Grocery Outlet (GO) Q2 2021 Earnings Call Transcript

Grocery Outlet (GO 1.89%)
Q2 2021 Earnings Call
Aug 10, 2021, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to Grocery Outlet fiscal second-quarter 2021 earnings results conference call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Arvind Bhatia, and thank you. You may begin.

Arvind Bhatia -- Vice President, Investor Relations

Thank you. Good afternoon, and thank you for joining us on today's call to discuss Grocery Outlet's second-quarter 2021 financial results. Joining me on today's call are Grocery Outlet's chief executive officer, Eric Lindberg; President RJ Sheedy; and Chief Financial Officer Charles Bracher. Following our prepared remarks, we will open the call for questions.

This conference call is being webcast live, and a recording will be available via telephone playback for approximately two weeks. It will also be archived in the Investor Relations section of our website. Participants on this call will make forward-looking statements, including our outlook for fiscal 2021 and future performance. These forward-looking statements are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements.

A description of these factors can be found in this afternoon's press release as well as in our periodic reports we filed with the SEC, all of which may be found on our website at investors.groceryoutlet.com or on sec.gov. We undertake no obligation to revise or update any forward-looking statements or information. These statements are estimates only and not a guarantee of future performance. During our call, we will also reference certain non-GAAP financial information, including adjusted items.

Reconciliations of GAAP to non-GAAP measures as well as the description, limitations, and rationale we're using each measure may be found in the supplemental financial tables included in this afternoon's press release and our SEC filings and the Investors tab of our website. With that, I will turn it over to Eric.

Eric Lindberg -- Chief Executive Officer

Thanks, Arvind. Good afternoon, and thank you for joining us for a discussion on our second-quarter performance. Let me begin by welcoming Arvind to the Grocery Outlet family. We look forward to benefiting from Arvind's Investor Relations leadership and experience as we continue to engage in the investment community.

We are pleased to have exceeded our expectations for the second quarter as we lapped the elevated sales experienced during the early months of the pandemic. Our comparable store sales were slightly better than expected at negative 10%, and on a two-year stack basis, increased 6.7%. Gross margin and adjusted EBITDA results also exceeded our expectations as we successfully managed the cost pressures facing our business. With respect to comp trends, we believe there are certain transitory dynamics such as additional stimulus funds and ongoing trip consolidation that continue to impact short-term shopping behavior.

We expect consumers' prioritization of value to increase as those dynamics subside. As such, our long-term strategy remains unchanged: to leverage our deep supplier relationships and passionate network of independent operators to provide the most compelling value in grocery retail, bar none. As we continue to execute against this strategy and reinvest in support of our long-term objectives, we remain confident in our ability to achieve sustainable, consistent, and profitable growth. From a purchasing standpoint, we are uniquely positioned to capitalize on current supply chain dynamics and are extremely pleased with the opportunities we are seeing across categories.

We are already capturing great buys in areas such as NOSH, stemming from the renewed focus on product innovation, the ramp in production, and the challenges of forecasting in this environment. Our team continues to do a fantastic job of sourcing opportunistic deals and strengthening relationships with existing and new suppliers alike. To that end, we are looking forward to our annual supplier meeting in September, which will mark our 23rd year for this special event. We are hopeful that we will be able to meet in person.

But regardless of format, we value the opportunity to connect and discuss long-term strategy with our supplier partners. They are a critical part of our success, and we are excited to exchange insights and ideas that allow us to expand our relationships with them. While our purchasing capabilities are second to none, our network of passionate, independent operators is really what sets our business apart. As the progression of COVID, including the Delta variant continues to be front and center, our IOs and their associates are navigating extraordinary labor and inflationary pressures.

To help offset those headwinds, we continue to make the investments, which allow our IOs to operate more efficiently and reduce end-to-end cost. That includes the ongoing improvement of ordering and inventory management tools as well as the upstream supply chain distribution efficiencies. For example, we recently brought temperature-controlled outbound transportation in-house, which improves store-service levels and helps reduce systemwide freight costs. We continue to pursue other opportunities to drive efficiencies throughout the chain that benefit both our operators and Grocery Outlet.

Despite the current headwinds, our IOs and their dedicated local store teams continue to do an excellent job of serving their customers and delivering the WOW! shopping experience. I tour stores every week, and I'm always very, very impressed with the passion, commitment, and resilience displayed by our operators. Similar to our supplier meeting, we are looking forward to our regional operator meeting in October, which we hope will also be in person. It's a valuable opportunity for us to discuss the business, including our near-term strategies, execution as well as our longer-term growth plans.

In addition to ongoing investments we make to advance our purchasing and supply chain capabilities, we continue to invest steadily in-store growth to bring market-leading values to more customers and communities. This remains a huge opportunity given the broad appeal and success of our value proposition across markets, geographies, and demographics. I'm proud to share that we reached an exciting milestone this year, the opening of our 400th Grocery Outlet store located in Hailey, Idaho, on June 24th. Hailey is just south of the Sun Valley ski resort and east of Boise, is being run by Grocery Outlet veteran Shane Anderson who has been warmly received by the local community.

In total, we opened 11 new stores in the quarter, including 1 in Pennsylvania. Our real estate and construction team continued to do a fantastic job getting new sites open despite all the challenges of sourcing equipment and securing trade labor. We remain pleased that the new store productivity is in line with our expectations with the trends at our new Mid-Atlantic stores, similar to those of the initial entry in Southern California. We are building the foundation for store growth in the East, including investments in purchasing and infrastructure.

