Natural Grocers by Vitamin Cottage, Inc.

Good day, ladies and gentlemen. Welcome to the Natural Grocers Second Quarter Fiscal Year 2022 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 now like to turn the conference over to Ms. Jessica Thiessen, Assistant Treasurer for National Grocers. Natural Grocers. Ms. Thiessen, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage second quarter fiscal year 2022 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 10Q and 10K. 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, everybody. We are pleased to report strong results for the second quarter of fiscal 2022. Like many retailers, during this period, we experienced challenges related to the pandemic, labor availability, and supply chain constraints. We believe our second quarter results demonstrated the strength of our business model to effectively respond to a dynamic operating environment. We were able to grow daily average comparable store sales by 4.3%, gross margin by 50 basis points, and diluted earnings per share by 33.3%. While comp sales was positively impacted by retail price inflation, it is important to note that transaction count comp has had a year-over-year increase for four consecutive quarters. Our second quarter comp sales was up a strong 13.5% relative to 2019, or pre-pandemic levels, reflecting consumers' continuing demand for our differentiated offering. Our unwavering commitment to our founding principles including offering the highest quality natural and organic products at always affordable prices, coupled with free science-based nutrition education, remain a key element of our success. These principles are particularly relevant as consumers are demonstrating a sustained commitment to prioritizing health and wellness. Our unique approach to marketing and promotional activity continues to drive high levels of customer engagement and sales growth. For example, in the second quarter, we offered a 21 Days to a Healthier You program, which featured a free series of nutrition education classes, each with an accompanying seven-day challenge. The program was developed by our nutrition education experts and covered several key topics, including eating for health and vitality, kicking sugar cravings, and a healthy approach to detoxifying. Customers who attended the in-person or live virtual class led by the store's nutritional health coach received a customized coupon book featuring Natural Grocers brand products curated to support participants in achieving each nutritional challenge. This cross-functional program is a good example of our differentiated marketing and offering. Our NPower loyalty program continued to grow, evidencing our deep and ongoing engagement with our customers. We ended the quarter with more than 1.6 million loyalty members, a year-over-year increase of 19%. The second quarter net sales penetration for NPower was 73%, consistent with the first quarter, and up from 70% a year ago. Aligned with our company branding, our natural grocers brand products, FUSE, premium quality products with affordable prices, creating a key point of differentiation that drives loyalty and sales growth. Our National Grocers brand products accounted for 7.7% of net sales in the second quarter, up from 7.3% in the second quarter of last year. During the quarter, we launched eight new branded products, including a line of truffles made in France and additional dietary supplements. Three weeks ago, we opened a store in Canyon City, Colorado, and we are very pleased with the community's response to our first store in their market. Opening new stores and relocating stores has been challenging over the last two years due to delays related to the construction process and equipment availability. Accordingly, our fiscal 2022 new store opening schedule has always been back and waited to reflect these challenges. We are pleased with our progress on the fiscal year 2022 stores, and we remain on track to open four to five new locations and relocate two stores. In future years, we expect to return to opening between six and eight new stores per year, subject to improving construction conditions. In closing, I want to thank every member of our Good4U crew for their execution of our operating strategies, including a commitment to exceptional customer service, which was instrumental in driving our strong quarterly 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 strong second quarter results were above our expectations, reflecting favorable sales growth and expense leverage. Our second quarter net sales increased 4.9% on a year-over-year basis to $271.8 million. Daily average comparable store sales were up 4.3%, average transaction size rose 2.5%, and average transaction count increased 1.8%. We experienced product cost inflation of approximately 5% during the second quarter, a slight uptick from the first quarter. Historically, our specialized supply chain has yielded more stable inflation rates than conventional groceries. We continue to pass along the cost inflation impact via pricing, and to date we have not observed customer trade down in response to the inflationary trends. Out of stock levels at the end of the quarter were in line with the levels we have been experiencing over the previous four quarters, although out of stock levels did increase for a few weeks in January. The strong sales performance and expense leverage helped drive margin expansion in the second quarter. Gross margin increased 50 basis points to 28.2%, which was primarily driven by improved product margin and store occupancy leverage. Store expenses as a percentage of sales decreased 60 basis points as our strong sales performance drove expense leverage. Like many retailers, we experienced an increased level of constrained labor availability in January, which improved in February and March. Overall, the quarter had lower labor hours compared to the second quarter of last year, which offset higher labor rates. Operating income increased 32.2% to $8.9 million, and operating margin improved 70 basis points to 3.3%. Net income of $6.4 million was up 35.1% year-over-year with diluted earnings per share of 28 cents compared to 21 cents a year ago. Adjusted EBITDA increased 11.8% to $16.1 million. Turning to the balance sheet and cash flow, our financial position remained strong at the end of the second quarter with $28.9 million of cash and cash equivalents. We had no outstanding borrowings under our $50 million revolving credit facility and a $19.7 million balance on our term loan. During the first six months of fiscal 2022, we generated cash from operations of $27.6 million and invested $12.3 million in net capital expenditures, resulting in free cash flow of $15.3 million. Today, we announced that our Board of Directors has declared a quarterly cash dividend of 10 cents per share of common stock. The dividend will be paid on June 15, 2022, to all stockholders of record at the close of business on May 31, 2022. Now, turning to our outlook for fiscal 2022. We are raising our full-year sales and earnings outlook previously established on November 18th, 2021. Our updated outlook is based upon the strong first half results, current trends, and our expectations for the second half of the fiscal year. The outlook considers the uncertainty of the pandemic, economic and inflationary factors, and supply chain trends, which are expected to impact our operations and financial performance through the balance of fiscal 2022. Our full year guidance includes the following. Open four to five new stores, relocate or remodel two stores, achieve daily average comparable store sales growth between 1% and 3%, achieve diluted earnings per share between 85 cents and 96 cents, and direct 28 to $35 million towards capital expenditures to support our growth initiatives. In closing, we had another strong quarter that we attribute to many factors, but foremost, our customers' high levels of engagement with our differentiated and relevant business model, our consistency, and the dedication of our crew. We continue to be encouraged by our operating trends and are confident in our ability to drive growth and enhance value for all stakeholders. 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 1 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 2. At this time, we will pause to assemble our roster. Our first question comes from Greg Badish-Cannion with Wolf Research. Please go ahead.

