million from year-end, with net leverage at 1.8 times adjusted EBITDA.

Turning to our outlook for the balance of the year, given the impact of late September and early October comps from the marketing and promotional adjustments we discussed, we now expect comp store sales for the year to be in the range of 0.6%-0.9%. We also want to note that given the very dynamic nature of funding for SNAP benefits in light of the federal government shutdown. Any potential disruption to sales resulting from delayed or missed SNAP benefits due to the ongoing shutdown is not currently factored into our guidance. As a reminder, the percentage of sales coming from electronic benefits transfer payments, a substantial portion of which may be related to SNAP benefits, was roughly 9% last year. In addition, we are adjusting the rest of our outlook as follows. For the year, we expect to add 37 net new stores compared with 33-35 previously.

Report net sales of $4.7 billion-$4.72 billion. Achieve gross margin in the range of 30.3%-30.4%, compared with 30%-30.5% previously. Deliver adjusted EBITDA of $258-$262 million, compared with $260-$270 million previously. Report adjusted EPS in the range of $0.78-$0.80 per fully diluted share, compared with $0.75-$0.80 previously. Book net interest expense of approximately $27 million. And we expect to end the year with share-based compensation of approximately $12 million. For the fourth quarter, this translates to comp store sales between flat and +1%. The addition of seven net new stores, gross margin between 30% and 30.3%. Adjusted EBITDA in the range of $72-$76 million. And diluted adjusted earnings per share between $0.21 and $0.23. As Jason shared, we're excited about the rollout of our model store concept, which we expect to contribute to comp sales growth in the next fiscal year.

While we're still working through our budget and will not be guiding 2026 until our fourth quarter earnings call, I did want to flag a couple of unique items to consider as you model 2026. First, 2025 included a 53rd week, which we expect to contribute an incremental $9 million in Adjusted EBITDA and 10 basis points of EBITDA margin expansion that will not repeat in 2026. Second, we expect that next year we'll be back to a more normalized comp growth rate, and as such, we expect a roughly $10 to $13 million headwind from cash incentive compensation versus this year, which we expect to be a partial payout year.

In closing, the important work we've done to stabilize and strengthen the business has set us on a path for renewed growth, and we expect the expanded rollout of our refreshed stores and approved execution across our fleet to support stronger comp growth in 2026. As we bring our strategy to life, we will remain disciplined and focused on continuing to deliver strong bottom-line results and improved returns on capital. We have a tremendous opportunity ahead, and we have the strategy and team in place to deliver on its promise. With that, we'll open it up for questions.

Operator (participant)

Thank you. We will now be conducting a Q&A session. If you would like to ask a question, please press Star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue.

You may press Star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the Star keys. Again, that is Star 1 if you'd like to ask a question. Our first question comes from Jeremy Hamblin with Craig-Hallum Capital Group.

Jeremy Hamblin (Senior Research Analyst)

Thanks for taking the question. So I wanted to start just with this same store sales. For Q3, the 1.2% comp, I just want to get the split of the transaction versus average ticket. Then as you progressed through the quarter and you noted some changes in the timing of marketing and some of the promotional events and mix. How did that play out in terms of where you saw the delta in comps? Was it primarily transaction-driven, or were you getting a mixture of downside coming from both transaction and ticket?

Jason Potter (President and CEO)

Yeah. Thanks for the question, Jeremy. It's Jason here. Just to walk through the timeline to give you a bit more detail. We were tracking in July at about 1.6% comp, and August 2.3%. So we were well within our expectation of comps with the guidance we provided. As I mentioned in my opening remarks, part of what we're doing here, we're doing a lot of experimenting. In late Q3, we were adjusting promotions, some of the activity we had been trying, as well as the marketing mix with some of the channel mix. As it turned out, we could see a strong correlation into September where we made those adjustments and saw the impact on comps. To give you kind of an idea here, transactions were running just under 2% and baskets down slightly.

