Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Natural Grocers Second Quarter Fiscal Year 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, today's call is being recorded. I'd now like to turn the conference over to Ms. Ashley MacLeod, Director of Finance and Investor Relations for Natural Grocers. Ms. MacLeod, you may begin. Ashley MacLeod - Director-Finance & Investor Relations: Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage second quarter and first half fiscal 2015 earnings conference call. On the call with me today are Kemper Isely, our Co-President, and Sandra Buffa, our Chief Financial Officer. As a reminder, all statements made on this conference call other than statements of historical facts are forward-looking statements. All forward-looking statements are based on current expectations and assumptions that 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 detailed in the company's most recently filed Forms 10-Q and 10-K. The company undertakes no obligation to update forward-looking statements. Our press release is available on our website, and a recording of this call will be available on our website, at investors.naturalgrocers.com. Now, I will turn the call over to our Co-President, Kemper Isely. Kemper Isely - Chairman & Co-President: Thank you, Ashley. Good afternoon, everyone. As we celebrate our 60th anniversary of empowering health, we are pleased to report solid results. Our sales increases and disciplined approach toward operating expenses continue to allow us to invest into future growth. During the second quarter of fiscal 2015, net sales increased 21% to $157.7 million and daily average comparable store sales increased 5.6%. Gross profit increased to $46.9 million and we continued to see leverage in administrative expenses. Net income increased 35.1% and our diluted earnings per share in the second quarter of fiscal 2015 was $0.24 compared to $0.18 last year. Our comparable store sales increased 5.6% in the second quarter, driven by a 3.2% increase in daily average transaction count and a 2.2% increase in average ticket. We continue to focus on our directed sales initiatives, outstanding customer service and operational excellence. We're excited to announce that new brand standards are now in place for all our print materials. And the new Natural Grocers website was launched as scheduled on April 1. Our new website provides intuitive navigation and supports the information consumers told us is most important: locations, product availability and information on in-store events. Our new website provides the foundation for our next innovation, our loyalty program called {N}power. {N}power has been designed to provide loyalty points for shopping, digital coupons for greater value, and clubs that create focused offers, education and information. In-market testing of {N}power begins soon, and we anticipate a rapid rollout thereafter. Moving to new store growth. We opened four new stores during the second quarter entering Arkansas for the first time and expanding our geographic footprint in Arizona, Kansas and Texas. Our new stores are performing in line with expectations, and we remain on track with our new store pipeline. We will continue to enter new states and markets and plan to open 18 new stores in fiscal 2015. Now I will turn the call over to Sandra to highlight our financial results for the second quarter of fiscal 2015.

