Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q4 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, welcome to the Natural Grocers' Fourth Quarter and 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 Fourth Quarter and 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 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 excited to report a solid finish to fiscal 2019, celebrating over 16 consecutive years of positive daily average comparable sales growth, with comps up 1.8% for the fourth quarter and up 3.1% for fiscal 2019. We continue to expand our store base as well as relocate existing stores to drive market share and enter new markets.Our balance of investing in growth and operational excellence is driving both revenue and expense efficiencies, which contributed to 6.4% revenue growth and 11.4% operating income growth during fiscal 2019. During the year, we were able to moderate the pressure on gross margin we saw during the prior year, while driving growth and leveraging store expenses. Today, we announced the initiation of our first quarterly dividend of $0.07 per share. This announcement reflects our continued growth, profit performance and confidence in our business, along with our strong financial position and cash flow. We are also pleased to announce the amendment and extension of our $50 million credit facility.During the year, we were proud to launch 47 new Natural Grocers brand products, in line with our projections. Our private brand products have been developed consistent with our core values and are positioned as a premium quality brand at an affordable price. We remain encouraged by the customer response to date, and we'll continue to expand our Natural Grocers brand offerings. Targeting the launch of an additional 70 products in fiscal 2020. We believe that Natural Grocers brand has significant long-term potential, and we plan to continue to focus on its growth and expansion.We are also identifying key new product categories that resonate with our consumers to drive sales. A recent example is the addition of Hemp-Derived CBD products across the majority of our stores during fiscal 2019, which have been very well received. We have worked diligently to source high-quality products produced by trusted suppliers and in GMP Certified facilities.Now I would like to review a few of the marketing accomplishments from 2019. Our initiatives have focused on our differentiation and contributed to our comparable store sales gains. We enjoyed a very successful 64th anniversary promotion in August, accounting for the highest sales day in the company's history. We were also proud to have participated for the third consecutive year in Organic Harvest Month. As America's organic headquarters, we raised over $100,000 for the Organic Farmers Association in September.In August, we celebrated our 1 millionth {N}power member, which we promoted through {N}power million member sweepstakes. By the end of the year, we increased total {N}power enrollment 39% over the end of fiscal 2018. {N}power sales now represent 67% of our total sales and penetration continues to expand. We believe the program is driving loyalty and providing incremental opportunities to market to and connect with our customers. Through this platform, we are able to e-mail personalized offers as well as coupons, recipes and other promotions, further enhancing the customer experience.As I have noted before, {N}power 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.Additionally, we continue to invest in brand awareness. Our paid media impressions in the fourth quarter were at an all-time high. As we mentioned on our last call, we are also investing in technology with system-wide software updates to increase network stability, enhanced integration to other software platforms and more effectively leverage data. In addition, we are upgrading network circuits to improve network speed and stability, create additional redundancy to drive operational efficiencies and enhance performance and customer experience.We will continue to emphasize the in-store customer experience to drive sales and build customer loyalty by making our customers feel welcomed and valued through world-class customer service. For example, we are investing in crew and leadership training, closely managing our out-of-stock inventory, curating and refining our assortment and have rolled out a new look to our produce department, including new racking that significantly improves presentation.We are carefully managing our delivery business to ensure we are not jeopardizing our in-store customer experience as some of our competitors are experiencing. We will not have our stores overwhelmed by online delivery teams.I would like to take a moment to comment on National Grocers' history regarding environment, social and governance initiatives, which, we are pleased, are finally becoming an increasing focus of investors. From the very origins of the company, we have always been cognizant that the choices we make today will impact our future, and we should positively benefit the health and well-being of our communities.At Natural Grocers, our choice is to make a difference to support human health, the healthy environment as well as our financial health. Our entire supply chain has always been built upon the goals of choosing vendors, products and practices that support these principles. We select products that are conscientiously produced and nurture the health of people and the planet we all share.Let me highlight a few examples of Natural Grocers alignment with ESG principles and values. Recently, we launched our new Produce Bag program to reduce the number of single-use plastic bags.In September, we added recyclable and compostable paper bags made from 100% recycled content. We will completely eliminate single-use plastic bags in our produce department over the next 3 to 6 months and replace them with plant-based bio bags that are certified non-GMO and compostable, which will be in addition to continuing to offer compostable paper bags.We support our communities in numerous ways. Our nutritional health coaches provide free science-based education, both in our stores and through community outreach.We have donated over $1 million to local food banks since we eliminated single-use plastic bags from checkout lanes in 2009 and began contributing $0.05 every time a customer shops with a reusable bag.In 2019, we raised over $18,000 on Earth Day from our Ladybug Love bag sales donations. And as already mentioned, we raised over $100,000 for the Organic farmers Association this year. We estimate that our bag-free checkout practice has saved an estimated $350 million single-use plastic bags from ending up in our planet soils and waterways. We have expanded our offering of 100% humanely and conscientiously raised meats and sustainable seafood. We support organic and regenerative agriculture practices, as evidenced in our 100% organic produce, 100% non-GMO bulk products, 100% pasture-based dairy and 100% free range of eggs and a wide variety of organic products that nurture the health of people in our planet.All of our supplements are GMP Certified with certificates of analysis required for authenticity of ingredients. We maintain a list of what we won't carry ingredients. Many of the supplements found on the Internet and that other retailers contain ingredients we will not carry or have not gone through, an extensive review process. Our suppliers are thoroughly