And we saw a little bit of a slowdown on the transaction count during that September period. And what happened was, into the last week of September and in the first week of October, comps went negative. Unfortunately, we've seen some lingering effects through October on that, but since course correcting, we've bounced back to positive comps. As I said, we're not where we want to be, but I'm really excited because we feel we have the solutions in our refresh concept, focusing on improving our Visa shop, standardizing our core assortment, and better communicating our unique value positioning with sharper marketing. All of those things are going to be really positive for us as we move through the end of this quarter and into next year.

Jeremy Hamblin (Senior Research Analyst)

Just a quick follow-up.

In terms of what you're lapping for the remainder of the quarter versus the first four or five weeks, the comps get easier or tougher from here?

Jason Potter (President and CEO)

Yeah. December is a little easier in kind of the quarter. November is a little tougher, but December is a bit easier.

Jeremy Hamblin (Senior Research Analyst)

Great. Thanks for taking my questions.

Jason Potter (President and CEO)

Absolutely. Thanks for the question.

Operator (participant)

And our next question comes from Corey Tarlowe with Jefferies.

Corey Tarlowe (SVP and Lead Equity Analyst)

Great. Thanks. I really appreciate you taking the time. I just had a question on kind of the performance in the quarter on the comp and the drivers that you highlighted. I believe it was the promotional activity and the marketing mix. Is there any way you could provide a little bit more color as to kind of what the learnings were, what you tried, and what may be the optimal strategy is going forward for those specific aspects?

Jason Potter (President and CEO)

Sure.

No, it's a great question, Corey. So part of what we're doing is we want to optimize everything we put into the business. We had been executing some promotions that just weren't delivering the combination of sales and return we were looking for. So we'd made some adjustments to those into September. We think that was still the right decision. The marketing, we had been experimenting with more social and had adjusted some of the traditional media that we had implemented. And we saw a pretty strong correlation there. And so what we did is course corrected on the marketing piece for Q4 and going forward. That was instructive. And frankly, some of the things that we've also been testing have worked well. So one example of that that's unique to us is our wine business. And we've seen some really strong favorable results related to promotion there.

There's a lot of opportunistic product on the market. And that's an area where we're doubling down, and we've put more of that into our planning for Q4.

Corey Tarlowe (SVP and Lead Equity Analyst)

Great. And then I just had more of a cost-related question. You've made some new hires, and I'm just curious about how to think about SG&A and what the comp leverage point there would be given the growth that you have in terms of stores and people. Thank you.

Chris Miller (CFO)

Yeah. Hey, Corey. It's Chris. Yeah. So we expect, not to get it too far into next year, but we do expect modest leverage next year. I talked about on a previous call our cost savings initiative to drive cost out of the company. And we've made a lot of progress there. It's actually completed. And we've identified $15-$20 million of cost savings over the next two years.

Most of that will fall into next year. Now, I should say a good portion of that is CapEx. And some of it's related to our supply chain. But there is SG&A cost reductions there, which will help with leverage next year. On the other side of that, though, is we are going to invest some of that savings in additional capabilities, primarily around merchandising. But net net, we should see some modest leverage next year.

Corey Tarlowe (SVP and Lead Equity Analyst)

Great. Thank you so much and best of luck.

Chris Miller (CFO)

Thank you.

Operator (participant)

And moving on to John Heinbockel with Guggenheim Securities.

John Heinbockel (Senior Managing Director and Senior Research Analyst)

Hey, Jason, two questions on the refresh program. Is your idea to cluster that as much as you can, try to get greater awareness of it? And then when you think about how long is that process taking for you and the IO to get done? Is there any disruption in the interim period?

Jason Potter (President and CEO)

Yeah. Great questions, John. Yeah. First and foremost, for sure, we're going to cluster. We're going to start in the core markets and work our way out from there. We think that clustering, it does all kinds of good things, right? There's marketing opportunity. There's labor leverage you can get as you're clustering. And it's helpful support for the IOs as you do that in an area. Through the pilot process we've had over the last six months, the IOs have been really instructive for us, giving us feedback on the things that we need to adjust as we've gotten ready now to go. And so that's important. So yeah, clustering for sure. And then on the timing, so really what this is, it's a fairly light touch in the store. But as you re-merchandise a store, there's disruption.