Thank you, Kemper. Good afternoon everyone. We're pleased to report net sales in the second quarter of fiscal 2015 increased 21% to $157.7 million. Daily average comparable store sales increased 5.6%, driven by a 3.2% increase in daily average transaction count and a 2.2% increase in average transaction size. Daily average mature store sales increased 2.6%. Gross profit during the second quarter of fiscal 2015 increased 20.9% to $46.9 million, driven by positive comparable store sales and an increase in the number of new stores. Gross margin remained flat due to increases in product margin offset by increases in occupancy costs. Store expenses increased 20.8% to $32.5 million in the second quarter. As a percentage of sales store expenses remained flat in the second quarter compared to the prior comparable period. During the second quarter gross margin and store expenses were positively impacted by the nature of new store openings and a reduction in our new store growth rate. Administrative expenses as a percentage of sales decreased 10 basis points as a result of the company's continued ability to support sales growth without proportionate investments in overhead. Additionally during the second quarter we accrued our full 401(k) match and also accrued our pay-for-performance incentive compensation at twice the level of last year and 50% of our maximum target. Pre-opening and relocation expenses decreased $300,000 during the second quarter compared to the prior comparable period, due to the number and timing of new store openings. During the second quarter of fiscal 2015 we opened four new stores, compared to five new stores in the second quarter of fiscal 2014. Net income increased 35.1% to $5.4 million with diluted earnings per share of $0.24 in the second quarter of fiscal 2015. EBITDA increased 29.4% to $14.5 million or 9.2% of sales. Touching briefly on our first half results. Net sales increased 21% and daily average comparable store sales increased 5.9%. Net income in the first half of fiscal 2015 increased 29.6% to $9 million with diluted earnings per share of $0.40. We opened eight new stores in the first half of fiscal 2015, resulting in a 17.3% trailing 12-month unit growth, compared to nine new stores opened in the first half of fiscal 2014 resulting, in a 24.6% trailing 12-month unit growth. We ended the second quarter with $7.2 million in cash and cash equivalents and no amounts outstanding on our credit facility. Now I will turn the call back to Kemper to discuss our new store growth and outlook for fiscal 2015. Kemper Isely - Chairman & Co-President: Thank you, Sandra. As I mentioned at the beginning of the call we continue to invest in new store growth. We opened four new stores in the second quarter, bringing our total count to 95 stores in 16 states. As of today we have signed leases for eight of the remaining 10 new stores we plan to open in the second half of fiscal 2015 in Arizona, Colorado, Kansas, Minnesota, North Dakota and Oklahoma and we have four signed leases for stores planned to open after fiscal 2015. By the end of fiscal 2015, we expect our geographic presence will cover 18 states west of the Mississippi. Our real estate strategy supports a broad range of communities. We continue to focus on opening new stores in both new and existing locations and in both smaller rural areas and larger metropolitan areas. Moving to our outlook, based on our first half results and expectations for the remainder of the fiscal year, we are not updating our annual guidance. However, we anticipate that our fiscal 2015 results will be on the higher end of our net income and EBITDA margins. During fiscal 2015, we expect to achieve daily average comparable store sales growth of 5% to 8%, deliver EBITDA margins of 7.3% to 7.5%, achieve net income margins of 2.1% to 2.3%, and achieve diluted earnings per share of between $0.63 and $0.66. Our fiscal 2015 guidance for the number of new stores and remodels will remain unchanged. We plan to open 18 new stores, resulting in 21% unit growth, and remodel 2 stores. We are moving one of our expected relocations into fiscal 2016, thereby, relocating one store rather than two stores in fiscal 2015. We are also updating the capital expenditures outlook to $41 million to $42 million for fiscal 2015. We anticipate cash on hand, cash generated from operations and availability under our credit facility will be sufficient to support our capital requirements. As our 60th anniversary year continues, we are excited about increasing our store base and also look forward to the expected opening of our 100th store. We continue to engage with our communities and increase awareness around our high-quality standards. We believe our quality standards make us the leader in the grocery and supplement industry and provide our customers with valuable confidence in what we sell at every day at affordable prices. More than ever, we remain focused on founding principles, which we believe significantly contributed to our success and will help guide us as we grow. Now I would like to open the lines up for questions. Thank you.

The first question comes from David McGee with SunTrust. Please go ahead.

Yes. Hi, everybody. Congratulations on the good numbers. Kemper Isely - Chairman & Co-President: Thanks, David.

I just had two questions. One is sort of a big picture. Kemper, what is your feeling about the sector health right now in terms of tailwind of consumer demand and what seems like that we have seen some increasing variability of numbers out there? Kemper Isely - Chairman & Co-President: You mean in our sector alone or the whole economy as a whole?

We can talk about that offline. Just more natural/organic sector? Thanks. Kemper Isely - Chairman & Co-President: I think the whole economy in the whole is having – there's a little bit of tailwinds right now. I think that the decrease in the price of oil has had quite an impact on a number of regions in the country and has had kind of a small detrimental effect on consumer confidence. And so, I think it's caused a little bit of tailwinds in our sector as well as other sectors in the economy.

And then more specifically how did the supplement part of the business do and how do you feel about the outlook there? Kemper Isely - Chairman & Co-President: It did fairly well. Overall we had a 21% increase in sales. Supplements were up about 17%. So they came in about how they've been faring over the last couple years at our stores, a few basis points lower than what our overall growth has been. But I haven't seen a diminishing in – we haven't seen people not coming in to buy supplements.

Okay, great. Thank you. Kemper Isely - Chairman & Co-President: Thanks, David.