vetted, and we carefully select all of our products, consider every ingredient the way the food has grown, fair trade and organic practices. Our objective is to offer only the best products to our customers. We are excited to be recognized by Consumer Reports as one of America's best grocery stores for healthy eating and cleanest grocery stores during 2019.Finally, diversity has always been important to us. We are proud to be recognized by 2020 Women on Board for having women comprised 29% of our Board of Directors. In addition, women currently account for over 50% of our upper level management positions. We continue to hold to these principles as the foundations of Natural Grocers, reflecting our commitment to all of our constituents.With that, let me turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon, everyone. We are pleased with our performance in fiscal 2019, driving both growth and improved profit performance in a competitive environment. Our emphasis on balancing our growth investments and a focus on operational excellence contributed to our improved profit and cash flow performance. The initiation of a quarterly dividend is a reflection of our performance, financial position, confidence in our future and is consistent with our goal of further improving shareholder value. During the fourth quarter, net sales increased 4.5% to $227 million. Daily average comp store sales increased 1.8%, and mature store comp increased 1.2%. The comp increase was driven by a 1.8% increase in average transaction size and daily average transaction count consistent with the fourth quarter of last year. While transaction count was flat year-over-year, the 2-year stack growth rate was 3.8%. We continue to face a competitive environment during the fourth quarter. However, the environment remained relatively stable, and our focus has been consistent. In that we believe we have a powerful differentiation story to tell.Additionally, inflation remained low at about 1%, and we experienced stable pricing and supply during the fourth quarter. Gross profit margin during the fourth quarter was 26.0% compared to 26.3% in the prior year. Gross margin during the fourth quarter primarily reflected lower product margin attributable to a shift in the sales mix toward lower-margin product categories. We continue to focus our primary promotional offers on grocery items, which generally carry lower gross margins than supplements and body care. Promoting grocery items has proven to be an effective method of highlighting Natural Grocers, higher-quality standards and affordable prices. However, we are working on a number of initiatives in fiscal 2020 to drive supplement and body care sales in order to mitigate the pressure on gross margin.Store expenses as a percentage of sales decreased to 22.0% during the fourth quarter compared to 22.1% in the prior year period. The decrease in store expenses was primarily driven by decreases in labor-related expenses, marketing expenses and depreciation, all as a percentage of sales. Throughout 2019, we have been able to address labor and wage pressures while still realizing 10 basis points of leverage in the fourth quarter and the fiscal year. At the store level, we have been implementing initiatives to reduce, shrink, manage our out-of-stock items and optimize inventory levels. We have also made investments in our core IT systems and infrastructure, which should also contribute to store efficiencies in the years to come.Preopening and relocation expenses decreased approximately $270,000 year-over-year, impacted by the timing of new store openings and store relocations. During the quarter, we opened 1 store and relocated 1 store, consistent with the fourth quarter of fiscal 2018.One additional store, which was originally anticipated to open late in the fourth quarter was opened early in the first quarter of 2020. This is our first store in Louisiana. We expect 1 additional store opening in the first quarter of fiscal 2020. Net income was $1.4 million with diluted earnings per share of $0.06 in the fourth quarter compared to net income of $2.1 million or $0.09 of diluted earnings per share in the fourth quarter of last year.Adjusted EBITDA was $10.3 million in the fourth quarter, down 8.4% compared to $11.3 million in the fourth quarter of fiscal 2018. During fiscal 2019, we generated cash from operations of $37.4 million and invested $31.9 million in net capital expenditures. These capital expenditures included the purchase of the property for 3 store locations. As Kemper mentioned, we have announced the declaration of a quarterly cash dividend of $0.07 per share. The dividend will be paid on December 17, 2019, to all stockholders of record at the close of business on December 2, 2019. We have also extended our $50 million credit facility, which extends the maturity date 5 years to November 13, 2024.In conjunction with the extension, the credit agreement was amended to provide the company with the flexibility to pay dividends as well as other improved terms. Now I would like to review our outlook for the upcoming year. First, please note that our 2020 outlook factors in the impact of the new lease accounting standard, which went into effect for us on October 1, given our September fiscal year-end.The leasing change is expected to have a $0.01 to $0.02 negative impact on our diluted earnings per share as a result of an increase in occupancy expense and depreciation, which will be partially offset by lower interest expense. This shift in the classification of expenses will also negatively impact gross margin by 20 to 25 basis points and result in a $2 million to $2.5 million negative impact to EBITDA. During fiscal 2020, we expect to open 5 to 6 new stores, relocate 1 to 2 stores, achieve daily average comparable store sales growth of 0.5% to 2.5%, achieve net income margin of 0.9% to 1.1%, achieve diluted earnings per share between $0.37 and $0.45, and we expect capital expenditures for the fiscal year in the range of $28 million to $33 million.Our guidance reflects the lease accounting change I just noted as well as our expectation that daily average comparable store sales will continue in a range relatively consistent with the fourth quarter 2019 trend. We anticipate continued moderate pressure on gross margin similar to the level we encountered during fiscal 2019, attributed to the continued impact of an unfavorable shift in mix. While we have several initiatives to drive supplement and body care sales, we anticipate slightly stronger comp growth in grocery than in supplement and body care. The gross margin pressure should be partially offset by an expectation for modest store expense leverage, depending upon the level of comps generated.In closing, we are pleased that in 2019 we continued to deliver sales, operating income and adjusted EBITDA growth and strong net income growth, excluding the noncash benefit of the tax reform act in the prior year. We remain focused on driving performance and communicating our differentiation through leveraging our founding principles, which include offering our customers the highest quality products at affordable prices while providing science-based nutrition education and maintaining our commitment to our communities and our good4u crew.We are committed to empowering our customers to take charge of their health while enhancing profitability and delivering value to our shareholders.With that, I would like to open the lines up for questions. Thank you.

