Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q3 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Natural Grocers' Third Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. I'd now like to turn the conference over to Mr. David Colson, Vice President and Treasurer for Natural Grocers. Mr. Colson, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage Third Quarter Fiscal Year 2019 Earnings Conference Call. On the call with me today are Kemper Isely, Co-President; and Todd Dissinger, Chief Financial Officer. As a reminder, all statements made on this conference call, other than statements of historical fact 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. 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, David, and good afternoon, everyone. We are pleased with our third quarter results as we continue to execute our marketing and operational excellence strategies while maintaining focus on our founding principles. These principles drive every aspect of our business, differentiate us from the competition and are the driver of our sustained comp momentum. We remain focused on delivering the highest quality standards, always affordable prices, nutrition education and commitment to our communities and our good4u crew. Third quarter results were highlighted by a 2.4% comp increase and 5.3% net sales growth of $224.4 million. As a result of our year-to-date performance and our expectations for the fourth quarter, we are increasing the midpoint of our expected diluted earnings per share guidance range, as Todd will discuss. We have now posted 9 consecutive quarters of comparable store sales growth, which is a reflection of our favorable positioning in the market and the continued growth of natural and organic foods, and nutritional supplements. It also reflects the initiatives we have implemented over the last several years to drive sales, effectively communicate Natural Grocers' differentiation, build customer loyalty, deliver both unrivaled quality and value to our customers and improve operational efficiencies. On the marketing front, we are working to increase brand reach and presence by tracking and analyzing total impressions across our advertising channels, allowing us to gain insight into what's most important and relevant to our customers, and to optimize the effectiveness and efficiency of our marketing efforts. Even in our mature markets, we believe there is an opportunity to reach new consumers as well as further penetrate our share of voice with existing customers. In May, we announced a strategic partnership with Alterra Mountain Company, becoming the official grocer for both the Steamboat Springs and Winter Park resorts, expanding our reach to 3 million annual resort visitors. Additionally, during the third quarter, we have executed successful events on Earth Day, Mother's Day and Father's Day. We continue to build loyalty through expanding and leveraging our Npower loyalty program. Npower membership increased to 950,000 members in the third quarter, up 45% over the third quarter of 2018. Npower members now represent 65% of our total sales and penetration continues to grow. Npower customers shop more frequently and generate a higher average basket size in the mid-$40 range compared to the total company average basket in the mid-$30 range. We have the ability to reach these customers through a cloud-based platform that manages their rewards and coupons and regularly sends marketing offers and recipes via e-mail. In June, we launched a new e-mail program to generate personalized offers to our Npower members based on each customer's historical purchases. Finally, we are excited that this summer, we will celebrate our 1 millionth Npower member through a sweepstakes that we believe will drive further enrollment. We are also building loyalty as well as enhancing margins through the continued expansion of our Natural Grocers brand product offerings. The goal is to offer a premium brand that is equal to or higher-end quality than the branded offerings in each category and at always affordable prices. Our Natural Grocers brand product was historically focused on both categories but is now successfully expanded into the grocery category over the last 2 years. Adoption of Natural Grocers brand products has been strong, with category penetration of 25% or higher in most of the initial categories launched. We are encouraged by the response to date and look forward to Natural Grocers brand products that are in the pipeline for rollout in the coming year. On the operational side, we are investing in training to enhance the customer experience and focus on efficiency and store productivity. We are working to reduce shrink loss, manage margins at a department level and increase labor efficiencies as well as continuing to reduce average inventory per store. We're investing in technology with system-wide software updates to increase network stability and enhanced integration to other software platforms. In addition, we are upgrading network circuits to enhance network speed, stability and creating additional redundancy to drive operational efficiencies. Finally, we are proud that we have been recognized by consumer reports as one of America's best grocery stores for healthy eating and cleanest grocery stores. With that, let me turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon, everyone. During the third quarter of fiscal 2019, net sales increased by 5.3% to $224.4 million, with daily average comp store sales growth of 2.4% and a mature store comp increase of 1.7%. The comp increase was driven by a 3.0% increase in average transaction size, slightly offset by a 0.6% decrease in daily average transaction count. While transaction count was lower year-over-year, we compared to a 4% growth rate of transactions in the third quarter of 2018, leading to a 3.4% transaction growth rate on a two-year stacked basis. The environment remains competitive, but relatively stable, both in terms of new competitor openings and relative pricing. As you know, we regularly perform price studies across product lines to ensure we maintain our competitive, always affordable prices. Further, on the supply front, we continue to see fairly stable prices, experiencing modest inflation of about 1% and ample supply of our key product categories. High-quality and premium products, such as organic, are generally less commoditized, and thus, less volatile in terms of inflation. During the third quarter, we relocated 2 stores and did not have any new store openings. So far, in the fourth quarter, we have relocated 1 store, and we anticipate 2 new store openings during the remainder of the fourth quarter. In total, we currently have signed leases for 6 additional new stores and have acquired the land and building for 2 more new stores, which we plan to open in 2019 and beyond. We continue to monitor new store performance and remain comfortable with our targeted store openings. There are plenty of growth opportunities in our targeted regions for the next several years, and our smaller store footprint provides the flexibility to succeed in both large and small markets. Recall that we moderated new store growth beginning in 2018, allowing us to increase our focus on operational efficiencies within our existing store portfolio in order to enhance profitability. This focus should help us continue to improve our store expense ratio and drive store-level efficiencies. We have also made numerous investments in our core IT systems and infrastructure, which should also contribute to store efficiency in the years to come. Gross profit margin during the third quarter was 26.0% compared to 26.7% in the prior year. Gross margin during the third quarter reflected lower product margin, attributable to a shift in sales mix towards lower-margin product categories. We continue to focus our primary promotional offers on grocery items as promoting grocery items has proven to be an effective method of highlighting Natural Grocers' higher quality standards and affordable prices. Additionally, gross margin was negatively impacted by an increase in occupancy cost as a percentage of sales, driven primarily by increases in common area maintenance expense. Store expenses as a percentage of sales decreased approximately 50 basis points to 21.6% during the third quarter compared to the prior year period. The decrease in store expenses as a percentage of sales was primarily driven by decreases in labor-related expenses and depreciation, both as a percentage of sales. Throughout 2019, we have been able to address labor and wage pressures while still realizing leverage on store expenses. Pre-opening and relocation expenses decreased approximately $230,000 year-over-year, reflecting the timing of new store openings and store relocations. Net income was $2 million, with diluted earnings per share of $0.09 in the third quarter of fiscal 2019, consistent with the third quarter of last year. EBITDA was $11 million in the third quarter of fiscal 2019, down a modest 0.5% compared to $11.1 million in the third quarter of fiscal 2018. During the first 9 months of fiscal 2019, we generated cash from operations of $28.3 million and invested $22 million in net capital expenditures. Now I would like to review our updated 2019 outlook, which reflects an increase in the midpoint of our expected diluted earnings per share range and a narrowing of our anticipated daily average comparable store sales growth range. During fiscal 2019, we expect to open 7 new stores, resulting in unit growth of 4.7%, relocate 5 stores; achieve daily average comparable store sales growth of 2.7% to 3.3%; achieve net income margin of 0.95% to 1%; achieve diluted earnings per share between $0.39 and $0.41; and we expect capital expenditures for fiscal 2019 in the range of $27 million to $30 million. We are pleased with our continued progress through 2019, and we are excited about our positioning going into the fourth quarter. We remain focused on working hard to achieve our objectives of driving traffic while enhancing profitability and delivering value to our shareholders, all while staying true to who we have always been. It is our founding principles that continue to drive our company into the future. Always striving to provide our customers with the highest quality products at affordable prices while providing science-based nutrition education and maintaining our commitment to our communities and our good-for-you crew. Now I would like to open the lines up for questions. Thank you.

