Executive Summary / Key Takeaways

• Grocery Outlet ($GO) is an extreme value retailer leveraging a unique opportunistic buying model and independent operator network, positioning it distinctly within the competitive grocery landscape.
• Recent financial results, including 8.5% net sales growth and a 110 basis point gross margin improvement in Q1 2025, demonstrate underlying business strength, driven by new store expansion and improved inventory management following prior system disruptions.
• The company is undergoing a strategic recalibration, including a Restructuring Plan to optimize its new store footprint and cost structure, alongside significant efforts to remediate operational issues stemming from a recent ERP system transition.
• Management has moderated the full-year 2025 comparable store sales outlook to 1-2% due to current trends and macroeconomic uncertainty, but maintains confidence in profitability targets (30-30.5% gross margin, $260-270M Adjusted EBITDA) citing cost control and expected operational efficiencies.
• Key factors for investors to monitor include the successful completion of system remediation, execution of strategic initiatives to drive basket size and new store performance, and the company's ability to leverage its differentiated model amidst competitive pressures and macroeconomic shifts.

Setting the Scene: Value, Velocity, and the Independent Edge

Grocery Outlet Holding Corp. ($GO) operates as a distinctive force in the U.S. grocery sector, carving out a niche as a high-growth, extreme value retailer. At its core lies a powerful, differentiated business model centered on opportunistic buying and a network of independently operated stores. Unlike conventional grocers or even traditional discounters, Grocery Outlet sources quality, name-brand consumables and fresh products at deep discounts, often 40% to 70% below conventional retail prices, by capitalizing on manufacturer overruns, packaging changes, or short-dated products. This flexible buying approach, honed over decades since the company's origins in 1946, provides a constant influx of unique "treasure hunt" items that drive customer traffic and excitement.

Complementing this buying model is the independent operator (IO) network. These entrepreneurial local partners run the stores, fostering a neighborhood feel and tailoring product offerings to local tastes and demands. This decentralized operational structure acts as a key differentiator, enabling nimble execution at the store level and personalized customer service. While not a technological moat in the traditional sense of proprietary software or hardware, this operational model provides tangible benefits: enhanced local market responsiveness, potentially lower labor costs at the store level (as IOs manage their own staff), and a motivated partner base directly incentivized by store profitability. The IO model allows Grocery Outlet to scale its footprint with partners deeply invested in their local store's success, a strategic advantage against competitors relying solely on centralized management.

The company's strategic journey has been one of consistent growth, marked by positive comparable store sales in 20 of the last 21 years cited historically. This history underscores the resilience and appeal of the value proposition across various economic cycles. More recently, strategic moves like the acquisition of United Grocery Outlet (UGO) in April 2024, adding 40 stores and a distribution center in the Southeast, signal a deliberate expansion into new geographies, leveraging complementary real estate opportunities to build a platform for future growth.

Operational Headwinds and Strategic Recalibration

Despite its foundational strengths and growth ambitions, Grocery Outlet has recently grappled with significant operational challenges. Starting in late August 2023, the replacement of key components of its enterprise resource planning (ERP) system – including financial ledger, inventory management, and product data warehouse – led to substantial disruption. This system transition impacted critical functions like ordering, inventory management, payment processing, and data visibility, adversely affecting results through the first quarter of fiscal 2025. The disruption was severe enough to result in a previously identified material weakness in internal control over financial reporting, specifically related to deficiencies in IT general computer controls. While remediation efforts are ongoing and expected to be substantially completed in fiscal 2025, the system issues have been costly and have required significant resources.

In response to these operational headwinds and a comprehensive review of its growth strategy, the company initiated a Restructuring Plan in the fourth quarter of fiscal 2024, continuing into 2025. This plan aims to build a stronger foundation for sustainable, profitable growth by optimizing the new store footprint and enhancing cost efficiency. Key actions include the decision to terminate leases for 28 unopened stores located in suboptimal areas, a move expanded by five additional stores identified during a review of the 2026/2027 pipeline. The company is also shifting its distribution infrastructure investment focus away from highly capital-intensive multi-temperature projects towards lower-cost dry goods facilities, cancelling certain warehouse projects in Q1 2025 to enhance capacity and improve inventory management in a more capital-efficient manner. Furthermore, headcount was reduced by approximately 40 full-time employees in Q1 2025 as part of building a more scalable cost structure. These actions, expected to be substantially completed by the first half of fiscal 2025, are projected to incur total costs between $59 million and $61 million, with $40 million to $42 million expected as cash expenditures.

The strategic recalibration also involves a more disciplined approach to new store growth. While the long-term white space potential is estimated at over 4,000 stores, the company plans to open 33 to 35 net new stores in fiscal 2025, focusing on existing markets and high-priority adjacent regions. This tempered pace and focused approach are intended to improve new store sales productivity and enhance returns on invested capital (ROIC), addressing prior challenges with stores in less developed new markets.