And so typically when you do a reline and you're moving things around. This is going to take about five weeks to execute in the store. So you see some sales pressure during that period, but an immediate pop afterward. And we're seeing that consistently as we've gone through these two more than a quarter worth of data in the two pilots. And as we introduce this to more stores, they're following a similar pattern. But early days there, but we have enough data now that we feel very confident in what we're doing.

John Heinbockel (Senior Managing Director and Senior Research Analyst)

And maybe as a follow-up, the 400 core items, right? So I don't know how many of those would be consistent across the base. But what are you doing to draw attention to that? Do you need an inventory investment? Do you need signage? Kind of drive home the point that you're consistently carrying those.

Jason Potter (President and CEO)

Yeah.

No, it took a consideration to make sure that that consistency is something that our customers have told us they really are asking us to deliver on. And so in changing the merchandising, we're changing the space to sales on those items, and we're creating signage around them. So they're very obvious to see. These are things that are on people's shopping list, typically. And so there is a very consistent core assortment there. And we've seen nice uptick, obviously, on the basket size, on the basket side, I should say, John, in the pilot stores as a result.

John Heinbockel (Senior Managing Director and Senior Research Analyst)

Okay. Thank you.

Jason Potter (President and CEO)

You bet. Thanks, John.

Operator (participant)

Moving on to Edward Kelly with Wells Fargo.

Edward Kelly (Managing Director and Analyst)

Hi. Good afternoon. And thank you for taking my question. I wanted to follow up on the comp weakness that you saw at the end of the quarter and the shift in strategy here.

It seems like the weakness was more traffic-driven. Which leads me to believe that maybe it was more tied to the shift in marketing. I was curious if you could maybe dig into that a little bit. And then if the comp hasn't bounced all the way back yet despite the shift, what is that saying?

Jason Potter (President and CEO)

Yeah. First and foremost, we saw a pretty strong correlation between the marketing channel mix decision we made towards the end of the quarter and the traffic kind of falling off towards the end of the quarter. So we got that back in place as quick as we could. And I've seen a bounce back. Sometimes these things tend to linger, but we feel good about the amount of marketing, the quantum we feel good about. And the mix is, I think we've made that appropriate for Q4.

So we're expecting some improvement in our run rate.

Edward Kelly (Managing Director and Analyst)

Okay. And then just a follow-up on SNAP. There's no impact from SNAP and guidance. And I guess it's dynamic, right? You have the November issue and then potential for SNAP cuts next year. I was curious if you could just talk about historically what you've seen during periods of changes in SNAP. And then as it pertains to sort of current business trends, do you think that some of that is already starting to work its way into the comp that you're seeing now?

Jason Potter (President and CEO)

Yeah. It's probably too early to tell on just given that it's been a handful of days that this has happened. But in the past, what I can tell you, the facts about our business. As Chris mentioned in the opening, SNAP accounts for about 9% of our sales.

In 2023, you might remember that there was a significant reduction in SNAP benefits. What happened here at that time was basically the tender types changed, but there really was no impact to sales. And typically, depending on when those benefits are paid, you'll see an immediate spend. And so again, depending on how long this goes. At this point, we're not speculating on that. But we did want to provide guidance that was clean of that, just given. We just don't know how that's going to turn out.

Edward Kelly (Managing Director and Analyst)

Great. Thank you.

Jason Potter (President and CEO)

Yeah. You're welcome, Edward.

Operator (participant)

Our next question comes from Joseph Feldman with Telsey Advisory Group.

Joseph Feldman (Senior Managing Director and Assistant Director of Research)

Yeah. Thank you for taking my questions. One of the questions I wanted to ask was about the localization effort.