[Operator Instructions]. And our first question comes from Greg Badishkanian of Citigroup.

This is actually Abigail Lake on for Greg. So comps accelerated 50 basis points sequentially this quarter on a two year stack basis. Could you give us some color on what's driving this? And then it looks like next quarter you're expecting a deceleration in comps, given the easier compares you're lapping after the first quarter. Could you give us a little more color on what you're expecting there?

Well, I would say that in the quarter, on a two year basis, we did better. But on -- and on a quarterly basis we were about the same as in the third quarter. So I think that will -- we're expecting to have a similar comp for this quarter. And then we go up against easier comp on a 2-year basis starting in the second quarter of next year. And so hopefully, we'll be able to accelerate our comp growth when we are up against the easier comp amounts in the second quarter of this year.

Okay. Great. And then it looks like you're anticipating a pretty wide range on EPS for 2020 from $0.37 to $0.45. Could you help us bridge the gap between the high and low end of that range?

Sure. Thanks for the question. So on the high end, we're anticipating comps to run similar to Q4 of 2019 or slightly better. And then margin, year-over-year pressure decline would be similar to what we experienced for the full fiscal year in 2019, plus we'll have some negative pressure impact from the lease accounting, which will be about 20 to 25 basis points on gross margin. And then the pressure there is coming from the continuation of the shift in mix as we continue to promote grocery and see higher comp in grocery. And we're anticipating some benefit from supplement and body care sales initiatives. And then store expenses would have leverage comparable to what we realized in 2019. And then on the low end, we would anticipate comps similar to Q4 of 2019 or slightly below. And gross margin on a year-over-year change would be in line with the change that we experienced in Q4 2019, and then, of course, plus the lease accounting impact. And the driver there would be the mix. And then no favorable impact from supplements and body care initiatives. And then store expenses would probably be flat to slight deleverage. And that would be driven by wage pressures and the lower sales volume.

