Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q3 2023 Earnings Call Transcript

Good day, ladies and gentlemen. Welcome to the Natural Grocers Third Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. Later we will conduct the question-and-answer session, and instructions will be given at that time. As a reminder, today's call is being recorded. I'd like now to turn the conference over to Ms. Jessica Thiessen, Vice President, Treasurer for Natural Grocers. Ms. Thiessen, you may begin.

Good afternoon and thank you for joining us for the Natural Grocers by Vitamin Cottage third 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 consists of 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 website, and a recording of this call will be available on the website at investors.naturalgrocers.com. Now, I will turn the call over to Kemper.

Thank you, Jessica, and good afternoon, everyone. We appreciate you joining us today. We delivered another strong performance in the third quarter, exceeding our expectations. We believe that Natural Grocers continues to be very differentiated in the market and uniquely relevant to consumers. Our third quarter sales trends were particularly strong. Daily average comparable store sales increased 4.4%, including a 1.9% increase in daily average transaction count. Moreover, strength was broad-based across categories. The monthly sales comp was relatively consistent throughout the quarter. We believe that our strong value proposition, especially our carefully vetted products at always affordable prices, aligns with current trends in the market. Sales also benefited from focused marketing initiatives and leveraging the Npower loyalty program. Our operations and marketing teams have transitioned well post-pandemic to focus on execution. I would like to share a few examples of their initiatives that benefited the third quarter. First, we developed market-specific marketing campaigns that have accelerated sales growth in underperforming stores without diluting margin. Second, effective pricing and promotion contributed to the third quarter gross margin improvement of 130 basis points. Finally, higher labor efficiency partially offset increased wage rates and drove store productivity. Our crew's commitment to operational excellence, ongoing improvement, and exceptional customer service were instrumental in driving our strong third quarter performance. We achieved diluted earnings per share of $0.31, an 82.4% growth compared to the third quarter of last year. The strength of our third quarter results prompted us to raise our comparable store sales and earnings per share guidance for the fiscal year. Todd will cover the results and outlook in more detail. Next, I would like to highlight two milestones achieved during the third quarter. The first milestone relates to our Npower loyalty program. We celebrated reaching two million Npower members during the third quarter. The net sales penetration for Npower was 77% in the third quarter, up from 75% a year ago. The continuing growth in membership and sales penetration demonstrates our customers' appreciation of the benefits and value provided by the program. Npower continues to be an effective tool for optimizing promotional activity and driving customer engagement. Examples include personalized emails that tailored promotional offerings to customers' preferences, market-specific marketing campaigns, and value-focused meal deals. On average, a Npower member's basket is almost twice the size of a non-member's basket. Our second milestone relates to sustainability. Natural Grocers was founded by my parents in 1955, who were inspired by founding principles that many people today would recognize — sustainability principles. As part of our longstanding commitment to the health and well-being of humans, animals, and the planet, we adopted single-use bag-free checkouts in 2009. Over the past 14 years, we estimate our policy has prevented more than 500 million single-use plastic bags from entering the waste stream and impacting the environment. Additionally, for each customer who brings their own shopping bag, we donate $5 to a local food bank, which has amounted to $2 million in donations since the program's inception. I encourage you to review our 2022 ESG report for more information on the practices we have implemented to further reduce packaging and waste throughout our operations. Turning now to new store development, during the third quarter, we relocated our store in Amarillo, Texas. Relocations are an important component of our store development strategy as they enable us to leverage an established market presence with a stronger facility in a prime location. Relocations generally realize double-digit sales growth off a mature sales base. For fiscal year 2023, we are on track to open four new stores and relocate or remodel three stores. Finally, I would like to thank every member of our good4u crew for their commitment to operational execution and exceptional customer service, which were instrumental in driving our strong third quarter performance. 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 strong third quarter results. Net sales increased 5.8% from the prior year period to $281.8 million. Our daily average comparable store sales increase of 4.4% was comprised of a 2.4% increase in daily average transaction size and a 1.9% increase in daily average transaction count. We estimate that product cost inflation was approximately 7%, on an annualized basis for the third quarter, which was down slightly from 8% in the previous two quarters. The item count per basket, compared to the prior year, is in line with recent quarters. We observed minimal trade-down in the third quarter. Our strongest performing departments were dairy, body care, meat, and dietary supplements. Our continuing growth of supplements indicates the stickiness of elevated pandemic demand. The growth in supplements further reflects our differentiation and strong competitive position in this important category, which is also margin accretive. The Natural Grocers brand represented 7.6% of total sales, down slightly from 7.7% a year ago. For the third quarter, gross margin increased 130 basis points to 28.9% and was driven by higher product margin attributed to effective pricing and promotions. Store expenses as a percentage of net sales decreased 40 basis points and was primarily driven by expense leverage on sales, partially offset by higher labor expense due to increased wage rates. Administrative expenses as a percentage of net sales increased 50 basis points and was primarily driven by higher compensation expense, software expense, and technology amortization. Operating income increased 60.8% to $9.1 million. The effective income tax rate was 14.1% and 22.1% for the third quarter of fiscal 2023 and 2022, respectively. The decrease in the effective income tax rate was primarily attributable to increased food donation deductions recorded during the third quarter of fiscal 2023. We anticipate our normalized effective income tax rate will be more aligned with the year-to-date tax rate. Net income was $7.1 million with diluted earnings per share of $0.31 in the third quarter. This compares to net income of $3.9 million or $0.17 of diluted earnings per share in the third quarter of last year. Adjusted EBITDA was $16.7 million. Turning to the balance sheet and cash flow. We ended the third quarter in a strong financial position with $8.6 million of cash and cash equivalents. We had no outstanding borrowings under our $50 million revolving credit facility. During the first nine months of fiscal year 2023, we generated cash from operations of $36.2 million and invested $24.3 million in net capital expenditures, primarily for new and relocated stores, resulting in free cash flow of $11.9 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 September 13, 2023, to all stockholders of record at the close of business on August 28, 2023. We are raising our fiscal 2023 outlook for comparable store sales and diluted earnings per share based on our strong year-to-date performance and current trends. We are also refining our outlook for the number of new stores, relocations, and remodels. Our guidance now includes the following: open four new stores, relocate or remodel three stores, achieve daily average comparable store sales growth between 2% and 3%, achieve diluted earnings per share between $0.86 and $0.94, 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, including a loyal and resilient customer base that prioritizes our healthy and sustainably focused offerings at always affordable prices. We continue to be encouraged by our operating trends and are confident in our ability to continue to drive profitable growth and enhance value for all stakeholders. With that, I would like to open the lines for questions. Thank you.

