Natural Grocers by Vitamin Cottage - Q3 2023

Transcript

Operator (participant)

Good day, ladies and gentlemen. Welcome to the Natural Grocers Q3 fiscal year 2023 earnings conference call. At this time, all 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. I'd like now to turn the conference over to Miss Jessica Thiessen, Vice President, Treasurer for the Natural Grocers. Miss Thiessen, you may begin.

Jessica Thiessen (VP and Treasurer)

Good afternoon, and thank you for joining us for the Natural Grocers by Vitamin Cottage Q3 fiscal year 2023 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.

Kemper Isely (Co-President)

Thank you, Jessica, and good afternoon, everyone. We appreciate you joining us today. We delivered another strong performance in the Q3, exceeding our expectations. We believe that Natural Grocers continues to be very differentiated in the market and uniquely relevant to consumers. Our Q3 sales trends were particularly strong. Daily average comparable store sales increased 4.4%, including a 1.9% increase in daily average transaction count. Moreover, strength was broad-based across categories. The monthly sales comp was relatively consistent throughout the quarter. We believe that our strong value proposition, especially our carefully vetted products at always affordable prices, aligns with current trends in the market. Sales also benefited from focused marketing initiatives in leveraging the {N}power loyalty program. Our operations and marketing teams have transitioned well post-pandemic to focus on execution.

I would like to share a few examples of their initiatives that benefited the Q3. First, we developed market-specific marketing campaigns that have accelerated sales growth in underperforming stores without diluting margin. Second, effective pricing and promotion contributed to the Q3 gross margin improvement of 130 basis points. Finally, higher labor efficiency partially offset increased wage rates and drove store productivity. Our crew's commitment to operational excellence, ongoing improvement, and exceptional customer service were instrumental in driving our strong Q3 performance. We achieved diluted earnings per share of $0.31 and 82.4% growth compared to the Q3 of last year. The strength of our Q3 results prompted us to raise our comparable stores sales and earnings per share guidance for the fiscal year. Todd will cover the results and outlook in more detail.

Next, I would like to highlight 2 milestones achieved during the Q3. The first milestone relates to our {N}power loyalty program. We celebrated reaching 2 million {N}power members during the Q3. The net sales penetration for {N}power was 77% in the Q3, up from 75% a year ago. The continuing growth in membership and sales penetration demonstrates our customers' appreciation of the benefits and value provided by the program. {N}power continues to be an effective tool for optimizing promotional activity and driving customer engagement. Examples include personalized emails that tailor promotional offerings to customers' preferences, market-specific marketing campaigns, and value-focused meal deals. On average, a {N}power member basket is almost twice the size of a non-member basket. Our second milestone relates to sustainability.

Natural Grocers was founded by my parents in 1955, who were inspired by founding principles that many people today would recognize as sustainability principles. As part of our long-standing commitment to the health and well-being of humans, animals, and the planet, we adopted single-use, bag-free checkouts in 2009. Over the past 14 years, we estimate our policy has prevented more than 500 million single-use plastic bags from entering the waste stream and impacting the environment. Additionally, for each customer who brings their own shopping bag, we donate $0.05 to a local food bank, which has amounted to $2 million in donations since the program's inception. I encourage you to review our 2022 ESG Report for more information on the practices we have implemented to further reduce packaging and waste throughout our operations. Turning now to new store development.

During the Q3, we relocated our store in Amarillo, Texas. Relocations are an important component of our store development strategy as they enable us to leverage an established market presence with a stronger facility and location. Relocations generally realize double-digit sales growth off a mature sales base. For fiscal year 2023, we are on track to open four new stores and relocate or remodel three stores. Finally, I would like to thank every member of our Good For You Crew for their commitment to operational execution and exceptional customer service, which were instrumental in driving our strong Q3 performance. With that, I will turn the call over to Todd to discuss our financial results and guidance.

