Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q3 2021 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the Natural Grocers Third Quarter Fiscal Year 2021 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. [Operator Instructions] I'd now like to turn the conference over to Ms. [ Jessica Teeson ], Assistant Treasurer for Natural Grocers. Ms. [ Teeson ], you may begin.

Good afternoon, and thank you for joining us for the Natural Grocers by Vitamin Cottage Third Quarter Fiscal Year 2021 Earnings Conference Call. On the line 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 website at investors.naturalgrocers.com. Now I will turn the call over to Kemper.

Thank you, Jessica, and good afternoon, everyone. Thank you for joining us today. We delivered another strong performance in the third quarter, exceeding our expectations. We saw sales trends improve sequentially, while continuing to face difficult year-over-year comparisons. Our focus on delivering the highest-quality natural and organic products at always affordable prices as well as being a resource for science-based nutritional education continues to drive high levels of engagement with our customers. First, I would like to highlight a few key performance metrics from the third quarter. Daily average comparable store sales for the third quarter were down 3.6% against a 15.5% increase in the third quarter of last year. On a 2-year stacked basis, daily average comparable store sales accelerated to 11.9% in the third quarter, up from 10% in the second quarter. On our second quarter earnings call, we noted that the transaction count comp had turned positive in April. Transaction count comp remained positive through the balance of the third quarter, creating a new inflection point with transaction count comp up 4.1% for the quarter, while basket size comp was down 7.4% as customers began to return to pre-pandemic patterns. The basket has remained elevated as compared to the pre-pandemic level, up over 20% compared to the third quarter of 2019. Operating income increased by 5.4% as compared to the third quarter of 2020, driven by lower store expenses and 40 basis points of gross margin expansion. And earnings per share of $0.22 was above our expectations and higher than the third quarter of last year. We were focused on several key initiatives in the third quarter, which contributed to our positive results. During the quarter, we were excited to open relocated stores in the communities of Pueblo, Colorado and Midland, Texas. Opening new stores and relocating stores has been challenging this year due to delays we are experiencing in the construction process and equipment deliveries. We intend to return to opening between 6 and 8 new stores per year as these conditions improve. The {N}power loyalty program remains an important tool for optimizing promotional activity and driving customer engagement. We ended the third quarter with over 1.4 million {N}power members, up 17% versus a year ago and up 4% sequentially. Our net sales penetration for {N}power was 71% in the third quarter compared to 68% a year ago and up slightly from the second quarter. During the third quarter, we continued to strengthen our portfolio of Natural Grocers brand products, a key point of differentiation versus our competitors. The relaunch of our private brand supplements that began in March grew in the third quarter to include a comprehensive range of over 115 vitamins, herbs, minerals and precision formulas. Our branded supplements are made from high-quality ingredients, are good manufacturing practices certified and affordably priced. Additional branded supplements are under development, and we expect to have approximately 150 SKUs at the completion of the initial rollout. We plan to further expand the number of SKUs over the coming years. In addition to supplements, we added 14 new products to our brand assortment, including jarred olives and vegetables and liquid dish soap. For the quarter, the sales penetration rate of our Natural Grocers brand products was 7.1%. We are also very excited to highlight our recent launch of GardenBox, which brings fresh, hydroponic, organic produce to the individual store location. We are piloting this program at our Green Mountain store in Lakewood, Colorado, starting with an assortment of lettuces priced at $1.99 per head. On the outside, the GardenBox looks like a regular shipping container. Inside, innovative technology controls every aspect of the growing process, including water, temperature, light and nutrients to optimize growth and nutrition. One of our core values is supporting our communities and good4u crew. During the quarter, we launched our National Grocers Heroes in Aprons Fund. This fund is a 501(c)(3) charitable entity, providing financial assistance to both our crew who experienced unanticipated hardships, and direct grants to Natural Grocers' charity partners in the community. We are excited and proud to have established a fund to oversee our legacy of providing support to our crew and communities. Finally, I would like to thank our good4u crew for their continued hard work and commitment. They are the key to delivering on our goals while staying true to our founding principles. With that, let me turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon, everyone. Our third quarter sales were in line with our expectations, reflecting the impact of our initiatives as well as strong store-level execution. Net sales of $258.6 million were down 2.4% from the prior year period. Daily average comparable store sales decreased 3.6% as we cycled a 15.5% increase in the third quarter of fiscal 2020. On a sequential basis, the third quarter improved from a negative 7% comp in the second quarter. Our supplements business continued its strong trend with a 6.2% comp in the third quarter, which represents an 11.2% comp on a 2-year stacked basis. Meat, dairy and bulk were the weakest performing categories in the third quarter as those categories cycled exceptional demand last year. It is worth noting that all of our major product categories had a strong performance on a 2-year stacked comp basis. Our grocery delivery sales as a percentage of net sales remained in the low single digits and were down slightly from previous quarters. The adoption rate and trend reflect the importance of our brick-and-mortar in-store experience to our customers as many of our core customers visit our stores multiple times per week. Inflation remained in the 2% to 3% range during the third quarter, which we continue to pass along via pricing. Transitioning now to expenses. We drove a 40 basis point improvement in gross margin during the third quarter. The increase was primarily driven by a higher product margin and lower shrink expense, partially offset by deleverage of occupancy expense. The strong supplement sales comp contributed to a favorable shift in product margin mix. On a 2-year stacked basis, gross margin increased 170 basis points. Store expenses were 22.1% of sales in the third quarter, flat on a relative basis to last year. Labor-related expenses normalized in the third quarter, consistent with the lower sales volume. On a sequential basis, compared to the second quarter, we leveraged store expenses by 40 basis points despite marginally lower net sales. Net income of $5 million or $0.22 per diluted share in the third quarter compared to net income of $4.7 million or $0.21 per diluted share in the prior year period. Lower store expenses and the gross margin improvement were the primary factors behind the increase in earnings per share. Third quarter EPS was ahead of our expectations. EBITDA was $14.5 million in the third quarter. During the first 9 months of fiscal 2021, we generated cash from operations of $31 million and invested $16.8 million in net capital expenditures. We relocated 2 stores in the third quarter, and the store count remained unchanged at 161, a net increase of 2 stores versus a year earlier. Our balance sheet remains strong with $14.5 million in cash, no outstanding borrowings under our $50 million revolving credit facility and a $24.1 million balance on our term loan. Our strong cash flow allowed us to accelerate the repayment of $10 million of principal on our $35 million term loan. Today, we announced that our Board of Directors has declared a quarterly cash dividend of $0.07 per common share. The dividend will be paid on September 15, 2021, to all stockholders of record at the close of business on August 30, 2021. Now turning to our outlook for fiscal 2021. We are updating our full year guidance range previously established on November 19, 2020, and raising our diluted earnings per share guidance based upon the third quarter results and our expectations for the fourth quarter. I would also like to note that our guidance reflects current trends in light of the evolving COVID-19 environment and related government mandates. The company cannot predict the duration or severity of the pandemic. We expect that these factors will continue to impact our operations and financial performance through the balance of the fiscal year. For fiscal 2021, we expect to open 3 new stores, relocate and remodel 4 to 5 stores, achieve daily average comparable store sales growth of between negative 1% and 1%, achieve diluted earnings per share between $0.68 and $0.74, and we expect capital expenditures for the fiscal year in the range of $28 million to $35 million. We are very proud of our performance in the third quarter in the face of an uncertain environment as the dynamics of the pandemic continue to evolve and as consumers return to pre-pandemic shopping habits. It is our unwavering commitment to our founding principles that sets us apart from the competition. As we close the year, we continue to strive to be the grocer of choice for the highest-quality natural and organic products at always affordable prices. Now I would like to open the lines up for questions. Thank you.

