Natural Grocers by Vitamin Cottage, Inc. Q2 FY2023 Earnings Call

Good day, everyone. Welcome to the Natural Grocers Second Quarter Fiscal Year 2023 Earnings Conference Call. As a reminder, today's call is being recorded. I will now hand over the conference to Ms. Jessica Thiessen, Vice President and Treasurer for Natural Grocers. Ms. Thiessen, you may begin.

Good afternoon, and thank you for joining us for the Natural Grocers by Vitamin Cottage second quarter fiscal year 2023 earnings conference call. On the call with me today are Kemper Isely, Co-President; and Todd Dissinger, Chief Financial Officer. As a reminder, certain information provided during this conference call are forward-looking statements based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially from those described in the forward-looking statements due to a variety of factors, including the risks and uncertainties detailed in the company's most recently filed Forms 10-Q and 10-K. The company undertakes no obligation to update forward-looking statements. Today's press release is available on the company's site and a recording of this call will be available on the website at investors.naturalgrocers.com. Now, I would turn the call over to Kemper.

Thank you, Jessica, and good afternoon, everyone. We are pleased with our second quarter results. Sales growth was particularly strong and exceeded our expectations. And as a result, we are raising our comparable store sales guidance for the year. Daily average comparable store sales increased 2.7% or 7% on a 2-year basis. The comp exceeded our expectations as we cycled strong pandemic-related trends and a labor strike at one of our competitors in the Denver market in the second quarter of last year. Customer count increased 2.7% for the quarter and 4.5% on a 2-year basis. Item count per basket was down by less than 1 item compared to the prior year and in line with recent quarters. We observed minimal trade down in the second quarter. The monthly sales comp accelerated sequentially through this quarter. The comp in April was just under the March comp. Our diluted earnings per share was $0.26, including a $0.03 impairment charge related to a store closure. Net of the $0.03 per share impairment charge, diluted earnings per share would have exceeded the prior year period earnings per share of $0.28. During the quarter, we made the decision to close 2 stores as part of our ongoing efforts to drive higher store productivity. The strength of our sales trends indicates that we have a loyal and resilient customer base that prioritizes our healthy and sustainably focused offerings. We believe that our high product standards, marketing emphasis on the strong value proposition, always affordable prices, excellent customer service, and a convenient and friendly shopping experience continues to resonate with consumers and position us as a leading destination for natural and organic products in our markets. One contributor to our success is our Natural Grocers branded products, which represent value and uncompromising quality. In the second quarter, our Natural Grocers brand accounted for 8.1% of total sales, up from 7.7% a year ago. We believe that our Natural Grocers brand has a long runway, and we are targeting sales penetration to grow by approximately 1 percentage point annually. Our team is working hard to identify new products and vendors that meet our rigorous standards. During the second quarter, we were excited to open 1 new store in McCall, Idaho. We are on track to open 4 to 6 new stores and relocate 2 to 3 stores in fiscal 2023. Over the next several years, we expect to return to opening between 6 and 8 new stores per year as we anticipate improving construction and supply chain conditions. During the second quarter, labor availability pressures moderated for the majority of our stores. We provided a $1 per hour wage rate increase for all hourly store crew in the first quarter of fiscal 2023. Following that increase, our company-wide average hourly wage rate for full-time store crew exceeds $20 per hour, including $1 per hour in vitamin sales. We do not anticipate additional blanket wage increases for the balance of this fiscal year. In February, we released our fiscal year 2022 environmental, social and governance report. The report tells the story of our legacy as a sustainably focused company and our long record of prioritizing initiatives and practices that