Natural Grocers by Vitamin Cottage, Inc. (NYSE:NGVC) Q2 2023 Earnings Call Transcript May 7, 2023

Operator: Good day, ladies and gentlemen. Welcome to the Natural Grocers Second Quarter Fiscal Year 2023 Earnings Conference Call. As a reminder, today’s call is being recorded. I’d like to turn the conference over to Ms. Jessica Thiessen, Vice President, Treasurer for Natural Grocers. Ms. Thiessen, you may begin.

Jessica Thiessen: 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 right 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.

Kemper Isely: 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 indicate 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 books. 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.

Todd Dissinger: 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.

Q&A Session

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

Scott Mushkin: Hey, guys. Thanks for taking my questions. And obviously, tremendous performance given the environment. So the first thing I wanted to ask a little bit about – actually, kind of more of a, I guess, kind of strategic longer term kind of business operating question. One of things we’re running in our consulting business is just with the companies we’re working on — with getting quality labor, maybe it’s getting a little easier to get labor, but a lot of people are struggling with getting quality labor. It always thought — I always thought that you guys maybe had an advantage that way. And I wanted you to maybe speak to that. Do you think you have an advantage? And how does that kind of work its way through maybe sales and just kind of the company going to market?

Kemper Isely: Well, I think over the last couple of years, definitely been challenging to get labor and particularly, quality labor. I think that that’s kind of changed in the last six months. And that 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’re able to keep our — 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.

Scott Mushkin: And then, Kemper, do you have any like 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?

Kemper Isely: You mean of the crew members at the store?

Scott Mushkin: Yes. Yes, the crew members.

Kemper Isely: 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.

Scott Mushkin: 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?

Kemper Isely: No, I think that in this inflationary environment that we’re able to get a little bit of boost just because of the inflationary environment. You buy in product at a — you have a higher retail and it takes a little while for the average cost to catch up to the higher retail so you get a little bump there. But going forward, for the next 2 quarters, we’re projecting that we should be in a similar type of situation that we are right now as far as 90 basis points up to 100 basis points up over the next 2 quarters. And then as far as ongoing goes, I mean, you’re not going to — once you get through the inflationary period, it’ll probably be – we’ll try to get incremental smaller increases in our margin through efficiencies.

Scott Mushkin: 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?

Kemper Isely: Well, we always have strived to have affordable prices. And so that has always been one of our defining characteristics. So we’re not considered a whole paycheck sort of company. And I think that’s very helpful, particularly in recessionary period of time. And then secondly, we’re getting — we have one point some million customers on our Npower program. And so we’re able to market to them four times a week our value proposition and also our quality proposition. And it’s really helping to increase our customer accounts at the moment and also to just get us through – just an increased sales in general.

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

Kemper Isely: Go ahead and ask the other one.

Scott Mushkin: 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?

Kemper Isely: 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.

Scott Mushkin: Thanks very much.

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

Johnny Baldwin: 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.

Kemper Isely: I would guess that for this quarter, it will probably be very similar to last quarter. We’re hoping that starting in the fourth quarter — our fourth quarter that it moderates somewhat. I don’t think that you’re going to get rid of it because there’s still a lot of inflationary pressures out there, particularly in the building trades area. And it’s entirely possible that energy prices could go up again. And there’s going to be probably some more wage inflation next year. So I think at the best that you’re going to get up to – in the 5% range by the end of the year, but I don’t think it’s going to go below that level.

Johnny Baldwin: 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?

Kemper Isely: Well, we have a really broad range on that — on the $0.70 to $0.90. And so perhaps we could have tightened that up a little bit on the low end. But we just wanted to — there’s always uncertainty going forward. And so we just wanted to keep that range broad for the moment. And hopefully, at the end of this next quarter, we’ll be able to tighten it up.

Johnny Baldwin: Got you. Thanks. Appreciate the color and that’s it from me.

Kemper Isely: All right. Thank you.

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

Kemper Isely: 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.

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