Natural Grocers by Vitamin Cottage, Inc.
Q3 2018 Earnings Call Transcript

Published: 2 Aug 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Natural Grocers Third Quarter Fiscal Year 2018 Earnings Conference Call. At this time, participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, today's call is being recorded. And now, I would like to turn the conference over to Mr. David Colson, Vice President and Treasurer for Natural Grocers. Mr. Colson, you may begin.

[David Colson:]

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage third quarter fiscal year 2018 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.

[Kemper Isely:]

Thank you, David, and good afternoon, everyone. It is my pleasure to discuss our strong third quarter results with you today. We have worked hard to improve both sales trends and profit margins, and our performance reflects those efforts. The third quarter marks our fifth consecutive quarter of positive daily average comparable store sales, with comps up 5.2% and mature store comps up 2.3%. As we anticipated, the year-over-year gross margin investment in our pricing and promotional strategies significantly decreased during the third quarter. This along with strong store expense leverage drove improved operating margins and higher earnings per share. As I will discuss in a moment, we are increasing our fiscal 2018 comp guidance and raising the low end of our earnings per share outlook. We firmly believe that our sales momentum is being driven by the success of our marketing, promotional efforts and price investments, coupled with our unwavering focus on our core values. We believe it is our core values that resonate most with our customers and differentiate us from our competition. Our marketing and promotions have successfully emphasized our industry leading product standards delivered at an affordable price. We believe the formula we have developed will continue to deliver positive sales momentum, while moderating the impact of gross margin and leading to enhanced profitability. With that, let me turn the call over to Todd to discuss our financial results.

[Todd Dissinger:]

Thank you very much, Kemper, and good afternoon, everyone. During the third quarter of fiscal 2018, net sales increased 9.5% to $213.1 million. And ask Kemper mentioned, daily average comparable store sales increased 5.2%. The comp increase was driven by a 4.0% increase in daily average transaction count and a 1.1% increase in average transaction size. The quarter's comp increase came despite a more challenging comp comparison and the promotional investments we began in the third quarter of last year. On a two-year stacked basis, the third quarter comp remained consistent with the second quarter, while our incremental investments in gross margin moderated. We believe this confirms our ability to retain our traffic and basket gains while moderating our incremental investment in gross margin. Gross profit margin declined approximately 40 basis points to 26.7% due to a lower product margin. Product margin when compared to the prior-year period was impacted by both sales mix given the strong comp in grocery and our promotional and pricing initiatives. Recall that we generate a higher gross margin in supplements and body care than in grocery, and our promotional and pricing efforts have been focused primarily on grocery, which has impacted our sales mix and thus our gross margin. The year-over-year decline in gross margin also continued to improve sequentially. The 40 basis point decline during the third quarter compares to 120 basis points and 215 basis point declines in the second and first quarters of fiscal 2018, respectively. Store expenses as a percentage of sales declined approximately 100 basis points to 22.1% during the third quarter compared to the prior-year period. The decline in store expenses as a percentage of sales was primarily driven by leverage on the strong comp sales. Preopening and relocation expenses declined $500,000 year-over-year due to the reduced number of new store openings, as well as the timing of openings and relocations. We opened two new stores and relocated one store during the third quarter of fiscal 2018 compared to opening five new stores and no relocations in the third quarter of fiscal 2017. The moderated gross margin decline along with good leverage on store expenses and reduced preopening and relocation expenses led to a 90 basis point improvement in operating margin during the third quarter. Our effective tax rate for federal and state income taxes for the third quarter of fiscal 2018 was 23.1%, which compares to 25.5% in the third quarter of fiscal 2017, reflecting the new federal corporate income tax rate. Net income increased 233% to $2 million, with diluted earnings per share of $0.09 in the third quarter of fiscal 2018 compared to $0.03 in the third quarter of last year. EBITDA was $11.1 million in the third quarter of fiscal 2018, up 20.7% compared to $9.2 million in the third quarter of fiscal 2017. During the first nine months of fiscal 2018, we generated cash from operations of $30.3 million and invested $16.7 million in capital expenditures. In addition to supporting our new store growth, we reduced the outstanding balance of our revolving credit facility by $3.3 million during the third quarter and have reduced the balance by $12.1 million during the first nine months of fiscal 2018. Now, I will turn the call back to Kemper to discuss unit development and guidance.