And I guess how will the effort be different from the current model, I guess, in terms of I thought one of the strengths of this business was you have IOs that localize their own stores because they're actually owners. And I guess if you could help me with understanding that localization effort a little better, I'd appreciate it. Thanks.

Jason Potter (President and CEO)

Sure, John. Some of the feedback we got from SoCal was a need for the company to provide more support to our local IOs. And some of that equates into making sure we're sourcing product that they need for their local community. And so in the case of what we're doing in Los Angeles is providing a suite of assortment now available for them to better address what they're asking for to supply their local customers. And so we've got that begun and excited about the initial results there.

And that's something that we think, as this business gets more focused on becoming a great selling organization, helping our stores localize and taking advantage of their strength is going to be a big win for us.

Joseph Feldman (Senior Managing Director and Assistant Director of Research)

Got it. Thank you. And then just on 2026, I know it's early, but from a store perspective, I fully understand the refresh. 150 makes a lot of sense. How should we think about new stores for next year? Are you guys rethinking the flow of stores compared to where the trend has been?

Jason Potter (President and CEO)

Yeah. I think we indicated on a previous call a range of 30-35 net new for next year. On the refresh piece, we've already begun to start to implement those retail fundamentals in our new store executions. And we intend to do that in all the new stores next year.

Joseph Feldman (Senior Managing Director and Assistant Director of Research)

Got it. Thanks for clarifying. Sorry for forgetting.

Jason Potter (President and CEO)

Oh, that's great. Oh, great question.

And Mark Carden with UBS has our next question.

Mark Carden (Equity Research Analyst)

Good afternoon. Thanks so much for taking the questions. So to start, you called out some heightened promotional activity impacting your gross margin. Was this essentially all tied to some of the tests you guys were doing in September, or did they expand beyond that? And then just related more broadly, what do you see in the competitive landscape? Thanks.

Jason Potter (President and CEO)

Yeah. Thanks, Mark. Yeah. There was some promotion in there for sure that we had been adjusting that we think turned into some net negative sales. But really, it was the marketing we believe was the major contributor there. Clearly, there's depending on the month, promotions ebb and flow. I think the latest reporting shows a little bit of an uptick in promotion in September.

But I think I'll leave that for you guys to discern. But we're not seeing anything in a significant way as far as a shift.

Mark Carden (Equity Research Analyst)

Okay. Great. And then as a follow-up, just how are IOs responding right now to the uneven macro? I know outside of the pilot improvement rollouts, you guys have been investing more in the training process. Have you seen any corresponding improvements in talent attraction? And just more broadly, what are you seeing in terms of IO satisfaction? Thanks.

Jason Potter (President and CEO)

Yeah. We spent some time on the road meeting with really all of our IOs earlier in Q3, middle of Q3. There is definitely excitement related to the improvements and things that are coming both from systems. We're seeing positive feedback there on our order guide. We're seeing positive feedback. And some real excitement related to the refresh program.

I think our IOs taking the feedback, working in a collaborative way with them to grow their business and make their incomes grow is obviously something that's really important to everybody. And we're seeing nice participation in our meetings and good communication back and forth. So we're feeling good about where this is going to go. And everybody always likes to win as a team. And we're seeing more and more of that as we roll these programs out.

Mark Carden (Equity Research Analyst)

Great. Thanks so much. Good luck, guys.

Jason Potter (President and CEO)

Thank you.

Operator (participant)

And moving next to Simeon Gutman with Morgan Stanley.

Zachary Winning (Financial Advisor)

Hi. This is Zach on for Simeon. Thanks for taking the question. I just wanted to follow up on the refresh program. What type of uplift are you assuming that will provide on a consolidated basis? And how does the timing of that look over the next few quarters?

Jason Potter (President and CEO)

Yeah.

The Pilot Stores, we've got nice mid-single-digit lift. Given the staging of rollout and quantum of stores. You can probably get a sense of the mechanical lift that we are expecting in our business next year. But this is definitely going to be a comp accelerator for us. And we're excited about what we see as the longer this is in our stores, we're seeing some nice acceleration as well. So feeling good about how that's going to play out in '26 for sure.

