Natural Grocers by Vitamin Cottage - Q4 2023

Transcript

Operator (participant)

Good day, ladies and gentlemen. Welcome to the Natural Grocers Q4 and fiscal year 2023 earnings conference call. At this time, all participants are in a 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 Ms. Jessica Thiesen, Vice President, Treasurer for Natural Grocers. Ms. Thiessen, you may begin.

Jessica Thies (VP and Treasurer)

Good afternoon, and thank you for joining us for the Natural Grocers by Vitamin Cottage Q4 and 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 (Chairman and Co-President)

Thank you, Jessica, and good afternoon, everyone. Thank you for joining us for our Q4 call. Today, I would like to highlight our financial results, outline several key drivers and accomplishments, and review our priorities and initiatives. Then Todd will discuss the Q4 results in greater detail and introduce our fiscal year 2024 guidance. Our fiscal year 2023 daily average comparable store sales growth of 3.6% marked our 20th consecutive year of positive comparable store sales. We are proud of this extraordinary accomplishment. For the fiscal year, we achieved record diluted earnings per share of $1.02 and an 8.5% increase compared to last year. Our Q4 sales trends were particularly strong. Daily average comparable store sales increased 6.9%, including a 3.6% increase in daily average transaction count.

Moreover, the strength was broad-based across our product categories. We attribute the strong Q4 and fiscal year sales to our differentiated business model and our responsiveness to the industry dynamics. We continue to be positively impacted by consumers prioritizing health and wellness. Our customers appreciate our carefully vetted natural and organic product offering. We believe that our value proposition of high-quality products at always affordable prices resonates with consumers in the current economic environment. During fiscal 2023, our targeted marketing and promotions effectively drove customer engagement. Our percentage of sales on promotion has been relatively stable over recent quarters. Further, our emphasis on the in-store shopping experience has been an important contributor to driving our strong traffic trends.

I would like to recognize our operations, purchasing, and marketing teams for how they have nimbly transitioned from pandemic conditions to focus on core execution and navigating the current macro environment. Our company's commitment to operational excellence and continuous improvement were instrumental in driving our strong Q4 and fiscal year performance. We developed and executed market-specific campaigns that accelerated sales growth in underperforming stores. Effective pricing and promotional strategies contributed to the fiscal year gross margin improvement of 70 basis points. Higher labor efficiency partially offset increased wage rates and drove store productivity. We prioritized driving engagement with our customers. During fiscal year 2023, we continued to enhance the personalization, frequency, and range of our {N}power Rewards program offers. In particular, we featured {N}power promotions with a focus on local store marketing.

In August, we launched a Natural Grocers mobile app, which provides {N}power members with enhanced access to exclusive offers, digital coupons, recipes, and articles. We believe these initiatives collectively drove the 17% increase in {N}power membership and were a major contributor to our broad-based sales growth. Our Natural Grocers brand products remain a key point of differentiation due to their emphasis on quality and price. In the Q4, private label brands represented 7.8% of total sales, up from 7.6% in the Q4 of last year. During fiscal year 2023, we expanded our line of Natural Grocers brand products with 59 new offerings, including a distinctive offering of organic eggs from regenerative farms launched in the Q4. We believe that we are the first national grocery chain to offer private label, regenerative, certified organic pasture-raised, and organic free-range eggs.

Our company has a long-standing commitment to investing in our crew as one of our founding principles. Earlier this month, we implemented another company-wide wage rate increase. Our all-in average hourly wage rate for full-time store crew now exceeds $21 per hour. To partially offset higher labor rates, we continue to implement productivity initiatives. Recent projects include improvements to the receiving process, enhancements to automated replenishment, and point-of-sale system updates designed to create labor efficiencies, improve inventory accuracy, and provide more pricing flexibility. These initiatives have enabled us to streamline and automate certain in-store tasks while maintaining a high level of customer service. New store development continues to be a priority for our company. During the Q4, we opened a store in Kennewick, Washington, relocated our store in Beaverton, Oregon, and remodeled our store in Norman, Oklahoma.