Okay. Great. If I could sneak in one more. So what would you expect for the cadence of the new units next year? And then what kind of return are you targeting for these stores? And how would we expect to accelerate that return further?

Well, in the first quarter of the year we will have -- we will open 2 new units. And then I think in the second quarter, we're scheduled for 2 of them. Yes, 2 in the second quarter. And in the...

I think it's one and one.

And then we have 1 and 1 scheduled for the following 2 quarters. And as far as -- what was -- I don't remember the question.

Our return.

Yes. I'll let you answer that, Todd.

So historically, our return objective has been to realize a cash-on-cash return in the fifth year of 30%. And given the recent -- or the competitive environment over the last couple of years, we're seeing that extend out to the sixth year. So that's our return objective.

Our next question comes from Shawn Collins [ph] of Citigroup Research.

Kemper and Todd, I wanted to ask a question on the cost side. I wanted to ask on your cost of goods. What product areas and categories stand out to you that you're seeing more inflationary type trends, and also deflationary like trends around products and categories, please?

I would say that this year things have been pretty stable as far as inflation goes, particularly on the commodity side. I mean last year we saw quite a lowering in the price on commodities. But this year it's been pretty flat so far. As far as price pressures, there seems to be some price pressure. There's always a lot of fluctuations in produce depending on the growing season. Right now there's a lot of price pressure on lettuce. Price of lettuce has kind of gone up a lot and the same with the price of broccoli. So in produce, we're seeing some price inflation right now. But it'll probably moderate once the growing season switches from Central California down to the desert areas of Arizona and Mexico. And then we've seen avocado prices stabilize. Finally, they went way up in the summertime, and now they're back down to a more reasonable level. And then like I said, the commodities in the bulk area have been pretty flat to just a little bit down this year. And then we haven't seen -- in the food area, we really haven't seen a whole lot of inflation this year so far and with supplement, other than normal like 2% to 3% price increases.

Okay. That's great. That's very helpful color. I appreciate it. Just a second question, if I could. On your private label business. I know that you launched 50 products in 2019. And I think you said you are looking to launch about 70 products in 2020. Can you just talk about some -- I guess when you look back at last year, I know it's only about a year, but can you talk about which products and categories you had some success with? And then can you talk about the 70 products that you're launching in 2020? Where you're focused? Which products and categories you're focused on, please?

Yes. Sure. In this past year, I would say that our biggest success was probably the launch of our chocolate line. And then we also launched a coffee line, both of those were well received over the last year. I mean of the previous -- of the original products we launched, the beans have been our best success so far. As far as what we're looking at in 2020, we're going to have a new paper line and a laundry line. Household products, I think, would be really successful coming up this year. And then we have a new bottled water line that's going to be in aluminum cans, which I think will be very successful during the coming year. Like Italian pizzas that are coming out, and a variety of products that I think will drive the success of the line over the year.

Great. That's helpful color and context. One last question, if I could. You talked about the sale of CBD and hemp-type products, or I guess, cannabis. That's a fairly growing and robust and widely -- a lot of attention around it. It's fairly new for us here at Citigroup. Could you just put a little bit more color and context around its size, scope and the nature of the business? And I guess some of the successes you've seen there and also some of the execution challenges that you might have seen there, please?

Yes. I mean right now it's in 117 of our stores. And so there are some states that are difficult regulatory-wise in selling it. And so we aren't able to sell it in some of the states that we're in. But in the stores that -- in the states that we're in, we're having really good sales growth. I think from the first quarter to the -- we introduced it in January of 2019 -- the January quarter of 2019 into the -- and I think the sales doubled from that quarter to the fourth quarter of the year. And one of the things that we're really focused on are standards around CBD. We require that we get testing on -- from each company that we dealt to make sure that it really has CBD in it and that it also doesn't contain too much THC, so that we don't run into other regulatory problems.

This concludes our question-and-answer session. I would like to turn the conference back over to Kemper Isely for any closing remarks.

Thank you very much for joining us to discuss our fourth quarter results. We hope you enjoy the upcoming holiday season, and we look forward to speaking with you on our next call to review our first quarter 2020 results. Have a great day. Thanks, everybody. Bye.

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