[Operator Instructions] Our first question will come from Scott Mushkin of Wolfe Research.

So I guess, I wanted a couple of them. First, I wanted to talk about the labor and what's going on there. Obviously, with a 2.4% comp and levering that line, given what's going on with wage inflation. Just curious how sustainable that is? What are you doing to make that happen? And where do you think your leverage point is? Usually, most companies have been talking about the 3% comp is what they really need to do to start to leverage that line. I was wondering what you guys think your comp needed there is?

Well, I think that, as our stores mature, we're able -- we still have a lot of young stores, and so we're able to get a lot more labor efficiency out of the moment -- out of the stores as they mature. And so for the next couple of years, we probably should be able to either see leverage or at least stability in the percentage of sales that we pay in labor costs if we can maintain at least 2% to 2.5% comp.

All right. Then my second question -- no, I guess a little follow-up to that one is, and then I'll ask my other question is, what you're doing with labor to leverage it? It sounds like you got some active programs there besides just the maturation or maybe it's just a maturation. So that's a follow-up and then my other question is just -- we're into the fourth quarter. What are you thinking about next year? It sounded like maybe you'll accelerate store growth a little bit. How do we start framing 2020? Can you grow EBITDA? Like, if you can give us some thoughts -- initial thoughts on 2020, it would be great.

I think that we'll probably maintain a similar pace of store growth to what we have done this year. And also, we consider moving the stores similar to a new store that -- hopefully in the 10 stores of new and move stores next year. As far as EBITDA growth. If we're able to continue to have -- it is going to be kind of difficult to measure EBITDA growth next year because of the new accounting rules. So it's hard to say how exactly that's going to happen because of the new lease accounting rules. So that is a difficult one to measure. At this point in time, we're not able to exactly have a clear picture on how the new lease rules are going to affect our EBITDA. And then going back to your labor question. As I said, it's primarily being able to become more efficient because of our younger stores.

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Kemper Isely for closing remarks.

Thank you very much for joining us to discuss our third quarter results. We look forward to speaking with you on our next call to review our fourth quarter and full fiscal 2019 results. I hope you have the opportunity to visit one of our stores on August 15 to celebrate our 64th Anniversary. Have a great day. Thanks.

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