We look forward to growing our presence and brand awareness in the region. Of the 36 to 38 stores we plan to open this year, we expect that three to five of those openings will be in the East, including our first store in New Jersey. We know that we have tremendous runway to expand our footprint based on the power of our value proposition and the portability of our model. As we look forward, we remain committed to our stated target of 10% annual unit growth; remain equally committed to making the critically important investments across the business, particularly in real estate, purchasing, recruiting and training and technology that all support that expansion.

We firmly believe our stores represent the most important growth driver, but we're also exploring complementary ways to reach new customers and deliver value. Higher demand for grocery e-commerce now provides an interesting opportunity for us to extend our industry-leading value and treasure hunt experience. We are excited to begin testing various e-commerce approaches to determine what works best with our unique model. RJ will discuss more of this in a few moments.

Before turning the call over to him, I am pleased to share that we completed our 11th annual Independence from Hunger campaign in July. This program has raised more than $14 million to date for local food banks, helping to reduce food insecurity in our communities. Our IOs surpassed last year's store-level donations, raising nearly $3 million for local food agencies. There were numerous examples of IOs engaging their customers in creative ways to support the cost.

For example, Tom Criss, the operator of Myrtle Creek Oregon store committed to camping on top of a semi-trailer in the Grocery Outlet parking lot until it was filled with food and supplies for its community. And just under two weeks, they tallied nearly $25,000 in cash donations and over seven pallets of food, at which point Tom was finally able to come down from his campsite. This effort is a powerful example of Grocery Outlet's unique culture, the strength of our operator community, and our shared mission of touching lives for the better. I'm so proud of the results and want to thank everyone who participated.

With that, I will turn the call over to RJ.

RJ Sheedy -- President

Thanks, Eric. Let me start with an update on opportunistic supply. We are highly encouraged by the continued growth in our supply pipeline as we are seeing a wider assortment of opportunities, bigger deals, and deeper values. We saw the increase in surplus products beginning in the first quarter, and that acceleration has continued through today.

Renewed investments in product innovation, together with increased capacity and production, are contributing to the breadth of items and brands in the marketplace right now. Overall, our inventory is healthy across departments, and we expect this strong pipeline of opportunistic products to continue as we move through the rest of the year. We believe that we are the partner of choice for our suppliers and are uniquely positioned to capture all buying opportunities as they arise. As Eric mentioned, we are excited to be hosting our annual supplier meeting again next month.

This is an invaluable event as we learn about our suppliers' initiatives, share our strategic direction and explore better ways of working together. Beyond discussing ideas and future initiatives, this is an opportunity to deepen our relationships and build new ones as we plan for the future. Looking forward, we will continue to invest in value as our first priority. At the same time, we will explore new ways to expand our share of wallet and broaden our customer base.

We plan to do this by increasing the relevance of our assortment, extending our consumer reach, and connecting with customers in a more personalized way. First, we will continue to strategically expand our assortment. We are leveraging consumer data and capitalizing on our strong supplier network to introduce more high-demand items across departments. NOSH remains one of our best-performing categories and is a primary focus for expansion along with our fresh departments.

In fresh, we recently introduced variable weight produce in all stores, and we are seeing positive results from new prepared products in both produce and fresh meat. To support this assortment expansion, we will adjust our marketing messages to feature both our deep value as well as the convenience of the full shop that we offer. We will also continue to communicate in and out deals and fresh product to promote trip frequency. We've had great success with prior assortment improvements, and we see additional opportunity to create greater excitement with the next phase of this initiative.

Second, as Eric mentioned, we plan to begin a test-and-learn approach to evaluate various e-commerce solutions such as delivery and buy online, pick up in store. These tests will assess several factors such as alignment with our unique model, operational and technical considerations and total market opportunity. We are currently in discussions with potential third-party partners, and we look forward to updating you as these tests launch and progress. Finally, we continue to move forward with our personalized customer marketing initiatives.

We have outlined a program and system requirements to capture and utilize transaction data to communicate with customers in a more relevant way. We expect to introduce a test of this new program in the first half of 2022, accompanied by the introduction of a mobile app. This initiative will enable us to more effectively communicate new products and our WOW! values to customers based on their preferences with the goal of driving more frequent trips and a higher basket. In parallel, we continue to enhance our marketing tactics in a variety of ways.

We have more precisely segmented our customer messaging via connected TV marketing and have increased our usage of certain app and digital platforms that have proven to show good returns in testing. We will also continue to optimize the mix of TV, radio, and digital on a market-by-market basis based on customer responsiveness. In conclusion, we remain confident in our long-term growth potential, and we are excited to build upon the core strengths of our business as we advance these important initiatives. We expect that they will allow us to capture more of our market potential by increasing our appeal with core customers, expanding our reach to new customers, and enhancing our communications with all the Grocery Outlet shoppers.

We look forward to sharing our progress as we move forward. With that, I will turn the call over to Charles.