Todd Dissinger (CFO)

Thank you, Kemper, and good afternoon. We are pleased with our strong Q3 results. Net sales increased 5.8% from the prior year period to $281.8 million. Our daily average comparable store sales increase of 4.4% was comprised of a 2.4% increase in daily average transaction size and a 1.9% increase in daily average transaction count. We estimate the product cost inflation was approximately 7% on an annualized basis for the Q3, which was down slightly from 8% in the previous two quarters. The item count per basket compared to the prior year and in line with recent quarters. We observed minimal trade down in the Q3. Our strongest performing departments were dairy, body care, meat, and dietary supplements.

Our continuing growth of supplements indicates the stickiness of elevated pandemic demand. The growth in supplements further reflects our differentiation and strong competitive position in this important category, which is also margin accretive. The Natural Grocers Brand represented 7.6% of total sales, down slightly from 7.7% a year ago. For the Q3, gross margin increased 130 basis points to 28.9% and was driven by higher product margin attributed to effective pricing and promotions. Store expenses as a percentage of net sales, decreased 40 basis points and was primarily driven by expense leverage on sales, partially offset by higher labor expense as a result of increased wage rates. Administrative expenses as a percentage of net sales, increased 50 basis points and was primarily driven by higher compensation expense, software expense, and technology amortization.

Operating income increased 60.8% to $9.1 million. The effective income tax rate was 14.1% and 22.1% for the Q3 of fiscal 2023 and 2022, respectively. The decrease in the effective income tax rate was primarily attributable to increased food donation deductions recorded during the Q3 of fiscal 2023. We anticipate our normalized effective income tax rate will be more aligned with the year-to-date tax rate. Net income was $7.1 million, with diluted earnings per share of $0.31 in the Q3. This compares to the net income of $3.9 million, or $0.17 of diluted earnings per share in the Q3 of last year. Adjusted EBITDA was $16.7 million.

Turning to the balance sheet and cash flow. We ended the Q3 in a strong financial position with $8.6 million of cash and cash equivalents. We had no outstanding borrowings under our $50 million revolving credit facility. During the first nine months of fiscal year 2023, we generated cash from operations of $36.2 million and invested $24.3 million in net capital expenditures, primarily for new and relocated stores, resulting in free cash flow of $11.9 million. Today, we announced that our board of directors has declared a quarterly cash dividend of $0.10 per share. The dividend will be paid on September 13, 2023, to all stockholders of record at the close of business on August 28, 2023.

We are raising our fiscal 2023 outlook for comparable store sales and diluted earnings per share based on our strong year-to-date performance and current trends. We are also refining our outlook for the number of new stores, relocations, and remodels. Our guidance now includes the following: open four new stores, relocate or remodel three stores, achieve daily average comparable store sales growth between 2% and 3%, achieve diluted earnings per share between $0.86 and $0.94, and direct $28 million to 35 million towards capital expenditures to support our growth initiatives. In closing, we had a strong quarter that we attribute to many factors, including a loyal and resilient customer base that prioritizes our healthy and sustainably focused offerings at always affordable prices.

We continue to be encouraged by our operating trends and are confident in our ability to continue to drive profitable growth and enhance value for all stakeholders. With that, I would like to open the lines for questions. Thank you.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Scott Mushkin of R5 Capital. Go ahead.

Scott Mushkin (Founder and CEO)

Hey, guys. thanks for, thanks for taking my questions, and it's clear that your, your initiatives are obviously having a, a nice benefit to the business, so congratulations on that.

Kemper Isely (Co-President)

Thank you, sir.

Scott Mushkin (Founder and CEO)

I don't know if you remember our last call, I was asking you, I think, a little bit about how you guys performed during the last recession. I kinda wanted to take that maybe to the next step of, you know, as you, as you look at your business and what's going on in the broader market, how much of the center store of a traditional grocery store is headed maybe to Amazon or Walmart? How do you think, like, a specialty market like yours fits into that picture?