Zachary Winning (Financial Advisor)

Thanks. And as a quick follow-up how should we assess the resources the company has and also the IO appetite for these rollouts? Are there any constraints, or is everybody on the same page, and should the rollout go according to plan?

Jason Potter (President and CEO)

Yeah. We really believe the value proposition of the IOs is compelling. We're not limited in this case in IO demand nor in CapEx.

What we're really doing here is making sure we're being responsible to support them with the right training. To ensure that we have sustainability in the changes. We're implementing new systems, methods, and procedures in the stores. There's new merchandising standards that they're working their way through. But mid-single-digit comp lift, basket improvement. All of those things create really nice returns for the company and even better returns. Our IOs are going to have their return in a matter of months. So. I think people are going to be very excited to see how this plays out.

Zachary Winning (Financial Advisor)

Thanks. Good luck.

Jason Potter (President and CEO)

Thank you. Moving next to Leah Jordan with Goldman Sachs.

Leah Jordan (Analyst)

Good afternoon. Thank you for taking my question. It sounds like you're still doing a lot of testing and learning on your business. And we had a little bit of a misstep with the marketing this quarter.

So I was just wondering, what's given you the confidence to go forward in a bigger way on the store refresh rollout? After just such a short period in a small number of stores, and why don't you think more testing needs to be done? And then of the initiatives that you have rolling out between the stores and the IO tools, I guess there's a long list there. So which of the items do you think will be the biggest driver to drive that comp acceleration next year?

Jason Potter (President and CEO)

Yeah. These things work together. So. We're really confident that the testing we've done over time on a couple of stores now seeing results on a wider group of stores initially.

The things we're doing are we're changing the fundamental customer experience through merchandising, implementing the methods, systems, and procedures we are, create the conditions so we have an in-stock that's going to be. Really a winning experience for the customer. And the lift associated with those things is clear to us. Improving ease of shop, making sure we're consistent, and. The communication-related value, all are things we've gotten feedback from the customers on. It's very clear. And the sales piece. So lots of retailers will put products into one or two stores and roll out when they have results. And we feel that we've done enough testing, and we've taken enough time, and done enough adjusting to make sure that we have a clear idea of what will happen. So. Retail fundamentals, some of the things we're doing here are really retail 101.

So we're not necessarily cutting new ground here. We're merchandising in logical ways. We're organizing the store in ways that the customers can understand, supported with great signage. And the tools we're implementing are simple and straightforward for IOs to execute at a higher level. So all of that, we feel, is going to contribute to a very predictable set of outcomes. And the great thing about this business is, as we implement this in, let's call it roughly 20 stores this quarter, we can make further adjustments as we go. But the fundamentals are there.

Leah Jordan (Analyst)

That's very helpful. Thank you. And then just one quick follow-up. I guess it sounds like you plan to accelerate comps next year and on the back of these initiatives. So if that comes to fruition, can you just remind us what comp you need to now leverage SG&A in the business?

I know you talked about lowering some costs next year to an earlier question, but just what is the actual leverage point of the business now?

Chris Miller (CFO)

Yeah. Hi, Leah. It's around 2.5% comp growth in order to leverage.

Leah Jordan (Analyst)

Great. Thank you. Thanks, Leah.

Operator (participant)

And we'll go next to Kendall Toscana with BofA Securities.

Kendall Toscano (Equity Research Analyst)

Hi. Thanks for taking my question. I was just curious if you could speak to as you're expanding the store refresh program. Can you share more detail on the types of markets where you've been able to test it so far and have the performance lifts on these stores been different in markets where the competitive landscape might look a little different, and particularly in markets where you're competing with deep discount players? Thanks.

Jason Potter (President and CEO)

Yeah. Kendall, thanks for the question. Yeah.