Charles Bracher -- Chief Financial Officer

Thanks, RJ, and good afternoon, everyone. Our second-quarter results exceeded our expectations, reflecting the outstanding efforts by our team and our independent operators as we continue to navigate COVID. Following our discussion of second-quarter financial results, we will provide some commentary on third quarter-to-date trends and our outlook for the remainder of the year. For the second quarter, net sales were $775.5 million, a decrease of 3.5% compared to the same period last year.

Comparable store sales decreased 10%, as compared to an increase of 16.7% in the second quarter last year. Versus the prior year, our comp decline reflects a decrease in average ticket as well as lower traffic. On a sequential basis, second-quarter traffic was up modestly versus the first quarter. Contributing to total sales was the impact of 38 additional stores opened on a net basis since the end of the second quarter last year.

We finished the quarter with 400 locations and remain pleased with the performance of our newly opened stores, including recent vintages, which continued to deliver sales productivity in line with our underwriting expectations. Second-quarter gross margin of 30.7% was above our expectations and roughly in line with pre-pandemic performance despite inflationary headwinds. Our purchasing, planning, and distribution teams continue to do a fantastic job leveraging the flexibility of our operational model to navigate rising commodity and freight costs. Versus the second quarter of 2020, our gross margin decreased 90 basis points, predominantly due to the normalization of inventory turns and the impact of inflation.

SG&A expense decreased 2.5% to $193 million due to lower variable commissions to independent operators and decreased incentive compensation expense. It was partially offset by store occupancy and maintenance costs related to a higher store count as well as ongoing investments in personnel and infrastructure to support our growth. Depreciation and amortization increased to $17 million, up 28.3% versus the second quarter last year driven by store growth as well as continued capital investments in systems and infrastructure. Stock-based compensation expense was $4.2 million in the quarter, compared to $10.2 million in the same period last year as prior-year expense included the final vesting of performance options related to our 2014 equity plan.

Net interest expense decreased 25.6% to $3.9 million versus the second quarter last year due to lower LIBOR rates as well as reduced borrowings under our revolving credit facility. Our GAAP results also reflect a $4 million insurance recovery related to the loss of our Paradise, California store in 2018 due to wildfire. Compared to our normalized tax rate of approximately 28%, we incurred an effective tax rate of 17.2% in the quarter due to the tax benefit associated with employee option exercises. As a result of these factors, GAAP net income for the quarter was $19.6 million or $0.20 per diluted share, compared to net income of $29.3 million or $0.30 per diluted share in the prior year.

Note that our non-GAAP measures exclude the $4 million gain associated with our insurance recovery. For the quarter, adjusted EBITDA was $50.8 million, representing 6.6% of sales. Adjusted net income was $23.3 million or $0.23 per diluted share based on an average of 99.6 million diluted shares in the quarter. Turning to our balance sheet and liquidity.

We ended the quarter with $126.6 million of cash and healthy inventory mix totaling $248.2 million. Total debt was $450.3 million at the end of the second quarter, net of discounts and issuance costs, which reflects a net leverage ratio of 1.6 times adjusted EBITDA. We generated $58.7 million in net cash from operating activities during the second quarter of fiscal 2021, a $36.5 million increase over prior year. We invested $29.9 million in total capex during the quarter as we continued to build new stores, reinvest in the existing fleet and make ongoing investments in infrastructure and technology.

Turning to the third quarter. Sales trends remained consistent with the second quarter, along with similar traffic and ticket patterns. As a result, quarter-to-date comp sales were down 6%. Assuming that current trends continue, we expect that comp sales for our full fiscal third quarter will be down in the negative mid-single digits.

In limited visibility today, we would expect fourth-quarter comps to be consistent with the third quarter on a two-year stack basis. With respect to gross margin, we expect third-quarter performance to be approximately 30.6%, modestly below pre-COVID levels, reflecting increase in inflationary pressures in commodity and freight costs. We continue to effectively leverage our flexible purchasing and distribution model to mitigate these headwinds. In terms of bottom-line performance, taking into account the inflationary environment as well as modest expense deleverage, we expect third-quarter adjusted EBITDA margin to be approximately 6.5% of sales.

Eric and RJ discussed, we continue to make important investments across the business to support future growth. Our store opening plans for 2021 remain at 36 to 38 new stores, and we continue to invest back into the existing fleet while making ongoing investments in infrastructure and technology. For the year, we expect to invest approximately $130 million of capex net of tenant allowances. The result of our ongoing investments, we expect depreciation and amortization expense will be approximately $18 million for both the third and fourth quarters.

In summary, we continue to be pleased with the underlying strength of the business across opportunistic supply, our product assortment, and our strong engagement with customers and independent operators. Looking forward, we are confident in our ability to build upon these points of differentiation as we make progress toward our long-term growth objectives. And with that, we can turn it back to the operator to begin Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Oliver Chen with Cowen and Company. Please proceed with your question.

Oliver Chen -- Cowen and Company -- Analyst

Hi. Thank you. The details are very helpful, and there's a lot of great initiatives on the horizon. The two-year comp stack had decelerated and with respect to the third-quarter guidance.

What would you attribute that to? And what do you see with respect to the changing nature of the consumer as well as, as we look forward -- as the compares get easier, will there be a path to normalization back to that plus 4% to 6% range?

Eric Lindberg -- Chief Executive Officer

Hey, Oliver. It's Eric. Just I want to make sure the audio is OK. We're getting a little bit of feedback on this, but thanks for the question.