positively impact the sustainability of our business and the environment. This year's report highlights our commitment to regenerative agriculture as an important practice with the ability to mitigate climate change. I encourage you to review our latest ESG report as another tool to better understand the differentiation of our business. Lastly, I would like to thank every member of our good4u crew for their continued hard work and commitment to delivering the highest quality natural and organic products at always affordable prices and excellent customer service. With that, I will turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon. We are pleased with our second quarter results. Net sales increased 4.2% from the prior year period to $283.2 million. Our daily average comparable store sales increase of 2.7% was comprised of a 2.7% increase in daily average transaction count and a flat daily average transaction size. We estimate that product cost inflation was approximately 8% on an annualized basis for the second quarter. In the quarter, we've passed along the cost inflation through pricing and expect to continue this strategy for the foreseeable future. In the second quarter, our strongest performing departments were dairy, meat, and grocery. The supplement sales comp was similar to the total company comp. Our Npower loyalty program membership grew 18% to more than 1.9 million members by the end of the second quarter. The Npower net sales penetration was 76%, up from 73% a year ago. Gross margin increased 90 basis points to 29.1% and was driven by higher product margin which again reflects our ability to offset cost inflation through increased pricing. Store expenses as a percentage of sales in the second quarter increased 110 basis points and was primarily driven by higher labor expense as a result of increased wage rates and an impairment charge related to a store closure. Administrative expenses as a percentage of sales were consistent with the second quarter last year. Net income was $5.9 million with diluted earnings per share of $0.26 in the second quarter. Diluted earnings per share was impacted by a $0.03 share impairment expense. This compares to net income of $6.4 million or $0.28 of diluted earnings per share in the second quarter of last year. Adjusted EBITDA was $16.8 million in the second quarter. Turning to the balance sheet and cash flow. We ended the second quarter in a strong financial position with $19 million of cash and cash equivalents. We had no outstanding borrowings under our $50 million revolving credit facility. During the first 6 months of fiscal 2023, we generated cash from operations of $34.9 million and invested $17.8 million in net capital expenditures, primarily for new and relocated stores, resulting in free cash flow of $17.1 million. Today, we announced that our Board of Directors has declared a quarterly cash dividend of $0.10 per share. The dividend will be paid on June 14, 2023, to all stockholders of record at the close of business on May 30, 2023. The dividend reflects our strong operating performance and financial position, confidence in our business model, and commitment to returning value to our stockholders. We are raising our fiscal 2023 outlook for comparable store sales based upon year-to-date performance and current trends. We are also increasing our outlook for the number of relocations and remodels. All other aspects of our guidance are unchanged. We plan to close two stores in June 2023, and all related costs are incorporated into guidance. The updated outlook reflects recent results, current operating trends, consumer trends, and the uncertainty of the economic environment, including inflationary factors. Our guidance includes the following: open 4 to 6 new stores, relocate or remodel two to three stores, achieve daily average comparable store sales growth between 1% and 2%, achieve diluted earnings per share between $0.70 and $0.90, and direct $28 million to $35 million towards capital expenditures to support our growth initiatives. In closing, we had a strong quarter that we attribute to many factors, but foremost our customers' high level of engagement with our differentiated and relevant business model. We continue to be encouraged by our operating trends and are confident in our ability to continue to drive growth and enhance value for all stakeholders. With that, I would like to open the lines up for questions. Thank you.