We've got a number of different competitors in the different markets and haven't seen because this is really execution, and I'll call it we're talking to the customers that we have. We're seeing a big jump in basket and then seeing some improvement, obviously, in the traffic as a result of the experience. And so feel good about the mix of stores and the competition and the results that we have. So again, giving us confidence to move forward.

Kendall Toscano (Equity Research Analyst)

Got it. That's helpful. And then other question was just on price gaps and how those are trending and whether that looks any different than it did pre-systems conversion. And also, is there any expectation that you'll continue to invest in price for Q4 or into next year?

Jason Potter (President and CEO)

Right. No, great question. We do checks every week. We did 10 major market MSA checks just last week.

We remain 15%-20% on a basket of goods, lower than discount, 35%-40% on conventional. And so things to remember there. Our IO mix 40% of sales. It's a core driver of value. We have real advantage there. No one's going to get around us on pricing there. It's a big contributor. Clearly, there's always an opportunity to adjust on an individual item basis. You're going to have situations where you're beat, but that's something the team monitors week to week, and we continue to make adjustments there. And we're really confident that the work we're doing right now on value messaging and telling our story is going to be super helpful in improving with the margins we are running at and the price advantages we have, a much better level of understanding from our customer base on the value that this business brings.

Kendall Toscano (Equity Research Analyst)

Thanks.

Jason Potter (President and CEO)

Thanks, Kendall.

Operator (participant)

And Michael Baker with D.A. Davidson has our next question.

Michael Baker (Managing Director and Senior Research Analyst)

Okay. Thanks, guys. Wondering if you've looked at comps in markets that might have higher immigration populations. There could be some spending impacts from some of the issues that are going on there. I'm wondering if that's something that you've seen with your customer at all.

Jason Potter (President and CEO)

No, Michael, good question. Nothing to report there.

Michael Baker (Managing Director and Senior Research Analyst)

Okay. And then I guess kind of, well, I don't know if it's a related question, but I'll ask this also. SNAP benefits. You talked about that a little bit on the call. And so nothing in your guidance. But have you done any work or estimates or anything to sort of say, "Okay, what if this does last a week or two weeks?" Or the impact of SNAP benefits going away for X amount of time would impact your business by X amount.

And perhaps maybe there's even a positive offset where you get some trade down. I'm not sure the way you think about it, but I'm wondering if you've done any tests on, let's say, this lasts for another week.

Jason Potter (President and CEO)

Yeah. I think we're assessing. We just don't have enough data yet to give you a determination. I think if there's anything significant that materializes in the next 30 days, we would create some kind of release to inform everybody. In kind of the proper way if there's something material there.

Michael Baker (Managing Director and Senior Research Analyst)

Okay. Nothing yet. One last quick one, if I could. At one point, you talked about, I think, "Normal comp for 2026." Remind us what you consider to be a return to normal comps.

Jason Potter (President and CEO)

Yeah. I think our objective is always to grow our business on a shared basis, grow faster than inflation. That's my objective here.

We intend to win. And so we're putting the pieces in place to do that for next year.

Michael Baker (Managing Director and Senior Research Analyst)

Okay. Fair enough. Thank you.

Jason Potter (President and CEO)

Thanks, Michael.

Michael Baker (Managing Director and Senior Research Analyst)

And moving on to Oliver Chen with TD Cowen.

Oliver Chen (Managing Director and Senior Equity Research Analyst)

Hi, Jason and Chris. The business model of Grocery Outlet has been amazingly resilient over a long-term basis in that mid-single-digit comp range. What do you think about, broadly, the path to getting there more consistently? Key drivers and milestones. I'm sure the refresh and stabilization of systems will play a role. And on the earlier topics around independent operators, what would you highlight as two to three key areas that they speak to in terms of IOs potentially needing more support or flexibility. And how changes may be impacting their day-to-day operations?

Jason Potter (President and CEO)

Yeah. No, great questions. Look. We benefit greatly by talking to our IO groups frequently.