Yes. I would say the answer to your question, we do continue to contend with some of the transitory factors such as trip consolidation, stimulus. We look at ring, we look at traffic, and ring continues to moderate, but it's ahead of where we were pre-pandemic, which is good. We are seeing some sequential improvement in traffic, but it's a little below our seasonal patterns.

Both are contributing to the modest decline that we're seeing on a two-year stack basis. But the two-year stack trend has stabilized. We've seen those trends developing nicely in June and July. We don't know exactly when the consumer returns and when we're going to see that.

Certainly, as we look forward, there's a lot of unknowns relative to Delta, relative to the consumer stimulus, everything we said to date. So I think your question is a good one. We're leaning into a lot of these initiatives, as you stated. We're excited about those.

We think some will take longer than others to develop. But if we look into third and fourth quarter, we're really confident in the things that sort of gotten us here: the value prop, supply is really healthy, customer loyalty is solid, IOs are engaged and strong. So we've got a lot of working for us right now.

Oliver Chen -- Cowen and Company -- Analyst

OK, Eric. And my follow-up, the e-commerce comments sound very innovative. Which ones might happen sooner? And how are you prioritizing the road map? There's a lot of different opportunities that are all possible, and you'll also have to make decisions in terms of managing margin relative to the convenience and technology investments.

Eric Lindberg -- Chief Executive Officer

Yes. Oliver, I can take those questions. So yes, in terms of timing on initiatives, we are mindful of being stretched too thin, I'll say. We take a very disciplined approach, a thoughtful approach and focused approach to the things that we do hear.

And we'll take the same approach to these initiatives that we've outlined. As far as timing on e-commerce goes, we -- as mentioned, we're in discussions right now with some potential third-party partners, just trying to figure out exactly how and when and what exactly looks like as far as the test goes. Our hope and intention is, though, that we have to test out market in the next several months. So hope to have that up and running soon, again, to test how well it fits with our model and some of the things that we've talked about, more unique to us in the past relative to e-commerce, the potential and then just more of the execution and system-based considerations there.

Personalization, as mentioned in my comments, would be a first half of '22 time frame. A lot of the work recently has gone into outlining of the program, thinking about the data that we'll collect. And ultimately, the use of that in an effort to speak in a more relevant and impactful way with customers. We already have really high engagement in the marketing that we put out, specifically mentioned the WOW! Alerts and store and item detail.

This then takes it down to the customer. So we think we'll see even higher levels of engagement there. And then in regards to your question on margin and how we might manage that in the midst of these things that we have on the list, I'd simply say we have a long-term history and track record of margin consistency, and that has been the case as this business has evolved, and it's evolved quite a bit over the past several decades in the face of increased everyday items in the assortment. We've maintained that margin stability through different cycles, macroeconomic cycles.

And beyond the model itself, how we buy product, which is unique to us and a great way that we've been able to manage consistency, we also always have a healthy list of margin enhancement initiatives and continue to pursue those opportunities. And so feel really good looking forward about our ability to maintain those stable margins. Thanks.

Oliver Chen -- Cowen and Company -- Analyst

Thank you very much.

Operator

Our next question comes from Robby Ohmes with BofA Global Research. Please proceed with your question.

Robby Ohmes -- Bank of America Securities -- Analyst

Hello. Hi, guys. Thanks for taking my questions. I was hoping that you could maybe talk more about what the pressures are that the IOs are facing right now.

I'd be curious like how are they handling the challenging wage environment. And are there other cost pressures that they're facing that's kind of impacting your profitability beyond what they would normally have to deal with? And maybe within that, it sounds like you guys are seeing plenty of supply, but is the kind of quality of the supply in line with historical norms? It would seem like it would be a different kind of supply versus the more historical normal environment. So are there any kind of issues getting the kind of items that would normally drive traffic? Maybe just give us a flavor for what the IOs are seeing and how they may be behaving differently in this environment.

Eric Lindberg -- Chief Executive Officer

Robby, Eric. Let me take the first question on the IO. It's a good question, and then I'll flip it over to RJ to let him talk a little bit more about the supply. Yes.

Look, I would say the IOs are just remarkably resilient. It's been a really tough run for the last 18 months. They moved from COVID in the major investments just to keep their stores safe and secure. And they moved right into this unprecedented labor market, something they've never seen, something we've never seen before.

It's been really tough as an operating environment. Now you've got the uncertainty of the Delta variant and sort of implications again for their stores and operations. And it's just a tough environment out of the stores. But that all said, they are very resilient.

They show up every day. They deliver without fail, and they continue to work really, really hard, improving their businesses. Ultimately, I think the biggest thing we can do is to drive sales and margin into their store, and that's what we're really focused on. We can really help them by driving things like sourcing and margin dollars, marketing investment, even e-com that we're talking about is something that will help benefit them.

And then on the back side or the behind the scenes, we're making a lot of investments in things like capex in the stores, new technologies and everything that we can do relative to efficiency so that we can help them save time, be more efficient and really streamline their own opex. So I would say that's going well. We've really focused this last year on staying close to them, being out in front of them, traveling a lot. And I'd say they're stressed, and I'd say it's been a tough environment.

But they're hanging in there. We do get some time with them in October. We're going to spend time out in all the regions, about 10 separate meetings, small groups, just sort of discussing. So we have ways to sort of make sure we're communicating and tell them what we're up to and listen as well.