The next question comes from Sean Naughton with Piper Jaffray. Please go ahead. Sean P. Naughton - Piper Jaffray & Co (Broker): Good afternoon and thanks for taking the questions. Kemper Isely - Chairman & Co-President: Good afternoon, Sean. Sean P. Naughton - Piper Jaffray & Co (Broker): Good afternoon, Kemper. Just a question for you in terms of product availability out there in the marketplace. How are things going in terms of procuring organic produce? Is there anything on the nut side on the bulk business that's causing a little bit of consternation? I know there's obviously some pressure in organic dairy but just anything across the store that you are having a little bit of a trouble getting your hands on it at this particular point in time? Kemper Isely - Chairman & Co-President: No, not really. I mean, the price not just gone up substantially as long as you're willing to pay the price you are able to – as far as organic produce, we haven't had any issues other than every once in a while there's a weather related issue. I think there was some problem with broccoli about two weeks ago but other than that we haven't had any issues with that. Other commodities, there haven't been any issues with supply at all. Sean P. Naughton - Piper Jaffray & Co (Broker): So inflation doesn't seem like it's a – it feels pretty normal for you at this particular point in time? Kemper Isely - Chairman & Co-President: I'd say it's running about the same as it was last year at this time. Sean P. Naughton - Piper Jaffray & Co (Broker): Okay. Great. And then just maybe asking a question on the competitive front. I know we've had your anniversarying or lapping some of the Trader Joe's impacts from last year. And there seems to be some stepped up price investments from a conventional player in your particular region. So just curious. There's a lot of discussions about it out there. Just wondering what you're seeing in terms of your pricing studies on how you are on like items compared to some of the conventional guys at this particular point in time? Kemper Isely - Chairman & Co-President: I would say that the conventional grocers and retailers have definitely decided to make natural and organic a focus and have decided to invest in pricing in this sector. And so they have become very competitive in pricing. It looks to us from our studies that they're about where they were last year. So I don't think they've stepped it up any more than they have last year. They have stepped up their marketing campaign. And so that has made the awareness of what they're doing more. But the price differential between us and them hasn't really changed from last year to this year. Sean P. Naughton - Piper Jaffray & Co (Broker): Okay. And so you feel pretty good about your pricing at this point in time? Kemper Isely - Chairman & Co-President: Yeah. We're pretty happy with it. We're not going to match every price that the conventional people come out with, because it isn't a profitable situation for us. I mean King Soopers in this area is selling bananas at $0.69, and we're just not going to match that price. Our customers know that we sell only organic bananas, and they're happy paying a few cents more for that organic banana at our store, rather than going to King Soopers and saving $0.06 or $0.10 a pound. Sean P. Naughton - Piper Jaffray & Co (Broker): Understood. Okay. Best of luck in the quarter. Take care. Kemper Isely - Chairman & Co-President: Thanks.

The next question comes from Mark Miller with William Blair. Please go ahead. Mark R. Miller - William Blair & Co. LLC: Hi. Good afternoon. Looks like I'll be the one to ask the question about Whole Foods announcement of its new format underway. I guess if you'd be willing to share your general thoughts? And specifically as you addressed your team this morning, I'd be interested to know what you said to them, along the following that we need to be excellent at what? Kemper Isely - Chairman & Co-President: At what we do. I mean we are based on our five founding principles, and that's what we'll keep focused on. That's what we've kept focused on. That's what our focus has been for 60 years and what has allowed us to stay in business for 60 years. And so by staying focused on providing everyday affordable pricing, the highest standards in the industry on products, nutrition education, supporting our staff and supporting our communities, we believe that we should keep focused on those and keep focusing on operational excellence that we'll be able to stay in business for another 60 years and thrive as we have for the last 60 years, particularly for the last 15 years to 17 years, since we took over the operation of the company. Mark R. Miller - William Blair & Co. LLC: All right. Well we'll obviously have to see what this all entails, but basically you feel that just executing your existing game plan, that's all you need to focus on? Kemper Isely - Chairman & Co-President: I mean if you're going back to Whole Foods, I think that they should focus on what they do best also, because I think that trying to create two things and do them well, could be difficult for anybody. Mark R. Miller - William Blair & Co. LLC: Understood. Let me shift to some of the numbers in the quarter. The productivity of the new stores looks to be good. Could you help us with the new store dailies (18:36)? I mean on your internal computations, how did the new store productivity come in? I think you said stores are doing well. But was it in line or was it a little bit better? Kemper Isely - Chairman & Co-President: It was a little bit better than expected. Mark R. Miller - William Blair & Co. LLC: Okay. And then on the store incentive compensation, twice that of last year, 50% of the max target, Kemper or Sandra, could you -- would you be willing to elaborate on the areas that you had more incentive comp but also the areas that you didn't quite reach your goals? Thanks – or the highest goals, I should say. Kemper Isely - Chairman & Co-President: Well, we have particular numbers that are set and if we don't hit those particular numbers then the incentive comp is reduced. So that is – not all of our goals were met. And so the incentive comp, we'll pay out at about half of what a maximum payout would be. Mark R. Miller - William Blair & Co. LLC: Okay. I am going to throw in one more. It appears the business did decelerate a little bit in the quarter or that's my perception. I guess, would you be able to give perspective on the cadence through the period? Thanks. Kemper Isely - Chairman & Co-President: I would say as the quarter went along that the comp sales decelerated a little bit. And as I said to David, at the beginning of the call, I think that the overall economy has had somewhat of a drag on sales towards – particularly in March, particularly in some of our regions because of – it seems like in April we came back somewhat. Mark R. Miller - William Blair & Co. LLC: All right. Thanks, Kemper.