In fiscal year 2023, we opened a total of three stores, relocated two stores, and remodeled one store. We are pleased with the performance of these stores. Our new store development was constrained in fiscal year 2021 through 2023 due to delays in permitting and construction and the availability of materials. Over the next several years, we are targeting a return to opening between six and eight new stores per year, subject to improving construction and supply chain conditions. I am pleased to announce that our board has declared a special cash dividend of $1 per common share, in addition to our quarterly cash dividend of $0.10 per common share, to be paid in December. The special dividend reflects our strong operating trends, financial position, confidence in our business outlook, and commitment to returning value to our stockholders.

Including the special and quarterly dividends announced today, we will have cumulatively returned $4.46 in cash per share to stockholders since initiating our dividend program four years ago. Finally, I would like to thank every member of our good4u Crew for their commitment to operational execution and exceptional customer service, which were instrumental in driving our strong performance in the Q4 that culminated in a record-setting year. 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. For the Q4, net sales increased 7.6% from the prior year period to $295.1 million. Our daily average comparable store sales increase of 6.9% was comprised of a 3.6% increase in daily average transaction count and a 3.3% increase in daily average transaction size. We are very encouraged by the strong customer traffic trends we have experienced over the past several quarters. We estimate that product cost inflation was approximately 5% on an annualized basis for the Q4, down 200 basis points from the Q3, and was approximately 7% for the fiscal year 2023. Our product cost inflation and disinflation have been less volatile than conventional grocery as a result of our specialized supply chain.

The item count per basket was down less than one half of an item compared to the same period in the prior year, reflecting an improving trend over the past several quarters. Our item count remains above pre-pandemic levels. Sales growth was broad-based across categories. Our strongest performing departments were dairy, body care, meat, and dietary supplements. The growth in supplements continues to be encouraging and reflects our differentiation in this important category, which is margin accretive. The {N}power rewards program represented 77% of net sales, reflecting the strength of our relationships with so many of our customers. For the Q4, gross margin increased 100 basis points to 28.6% and was driven by higher product margin attributed to effective pricing and promotions, partially offset by higher shrink expense.

Store expenses as a percentage of net sales decreased 70 basis points and was primarily driven by lower long-lived asset impairment charges as compared to the prior year period. Administrative expenses as a percentage of net sales increased 10 basis points and was primarily driven by higher compensation expenses, technology amortization, and legal expenses. Our operating income increased 114% to $7.7 million. The effective income tax rate was 15% and 26.5% for the Q4 of fiscal 2023 and 2022, respectively. The decrease in effective income tax rate was primarily attributable to increased food donation deductions. Net income was $5.9 million, with diluted earnings per share of $0.26 in the Q4.

This compares to net income of $2.2 million, or $0.09 diluted earnings per share in the Q4 of last year. Adjusted EBITDA increased 18.5% to $16.1 million. Briefly touching on the full year results. For fiscal year 2023, total revenue increased 4.7% to $1.1 billion.... Our daily average comparable store sales growth was 3.6%, resulting in an increase of 6.2% on a two-year basis. Gross margin was 70 basis points higher than the prior year. Store expenses as a percentage of sales were 40 basis points higher than the prior year. The effective income tax rate was 18.1% and 23.1% for the fiscal year 2023 and 2022, respectively.

The decrease was primarily attributable to increased food donations. We anticipate our normalized effective income tax rate will be between 20% and 21% during fiscal 2024. For fiscal year 2023, diluted earnings per share was $2, compared to 94 cents in fiscal 2022. Adjusted EBITDA in the fiscal year 2023 was $63.4 million. Turning to the balance sheet and cash flow. For fiscal year 2023, we generated cash from operations of $64.6 million and invested $38 million in net capital expenditures, primarily for new and relocated stores, resulting in free cash flow of $26.7 million. We finished the year in a strong liquidity position with $18.3 million of cash and cash equivalents.