[Operator Instructions] The first question comes from Greg Badishkanian with Wolfe Research.

This is Spencer Hanus on for Greg. Nice quarter again. I just wanted to ask on gross margin. It was up 40 basis points this quarter. How sustainable do you think the higher margins are as we sort of get into a more normalized environment?

I think that we'll continue to have momentum with margin for at least probably the next year.

Okay. And then in terms of inflation, I think you mentioned 2% to 3% in the prepared remarks. Are you seeing any challenges with passing through those increases? And then as we look to 2022 and you start to get sort of price increases from your CPG partners, what do those look like? And how sticky do you think this higher inflation is?

I think the higher inflation is here for a while as far as the stickiness of it. We are -- essentially, we base our -- we sell our products at a margin. So when we get a price increase, we just increase the price based on our margin. And we've not had an issue with being able to pass along the majority of those price increases. I mean, there are some products that you have to be particularly price conscious of. But you can't -- but 95% or 99% of the products that we sell, we can.

That's helpful. And then although as you raised guidance, I think it still implies that EPS is going to be down in 4Q. Could you just talk about sort of what you're seeing quarter-to-date from the comp? And I guess, maybe gross margin perspective that sort of leads to -- led to not raising guidance, as you start raising EPS even more?

I would say that currently, the comp is -- I mean, the July comp was very close to 0. So we almost -- we're pretty -- I mean, we're slightly negative. But we've seen an improvement in comp in June and July compared to the rest of the other 2 months in that quarter. So we're predicting we should be somewhere in that range on comp for the rest of the quarter. As far as our guidance on -- was it on -- did you catch that part?

I think the second -- Spencer, the second part of your question had to do with a lower EPS for the fourth quarter. Is that correct?

Yes. Yes, the EPS guidance. So sort of what's driving that?

Yes. So we don't anticipate quite as high a margin in the fourth quarter as we experienced in the third quarter. At this point, also, we have some risk in terms of we have some major events in the fourth quarter. And until we've gone through those events, we're cautious. We have a big anniversary sale that's a 3-day event that we're very optimistic about. But in this new environment, we're careful in terms of our building the sales into our guidance. And then we have built into our guidance a lot of upside in September when we have the Organic Month headquarter event that runs the entire month. Last year, September was the weakest performing month of the 3 months in the fourth quarter. So we're hopeful we'll have a strong September, but we're being careful in our guidance.

Yes. That makes sense. And then, I guess, there's been increased COVID cases with the Delta variant. Have you seen any change in consumer behavior in terms of traffic or basket size as cases have started to rise?

I would say that it's too early to see any trends yet in regards to that particular issue.

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. This month marks our 66th year serving our communities. I encourage you to visit one of our locations between August 12 and August 14 to help celebrate our anniversary and our founder, Margaret Isely's birthday. We look forward to updating you on our next call regarding the fourth quarter and full fiscal year 2021 results. Please stay healthy and safe, and have a great day. Thank you.

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