The next question comes from Mark Sigal with Canaccord Genuity. Please go ahead.

Yeah. Hi. Good afternoon. I wanted to touch a bit more on the comp. If I recall correctly, Q1 December was your strongest comp quarter approaching the upper end of the full year guidance range. So it appears that the comp deceleration was fairly abrupt. One, would you categorize that as accurate, and two, is there anything else you can comment on the deceleration beyond the kind of macroeconomic sensitivity? Was there anything abnormal in terms of competitive pricing? I mean, it's a bit of paradoxical dynamic. I think your competitive overlap was supposed to be about half of what it had been around peak. So just curious to get kind of more color around the comp deceleration? Kemper Isely - Chairman & Co-President: Well, as I said, we really attribute the issue primarily to the macroeconomic condition. So I don't believe that it has a lot to do with competitive situations. As I told to Sean, the King Soopers in this area spent a lot of money advertising natural but we're in a lot of other markets without them and so we had similar situations in most of the other markets that we had in the Colorado area. So I don't think it was a competitive thing. I think it was more of an economic thing.

Okay. And then it looks as though the average ticket decelerated more rapidly on a sequential basis than the transaction count. So are you comfortable with your pricing versus competitors? I know, you carry a heritage of low kind of value everyday pricing, but given that you've been building on product gross margin quite nicely, I'm wondering if there's any appetite for any adjustments on the pricing side. Kemper Isely - Chairman & Co-President: We're pretty happy with where we are specifically price wise with our competitors. As far as average ticket goes, we were up slightly from quarter one and so we're pretty happy with that also. And we're actually pretty happy with most of our comp store gain was in customer count, which is important to us. We think that, as we roll out our {N}power Loyalty Program over the next two quarters that that will be very beneficial to average ticket. And so we're looking forward to that.

Okay. And then just, lastly, could be fairly difficult to quantify, but can you talk about the potential impact on the comp that the full rollout the extended store hours may have had? Kemper Isely - Chairman & Co-President: We are still analyzing that and so we don't really have a good answer for that question. We are looking at – from appearances it had a real nice impact on comp. But we need to look at how much it cannibalized sales from the previous hours and we haven't quite finished that study yet.

Understood. Okay. Thank you.

The next question comes from Joe Edelstein with Stephens, Inc. Please go ahead.

Hi, good afternoon. Thanks for taking the question. Kemper Isely - Chairman & Co-President: Thanks for asking it Joe.

Kemper, you mentioned the regional performance. I was just curious how big of a spread did you see really across the store base. I imagine that the stores in Texas perhaps softened a bit more than some other regions, but I was hoping you could just give us a little more color there please? Kemper Isely - Chairman & Co-President: We definitely saw a deacceleration in Texas in the (25:11) quarter. Colorado is pretty big into the energy business also and so is Wyoming. But I mean it was – there was definitely some deacceleration across most regions. Not all of them though had deacceleration.

Okay. And if I could just go back to kind of the original guidance for the year and just the trends I guess that you put up to date, I just want to make sure I fully understand, be clear here. The guidance originally assumed that you'd have 100% accrual of that incentive comp, but at this point you're just running roughly 50%, at least that's what you did in the second quarter. Is that correct? Kemper Isely - Chairman & Co-President: Yes.

Okay. Thanks. And good luck for the rest of the year. Kemper Isely - Chairman & Co-President: Thanks.

