North West Company Inc. (The)

Welcome to the Northwest Company, Inc. Second Quarter Results Conference Call. I would now like to turn the meeting over to Mr. Dan McConnell, President and Chief Executive Officer. Mr. McConnell, please go ahead.

Thank you very much, and good morning and welcome to the Northwest Company Second Quarter Conference Call. I'd like to start off by introducing John King, our Chief Financial Officer, and Amanda Sutton, our VP of Legal Corporate Secretary. Actually, we're residing today over in Sitka, Alaska, where we just concluded our board meeting, so it's been a delight. But I'm going to start off by asking Amanda to read our disclosure statement.

Thank you, Dan. Before we begin, I remind you that certain information presented today may constitute forward-looking statements. Such statements reflect Northwest's current expectations, estimates, projections, and assumptions. These forward-looking statements are not guaranteed the future performance and are subject to certain risks which could cause actual performance and financial results in the future to vary materially from those contemplated in the forward-looking statements. For additional information on these risks, please see Northwest's Annual Information Forum and its MD&A under the heading Risk Factors. Jen?

We continue to hold our ground in overall top line sales. These are rapidly changing economic times for our customers and our business. The conditions of the current quarter are different from the same quarter in 2021 and 2020. Increase in community spending over the past two years was fueled largely by COVID-19 related income support payments, which has been substantially eliminated, as well as by travel restrictions that are no longer in place. This translated into softer same store sales into last quarter, our bottom line continues to be impacted by inflationary cost pressures, particularly with freight and general merchandise costs increases, but we have also seen some of our expense lines, such as utility costs, trend higher. That said, our results continue to be strong, especially if we compare it to the pre-pandemic levels in both sales and earnings gains compared to 2019. I'll start by providing some colour around our consolidated results before diving into our results by division, including the airlines. Okay, in terms of sales, second quarter consolidated sales increased 2.4% to $579 million with the international operations mitigating softer sales in Canada. On the same store basis, sales were down 4.1% as we continue to cycle through COVID-19 related factors that resulted in significant sales gains over the past two years. However, it's worth noting that compared to 2019 pre-pandemic levels, Same-store sales are up 16.3%, with food up 16.2%, and general merchandise up 17.1% to the quarter. In general, the trends from the previous quarter have continued into the second quarter as our customers are trying to adapt the best they can to a new reality of lower income support and higher inflation. Our gross profit rate was down 1%. quarter mainly due to the impact of a higher fuel-related freight and merchandise cost inflation that was not only passed through on retail prices, but also was combined with a change in our sales plan. Like many other retailers, we have also had some higher markdowns on seasonal and general merchandise. As highlighted in previous quarters, our focus has remained on maintaining keeping our momentum on sales and closely monitoring competitive pricing levels. The speed at which some of these cost increases are coming through, particularly some like the fuel prices and surcharges on freight, are challenging to manage, especially as we maintain a balanced approach, as I just described. Our teams are diligently monitoring costs, maintaining disciplines around purchasing and pricing, and engaging in conversations with our vendors and freight carriers to help mitigate pressures over margins. Now in terms of inventory levels, we have highlighted over the past couple of quarters the importance of maintaining our in-stock position on key items that our customers need. This is particularly important for sea lift and winter road stores in Canada in order to maximize efficiencies on our supply chain costs as well as getting ahead of some product shortages that still persist. As we noted in our report, a large portion of the increase in inventory is due to centre store grocery and core categories such as transportation, home furnishings and appliances. We do have some pockets of inventory and apparel in other seasonal categories that we're watching closely as we approach this holiday season. Below the gross profit line, our operating expenses increased 5.1% in the quarter, and this is largely due to inflationary cost pressures and the impact of the new stores in Alaska. The combination of all these factors resulted in a decrease in net earnings in the quarter of $32.4 million compared to $42.4 million last year. However, after adjusting for share-based compensation and insurance gains last year, adjusted net earnings were up 13.2 million, or 63.9%, compared to pre-pandemic earnings in the second quarter of 2019. That's the overview of the consolidated results for the quarter. Let me just take a moment now to provide some additional color around our Canadian and international operations. Canadian operations came in at $323 million and were flat to last year as airline and fuel revenues mitigated softer performance retail sales. Within the current high inflation environment, we continue to see consumers' spending shift away from discretionary general merchandise and over to food. Again, I think it is important to point out that all of our sales are down compared to To point out that all of our sales are down compared to the strong COVID-related sales over the last couple of years, our same-store sales are up 17% compared to pre-pandemic sales in the second quarter of 2019. In terms of the airline performance, North Star Air's revenue increased on the back of higher passenger volumes as travel restrictions get lifted, coupled with increases from fuel surcharge rates on both cargo and the passengers. To provide some perspective on this, jetty fuel costs increased. It was around 60% compared to Q2 of last year. This increase drove top-line sales as we've been taking steps to pass through these costs increases the same way other carriers in the industry have been doing this inflationary cycle. Having said that, this fuel-related increase in sales is a pass-through cost, so it had a deflationary impact on our gross profit rate. The increase in jetty fuel costs is also an example. higher freight costs have had on our retail gross profit rates. On the international side, sales increased 1% to $199 million, led by the impact of the new Alaska stores and improved tourism compared to last year in territories like the BVI, which mitigated softer sales performance as we cycled through the impact of income support payments from the American Rescue Plan last year. While the impact of an increase in tourism was a positive factor in the PBI, and to some extent in Alaska, we did see the impact of lower travel in other Caribbean markets. I will also point out that we did not have the sales of USDA farmers to family food box programs that we had last year in Alaska. In addition to these top-line factors, the earnings in Canadian and international operations were impacted by the gross profit and expense factors I previously mentioned. which they expect to cycle through by the end of this year. Having said that, we do expect earnings in the second half of this year to be lower than last year, but meaningful above pre-pandemic levels. In international operations, the PFD payment will be $3,200 compared to $1,100 last year, which will help offset the impact of the increase in SNAP benefits that occurred in the third quarter last year. In the short term, we will double down our focus and pricing across the entire organization. Our customers and communities are continuing to adapt to lower income support and high inflation, and we are focused on ensuring our essential products and services offerings meet the customer's needs. With that, let me open it up for any questions that you might have. Thank you.