But that's a little bit on the IO health and sort of where we are. I'll flip it over to RJ for product.

RJ Sheedy -- President

Yes. Robby, in terms of supply, the quality is really good. We're seeing healthy lifts. We're seeing nice mix across departments and categories.

We're just seeing great opportunities come through. Some of the themes that we're hearing from suppliers as product is coming our way, definitely seeing the impact of increased production, investments in capacity. Suppliers have found new sources of supply in the past year to address bottlenecks. So we're seeing those investments play through.

And in this year that has proven difficult -- or more difficult to forecast, that yields some of the product that we're seeing. Innovation pipelines are healthy. It's a frequent conversation and topic of discussion as they've reinvested profit back into innovation and long-term growth. And so whether that is pack size changes or rebranding labels or new items, some of the things around as consumer trends have changed, those have yielded product opportunities for us.

And then just more generally, you think about the amount of adjustment changes that have occurred in products and assortments to meet what has been a very dynamic consumer environment, those have yielded products as well. So I feel really good about the product, the partnerships that we have and, as mentioned, feel that that continues well through the rest of the year.

Robby Ohmes -- Bank of America Securities -- Analyst

All right. Great. Thanks so much, guys.

Operator

Our next question comes from John Heinbockel with Guggenheim. Please proceed with your question.

John Heinbockel -- Guggenheim Partners -- Analyst

So what are you guys seeing with regard to inflation overall, right? And I would imagine since you're the price leader, there would be an opportunity to pass that through. Is that happening? Or is there some wariness with that with the comp trend as it is?

Eric Lindberg -- Chief Executive Officer

Hi, John. Yes,. Definitely seeing inflation, well-publicized stresses out there in the supply chain. We hear it directly in our supplier conversations as well, whether it's increased commodity costs or freight rates or the impact that the labor shortages and challenges are -- the strand they're putting on the supply chain.

We do expect it to remain a headwind here for us, all of us as we look forward. We noticed some acceleration in Q2. It continues so far through the third quarter. This model does mitigate those risks and pressures more so than traditional retailers.

We do still feel the effects of it. However, we mitigate it through a highly diversified supplier base. We've got an ever-changing mix of products. We're in and out of opportunistic and everyday items.

We're back and forth between suppliers. So that offers us some protection. We price items all the time. So we're constantly able to manage that sales margin relationship, if you will.

And as already mentioned, we're always pursuing healthy margin enhancers to offset pressures such as these. In terms of pricing, we price to value. So we're always focused on value first. And as we deliver that value, we'd become an even more compelling place to shop.

And as we see prices being adjusted in market out of other retailers, we adjust accordingly. We always pay very close attention to that, continue to pay close attention to it as well, and we'll maintain value and be able to move with the market as that occurs.

John Heinbockel -- Guggenheim Partners -- Analyst

Maybe as a follow-up, the -- so do you think -- as you embrace e-commerce, do you think it's more -- your customer wants more delivery or BOPUS? I assume you're not going to put the labor -- the picking, right, the order selection on the IO, so that will be done by the third party. And then I know you guys have always said it's hard to replicate what you do online. Have you found a good way in terms of the mobile -- in terms of the app, right, to present the treasure hunt in an effective way, right for your customers?

Eric Lindberg -- Chief Executive Officer

Yes. All good questions, John. Those are exactly the things that we'll be testing as we get something out in the market. And you're right, we have talked about these things in the past as being just, I'll say, more unique to us, not a straightforward standard approach, if you will, to e-commerce.

Delivery BOPUS, we want to explore both of those. The adoption for both of those have increased. So we think they're both potentially interesting opportunities or approaches for us. So that's very much -- both of those are in scope of -- as we're thinking about a test.

Treasure hunt as well. Great question. That's part of the test also how well does that translate online as items are in and out, does that come across -- do customers see the excitement online as they would walking up and down the aisles of the store, we'll get a better read on that once we get out there in market, which is really the point of this thing is to try a few different options. There are lots of different ways companies are going about it.

We think the right approach for us is a, I'll call it, a lighter investment, lower capex investment approach to learn. And then once we settle on the one, two, or three several options that are a good fit, we'll adjust and figure out our longer-term plans from there.

John Heinbockel -- Guggenheim Partners -- Analyst

Thank you.

Operator

Our next question is from Simeon Gutman with Morgan Stanley. Please proceed with your question.

Michael Kessler -- Morgan Stanley -- Analyst

Hey, guys. This is Michael Kessler on for Simeon. Thank you for taking our questions. I wanted to first ask and go back to the comp trajectory and trends on a two-year basis.

They are running below your historical trend and below what the kind of broader food retail industry is doing. And you've mentioned at a high level a couple of factors that might be influencing that. So I guess I was wondering if you could go into a little more detail as far as sizing them up or ranking them as far as what is most impactful relative to what we were going to be seeing pre-COVID? And could you bucket them into whether they were driven primarily by consumer changes brought on by the pandemic or anything else that you're seeing in the market?

Eric Lindberg -- Chief Executive Officer

Michael, I would say it's slightly more weighted toward basket decel than it would be customer count. I think if we look at some of the trends for the consumer, we really need the stimulus to abate. We need some of the sort of activities that people have stopped doing, hitting multiple stores, looking for just a primary shop, those to abate as well will help us. But look, I'd say everything we're doing right now -- we just don't know when value returns as sort of a capital V for the customer.