Performance Under Pressure: Q1 2025 Results

Against this backdrop of operational challenges and strategic adjustments, Grocery Outlet reported its first quarter fiscal 2025 results, demonstrating resilience in key areas while highlighting ongoing impacts. Net sales increased by 8.5% to $1.13 billion compared to $1.04 billion in the prior year period. This growth was primarily fueled by the contribution from non-comparable stores, including the 69 net new stores acquired or opened over the preceding 12 months, alongside a modest 0.3% increase in comparable store sales. The comp sales growth was driven by a 2.3% increase in transaction count, partially offset by a 2.0% decrease in average transaction size. The timing shift of the Easter holiday also impacted the Q1 2025 comparable sales figure.

Gross profit saw a significant increase of 12.7% to $342.4 million, resulting in a gross margin of 30.4%, a notable 110 basis point improvement from 29.3% in Q1 2024. This margin expansion was primarily attributed to improvements in inventory management capabilities, leading to lower inventory shrinkage, a recovery from adverse impacts experienced during the prior year's system upgrades.

Selling, general and administrative expenses (SGA) rose by 9.1% to $331.1 million, or 29.4% of net sales. This increase was driven by higher store-related costs, including occupancy and depreciation from new stores and additional personnel costs from the acquired UGO stores, as well as increased corporate expenses supporting business growth. However, SGA as a percentage of net sales saw a slight increase, primarily due to the UGO acquisition's personnel costs and other store expenses, partially offset by the absence of elective commission support provided to IOs in the prior year.

The impact of the Restructuring Plan was evident in the operating results, with the company reporting an operating loss of $22.5 million in Q1 2025, compared to operating income of $0.6 million in Q1 2024. This loss included $33.9 million in restructuring charges incurred during the quarter. Net interest expense more than doubled, increasing by 105.3% to $6.5 million, primarily due to higher average principal debt outstanding from prior share repurchases, the UGO acquisition, and cash expenditures related to the Restructuring Plan. Ultimately, the company reported a net loss of $23.3 million, or $0.24 per diluted share, compared to a net loss of $1.0 million, or $0.01 per diluted share, in Q1 2024.

On an adjusted basis, which excludes the impact of certain special items like restructuring charges and acquisition costs, the picture was more favorable. Adjusted EBITDA increased by 31.7% to $51.9 million, resulting in an adjusted EBITDA margin of 4.6%, up 80 basis points from the prior year. Adjusted net income rose by 47.7% to $13.0 million, or $0.13 per diluted adjusted share.

Cash flow from operations saw a substantial increase, providing $58.9 million in Q1 2025 compared to $7.8 million in Q1 2024. This improvement was largely due to favorable changes in working capital, including accrued liabilities, compensation, and inventory levels, partially influenced by the prior year's system disruptions and current restructuring accruals. Net cash used in investing activities increased to $68.7 million, primarily due to higher capital expenditures on property and equipment for new and future stores and supply chain investments. The company ended the quarter with $50.9 million in cash and cash equivalents and $205.5 million of remaining borrowing capacity under its revolving credit facility, remaining in compliance with its debt covenants. Capital expenditures, net of tenant allowances, totaled $57.3 million in Q1 2025 and are projected to be approximately $210 million for the full fiscal year 2025.

Competitive Landscape: Agile Value vs. Scale Efficiency

Grocery Outlet operates in a highly competitive U.S. grocery market, facing off against a diverse set of players ranging from national giants to regional chains and other discounters. Key publicly traded competitors include Kroger (KR), Walmart (WMT), Target (TGT), and Costco (COST).

Compared to scale players like Walmart and Kroger, Grocery Outlet's market share is significantly smaller. Walmart dominates with roughly 25% of the market, leveraging massive economies of scale, advanced logistics, and a vast store network (>5,000 stores). Kroger holds a substantial share (9-10%) with an extensive footprint (>2,700 stores) and strong private-label presence. These giants benefit from superior supply chain efficiency and technological integration, enabling faster inventory turnover and order processing. Target and Costco also command notable market shares (2-3% and 8-9% respectively), with Target focusing on a curated value proposition and digital integration, and Costco excelling in bulk sales and membership loyalty.

Grocery Outlet differentiates itself primarily through its extreme value proposition driven by opportunistic buying. While competitors like Walmart and Target offer value, GO's ability to provide discounts of 40-70% on name brands is a distinct advantage. This model allows for cost agility, potentially leading to competitive gross margins (30.4% in Q1 2025) that can rival or even exceed those of some larger players (e.g., KR's 22-24%, WMT's 24-25%, TGT's 25-27%), although Costco's membership model results in lower gross margins (12-13%) but strong overall profitability.