Thank you. We'll now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star 1 on your device's keypad. You may answer your question at any time by pressing star 2. Please press star 1 at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. Next question is from Michael Van Elst from TD Securities. Please go ahead.

Great. Thanks very much. I'm wondering if you could help us understand where out of community spending is roughly in Q2 relative to pre-pandemic levels and if you see that changing much more going forward. Do you see it getting back to 2019 levels or somewhere in between?

Okay, Michael, you know what? Could you just repeat the beginning of your question, please? yeah so i'm trying to understand where the out of community spending is uh relative to pre-pandemic levels okay well okay so so to pre-pandemic levels uh well as you can see our sales are still considerably higher than they were pre-pandemic levels i i expect that uh for the remainder of this year we're going to see some uh it's going to be i think we're going to be meaningfully above 2019, but obviously less than the last two years. People, I think, because of now the increases in fuel will prevent people from probably leaving the market as they might have done in 2019. So I think it will be meaningfully above 2019, but obviously considerably down from the last two years. And then kind of cycling through this for the remainder of this year, I expect that income levels will be considerably higher in Q1, Q2 of 2023 because of some of the things that we've talked about in the previous calls with some of the income that will be filtered into the market through some of the settlement payments.

Can you remind us the magnitude of those settlement payments and how much of an impact it can have on the income?

Well, I would say there's a couple out there. I think you probably want to, I mean, one of them, they're in the billions. So depending on which one, there was the water settlement you might want to take a look at. And then also the home care. I'm sorry, I can't remember what it was. How was it termed, John? Child care. Child care payment that's going to be issued again. And I think about Q2 of 2023 is what we're predicting currently. But then also to do it on a consolidated basis, as I indicated, there is going to be some incremental income, particularly in Alaska through that PFD, which is more than almost tripled from what it's been in historical levels.

Okay. And you said that would be offset by lower SNAP benefits?

You got it.

What's the magnitude of the offset?

Michael, the SNAP benefits were increased last year, and I don't have the quantum in terms of the direct offset from the PFD, but when you look at the payments in total, we would expect the PFD this year to comp the benefits that were paid out last year. And there were a number of them, whether it was SNAP, there was some school payments to schoolchildren in the U.S., Certainly in Canada, we saw the tail end of the COVID income support payments in Canada continued certainly into Q3. By Q4, they were largely being phased out. So that, and just to clarify, the comp that we're talking about was in the international operations, obviously the PFD to the SNAP. But, you know, in addition to that, we also had the COVID payments from last year that we're up against in Q3.

Okay. All right. And then you talked, you mentioned that you still expect the second half of 22 to be below the second half of 21. The first half, if we look at, EBITDA excluding stock-based comp, you're down kind of low double digits. Are you expecting that pace of decline to moderate meaningfully?

I would say it's, no. I think it's going to be around the same. I would suspect it's going to be around the same or somewhat better.

Sorry, somewhat better.

Yeah, I think maybe I'll jump in Michael in terms of the quarters. If you look at as as Dan said, will be that gap to last year will continue certainly through Q3. We had a very strong Q3 last year. We talked about the payments that came through, particularly in Canada. The last we'll call it tranche and cycle of payments for COVID. We saw some travel restrictions last year, It won't be until Q4 that we really start to, and the latter part of Q4, quite frankly, that we really start to see the cycle through. And even in Q4, as I think about last year, we had some work travel restrictions that came on, I think later in the quarter with variants and so on. So it really will be until the end of the year that we take the cycle through this.