We had no outstanding borrowings under our $50 million revolving credit facility. Additionally, today, we announced that we have amended our credit facility to increase the revolving credit facility commitment to $75 million and extend the maturity to November 16, 2028, to further enhance our liquidity. As Kemper noted, our board of directors has declared a special cash dividend of $1 per common share, in addition to a quarterly cash dividend of $0.10 per common share. The special dividend reflects our commitment to returning capital and maximizing value for our stockholders, recognizing our strong cash flow, cash position, and modest financial leverage. To fund the dividend, we will use cash on hand and borrowings under the revolving credit facility. We expect to continue investing in profitable growth and development initiatives, including new stores and store relocation opportunities.

Both dividends are payable on December 13, 2023, to all stockholders of record at the close of business on November 27, 2023. Now, I would like to introduce the company's outlook for fiscal year 2024. Our guidance was developed based upon consideration of current operating trends, consumer trends, and the uncertainty of the economic environment. Our outlook includes the benefits of new store growth, targeted marketing focused on our value proposition and customer engagement, and operating initiatives. Our current expectation is that sales comps will be at the high end of our outlook range in the first half of the year and more challenging in the second half of the year as we cycle stronger comps in the back half of fiscal 2023. Decelerating inflation will likely be a factor as the year progresses.

Our outlook anticipates that year-over-year gross margin will be higher in the first half of the year and flat in the second half. Lastly, we expect store expenses as a percentage of sales to increase, driven by higher labor rates, resulting in modest deleverage. For fiscal year 2024, we expect to open 4-6 new stores, relocate or remodel 4-6 stores, achieve daily average comparable store sales growth between 2% and 4%, achieve diluted earnings per share between $1 and $1.10, and direct $30-$39 million towards capital expenditures to support our growth initiatives. In closing, we had another strong quarter and record-setting year. During 2023, our team transitioned from the challenges of the pandemic and redirected their focus to driving customer engagement and store productivity.

Over the past four years, daily average comparable store sales have increased 19.9%, gross margin has improved 230 basis points, and diluted earnings per share has grown 143%. We have effectively managed the challenges over the past four years and have reset our priorities to maximize the opportunities ahead. 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 touchtone 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. Please go ahead.

Scott Mushkin (Founder and CEO)

Hey, guys. Wow, unbelievable. Incredible. Kind of along the lines where we talked about last quarter about, you know, maybe the specialty Europe format resonating a bit more, as we come out of the pandemic. So it does, though, if I look at it, you obviously had a real easy compare. I go back and forth on stacks, but, you know, how much do you think that played into the big acceleration of the comp, in the Q4, versus the third?

Kemper Isely (Chairman and Co-President)

You know, it definitely played a little bit into that acceleration because, as you said, we had pretty sad comps last year. But I don't think... I think we had really strong consumer customer count growth, and so I think that's the real positive out of what we got for the quarter.

Scott Mushkin (Founder and CEO)

Remind me what the count growth was in the Q3. Did it accelerate year-over, quarter-to-quarter sequentially?

Kemper Isely (Chairman and Co-President)

Yes, it was, do you have that there handy, Todd, Jessica?

Jessica Thies (VP and Treasurer)

1.9-3.6.

Kemper Isely (Chairman and Co-President)

Yeah, it went from 1.9 to 3.6 in the quarter, so it was a substantial acceleration of customer count growth-

Scott Mushkin (Founder and CEO)

Yeah.

Kemper Isely (Chairman and Co-President)

in our stores.

Scott Mushkin (Founder and CEO)

So, if you had to frame it as, okay, this is what we're doing that's driving this, you know, really good performance on sales, and this is kind of what we think is macro, you know, related, our format's resonating more, how, you know, how would you break that down? And then when you look at your own drivers, what do you think the top ones are?

Kemper Isely (Chairman and Co-President)

Well, I mean, our primary driver is that we're communicating with our, you know, 78% of our customer base four or five times a week via our {N}power promotions and emails to those customers. And so that's really helping to get those customers more engaged, and then the word of mouth is getting out there. And then we're doing an effective job with out-of-home promotion, with our billboards and targeted social advertising to get new customers into the stores. And then the third thing is, you know, our pricing strategy is one of affordability, so customers like that quite a bit.