Kemper Isely (Co-President)

Well, I think because we are so differentiated from a conventional grocery store and, and, and a Walmart or Amazon, for that matter, that it doesn't have as much of an effect on our business. I mean, you can see it just in our supplement sales. We've, we've had... You know, our supplement sales have actually outperformed our comp. You would think that supplement sales would just naturally migrate to online, but a lot of people need some guidance and customer service and to select their supplements, so you can get that at our stores. So it, it means that we have a lot of stickiness with our sup- a lot of loyalty and stickiness with our supplement customers, and we're actually increasing market share because of that.

As far as the center of the store goes, you know, our, our standards just make it a lot easier for our customers to come and shop and not have to worry about whether or not they're buying something that's that they don't really wanna buy because of its ingredients at Walmart or Amazon, or Costco, for that matter. Also we have, you know, the, the shopping experience in our store is very different because we have the smaller format that's easier and not as intimidating to shop.

Scott Mushkin (Founder and CEO)

Next to that, the where, where I was going with that, actually, is that in some ways I'm starting to think you guys are some, like, almost complementary, right? Like, if you're looking for specialty items or you want that consultation, you're gonna head to a Natural Grocers, or maybe, you know, The Fresh Market if you're looking for that type of produce, and then, you know, really almost complementary to the online and what Walmart's doing. That was kind of where I was headed with that.

Kemper Isely (Co-President)

Yeah, maybe.

Scott Mushkin (Founder and CEO)

Let's, let's make the thought process that maybe that's true. Talk about, like, your real estate plans going forward, how many new stores you think you can grow? Maybe you said this before, but maybe I just need a reminder. I heard the real estate plans for this year, but as we think about your real estate plans going forward, is there a thought maybe a little of acceleration, or how, how should we think about that?

Kemper Isely (Co-President)

Well, the last couple of years have been a little bit slow in, in new store development, but our plan going forward is to do 6-8 new stores a year. Then part of our strategy, of course, is to relocate or remodel stores because we get quite a substantial lift in, in our comp when we relocate or remodel a store. So, you know, we do 2-5 of those a year also.

Scott Mushkin (Founder and CEO)

Thank you. Any thoughts are re-accelerating, or you just kind, you're happy with that, you know, 6-8?

Kemper Isely (Co-President)

We're right at the moment, we're pretty happy with the 6-8. Then the, like I said, 2-5 relocations a year, it, it keeps us pretty busy, and that means that we can be more selective in our site location, and we can also be, you know, it's not as dilutive to our earnings to open just piles and piles of stores.

Scott Mushkin (Founder and CEO)

Right. Then, this is probably gonna be, like, an off-the-wall question a little bit, but even stepping back, like, strategically, I don't think you guys have done a, maybe no M&A. I mean, how are you guys thinking about that type of activities, or is that just not even on the, on the radar?

Kemper Isely (Co-President)

Are you talking about mergers and acquisitions by us?

Scott Mushkin (Founder and CEO)

Yeah.

Kemper Isely (Co-President)

We really, we really don't have that as a, as part of our strategy.

Scott Mushkin (Founder and CEO)

All right, guys. Listen, we have real solid, solid quarter. Congratulations again.

Kemper Isely (Co-President)

Thanks. You have a good day now, Scott.

Scott Mushkin (Founder and CEO)

You too.

Operator (participant)

As a reminder, if you have a question, please press star, then 1. We will wait 1 moment in case anyone else joins. With no further questions, this concludes our question and answer session. I would like now to turn the conference back over to Kemper Isely for any closing remarks.

Kemper Isely (Co-President)

Thank you very much for joining us to discuss our Q3 results. This month marks our sixty-eighth year serving our communities. I encourage you to visit one of our locations between August 17 and 19th to help us celebrate our anniversary. We look forward to updating you on our next call regarding the Q4 and full fiscal year 2023 results. Thank you, and goodbye.

Operator (participant)

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