But in the meantime, everything you hear we're doing is -- just putting into additional marketing and efforts, expanding the assortment, adjusting the marketing message to now include not only the deep value but convenience. Even the e-commerce for us, I think we're going to learn something that will be beneficial. And then certainly the personalized marketing. So look, we don't have perfect visibility toward sort of the future quarters.

I think that's why we've sort of held with that cadence for Q3, very similar to where we are right now. And look, any upside we have to that we can manage, certainly from a supply chain and certainly capacity in the stores. So look, we're bullish on the value that we have. The IOs are ready, and we're doing some pretty exciting things that we think will impact us in Q3 and four.

Michael Kessler -- Morgan Stanley -- Analyst

Great. And quick follow-up and not to pile on e-commerce, but one more on that one. I guess, first, why now? And second, have you kind of thought through or even maybe had discussions with your CPG supplier partners about the idea of having discounted merchandise from the brands online? I know that it's something you guys have mentioned in the past as a potential barrier of listing them online.

Eric Lindberg -- Chief Executive Officer

Yes, Michael, I'll take part one, and then RJ can take part two. Look, you've listened to us for a couple of years talk about e-commerce and sort of what our attitude is, and that is quite simply that stores continue to really represent the most important growth driver for us. But I think what's hit us for e-commerce, particularly in foods that took about 10 years to go from 1% to 5% penetration, and then in two quarters, it went up to 10%. And the reality from our perspective is, it's not going to go back to 5%, but it's more likely to go to 15%.

So that gives us certainly a lot of confidence. It's here, and we can explore a way to go out and reach to new customer and deliver what we think are leading values in the entire industry to our existing and new customers. And so that's got us pretty excited. How we do it, what the reaction is, I mean, there's a lot of work to be done there.

You guys know that. I'd say just the key difference to the why now is just the demand is so much different than we would have projected even a year or two ago. So -- but let RJ provide a little bit more around the supplier and how we'll handle that right now.

RJ Sheedy -- President

Yes. Michael, one of the reasons that we are a preferred partner for our suppliers is because we protect the brand or we protect the brands for the items that they sell both in-store and from an external marketing standpoint. We take a supplier-specific approach. Each has different requests or preferences for where the brand is seen or the item is seen or not seen, and it can even be deal-specific.

So we have the infrastructure and the approach and the history here of doing that with relationships that go back a long time. E-commerce won't be any different. We're going to do it in the way that works right by the supplier point of view. And we'll -- I would imagine, we'll take a supplier-specific approach just as we have with everything else.

So very much a part of the conversation and no issues on our end managing that way. Thank you.

Operator

Our next question comes from Karen Short with Barclays. Please proceed with your question.

Unknown speaker

Hi, guys. This is Zeyn Burak on for Karen Short. I wanted to piggyback on the comp question. The slowdown on a two-year trend, is it -- are you seeing that in certain categories? Is there a divergence in IO performance by cohort, older versus new, and also market-by-market? Or has the performance been pretty consistent across the chain in terms of the two --

Charles Bracher -- Chief Financial Officer

It's Charles. With respect to those trends, it really has been broadly consistent. There has not been a discernible trend by market or by vintage or by product. As Eric said, it has been -- it's come from both a moderation in ring, which remains elevated versus pre-COVID, but it has moderated.

And then traffic continues to increase, but it is increasing a bit slower than we have seen historically on a seasonal basis. So of the two, I'd say, ring is a slightly larger contributor to that moderating two-year stack, but feel good that over the past eight weeks or so, that trend has stabilized, the two-year stack trend has stabilized and would anticipate that given what we know now to carry it forth through the balance of the year.

Unknown speaker

And maybe one on gross margin. I guess like how do you characterize the competitive landscape in general in the current promotional environment? And you mentioned some color on gross margin in the -- for the third quarter. Any puts and takes, maybe the basis point impact from commodity inflation versus freight and so on?

Eric Lindberg -- Chief Executive Officer

It's Eric. Yes, so we are seeing an increased promotional activity from other retailers. I wouldn't say we're back to where we were in 2019, but it's certainly higher than 2020. What we're doing is focusing on just maintaining value, the spread between us and the next nearest competitor.

We continue to follow our pricing and our marketing plan. We're monitoring prices across a variety of stores and then making any adjustments that we need to, to make sure that, that spread roughly 40% on basket for regular retailers and 20% for value is there. And then ultimately, we think values that we provide on the brand names and the local shopping experience is what will win the day for consumers. Charles, maybe you want to share a little bit more in terms of cost and commodities?

Charles Bracher -- Chief Financial Officer

Yes. With respect to gross margin, speaking specifically to the second quarter, relative to prior year, the largest factor there was just normalized shrink as sales have moderated versus last year. But clearly, inflationary pressures having an impact as well, particularly with respect to fresh departments, along with freight and fuel costs in addition. But relative to prior year, it really is the moderating turns.

That's the biggest factor. But I feel great about how we're managing gross margin in light of what's an extraordinary inflationary environment to be tracking roughly in line with pre-COVID levels. Really proud of the team's efforts there.

Operator

Our next question comes from Michael Lasser with UBS. Please proceed with your question.