The next question comes from Mitch Pinheiro with Imperial Capital. Please go ahead.

Yeah. Hi good afternoon. Kemper Isely - Chairman & Co-President: Good afternoon, Mitch.

Hey and not to belabor the macroeconomic sort of issues, but are you basically saying, I mean it's an energy related sort of headwind for you? Is that what we see? Or is there more than that? Is there anything else that you can attribute it to? Kemper Isely - Chairman & Co-President: That's what we're seeing. I am not the Federal Reserve economist, but that is what we're seeing. I mean that's all I can – I've been reading a lot about it, and that's where I'm seeing it.

Okay. Fair enough. And then when I look at your stores and prepared foods, would you ever – is prepared foods going to remain sort of at the same level that you have? Or would you ever consider a greater emphasis on that? Kemper Isely - Chairman & Co-President: That's a step – I'm glad you asked that question. Right now we're in the process of rolling out a thing called Grab & Go at our stores. And what we'll be doing is we'll be producing salads, sandwiches, wraps, et cetera, on a daily basis at some of our stores as an experiment to see how that goes and see if that is a successful implementation.

Are you doing that in a number of markets? Or is it concentrated in any market right now, the test? Kemper Isely - Chairman & Co-President: The test is concentrated in some of our Arizona stores.

Okay. And I missed the very beginning of the call. I was wondering did you see any impact on gross margin from produce pricing early in the quarter? Kemper Isely - Chairman & Co-President: No. Produce was very consistent in contribution as it normally is.

Okay. All right. That's all for me. Thank you very much. Kemper Isely - Chairman & Co-President: All right. Thank you.

The next question comes from Rupesh Parikh with Oppenheimer. Please go ahead. Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker): Thanks for taking my question. So I just wanted to dive a little deeper into your gross margin performance. So it was a better performance this quarter, so I just wanted to understand what the drivers of the improvement were sequentially? Kemper Isely - Chairman & Co-President: Well primarily we had a really nice shift into our Body Care Department, and that helped margin quite a bit. And then just in general making sure we have a focus at our stores of trying to sell products that have – we've got them on a focus of selling products that have a little bit better margin. And so I think that has been helping to drive gross margin a little bit. Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker): So was the product margin increase greater than what you saw last quarter? Kemper Isely - Chairman & Co-President: Sandra, do you have the answer to that?

We saw increases in product margin that was pretty similar quarter-over-quarter. Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker): Okay. Okay. And then just switching topics on some notes to some of your new stores. In terms of some of your newer markets like Nevada, how is the performance of the stores performing thus far versus your expectations? And are there any differences that you're seeing? Kemper Isely - Chairman & Co-President: Our new stores that opened since the beginning of this year have done very well. Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker): And within some of those newer markets, are you seeing differences in terms of your consumer purchasing or behavior? Kemper Isely - Chairman & Co-President: I wouldn't say that we are seeing a lot of difference in how our new stores open. But I would say that they are performing at a higher productivity than – at a better – at a higher productive rate than we have seen in the past. Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker): Okay. Thank you.

The next question comes from Bill Kirk with RBC Capital Markets. Please go ahead.

Thank you for taking the question. In the quarter, administrative expenses were a little lower than I would have thought. Does that start to ramp up next quarter when the website design and those types of things maybe come into their line item? Kemper Isely - Chairman & Co-President: The website design has already come in to that line item. We are filling some key corporate positions so over the next couple of quarters; we could have a little bit of a ramp up in administrative expense because of that.

Okay. Thank you. And then kind of back on Whole Foods, in addition to their kind of new format concept that they announced yesterday, they mentioned store refreshes in the Colorado market. Is that something you'd characterize as less concerning or more concerning than the new store concept that they also announced? Kemper Isely - Chairman & Co-President: I think, they refreshed their Boulder store couple of years ago, and it helped our Boulder store substantially when they did that. So I would say that when they do the refreshing, it's always good for our business also.

Okay. That's very useful. That's all I have. Thank you. Kemper Isely - Chairman & Co-President: All right. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Kemper – I can't read my own writing. Kemper Isely - Chairman & Co-President: Isely.

Isely. My writing is terrible today. I apologize and sorry, Isely. Any closing remarks today? Kemper Isely - Chairman & Co-President: Thanks, everybody for being on the call. I hope you have a great rest of your afternoon. Goodbye.