Natural Grocers by Vitamin Cottage, Inc.

Good day, ladies and gentlemen. Welcome to the Natural Grocers fourth quarter and fiscal year 2020 earnings conference call. At this time, all participants are in the 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 would now like to turn the conference over to Mr. David Coulson, Vice President and Treasurer for Natural Grocers. Mr. Coulson, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage fourth quarter fiscal year 2020 earnings conference call. On the call with me today are Kemper Isley, 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, David, and good afternoon, everyone. Thank you for joining us today. We faced many challenges and opportunities in fiscal 2020. and our response resulted in a record performance, including achieving over $1 billion in net sales and $0.89 in diluted earnings per share. Fiscal 2020 was also our 17th consecutive year of positive daily average comparable store sales growth. Our fourth quarter comp was up 13.2%, and the full fiscal year comp was 12%. Our strong comp trends have continued through October. During fiscal year 2020, we also continued to enhance store performance with our margin expansion efforts. Supported by the strong sales momentum, we realized significant improvement to adjusted EBITDA during the year with 28.1% growth in the fourth quarter and 29.1% growth for the full fiscal year. We are pleased to announce that we are declaring a special cash dividend of $2 per common share in addition to our quarterly cash dividend of 7 cents per common share. The special dividend reflects our strong business performance, financial position, cash flow, and our commitment to return value to our shareholders. Fiscal 2020 was an unprecedented year presenting numerous challenges amid the global pandemic and related government mandates. We are very proud of our strong response and performance. Our entire Natural Grocers family adapted quickly and successfully to these challenges while staying true to our founding principles. We navigated through the toughest of operating environments while delivering the highest quality natural and organic foods to our valued customers. Our strong results in both the fourth quarter and full year reflect our ability to leverage our core competencies and values. Our longstanding focus on health is an important differentiator in the on-trend given the current environment where customers are focused on making informed health and nutrition choices, including an emphasis on strengthening the immune system. Our quality offerings coupled with our always affordable value proposition is very relevant in today's uncertain economic environment. Additionally, customer confidence in our products, store cleanliness, and safety measures are driving our growth. Our differentiated model includes industry-leading quality standards, a focus on providing free science-based nutrition education, strong alignment with our customers' and communities' shared values, only offering 100% organic produce, a prepackaged bulk offering that is more relevant today than ever, a focus on providing the ingredients and recipes for healthy cooking at home, and a convenient store layout supported by exceptional customer service. Let me highlight a few of our recent marketing initiatives, which continue to drive customer excitement and interest and contributed to our strong sales performances. In July, we promoted the art of burgering, focused on healthy grilling techniques and ingredients. In August, we celebrated our 65th anniversary with a highly successful anniversary event that featured a sweepstakes, free products, and exciting promotions. This sale was extended to a three-day event this year to facilitate social distancing. In September, which was National Organic Harvest Month, We highlighted our commitment to organic farming with our Organic Month event, utilizing special promotional offers, activities, and a fundraiser supporting Beyond Pesticides. Our NPower Customer Loyalty Program continues to contribute to growth, drive loyalty, and enhance our ability to market to our customer base. NPower membership has now reached 1.3 million customers and represented 68% of sales in the fourth quarter. Additionally, our ongoing Feed Your Family of Four initiative, which is a promotion aimed at feeding a family of four for under $10 to $16, has been timely and well-received. This promotion highlights and educates families so they can cook affordable, high-quality meals, even in challenging economic times. We offer both the ingredients and recipes for families to follow, many featuring our Natural Grocers brand products. We are seeing continued growth of our National Grocers brand products. We have grown our private brand offerings by 54 SKUs during 2020, bringing our total number of National Grocers SKUs, including both prepackaged products and supplements, to over 1,000 at fiscal year-end. In the fourth quarter, private brand sales represented 7.3% of total sales, compared to 6.8% in the same period of the prior year. Our private brand products have been developed and sourced consistent with our core values and are positioned as a premium quality brand at an always affordable price. We continue to be encouraged by the adoption of our branded products with strong category penetration rates. We believe our natural grocers brand has significant growth potential in the years to come. In 2020, we continue to support our communities in many ways. During the fourth quarter, natural grocers and our customers partnered to raise over $500,000 for charitable purposes. These efforts focused on many important causes and included raising approximately $250,000 for local food banks, in addition to our ongoing commitment to donating food. In September, we launched our Ladybug Love Your Neighborhoods partnership with Beyond Pesticides. in honor of National Organic Harvest Month and raised over 120,000 reduced pesticides in neighborhood parks. As we have discussed before, these recent efforts are just a small part of how Natural Grocers' brand is deeply rooted in a history of environmental and social leadership to benefit all stakeholders. At Natural Grocers, we believe the sustainable choices we make today directly impact the world tomorrow, and we work hard to ensure our stores, operations, and supply chain reflect these values. We are committed to building a healthy, sustainable future for our customers, our Good4U crew, and our broader communities. Lastly, I would like to highlight our commitment to our Good4U crew during 2020. We have been proactive throughout the pandemic, focused on implementing safety measures for our crew. We are supporting our crew through a permanent $1 per hour wage increase for our hourly crew, which was implemented in March 2020, and we have paid periodic discretionary bonuses throughout the pandemic. Our wage and bonus enhancements represented approximately $3.3 million of incremental expense in the fourth quarter, which was the equivalent of 87% of quarterly net income. For the full year, the pay enhancements were approximately $10.3 million, or 52% of fiscal 2020 net income. In closing, I want to thank each and every crew member for their commitment to helping us deliver the highest quality natural and organic products at always affordable prices. I am confident in our ability to continue to drive growth and value for all of our stakeholders. With that, let me turn the call over to Todd to discuss our financial results and guidance.