[Kemper Isely:]

Thank you, Todd. During the third quarter, we opened two new stores and relocated one store. Thus far during the fourth quarter of fiscal 2018, we have relocated one store in Colorado. We have signed leases for seven additional new stores to open in fiscal 2018 and beyond. We continue to monitor new store performance and remain comfortable with our targeted store openings. As I noted, we are increasing our fiscal 2018 outlook for daily average comparable store sales growth and raising the low end of our earnings per share guidance. During fiscal 2018, we expect to

[Operator:]

And our first question comes from Rupesh Parikh from Oppenheimer. Please go ahead.

[Rupesh Parikh:]

Good afternoon, and thanks for taking my question, and congrats on a nice quarter.

[Kemper Isely:]

Thanks, Rupesh.

[Rupesh Parikh:]

So, my first question is, as we look at your performance quarter-to-date, is there any color you can provide in terms of what you're seeing from a comp perspective?

[Kemper Isely:]

You mean for this quarter?

[Rupesh Parikh:]

Yes.

[Kemper Isely:]

We're trending as we expected to be. Similar to...

[Rupesh Parikh:]

Okay.

[Kemper Isely:]

Yeah. (00

[Rupesh Parikh:]

Okay. And then, on the direct store expense line, this quarter we saw a much better leverage even with the lower comp in Q2. So I was curious what's driving that incremental leverage sequentially versus what we saw in Q2.

[Kemper Isely:]

Todd, do you want to answer that?

[Todd Dissinger:]

Yeah. So, we had lower marketing expenses in the store expense category. Depreciation was down. Some other expenses were down year-over-year. Store labor was about flat.

[Rupesh Parikh:]

Okay. And do you believe that some of these improvements can continue into Q4?

[Todd Dissinger:]

Yes.

[Rupesh Parikh:]

Okay. And then, on the competitive front, so obviously during the quarter, Whole Foods was more aggressive with some of their new rollouts with Prime discounts, and I guess the Amazon Prime now within your market, are you seeing any impact related to some of their efforts? And I'm also curious, there clearly is some – I guess dissent from some of the non-Prime members at Whole Foods and maybe some other customers that don't like their, I guess, lower standards that they have in stores. So I'm also curious if you're seeing any benefit from some of the changes that are happening at Whole Foods.

[Kemper Isely:]

Well, in regards to Prime, we're not really seeing any significant effect on our sales because of their Prime initiatives. As far as dissatisfaction with their customers, it would be hard for us to really quantitate that issue.

[Rupesh Parikh:]

Okay, great. Thank you.

[Operator:]

And our next question comes from Ryan Gilligan from Barclays. Please go ahead.

[Ryan Gilligan:]

Hi. Thanks for taking the questions. On the gross margin decline, can you break out how much of that was mix and how much was price investment?

[Kemper Isely:]

It was over half mix, so...

[Ryan Gilligan:]

Got it.

[Kemper Isely:]

(00

[Ryan Gilligan:]

Okay. That's helpful. And then I guess just where do you think you are in terms of price investments, like what inning are we in? How much further in price investment do you need to make before – and you feel comfortable with where you are from a pricing perspective?

[Kemper Isely:]

I think we pretty well are – I mean, we really cut the amount of lower margin compared to a year ago in the last quarter, and we'll probably be similar in the next quarter. And then, we'll probably have maybe a little bit of a positive effect in the first quarter of next year.

[Ryan Gilligan:]

That's helpful. Thanks. And then on beer and wine, I think it's at a small amount of stores now, but can you just confirm what the impact was on comps if it was immaterial, and then also, I guess just in your thoughts in how many stores they can get to over time?

[Kemper Isely:]

Well, at the moment it's pretty immaterial. I mean, it was rolled out to I think six Oregon stores in July. So, we didn't really have much of a – there was really no impact in the last quarter on our comp because of beer and wine.

[Ryan Gilligan:]

Got it.

[Kemper Isely:]

As far as future markets, as we'll analyze and see what is desirable for us as far as that goes. It is an investment into that category.

[Ryan Gilligan:]

Got it. Thank you very much.

[Operator:]

And our next question comes from Bill Kirk from RBC Capital Markets. Please go ahead.

[William Kirk:]

Yes. Thank you for taking the question. On the beer and wine topic, what changed philosophically to decide to start adding that to your stores?

[Kemper Isely:]

Well, we added it in a very limited basis. I mean, the wines that we're selling have to be either organic or biologic. The beers are local craft beers. And then, we're selling some also hard cider which is organic, and then some kombucha with alcohol content that's organic. So there is quite a bit of demand for alcoholic beverages, and we thought that by offering a curated selection of high-quality organic wines and local craft beers in markets that had favorable regulations towards beer and wine would be a benefit to our customers.