Thank you. And the first question comes from Scott Mushkin with R5 Capital.

Thank you for the opportunity to ask questions. Firstly, I want to commend the impressive performance considering the current environment. My first question pertains to a strategic long-term operational aspect of the business. In our consulting operations, we are observing that while it may be getting slightly easier to find labor, many companies are still facing challenges in acquiring high-quality workers. I had always thought that your organization might have an edge in this area. Could you elaborate on whether you believe you have this advantage and how it influences your sales and overall market strategy?

Well, I think over the last couple of years, it's definitely been challenging to get labor and particularly, quality labor. I think that that's kind of changed in the last six months. And the ability to attract labor and quality labor has improved substantially. And then, of course, our getting up to $20 per hour for the hourly people has really helped enhance our ability to keep quality labor at the stores. As far as being able to attract quality labor, I think that because of our foundational principles, we're able to attract labor - people to - the quality labor to our company because they are attracted to the fact that we have a company that has values and lifestyle attributes that they would like to live and be part of. And so at our home office, we've been able to keep our staff really consistent with a lot of really high-quality people. The store level is a little bit harder just because the wage levels are a lot lower. But now that we're up with this $20 per hour average wage, it’s become a lot easier to keep the staff at the store levels.

And then, Kemper, do you have any feel about like at the store, how many people are kind of committed to the healthier lifestyle and are there because it's part of their kind of ethos?

I would say that over half of the crew members at each store is there because of the ethos and the quality lifestyle that they're able to live because of working at our company.

Okay. And then turning to the gross margin performance in the quarter. I know you guys talked about, I guess, I think it was product mix. Obviously, pretty significant plus 90 Bps. How should we think about that going forward? And any more kind of insight into what drove that performance in more details and how we should think about gross margin as we move forward, especially if the economy were to weaken up?

In the current inflationary environment, we are seeing some benefits as we buy products at a higher retail price. It takes time for the average cost to align with the increased retail prices, which provides a temporary advantage. Looking ahead to the next two quarters, we anticipate maintaining a similar situation with margins improving by about 90 to 100 basis points. After this inflationary period, we aim for smaller, incremental increases in our margins through enhanced efficiencies.

Okay. And then, I guess, turning my last one, and I don't know how many people on the call, so hopefully, I'm not dominating here. But the - obviously, sales came in, I think they were above our thought process. We are seeing kind of the economy weaken up, but you guys think - feel pretty good about things going forward, maybe a little better than coming into this quarter. Why do you think that's happening? Like - and how do you feel the business is likely to perform something we asked last quarter? If we get into the back half of '23 and unemployment rate goes up and the economy weakens further, how should we think about your particular business in that type of environment?

We have always aimed to maintain affordable prices, which is a key aspect of our identity. This position benefits us, especially during economic downturns. Additionally, we have over a million customers in our Npower program, allowing us to communicate our value and quality offerings to them regularly, which is currently driving growth in our customer base and overall sales.

Okay. Great. I actually have one more if there's not too many people, and I'll get back in.

Go ahead and ask the other one.

Okay. So obviously, we have a big merger taking place in sort of one of your core markets there's likely to probably be a spin. I mean, do you think the - just the merger itself is likely to help your business? Do you have any feel of what the overlap of your customer base is with Safeway and, I guess, King Soopers, Kroger?

Well, I think it's pretty substantial. I think that if the merger goes through, they'll probably make them spin off quite a few of the Safeway locations that are in our market areas. And I don't think that that's going to make the new spin-off company stronger. So I think in the overall end of things it would be beneficial to us.

Thanks very much.

Thank you. And the next question comes from Greg Badishkanian with Wolfe Research.

This is Johnny Baldwin on for Greg. I just have a quick one on inflation. It seems like it was roughly in line with last quarter at 8%. Just curious how you're thinking about inflation to play through the back half of the year? Should we think about maybe like a low single-digit exit rate in 4Q? Any commentary there would be helpful. Thanks.

I would estimate that this quarter will likely be very similar to the last one. We are optimistic that starting in the fourth quarter, it will ease somewhat. However, I believe that the inflationary pressures, especially in the construction sector, will remain significant. There is also a chance that energy prices might rise again, and we may see additional wage inflation next year. Therefore, I think the best-case scenario would be reaching about 5% by the end of the year, but I don’t expect it to drop below that level.

Got you. That's helpful. And then just one more for me just on the 2023 guidance raising the comp guide, but then leaving EPS at $0.70 to $0.90. Just curious like sort of what you're seeing there to not flow that through on the bottom line?

We have a wide range for our guidance at $0.70 to $0.90. We could have potentially narrowed it on the lower end, but we prefer to keep it broad for now due to the uncertainty ahead. By the end of the next quarter, we hope to refine that range.

Got you. Thanks. Appreciate the color and that's it from me.

All right. Thank you.

Thank you. And this concludes the question-and-answer session. I would like to turn the call to Kemper Isely for any closing comments.

Thank you for joining us to discuss our second quarter results. We are encouraged by our performance. We look forward to speaking with you on our next call to review our third quarter 2023 results. Thank you, and have a great day. Bye.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.