Michael Lasser -- UBS -- Analyst

Good afternoon. Thanks a lot for taking my question. As you look out over the next couple of quarters, you're expecting the trends to moderate, the multiyear stack. Is there any reason why you won't get back to positive comps as you look out to '22 if this is just a short-lived reopening e-commerce drag-type situation?

Charles Bracher -- Chief Financial Officer

Michael, it's Charles. Yes, let me just offer a few comments there without being overly specific to future year guidance. But I think what you are saying is admittedly this current backdrop doesn't necessarily play to our strengths as customers continue to consolidate their trips and have lots of cash in their pockets. But feeling great about the underlying health of the business as we look across opportunistic supply, product assortment, customer excitement, engagement, and loyalty.

So feel great about that. And the one thing we really haven't talked about as well is talk with respect to new store growth, really proud of the team's efforts, getting stores open in a challenging environment and continue to feel great about the runway for growth we have there. And you add to that all of those elements, the underlying health of the business, the things we're doing to further extend our reach and deliver value to the customer, we feel great about how we're set up for kind of the long term. And ultimately, that return to value that we know is coming.

Hard for any of us to say exactly when that kicks in, but we'll be well-positioned when it happens.

Michael Lasser -- UBS -- Analyst

And my follow-up is that, as you mentioned previously, your IOs have never really operated under these conditions where they've been experiencing negative comps and impact to their paycheck, especially as gross margin has been under pressure and you're feeling it on the wage expense side and now they might have to be mindful of an e-commerce element to the business. How do you prevent the IOs from sacrificing long-term outcomes at the expense of just trying to maximize the short run? Said another way, how do you make sure they remain focused on operating the optimal business in this environment where there's just a ton of distractions?

Eric Lindberg -- Chief Executive Officer

Michael, it's a thoughtful question. We've got a long, long history of communication and coordination with the IOs. We're out a lot. We have a team.

Our field team is close to 100 people. And so what guides a business is sort of a group of standards that we all agreed to that we didn't set and tell them, we've set together. And it has a lot to do with fullness and service levels in the stores to inventory to variety to shrink to freshness to display. It's all those sort of keys around retail.

And so short term, any operator can kind of take a pass on investing in their store and investing in labor and investing in marketing. But long term, it pops on a number of different sort of radar screens around us. And that creates a conversation for us to go back, look at a business plan, look at the long term and make sure that we're seeing the same things. And we're addressing any short-term issues through the long term.

But we do believe a lot of what we're seeing -- last year was a good financial year for most of our operators, but a very challenging operating year this year, a more challenging financial year and still a tough operating year. So we'd like to see them come through this in 2022 smarter, wiser, a little bit more battle-worn, which is where we're headed. They're hanging in there. We're supporting them in a lot of different ways, again, communicating a lot with them and trying to stay as close as we can so that we don't have any big sort of distractions, as you say.

Operator

Our next question comes from Krisztina Katai with Deutsche Bank. Please proceed with your question.

Krisztina Katai -- Deutsche Bank -- Analyst

Hi. Good morning, and thanks for taking my question. I wanted to follow up on the headwinds that are out there from inflation to freight to food cost and wages. You talked about how you're helping the IOs.

But I was wondering if you are seeing any signs that the IOs are getting a little bit more frustrated and perhaps turnover could increase in the coming months or year given the difficult environment and now we're also adding in the added complexity of e-commerce. And then I have a longer-term question.

Eric Lindberg -- Chief Executive Officer

Yes. I would say we haven't seen it. I would say that we did have a lot of turnover last year. We've had a little bit more this year, but I wouldn't say it's out of the ordinary.

We're still well below that sort of 10%. I think we're looking forward to the end of the year being under that 10% number. So look, the environment is certainly stressful. It's not really just turnover at the store level.

The more difficult and challenging thing is you just can't find people that want to work. That will change as people realize that the stimulus is coming to an end. I think that's right in front of us. I can't tell you exactly when it is.

In the absence of finding people that can come and work, they're getting -- the operators are getting a little bit of leverage -- financial leverage on the labor line because they just can't put enough people to work. But that means the individual operators are working even harder, more hours, which is not sustainable. So time will tell when that returns. You're right, we are supporting them a ton and try to do everything we can.

Again, the biggest thing we can do is drive gross margin dollars to their store, support them through buying, support them through some of the back-office efficiencies and just be very sensitive to the situation that most of them are in.

Krisztina Katai -- Deutsche Bank -- Analyst

Got it. And I had -- my longer-term question would be if we were to assume that these shopping habits that consumers have created since March of last year are going to be sticking around, so trip consolidation becomes more permanent, what changes do you think you need to make to your model, whether it's the size of the box, any changes to the assortment or whether it's a good e-commerce business to really make sure that you do regain that market share and you get back to your previous comp algorithm?

Eric Lindberg -- Chief Executive Officer

Yes. Krisztina, we're not -- there's no change to the model. We're really, really confident that the consumer will revert. We again can't say exactly when.

But look, for seven decades, we have been seeing value become increasingly more important to the consumer. So that's very heartening to us. We do have our own survey data we use and we rely on as sort of a north star. And we're seeing high satisfaction on the current customers.

We're seeing a high intention to return from some of the lapsed customers. And we've got just a high level of confidence that once stimulus support subsides, consumers will return more and more to value.

