Natural Grocers by Vitamin Cottage, Inc. (NGVC) Q3 2022 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Natural Grocers Third Quarter Fiscal Year 2022 Earnings Conference Call. [Operator Instructions]. As a reminder, today's call is being recorded. I'd now like to turn the conference over to Ms. Jessica Thiessen, Vice President and Treasurer for Natural Grocers. Ms. Thiessen, you may begin.

Good afternoon, and thank you for joining us for the Natural Grocers by Vitamin Cottage third quarter fiscal year 2022 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 website at investors.naturalgrocers.com. Now I will turn the call over to Kemper.

Thank you, Jessica, and good afternoon, everyone. We are pleased with our results for the third quarter of fiscal 2022, including daily average comparable store sales growth of 2.5% and diluted earnings per share of $0.17. Since the third quarter of fiscal 2019 or pre-pandemic levels, our daily average comparable store sales have increased 14.1% and diluted earnings per share have grown 88.9%, demonstrating the enduring strength of our business model. Key to our success and differentiation is our steadfast commitment to our founding principles, including offering the highest-quality natural and organic products at always affordable prices and free science-based nutrition education. I would like to highlight a few key sales metrics from the quarter. The third quarter comp sales of 2.5% was positively impacted by retail price inflation of about 6%. Historically, our specialized supply chain has yielded more stable inflation rates than conventional grocery. We continue to pass along the cost inflation impact via pricing on the majority of products. The average transaction size increased 2.7% and remained in the mid-$40 range, which is up more than 20% from pre-pandemic levels. The transaction count comp was relatively flat at negative 0.2%, which we believe was driven by a shift in consumer trends towards food away from home, in particular, consumers traveling more frequently than a year ago. The third quarter item count per basket remained relatively stable, down a fraction of an item compared to the previous 4 quarters. Our item count per basket increased by 12% compared to pre-pandemic levels. Through the third quarter, we did not observe customer trade down in response to inflationary trends. Our AG offering is a good indicator of shifts in consumer behavior because there are 3 distinct categories offered at different price points, free-range, organic and pasture-raised. Our analysis of the third quarter indicated that we did not experience trade down in this vertical and quantities remained relatively consistent across each category. Our {N}power loyalty program remains an important tool for optimizing promotional activity and driving customer engagement. We ended the quarter with more than 1.7 million loyalty members, a year-over-year increase of 19%. The third quarter net sales penetration for {N}power was 75%, up from 71% a year ago, evidencing our customers' awareness of the value provided by this program. The average {N}power basket size is approximately 50% higher than a non-{N}power basket. Our Natural Grocers brand products are premium quality products at affordable prices, creating a key point of differentiation that drives loyalty and sales growth. Our Natural Grocers brand products accounted for 7.7% of net sales in the third quarter, up from 7.1% in the third quarter of last year. During the quarter, we launched 8 new branded products across body care, bulk and supplements. During the quarter, we were excited to open a new store in Canyon City, Colorado. And subsequent to the quarter, we opened our first South Dakota store in Sioux Falls Falls. We are pleased with both communities responses to these new store openings. We are on track to open a total of 3 to 4 new locations and relocate 2 stores in fiscal year 2022. Over the next several years, we expect to return to opening between 6 and 8 new stores per year, subject to improving construction and supply chain conditions. Caring for our crew is one of the company's 5 founding principles. We offer competitive pay, unique benefits and career growth opportunities that attract, engage, develop and retain our workforce. As part of our commitment to our crew, during the fiscal year, we have invested more than $14 million in incremental wage increases on an annualized basis. In closing, I want to thank every member of our good4u crew for their strong execution of our operating strategies, including a commitment to exceptional customer service, which has been instrumental in driving our results. With that, let me turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon. The third quarter results were in line with our expectations. Our third quarter net sales increased 3% on a year-over-year basis to $266.3 million. Daily average comparable store sales were up 2.5%. Average transaction size increased 2.7% and average transaction count decreased 0.2%. The categories with the strongest comparable sales were meat, grocery and dairy supplements comp similar to the company total. Out of stocks continued to improve through the quarter and were at the lowest level since the pandemic began. Gross margin of 27.6% was 10 basis points lower than the prior year, driven by lower product margin attributed to higher freight, distribution and shrink expenses partially offset by store occupancy leverage. The increase in the shrink rate included cycling the benefit of an insurance claim recovery in the third quarter of last year associated with product losses from the February 2021, severe weather in our South Central and Pacific Northwest markets. Excluding this onetime item, gross margin would have been flat year-over-year. Store expenses as a percentage of net sales was 22.6%, up from 22.1% in the third quarter of fiscal 2021. The increase was primarily driven by higher labor expense as a result of increased wage rates. Operating income was $5.7 million and operating margin was 2.1%. Net income was $3.9 million with diluted earnings per share of $0.17, and adjusted EBITDA was $13 million. Our financial position remains strong at the end of the third quarter with $19.9 million of cash and cash equivalents. We had no outstanding borrowings under our $50 million revolving credit facility and a $17.7 million balance on our term loan. During the first 9 months of fiscal 2022, we generated cash from operations of $29.5 million and invested $18 million in net capital expenditures, resulting in free cash flow of $11.5 million. Today, we announced that our Board of Directors has declared a quarterly cash dividend of $0.10 per share of common stock. The dividend will be paid on September 14, 2022, to all stockholders of record at the close of business on August 29, 2022. Now turning to our outlook for fiscal year 2022. We are refining our new store openings, comparable store sales and earnings outlook previously updated on May 5, 2022. Our outlook considers year-to-date performance and current trends. Additionally, it considers that we are cycling strong sales and margin performance in the fourth quarter of last year, and we are currently operating with higher store wage rates. Finally, the outlook considers the uncertainty of the pandemic and economic and inflationary factors. Our full year guidance includes the following: open 3 to 4 new stores, relocate or remodel 2 stores, achieve daily average comparable store sales growth between 2% and 3%, achieve diluted earnings per share between $0.87 and $0.96 and direct $28 million to $35 million towards capital expenditures to support our growth initiatives. In closing, we are pleased with our results for the third quarter. The performance was in line with our expectations and positions us to meet our fiscal 2022 sales and earnings outlook. Our unwavering commitment to our founding principles, our consistency and the dedication of our good4u crew differentiates us from the competition. As we close the year, we continue to strive to be the grocery of choice for the highest-quality natural and organic products at always affordable prices. Now I would like to open up the lines for questions. Thank you.