Thank you, Kemper, and good afternoon, everyone. As Kemper mentioned, we had an outstanding fourth quarter and fiscal year amid a challenging operating environment. Our financial results reflect the commitment of our Good4U crew to our customers and the communities we serve. Net sales during the fourth quarter increased 16.3% to $264.2 million, with daily average comparable store sales increasing 13.2%. The fourth quarter comp increase was driven by a 23.7% increase in average transaction size. The strong transaction size was partially offset by an 8.5% decrease in daily average transaction count, reflecting a continuation of the trend of less frequent shopping trips as customers practiced social distancing. Meat, frozen, produce, bulk, and dairy categories outperformed the company average comp. Supplements also performed well, with a fourth quarter comp of 8%. Additionally, we saw continued penetration of online and delivery sales through our partner, Instacart, although volume moderated compared to the third quarter. We continue to see modest inflation, which was approximately 3% during the fourth quarter. I would like to also note that we have seen an improvement in vendor out of stocks as our partners continue to adapt to the environment. Gross profit margin during the fourth quarter was 27.4% compared to 26% in the prior year period. The improvement in gross margin over the fourth quarter 2019 was primarily attributable to higher product margin as a result of reduced promotions. We also saw improvement in store occupancy leverage and shrink expense as a percentage of sales. The product margin, occupancy leverage, and shrink expense improvements were partially offset by the adoption of the new lease accounting standard, which negatively impacted gross margin by approximately 20 basis points. Store expenses as a percentage of sales increased to 22.8% during the fourth quarter compared to 22% in the prior year period. The year-over-year increase in store expenses as a percentage of sales was attributable to increased labor-related expenses, which were partially offset by lower marketing and depreciation expenses, all as a percentage of sales. The increase in labor-related expenses was driven by a $1 permanent increase in all hourly wages, which was implemented in March and periodic discretionary bonuses to our hourly crew. Additionally, we are operating with increased store labor hours to support operational requirements to comply with government mandates related to the pandemic. Net income was $3.7 million, with diluted earnings per share of 16 cents in the fourth quarter. This compares the net income of $1.4 million, or 6 cents of diluted earnings per share, in the fourth quarter of last year. Adjusted EBITDA was $13.3 million in the fourth quarter, up 28.1% compared to $10.3 million in the fourth quarter of last year. For full fiscal 2020, we generated cash from operations of $66.5 million and invested $29.6 million in net capital expenditures. Capital expenditures included the opening of six new stores and one relocation during the fiscal year. Free cash flow was $36.9 million. We finished the year in a strong liquidity position with $28.5 million in cash and cash equivalents and no debt. As of year end, we had $48.7 million available under our $50 million revolving credit facility. Additionally, we have secured a $35 million term loan facility from our existing lender to provide financial flexibility and support our special dividend. Our balance sheet and liquidity remain strong and positions us to face an uncertain operating environment. As Kemper noted, our Board of Directors has declared a special cash dividend of $2 per common share, or a total of approximately $45 million in the aggregate. Our Board has also declared a quarterly cash dividend of 7 cents per common share. Both dividends will be payable on December 16, 2020, to all shareholders of record at the close of business on November 30, 2020. Given our strong cash flow, cash position, and modest leverage, the special dividend provides an opportunity to return capital and maximize value for our shareholders. To fund the dividend, we will use cash on hand as well as the new $35 million term loan facility. The new term loan facility preserves our revolver availability to maintain financial flexibility. We expect to continue investing in profitable growth initiatives and anticipate a continued trend of favorable cash flow. Now I would like to introduce the company's fiscal 2021 outlook. Our guidance reflects current trends in light of the rapidly evolving COVID-19 environment and related government mandates. While the company cannot predict the duration or severity of the pandemic and related government mandates, the company expects these factors will continue to impact our operations and financial performance through fiscal 2021. For fiscal 2021, we expect to open five to six new stores, relocate three to five stores, achieve daily average comparable store sales growth of between negative 2% and 2%, achieve diluted earnings per share between $0.60 and $0.70, and we expect capital expenditures for the fiscal year in the range of $28 to $35 million. Our current expectation for new store growth in 2021 is and over the next several years is consistent with recent trends. Our 2021 outlook reflects our expectation that comps in the first quarter and in January and February of the second quarter will remain consistent with the comp trend in the fourth quarter of 2020. In March, we will anniversary the start of the COVID-19 pandemic. As you will recall, our comp was over 40% in March of 2020. In the second half of the fiscal year, we anticipate comp to be roughly flat. We anticipate slightly higher year-over-year gross margins in the first half and flat year-over-year margins in the second half of the fiscal year. We anticipate store expenses as a percentage of sales will be higher as a result of higher labor-related expenses through the second quarter and then will level off as we anniversary increases implemented in the second half of 2020. In closing, we had a strong record-setting year that we attribute to our commitment to our principles and values and the dedication of our crew. We are confident in our outlook for 2021. With that, I would like to open the lines up for questions. Thank you.