Operator

Our next question comes from Joe Feldman with Telsey Advisory Group. Please proceed with your question.

Joe Feldman -- Telsey Advisory -- Analyst

Yes. Hey, guys. Thanks for taking two questions. I wanted to ask about -- with regard to inventory, I know the supply sounds great, but it did seem like it's a bit high relative to sales.

And you kind of touched on it in the prepared remarks, but can you just give a little more color on what's going on there? Is some of that more driven by inflation? Is it just because sales are a little softer because it sounds like sales came in better than what you thought? So I just wanted to address just the inventory issue a little bit.

Charles Bracher -- Chief Financial Officer

Joe, it's Charles. I can take that. For us, if you recall, given the opportunistic nature of the business, inventory doesn't necessarily track in a linear fashion with sales. And so it will quarter to quarter fluctuate a bit.

On a longer-term basis, yes, there's that correlation to sales. But we feel, as RJ said, feel great about both the quantity and the composition of inventory. It's just -- it's healthy across categories and items and the mix between opportunistic and every day. So we feel really good about where we stand here as we're already into the back half of the year.

Operator

Our next question comes from Jeremy Hamblin with Craig-Hallum. Please proceed with your question.

Unknown speaker

Hey, guys. This is Ryan on for Jeremy. I wanted to go back to same-store sales. Can you maybe provide more detail on the month-to-month cadence from, say, June then here in the first couple of weeks in August? And I believe the Q4 commentary you provided actually indicates a slight pickup from Q3.

So assuming that's correct, is that purely a function of easier compares? Or do you expect things to normalize just a bit?

Charles Bracher -- Chief Financial Officer

Ryan, it's Charles. Let me try to tackle that. I think I'll hit on everything you asked here. But yes, as we look at Q2, the backdrop, I would say, was largely the same factors at play throughout the quarter.

So trip consolidation, more spend going toward food away from home, the impact of stimulus as we talked about. I'd say overall, the monthly top-line trends on a dollar basis, they were pretty consistent throughout the quarter. Monthly comp trends did improve as we progressed through the quarter. To your point, as comparisons -- prior-year comparisons began to ease a little bit.

And we talked about the two-year stack didn't moderate as we moved through the second quarter since it stabilized. So as we look here at the third quarter, really, the same themes are at play. On a comp basis, the results continue to get a little bit better here as comparisons continue to ease. Q3 to date stands at a negative 6%.

As we think about that two-year stack, that puts us -- our expectation for Q3 in total of a negative mid-single-digit comp. And then based on what we know now and obviously lots to play out here for the balance of the year, but our expectation would be to hold that two-year stack trend from Q3 into Q4.

Operator

Our next question comes from Brian McNamara with Berenberg. Please proceed with your question.

Brian McNamara -- Berenberg Capital Markets -- Analyst

Thanks for taking the question. Just given the comp deceleration and the apparent share loss in the conventional grocery and club stores, do you have a sense of how you're performing relative to your closeout grocery peers? And what I'm trying to get at is, are conventional grocery and club simply growing faster relative to the closeout market at the moment?

RJ Sheedy -- President

Yes. Brian, it's RJ. I'll handle that question. Yes, I think we've hit on a lot of the points, our view on comp, the current environment not in our favor.

And it's a good question because we're a different kind of store than conventional grocery retail. Customers do shop us differently. And we talk about things like the trip consolidation and the impact of stimulus, those are going to impact us, and they are impacting us differently than conventional. So all those things would explain some of the differences that you see our numbers to others.

I can't comment necessarily on other closeout grocery. We're a little more unique in that regard, certainly, other closeout retailers, different categories. But again, for us, we look at some of the fundamental metrics and things that we use to manage the business, the delivery of value, the health of the assortment, state of the operator and what they're providing by way of customer service and connection to the communities within each of their stores and then take a longer-term view. We -- and I think all of this has been mentioned, but continue to be very excited about the long-term potential.

We believe we will get past these transitory factors, environment. And we'll be positioned really well from a comp standpoint, when you look at those numbers as we cycle. And then as Charles mentioned, the new store growth continues to be something that we're marching forward on 10% new stores on the base and the growth potential or opportunity that, that provides. So we feel really good about all those things and playbook that we're following to capture it.

Operator

We have reached the end of the question-and-answer session. At this time, I'd like to turn the call back over to Eric Lindberg for closing comments.

Eric Lindberg -- Chief Executive Officer

Thanks, everyone. Really appreciate your questions, engagement. Thank you. We look forward to catching up with you right now one on one.

And thanks for everyone listening. Appreciate it. Talk to you soon.

Operator

[Operator signoff]

Duration: 66 minutes

Call participants:

Arvind Bhatia -- Vice President, Investor Relations

Eric Lindberg -- Chief Executive Officer

RJ Sheedy -- President

Charles Bracher -- Chief Financial Officer

Oliver Chen -- Cowen and Company -- Analyst

Robby Ohmes -- Bank of America Securities -- Analyst

John Heinbockel -- Guggenheim Partners -- Analyst

Michael Kessler -- Morgan Stanley -- Analyst

Unknown speaker

Michael Lasser -- UBS -- Analyst

Krisztina Katai -- Deutsche Bank -- Analyst

Joe Feldman -- Telsey Advisory -- Analyst

Brian McNamara -- Berenberg Capital Markets -- Analyst

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