[Operator Instructions]. Our first question comes from Spencer Hanus with Wolfe Research.

Great. Can you just talk a little bit about what you're seeing quarter-to-date? Because the guidance does imply that comps will decelerate in 4Q? And then any update on what your outlook is for inflation for the full year?

Well, we're expecting -- for this quarter, we're in line with where we expected to be with the normalized vacation trends of our customers. So slightly lower than last quarter. And as far as inflation, we do not see a moderation in inflation for the rest of the year. So we're expecting somewhere in the 6% to 7% range for the rest of the year on it.

Okay. Got it. That's helpful. And then you mentioned that inflation was tracking up 6% in the quarter, but you aren't seeing any signs of trade down. Has that been surprising? And as you think about planning the business for the second half of this year, are you expecting to see more trade down or any impact on units in the second half here?

No, I don't believe there should be a significant amount of trade down for our customers. I mean, our customers are pretty loyal and our...

Okay. And then, just give me...

Our prices are always affordable. So that really helps with keeping new customers from trading down.

Got it. Got it. And then taking a step back and thinking about the industry and where we are from a unit standpoint, I think a lot of grocers are reporting declines in units. Do you think that there's going to be an acceleration in promotions once the supply chain starts to normalize and a lot of these operators prioritize unit growth going forward?

No. I really don't see that there can be a lot of more promotional activity in the industry, the wage pressure, et cetera, just makes it really hard for people to cut their margins right at the moment. And then secondly, I really don't see that we're going to have much -- I mean our slight decrease in number of items in a basket, we attribute almost entirely to a more normalized summer vacation pattern rather than anything else. And we figure that in the fall that our basket size will stabilize and become more similar to what it was last year.

Okay. And then just in terms of the unit growth and getting back to that 6 to 8 stores a year, do you think you'll be able to do that next year given the supply chain constraints that are out there for building new stores? And any additional color you can provide on that front?

I think we've gotten -- we've learned to be very proactive on our acquisition of equipment and construction materials. So we're -- once we get a store into the go phase, we are being proactive in ordering the equipment and our items that have had long lead times ahead of time so that we can get them -- get to have them on time for the stores to get opened. And then secondly, we've learned that we need to get our plans into the cities quicker so that we don't have delays in permits. I mean, the delays in permits from cities has been somewhat problematic lately, too. But we seem to -- we've learned from this year that we need to accelerate the planning into the cities. And as far as us getting to the -- we definitely think we'll get to the 6 stores that we're planning on opening next year and then probably the relocation of 2 to 3 stores next year. Right now, we have 4 stores that are on the -- that we are -- we have 3 stores with signed leases for next year and then 1 store that's almost with the signed lease should have it signed next week. And all of those should open within the first, I guess it depends on how you look at the year. But anyway, by the third quarter of next year.

[Operator Instructions]. At this time, there are no further questions. So 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 67th year serving our communities. I encourage you to visit one of our locations between August 18 and 20 to help us celebrate our anniversary. We look forward to updating you on our next call regarding the fourth quarter and full fiscal year 2022 results. Thank you. Goodbye.

This concludes the conference. Thank you for attending today's presentation. You may now disconnect.