Hi. Good afternoon. This is Spencer Hannis on for Greg. Can you just talk about your unit trends throughout the second quarter?

In regards to our unit trends? In basket? In basket size? Yeah, in basket size. It was very consistent with our last quarter, and it's up about 12% compared to 2019. We didn't really see any decline. We saw a very steady number of units per transaction in our baskets.

Got it. That's helpful. And then how are you guys thinking about inflation as we go throughout the rest of the year? Are you expecting a moderation, or do you think it will continue to move higher as we look into 3Q and 4Q?

I think it's going to probably stay about where it has been. We've been seeing about 5% inflation, and I would expect that we'll see that for the remainder of the year. I don't see it moderating very much.

That's helpful. And then how are you thinking about gross margins throughout the year? Obviously, you posted good margins again this quarter, but how should we think about the sustainability as the comps in the supplements categories gets tougher later this year?

I think we'll probably be able to be about flat compared to last year. I don't think we'll have a lot of gain because of how hard it will be to comp in the supplement category coming up in the fourth quarter of this year. But I think we should be at least able to maintain our margin for the rest of the year. The price inflation is actually kind of a tailwind to our margins. we should be able to keep with those steady price increases, we should be able to keep our margin pretty steady for the rest of the year.

Great. Thank you so much. Thank you.

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

Thank you very much for joining us today. We are proud of our performance in the second quarter, including the 4.3% sales comp and four consecutive quarters of positive transaction count comps. In the quarter, we were able to pass along our cost inflation of approximately 5% through price, which also, well, also generating gross margin growth of 50 basis points. The size of the basket over the past four quarters has been consistent at approximately 45 dollars. And the second quarter item count per basket was in line with the average count we have seen over the last four quarters. Our item count per basket has increased by 12% compared to pre-pandemic levels in 2019. Additionally, we did not see customer trade down. For example, in eggs where our minimum standard is free range, customers have a choice to trade down from pasture to organic or free range in quantities held up across each category. This culminated in a net income growth of 35.1%. And we are proud of our history of providing the highest quality natural and organic products at always affordable prices to the communities we serve. We look forward to speaking with you on our next call to review our third quarter 2022 results. Please stay healthy and have a great day. Thank you. Goodbye.

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