Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q3 2020 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Natural Grocers' Third Quarter Fiscal Year 2020 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 2020 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 website, and a recording of this call will be available on the Web site at investors.naturalgrocers.com. Now, I will turn the call over to Kemper.

Thank you, David, and good afternoon everyone. Thank you for taking the time to join us today. We hope you are all well and staying safe as we continue to navigate these unprecedented times together, and we appreciate your continued support. The entire Natural Grocers family has worked diligently to support our communities and customers by supplying the highest quality natural and organic products in a safe and convenient shopping environment. I'm extremely proud of the diligent work of our heroes in masks and aprons. We are successfully navigating these challenging times as we provide an invaluable service to all of our customers. The loyalty of our customers is a direct reflection of the entire organization's commitment to executing at the highest level in terms of safety, cleanliness, product availability, quality, and customer service. I'd like to walk through some of the highlights of the quarter and provide an update on how we are responding in Natural Grocers to the COVID-19 pandemic and related government mandates. I will then turn the call over to Todd to discuss our financial results in greater detail. During the third quarter, our strong sales trends continued with daily average comparable sales growth of 15.5%. We have seen consistently robust sales trends since late February as stay-at-home orders were implemented and food away-from-home offerings were limited in response to the onset of COVID-19 and government mandates. After the initial pantry loading period, which peaked in mid-March, our sales levels have continued at an elevated rate and remained relatively consistent throughout the third quarter. It is clear that consumers are reducing their frequency of shopping trips while purchasing higher volumes per visit. Our comp for the third quarter was driven by a 31.5% increase in basket size, partially offset by a 12.2% decrease in transaction count, reflecting customers' social distancing efforts. As the quarter progressed, average basket growth moderated from a 40.4% increase in April to a 31.6% increase in May, followed by a 23.3% increase in June, while average traffic declines improved from negative 17.9% to negative 10.8% to negative 7.8% by month for the same 3 respective months. We have seen these trends continue into July, with comps holding relatively stable with the prior three months. Reflecting the strong comparable store sales, we generated gross margin expansion of 130 basis points during the quarter. We also more than doubled net income and generated 32% EBITDA growth. We remain focused on delivering exceptional value to our consumers, which is more important now than ever, given the economic challenges facing many of our customers and communities. Part of our efforts to deliver value include our most recent marketing campaign focused on providing customers the ability to create a meal for a family of 4 using Natural Grocers products for under $12. We have seen an increase in our inflation rates of about 2% to 3% during the quarter, which is more modest than the industry overall. Now I'd like to walk through how we continue to support our good4u crew and communities we serve when they need us most. In March, we permanently increased wages by $1 per hour for all of our store hourly crew. We also increased our starting wages by $1 per hour for our store crew and have provided hero pay in the form of monthly bonuses. Collectively, all of these wage and bonus enhancements represented approximately $3.9 million and 82% of our third quarter net income. We remain focused on the safety of our good4u crew customers and continue to enhance our extensive in-store safety and cleaning measures. We are also committed to helping give back to our community during this time of great need. As part of our in-store efforts to commemorate the 50th anniversary of Earth Day in April, we donated over $50,000 in gift cards to local food banks. This donation was in addition to our ongoing daily donations to local food banks. Finally, I want to again thank each and every one of our crew who continue to help ensure that we are serving the communities that depend on us with the safest, most convenient shopping environment with the highest-quality natural and organic products at always affordable prices. With that, let me turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon, everyone. As Kemper discussed, we are working hard to provide the safest and most convenient shopping experience for our customers. We have adapted quickly to the dynamic landscape, and we are so proud of our crew who continue to work selflessly to support our customers and communities. During the third quarter, we saw strength across all product categories with above-average comp increases in grocery, including meat, dairy, frozen foods, produce and bulk. Conversely, we saw comps in supplements and body care normalized compared to the strong second quarter. We saw further penetration of the Natural Grocers brand products as we continued to expand our offering throughout the year. We have generally recovered from the initial supply and out-of-stock challenges we faced in the second quarter. We continue to work closely with our supply chain partners as they are still addressing elevated levels of demand. We anticipate ongoing out of stocks in certain items as our manufacturers prioritize their portfolio of products. Net sales during the third quarter increased 18.1% to $265.1 million. Daily average comp store sales increased 15.5% and mature store comp increased 12.5%. The third quarter comp increase was driven by a 31.5% increase in average transaction size, partially offset by a 12.2% decrease in daily average transaction count. Additionally, we continue to see an increase in online and delivery sales through our partner, Instacart. Gross profit margin during the third quarter was 27.3% compared to 26% in the prior year period. The increase in gross margin year-over-year was driven by an improvement in store occupancy expense as a percentage of sales, reflecting our strong daily average comparable store sales growth. In addition, we saw an improved product margin, which included higher margins across most product categories, partially offset by an unfavorable shift in sales mix. The occupancy leverage and product margin improvements were partially offset by the adoption of the new lease accounting standard, which negatively impacted gross margin by approximately 20 to 25 basis points. Store expenses as a percentage of sales increased to 22.1% during the third quarter compared to 21.6% in the prior year period. The year-over-year increase in store expenses as a percentage of sales was primarily driven by increases in labor-related expenses, partially offset by lower marketing expense. The increases in labor-related expenses reflect both higher wage rates and bonuses as well as higher cost of store operations attributable to the COVID-19 pandemic and government mandates. Pre-opening and relocation expenses increased approximately $100,000 year-over-year, impacted by the timing of new store openings and store relocations. During the quarter, we opened 2 new stores compared with opening no new stores and relocating 2 stores in the third quarter of fiscal 2019. Net income was $4.7 million with diluted earnings per share of $0.21 in the third quarter compared to net income of $2 million and $0.09 of diluted earnings per share in the third quarter of last year. EBITDA was $14.6 million in the third quarter, up 32.2% compared to $11 million in the third quarter of last year. During the first 9 months of fiscal 2020, we generated cash from operations of $61.5 million and invested $25.5 million in net capital expenditures, which resulted in free cash flow of $36 million. We finished the quarter in a strong liquidity position with $29.9 million in cash and cash equivalents and no debt. As of the quarter end, we had $48.7 million available under our $50 million credit facility. Our balance sheet and liquidity put us in a strong financial position as we move forward and face the challenges and uncertainties of the current macroeconomic environment. Today, we announced that our Board of Directors has declared a quarterly cash dividend of $0.07 per share. The dividend will be paid on September 15, 2020, to all stockholders of record at the close of business on August 31, 2020. Now I would like to discuss the company's fiscal 2020 outlook. We are updating our fiscal 2020 outlook to reflect current business trends in light of the rapidly evolving COVID-19 environment and government mandates. The company cannot predict the duration or the severity of the pandemic and government measures or how they will impact the economy and our financial results. Our guidance does not contemplate significant additional changes to the current operating environment. Specifically, during fiscal 2020, we expect to open 7 new stores, relocate 1 store, achieve daily average comparable store sales growth of 11% to 13%, achieve net income margin of 1.6% to 2%, achieve diluted earnings per share between $0.79 and $0.83, and we expect capital expenditures for the fiscal year in the range of $28 million to $31 million. The third quarter was our first full quarter of the pandemic, and our entire organization has been working tirelessly to deliver the highest quality products at always affordable prices. We continue to lead in providing a safe and convenient shopping environment with exceptional service. Lastly, we are excited to celebrate our 65th anniversary with a 3-day event, August 13 through August 15. We are taking all the necessary precautions to ensure the safety of our customers and our crew as we celebrate this milestone. I hope you can join us at one of our locations to help us mark 65 years of improving lives. With that, I would like to open up the lines for questions. Thank you.