Thank you. 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're 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 Greg Battish-Kanion with Wolf Research. Please go ahead.

Good afternoon. This is Spencer Hannes on for Greg. Congrats on a nice quarter, guys.

Thank you.

So I guess my question was just on the comp trends that you're seeing quarter to date. Can you quantify what those are running currently? And then are you seeing any signs of consumers stocking up again as the virus rises in parts of the country? And has the supply chain shown any signs of weakness given the rising cases?

Well, currently, comp trends are running similar to how they ran in quarter four as far as Supply chain, we haven't seen. We've actually seen improvement in supply chain in stock over every month essentially since about May. As far as people stocking up, they are stocking up slightly but not significantly compared to how they did in March of this year.

That's really helpful. And then, can you talk about the components of the gross margin expansion that you saw during 4Q? And as we look to 2021, how much of the gross margin benefits that you saw in 2020 should we expect to stick next year?

Thank you, Spencer. So, the drivers have been less promotional activity. Most of the promotional activity has been supported by vendors. We see that continuing into the first half of 2021. We would expect to see elevated margins similar to where we were in Q4 through the first half. And then margins should, when we hit March, level off. And March would probably be down on a year-over-year basis because of how strong March of 2020 was. And then the second half of the year, we would expect to be about flat on a year-over-year basis.

Okay. And I think you mentioned that e-commerce sales slowed a little bit on Instacart. Can you talk about what the percent of sales e-commerce represents today? And how sticky do you think those sales will be next year in that channel?

Sure, Spencer. So we don't give the exact data out on our Instacart sales. It represents a couple percent of our total company sales, and that would compare to a little bit less than 1% in the prior year, like, say, fourth quarter. And we've seen that moderate in Q4 versus Q3. So, it's hard to say long-term how sticky that will be. Certainly, while the COVID environment is challenging, there will be some customers opting for delivery.

And then the final one is just on unit growth. I think your guidance calls for five to six new stores next year, which is less than 5% growth that you've run in some years in the past. When do you think there'll be an acceleration in new units, and how are you thinking about new unit growth here?

Right at this moment, we don't anticipate accelerating our growth beyond the five to six units that we're planning on growing next year. We think that moderated growth is prudent and is helpful to us so that we can make sure that we pick premium sites and that we can keep on giving operational excellence in our new stores.

Great. Thank you, guys. Thank you. Thanks.

Again, if you'd like to ask a question, please press star, then 1. Showing no further questions, this concludes our question and answer session. I would like to turn the conference back over to Kempfer Isley for any closing remarks.

Thank you very much for joining us to discuss our fourth quarter results. We remain confident in our business based upon our 65-year history. We look forward to speaking with you on our next call to review our first quarter 2021 results. Please stay healthy and safe and have a great day. Thanks. Goodbye.

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