Got it. Okay, and then finally, when you talked about gross margin and not fully passing on the higher costs, you talked about trying to balance the pass-through with the competitive activity and whatnot. Can you just give us a little bit more color as to what's actually going on there? Is it more competitive pressures that are holding you back, or are you trying to actually invest to improve your relative positioning, or what?

There's a little bit of both. Uh, but I would say that it's, uh, more so it's cost inflation has been happening at such a rapid pace. It's, uh, to be frank, it's just really trying to capture all those costs that you can pass on. And obviously, uh, you can't, uh, some of the times that when you're going into this scenario, you just have to, uh, if it will lead to the discontinuance of different products that you might be offering, or now it's just up to us to adjust to the, to the new times we're looking at other ways to maintain and, and, uh, our margins, and that's through making substitutions with other lower-cost products, but obviously keeping our gross profit dollars and rate in such that we think we're going to improve the situation from where we are today. It's both, but I wouldn't say at the end of the day our competitors are going to be faced with the same increases. If it takes them a little longer to catch up, it's a pretty eye-opening experience when get their next invoice of inventory. So I don't think that is going to be a longstanding systemic issue at all. And if anything, I think it's going to allow us to take further ground on our competitors. But it is a factor currently, but it's not the biggest factor by any stretch.

Why would it take a longer time for your competitors to see the cost increases?

It's not as much see them, but it's maybe reacting to them. So that's how, but like I said, it's not the biggest factor. It's maybe 25%, 20% of it, but it's a learning that comes quickly. And it's just because, I mean, we have, there's been instances where you've had product increases of, you know, sometimes 60% over, you know, a very short duration of time. So it's caused definitely some delays and just being able to react to some of those cost pressures and be able to reflect that in your retail pricing. But again, it's not the leading cause of our margin erosion.

Okay, thank you. Thank you. As a reminder, you may press star one if you have a question. The next question is from Stephen McLeod from BMO Capital Markets. Please go ahead.

Thank you. Good afternoon, guys, or good morning. I just wanted to clarify one thing. When you talked about back half earnings being down year over year, was that consolidated or are you talking about just the international business? I think I understood it as consolidated, but just want to clarify that.

That's right. No, you're right. It's consolidated. Yeah.

Okay. Okay, great. Thank you. And then just when we think about gross margin, lots of good color around some of the cost increases that are coming through. Sounds like you'll see some pressures on the back half of this year. But do you see any sort of life at the end of the tunnel as you get into fiscal, the next fiscal year, sort of Q1, Q2, when you begin to cycle some of the declines from this year?

Absolutely. Yeah, we're quite optimistic, actually, for some of the reasons that I mentioned previously. We do think that it's going to be a delightful experience. as opposed to obviously having some of the decreases that we've experienced now, even though it was expected. I mean, we had nearly doubled our business, obviously, during COVID-19 on an earnings perspective. So it was expected, but it's still never easy to take. But we're definitely gearing up and we feel we're in a really good place, a lot better than we were coming out of 2019 or going into 2019, I should say. So, yes, I would say the horizon is optimistic. Okay.

And is it fair to say that when you're talking about the earnings weakness in the back half of the year, is it a combination of just those sales headwinds as you comp against some of those income programs, as well as gross margin headwinds in the back half of the year? You got it. Yeah. Yeah. Okay. Okay, great. Thank you. And then just one final one, thinking about the inventory composition, you gave some color in your prepared remarks. How much of that inventory is sort of seasonal product that you might have to face, you might have to put for the markdowns on?

We feel like we've actually managed it fairly well. We're coming into a big selling season. We've modified our purchases to adjust to our big selling seasons, our Black Friday events and some of the bigger selling events we have in Q3. So I think that we're sitting well. We anticipated this knowing our business. We knew the amount of money that was in the market obviously last year. It's never an exact, I wouldn't say we hit it right on the head, but we definitely were more cautious doing our general merchandise buys through 2022. So I don't feel that we're in a tough position going on into the third and fourth quarter this year on our general merchandise. Right.

Okay. Okay, great. Thanks, Dan. And then I just wanted for John, just curious if you could give a little bit of color, if you have any insight or views into the tax rate for the balance of the year.

Nothing more to add, Stephen, than what we put in our report. I mean, it does fluctuate around based upon the earnings across the different jurisdictions that we're in. Really, that's it. You always have some... you know, non-taxable items and things like that. But that, you know, that's all I would comment on on that.

Yeah. Okay. Okay, that's great. Thanks, guys. Appreciate it.

Thanks, Stephen.

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. McConnell.

Thank you very much, and I appreciate the opportunity the questions and we'll look forward to speaking with you next quarter. Thank you.

The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.