And then fourth, we just have our standards resonate in this world we live in now, and people appreciate the fact that you know, we're well over 50% organic in all the products we sell. Our produce is 100% organic, and we're using you know, we're promoting pasture-based animal products, which are actually beneficial to the in you know to climate change, rather than a negative, which is what most other of the retailers have with their animal products, you know, because they're raising them in confined quarters, and that actually has a negative connotation for climate change. And so our customers, I think it really resonates with our customers because we're able to communicate with them effectively through our {N}power program.

Scott Mushkin (Founder and CEO)

And then-

Todd Dissinger (CFO)

Oh, go ahead. Scott, I think I'd add to that, too, that, you know, we've got a pretty diverse customer base, but we may be less dependent on the lower income customer. One data point that we have is the SNAP EBT, which is really only about 2% of our total business, and we saw a significant drop in transactions with those customers this past quarter.

Scott Mushkin (Founder and CEO)

And then, that's actually a good segue. I'm usually, like, one of the only people on this call, so if I'm, you guys just tell me to shut up. I have a couple more questions, so hopefully that's okay. But it's, it's a good segue into demographics. Have you seen a notable shift, maybe younger, in the last couple of years to your demographics that are coming into the store?

Kemper Isely (Chairman and Co-President)

We definitely have a good group of millennials coming into the store and families coming into the store. Although, as Todd said, we kind of do skew a little bit on a higher income level basis, and the baby boomers who have less financial strain are definitely the backbone of our business.

Scott Mushkin (Founder and CEO)

And have there been any big changes as you look through your frequent shopper data, or has it kind of been steady?

Kemper Isely (Chairman and Co-President)

It's been pretty steady.

Scott Mushkin (Founder and CEO)

Okay. All right, last but not least, is my special dividend question, which it seems like, you know, you guys are, I wouldn't consider you underlevered. It seems like your adjusted leverage is about 3x. I don't know if you agree with that. Using up all the cash and putting out a little bit more debt to pay a special div, I just wanted to understand kind of, you know, I... It seems, I'm not going to call it aggressive, but it seems a little bit more that way, and kind of just walk me through what the thought process is and walk me through if you think I'm right or wrong about what I said.

Kemper Isely (Chairman and Co-President)

Well, the way we look at it is that if we had two ways of going. We could have increased the size of our quarterly dividend or issued a special dividend. And then we also look at stock buybacks, so we don't look. We don't, we're not gonna, you know, we don't. You'd have to spend a significant amount, significantly more money on stock buybacks to get the impact of a special dividend to our shareholders. But if you look at it on a cash flow basis, the special dividend will be paid off fairly rapidly, and it won't cause any difference in our cash flow over the next three years.

Whereas if we had done the increase, and it gives a really good value back to our shareholders, and then whereas if we'd done the increase in the quarterly dividend, that's just a constant outflow of the cash. I don't know if that makes sense to you, but that-

Scott Mushkin (Founder and CEO)

Yeah.

Kemper Isely (Chairman and Co-President)

-that's the way we look at it. We look at it from a, we look at it from our cash, you know, how fast are we gonna be able to regenerate that cash from the, you know, from the special dividend into the company? And it really has no effect whatsoever on our cash outlays compared to where we would have been before. So we thought it was well worth doing.

Scott Mushkin (Founder and CEO)

Sounds good, guys. You get another just great quarter, so-

Kemper Isely (Chairman and Co-President)

All right, thanks.

Scott Mushkin (Founder and CEO)

Yep.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Kemper Isely for any closing remarks.

Kemper Isely (Chairman and Co-President)

Thank you for joining us to discuss our Q4 results. We take great pride in all of the company's accomplishments in fiscal 2023. We are committed to maximizing value for our stockholders. Today's declaration of our second special cash dividend yields a cumulative payout of $4.46 since the dividend program's inception 4 years ago. We look forward to many opportunities in fiscal year 2024. Thank you, and have a great day. Bye.