[William Kirk:]

Okay. And a different question, maybe this is for Todd, but it looks like the CapEx was lowered for the full year. So maybe could you highlight what changed on your spending needs from that perspective?

[Todd Dissinger:]

Sure. So, there is one less new store in our guidance.

[William Kirk:]

Okay.

[Todd Dissinger:]

And our CapEx this year versus last year was substantially lower. We did have some contingency built into our CapEx and some projects, so we thought we might be funding were delayed (00

[William Kirk:]

Okay. That's it from me for now.

[Kemper Isely:]

All right. Thanks.

[Operator:]

And our next question comes from Scott Mushkin from Wolfe Research. Please go ahead.

[Scott A. Mushkin:]

Hey, (00

[Kemper Isely:]

Well, we watch our labor budgets very carefully and we believe that we can get higher labor productivity from our stores to offset the higher labor costs in some of our markets.

[Scott A. Mushkin:]

(00

[Kemper Isely:]

And then also in regards to – as our comp – when our comp comes in at a nice level, it's off the label. Yeah, I mean, that just helps the productivity of the labor quite a bit. I mean, that's why we think...

[Scott A. Mushkin:]

Oh, yeah, absolutely. I was just wondering (00

[Todd Dissinger:]

Well, just for clarification to the earlier question, the expenses that we talked about were all as a percent of sales, not dollars.

[Kemper Isely:]

Yeah.

[Scott A. Mushkin:]

Oh, okay. That's just perfect. Thanks for the (00

[Todd Dissinger:]

Thank you for asking that.

[Scott A. Mushkin:]

(00

[Kemper Isely:]

Well, I mean, at 25% off for a week, they will be at about our normal price on supplements. So, I bid (00

[Scott A. Mushkin:]

Okay. Thanks, guys. I appreciate the questions.

[Todd Dissinger:]

Sure, thanks.

[Operator:]

And the next question comes from Greg Badishkanian from Citi. Please go ahead.

[Garrett Klumpar:]

Hey, it's actually Garrett on for Greg. Thanks for taking the question. Just wanted to get your thoughts on inflation, what you're seeing by category and if that's changed materially since second quarter? And then, are you still expecting kind of flat inflation for the year?

[Kemper Isely:]

So far inflation has been pretty same (00

[Garrett Klumpar:]

Okay, that's helpful. And then just switching gears to delivery, could you give us an updated number on the locations offering Instacart, and then just any color around how the Instacart comps are progressing sequentially?

[Todd Dissinger:]

Sure. So we have 112 stores that are supported by Instacart as of the end of the quarter. And the volume with Instacart is just not material to be a driver in terms of our comp. And we've been adding so many stores on a year-over-year basis that it's hard to make a comparison over prior years, so everything's just ramping up.

[Kemper Isely:]

The stores that have been on for a length of time are about flat in sales.

[Garrett Klumpar:]

Okay, that's helpful. Thank you.

[Operator:]

And our next question is a follow-up from Rupesh Parikh from Oppenheimer. Please go ahead.

[Rupesh Parikh:]

Thanks. Thanks. Just two quick follow-ups. So on the private label front, I know that's been a bigger an issue (00

[Kemper Isely:]

We're steadily by the month adding new SKUs at private label. We're actually not really calling it private label, we're calling it the Natural Grocers brand. And we're going to officially launch the brand in September with a pretty good marketing campaign.

[Rupesh Parikh:]

Okay, great. And then the second question I was – your {N}power program, it appears to I think continue to gain traction. So just curious what you're seeing with the program and some of the bigger opportunities you see going forward.

[Kemper Isely:]

Yeah. I mean, we're adding about 20,000 to 25,000 members per month and we're up over 600-and-some-thousand members right now. The average ticket for the {N}power customer is substantially higher than the average ticket for our regular customers. And our marketing to our {N}power members is definitely helping us to drive sales.

[Rupesh Parikh:]

Okay, great. Thank you.

[Operator:]

And this concludes our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

[Kemper Isely:]

Thank you very much for joining us to discuss our third quarter results. We look forward to our 63rd Anniversary Celebration on August 16. Please visit any of our 147 stores, party like it's 1955. We look forward to speaking with you on our next call. Have a great day. Thank you.

[Operator:]

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