[Operator Instructions] The first question today comes from Greg Badishkanian of Wolfe Research. Please go ahead.

Good afternoon. This is actually Spencer Hanus on for Greg. Congrats on another nice quarter here, guys.

Thank you.

Thank you.

My first question is just on gross margins. Can you just talk about the puts and takes to the improvement this quarter, and then we've heard from some of your competitors about stepping up promotions in June. Did you see any impact from that? And are you expecting promotions to tick up or tick down over the next few quarters?

I would say that promotions have moderated since the beginning of the government shutdowns, and they didn't really pick up in June. As far as future promotions go, we believe that our always affordable pricing strategy doesn't really necessitate having a lot of product on promotional pricing. We have started to promote meal deals at our stores where you can feed your family of four for under $10 or under $12 or under $16, and those seem to be resonating pretty well with customers. Todd, I'll let you answer the question about margin.

Sure. So as I mentioned earlier, we did see a shift in mix but we saw improvements -- an unfavorable shift in mix, and we saw improvements in the margin rate in just about all categories. So we were able to offset the larger sales in the grocery categories. Supplements were down relative to the second quarter, which is where we have a very strong margin, and we are seeing an improvement in supplements in June and into July.

That's helpful. And then can you just talk about the COVID-related costs that you guys incurred in the third quarter? And what proportion of those are you expecting to recur in future periods, and which portion of those are going to be more variable in nature and should go away?

Well, primarily, the COVID costs were wage-related. So I mean, we paid out essentially $3.9 million in additional compensation to our crew during the quarter, and as we have said in the past, we've had a $1 permanent increase in our starting wages and also to all of our good4u crew, and that adds up to about $7.2 million per year in additional wages that we'll be paying out ongoing. The other costs are minimal compared to that.

On the other costs, I think we probably have some puts and takes in terms of obviously, supplies are up but travel's down, those types of trade-offs, and we did have more hours over prior year.

Yes.

Okay. That's really helpful as well. And then I guess, on your guidance, it looks like the midpoint implies that EPS is going to be roughly flat next quarter. Can you talk about what is driving that?

Well, we're certainly anticipating higher levels of sales than our view back in May when we updated our outlook at that point in time. Certainly in Q4, we anticipate higher COVID-related and government mandate-related sales than we did a couple of months ago. We also expect that we'll probably see margin increases year-over-year, similar to what we experienced in Q3, and then we're dealing with the higher labor costs that Kemper just detailed. Those are the key drivers.

Got it. That's really helpful. Thanks, guys. Best of luck.

Thank you.

Thanks.

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 third quarter results. As Todd mentioned, we encourage you to join us at any of our locations to help us celebrate an amazing 65 years of serving our communities. We're having this event on -- starting on August 13, which would be my mother's 99th birthday, and a very bright future for us. We look forward to speaking with you on our next call to review our fourth quarter 2020 results. Please stay healthy and safe, and have a great day. Bye.

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