We do these things called backroom meetings, and we meet groups of 20 IOs and really try to understand what's happening at the ground level. There's two big pieces to getting comps to, I think, on a sustainable basis in a great place. One is obviously getting the systems distraction behind us. We're getting very close there. We're restoring full functionality on pre-SAP implementation for order guide has been a great win. We've made a number of systems improvements over time.

So that is something that our IOs give us feedback on, have been giving us feedback on as it's been painful for everybody, and people want to move past that to a place where, and this is what I've told the IOs, "I want to make sure this business is really easy to run." And we want to make sure we're providing them with the tools and support that makes their day-to-day their focus is on the customer and their local community and doing everything they can with their team to execute. And so that's our orientation. The refresh program is going to be a big chunk of how we create a consistent execution in the stores. We're providing some very specific tools and new SOPs.

We've made adjustments to the merchandising that we've thought through, understanding what's happening with the customer and getting feedback from the IOs locally, tuning that in. And then another piece of feedback is localization. So again, the company in this case needs to do more to support our IOs with product that really is relevant for their local community. And in this case, in Los Angeles in particular, is a really nice opportunity for us to demonstrate to our IOs the power of working together on that, but giving them what they are asking for in order to deliver on an experience for their customers that's relevant. And we think that our business in a place like Los Angeles is a very strong fit.

We just need to do what we need to do to make sure that the assortment and the communication, the execution in that new way is done collaboratively. And we're excited about what that's going to mean for this business as we go forward. So those are some examples.

Oliver Chen (Managing Director and Senior Equity Research Analyst)

Okay. Thanks, Jason. A follow-up. The buying team, in many ways, we view as the secret sauce of an organization such as yourself. What are your thoughts about changes or not changes there in terms of how that talent is going to orient in light of what you're doing? And second, as you test reasonably around the marketing programs, what are you seeing in terms of customer perception lags or not lags? Our surveys show that a lot of customers really want these core items for a long time. So just love your thoughts on any hypotheses you have there too.

Thanks a lot.

Jason Potter (President and CEO)

We're having a hard time hearing you. I don't know if there's something on our end here or on your end. Could you repeat the question or try again? It just blew up. Yeah.

Oliver Chen (Managing Director and Senior Equity Research Analyst)

First one was the buying team, and just the buying team being the secret sauce and what's happening with the nature of that talent as you think about these changes you're making. And second question follow-up was on customer perception lags between the marketing and changes you're making relative to when customers are noticing. Our surveys say that this is a really good change. Thanks a lot.

Jason Potter (President and CEO)

Great. Great. Yeah. I think we're doing everything we it's really important for us to when we talk about being a great selling organization. We are a great buying organization. And it's an and.

And so the conversation we're having with our buying teams are, we want them out there. The relationships they've built over time are exceptional. It's a very unique business in that respect. Typically, what you see in retail is a more, at times, can be contentious set of relationships with vendors. In our case, this is. I feel like one team. Many of the times when I am able to participate in some of the sessions. And so we're just doing everything possible to make sure we're giving them those tools to continue to nurture those relationships and have close connection there. And then on marketing lag, customer perception, it does take time. And we believe that these changes over time and what we've seen in the pilot markets, the customers respond pretty quickly, and they can recognize in a pretty remarkably fast way if something is good or not.

I mean, in retail, you get feedback the first day. And it doesn't take that long to figure out if you're doing something that works and they appreciate because literally they tell you. We've been standing in stores days on end as we make these changes, and customers will tell us what they like and what they don't like. And they tell our IOs what they like and they don't like. And so our job is to make sure we're listening carefully to respond to the things they like and get rid of the friction points for our customers. And so that's really what this is. It's not necessarily anything magical. It's responding to what customers want and making sure we're delivering that consistently.

Oliver Chen (Managing Director and Senior Equity Research Analyst)

Thank you. Best regards.

Jason Potter (President and CEO)

Thank you very much, Oliver.

Operator (participant)

And ladies and gentlemen, thank you for your participation. This does conclude today's teleconference.

Jason Potter (President and CEO)

You may disconnect your lines and have a wonderful day.

Thanks, everyone.