However, GO faces disadvantages in scale and technological integration compared to its larger rivals. The recent ERP system issues highlighted vulnerabilities in its operational technology, impacting efficiency and data visibility, areas where competitors like Walmart and Target have invested heavily to achieve faster processing and fulfillment speeds. While GO's IO model provides local responsiveness, it lacks the centralized logistical efficiency and digital capabilities of its larger peers. The company's profitability metrics, particularly operating and net margins (Operating Loss in Q1 2025, Net Loss of 0.39% TTM), currently lag behind the typically healthier margins of KR (2-3% operating, 1-2% net), WMT (4-5% operating, 2-3% net), and TGT (4-5% operating, 2-3% net), partly due to recent operational disruptions and restructuring costs. GO's ROIC also trails peers, indicating weaker capital efficiency, an area the strategic recalibration aims to address.

Strategically, Grocery Outlet positions itself by emphasizing the "treasure hunt" experience and local connection through its IOs, targeting value-seeking customers across various income segments. The acquisition of UGO is a move to expand its geographic reach and leverage a complementary opportunistic buying operation. However, increased promotional activity from competitors and the rise of indirect competitors like online grocery services pose ongoing pressures on its value proposition and market share.

Outlook and Strategic Path Forward

Looking ahead, Grocery Outlet's guidance for fiscal year 2025 reflects a business focused on executing its strategic recalibration while managing ongoing operational improvements. The company reiterated its full-year outlook for total net sales, gross margin (30% to 30.5% ), Adjusted EBITDA ($260 million to $270 million), and Adjusted EPS ($0.70 to $0.75). However, it moderated its full-year comparable store sales growth expectation to a range of 1% to 2%, with Q2 2025 comps expected to be approximately 1%. This adjustment reflects current business trends, specifically pressure on average transaction size, and broader macroeconomic uncertainty impacting consumer spending. Management noted that while traffic remains strong, increasing the basket size is a key focus area that will take time to execute.

Despite the moderated comp outlook, the company expressed confidence in its profitability targets, citing the strong Q1 gross margin performance driven by improved inventory management and efforts to contain expenses through initiatives like the cost efficiency program led by the CFO. The increase in total restructuring charges to $59 million-$61 million is primarily due to identifying additional suboptimal store leases to terminate, aligning with the refined new store growth strategy focused on ROIC. Net interest expense for the year is now expected to be lower, at approximately $32 million.

The strategic path forward, as outlined by the new CEO Jason Potter, centers on four key imperatives:

1. Tackling New Store Performance: Piloting a new commercial execution playbook and focusing new openings (33-35 net new stores in 2025, 30-35 in 2026) on existing and high-priority adjacent markets, including lower CapEx store pilots, to improve year one sales and ROIC.
2. Securing Top Talent: Bringing in new leadership (new CIO, search for merchandising, store development, and supply chain heads) to drive strategy execution.
3. Addressing Execution Gaps: Continuing progress on systems integration, including the rollout of the real-time order guide (expected complete by end of Q2 2025) to improve inventory visibility, planning, and in-stock levels.
4. Improving Ability to Execute at Scale: Strengthening opportunistic buying, becoming a leading selling organization through enhanced training, data/insights for IOs, and merchandising efforts (tightening price gaps, promoting opportunistic/private label mix, improving produce quality). This also includes supply chain advancements like DC consolidation in the Pacific Northwest and activating a new low-CapEx DC in the East.

Management believes these initiatives, coupled with the expected completion of system remediation in fiscal 2025, will build momentum throughout the year, positioning the company for profitable long-term growth and reinforcing its competitive moat. The vision remains to become a most loved brand by building trust, consistency, and excitement among stakeholders.

Conclusion

Grocery Outlet stands at a pivotal juncture, balancing the inherent strengths of its differentiated extreme value model and independent operator network against the recent operational disruptions and the need for strategic recalibration. The first quarter of fiscal 2025 demonstrated top-line growth and significant gross margin recovery, signaling underlying business health and the initial benefits of addressing system-related inventory issues. However, the impact of restructuring charges and a moderated comparable sales outlook underscore the ongoing work required to fully stabilize operations and reignite consistent growth momentum.

The strategic shift towards a more disciplined new store expansion pace, optimization of the cost structure, and focused execution on core operational improvements and merchandising initiatives are critical steps aimed at enhancing profitability and ROIC. While the competitive landscape remains challenging, Grocery Outlet's unique value proposition and local IO model provide a distinct position. Investors should closely monitor the progress of the ERP system remediation, the successful implementation of the new strategic imperatives, and the company's ability to drive basket size and leverage its opportunistic buying power to navigate macroeconomic uncertainties and competitive pressures, ultimately determining its path back to consistent, profitable growth and shareholder value creation.