We will now begin the question-and-answer session. Our first question comes from Scott Mushkin of R5 Capital. Please go ahead.

Hey, guys. Thanks for taking my question. It's clear that your initiatives are obviously having a nice benefit to the business. Congratulations on that.

Thank you, Scott.

I don't know if you remember our last call, but I was asking you a little bit about how you guys performed during the last recession. I wanted to take that maybe to the next step of how you look at your business and what's going on in the broader market. How much of the center store or a traditional grocery store is headed maybe to Amazon or Walmart? How do you think a specialty market like yours fits into that picture?

I think, because we are so differentiated from a conventional grocery store and a Walmart or Amazon, it doesn't have as much of an effect on our business. You can see it just in our supplement sales. Our supplement sales have actually outperformed our comp. You would think that supplement sales would naturally migrate online, but a lot of people need guidance and customer service to select their supplements, and so you can get that at our stores. We have a lot of loyalty and stickiness with our supplement customers, and we're actually increasing market share because of that. As far as the center of the store goes, our standards make it a lot easier for our customers to shop without worrying about whether they are buying something undesirable due to its ingredients at Walmart or Amazon. We also have a very different shopping experience in our stores because we have a smaller format that is easier and not intimidating to shop.

Thanks for that. The question I was going with is that I’m starting to think you guys are almost complementary. If you're looking for specialty items or you want that consultation, you're going to head to a Natural Grocers or maybe a fresh market if you're looking for that type of produce, really almost complementary to the online and what Walmart is doing. That was kind of where I was headed with that. So, let's assume that's true. Talk about your real estate plans going forward. How many new stores do you think you can grow? I heard the real estate plans for this year, but as we think about your real estate plans going forward, is there a thought of maybe a little acceleration, or how should we think about that?

The last couple of years have been a little bit slow in new store development, but our plan going forward is to open six to eight new stores a year. Part of our strategy, of course, is to relocate or remodel stores, because we see a substantial lift in our comp when we relocate or remodel a store. We do two to five of those each year as well.

Thank you. Any thoughts on re-accelerating, or are you just kind of happy with that 6% to 8%?

At the moment, we're pretty happy with the 6% to 8%. And like I said, two to five relocations keep us very busy. This approach allows us to be more selective in our site locations, and it is not as dilutive to our earnings to open just piles of stores.

Right. And this might be an off-the-wall question, but stepping back strategically, I don't think you guys have done any M&A. How are you thinking about that type of activity, or is that just not even on your radar?

We really don't have that as part of our strategy.

Okay. All right guys. Real solid quarter, congratulations again.

Thanks. You have a good day now, Scott.

You too.

We will wait one moment in case anyone else joins. With no further questions, this concludes our question-and-answer session. I would like now to turn the conference back over to Kemper Isely for any closing remarks.

Thank you very much for joining us to discuss our third quarter results. This month marks our 68th year serving our communities. I encourage you to visit one of our locations between August 17 and 19 to help us celebrate our anniversary. We look forward to updating you on our next call regarding the fourth quarter and full fiscal year 2023 results. Thank you and goodbye.

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