Natural Grocers by Vitamin Cottage Inc (NGVC) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Natural Grocers third Quarter fiscal year 2014 earnings conference call. At this time all participants are 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 would now like to turn the conference call over to Mr. John Bourne, Vice President, General Counsel for Natural Grocers. Mr. Bourne, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage third quarter and year-to-date fiscal 2014 earnings conference call. On the call with me today are Kemper Isely, our Co-President, and Sandra Buffa, our Chief Financial Officer, as well as Ashley MacLeod our Director of Investor Relations.

Before we start let me remind you that all statements made in this conference call, other than statements of historical fact, are forward-looking statements. All forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from those described in the forward-looking statements because of factors such as industry, business, strategy, goals and expectations concerning our market position, the economy, future operations, margins, profitability, capital expenditure's, liquidity and capital resources, other financial and operating information and other risks detailed in the Company's most recently filed Forms 10-Q and 10-K.

The information we present is accurate as of the date of this call. The Company undertakes no obligation to update forward-looking statements. The Company's earnings release was issued and made available this afternoon. The discussion that follows assumes you have had the opportunity to read this release. The release, along with a transcript of a recording of this call and reconciliation of a non-GAAP measure used by us, will be available at our website at www.investors.naturalgrocers.com for a minimum of 30 days. If you have not had the opportunity to read the release we recommend that you read it in conjunction with or after this call.

Now, I will turn the call over to our Co-President, Kemper Isely.

Thank you, John. Good afternoon, everyone. We are pleased with our financial results this quarter. Our increased sales and disciplined approach toward operating expenses have resulted in solid financial results which allowed us to continue our investments into growth. During the quarter net sales increased 18.4% to $134 million.

Our daily average comparable store sales increased 3.1% during the quarter and we experienced positive sales trends across all departments. Gross profit increased to $38.6 million and we continued to see leverage in administrative expenses. Net income increased 16.6% quarter-over-quarter and our diluted earnings per share were $0.15 this quarter compared to $0.13 in the prior comparable quarter.

We opened 3 new stores during the quarter and expanded our geographic footprint in Oregon, Utah, and Washington. Our new stores are performing in line with expectations and we remain on track with our new store pipeline. We plan to continue our 20% unit growth into fiscal 2015 by opening 18 new stores.

We are excited about the increasing demand for natural and organic food and believe this supports the growth opportunity we see ahead of us. And as discussed last quarter our comparable store sales have recently been impacted by increased localized competition. And we are currently testing different marketing and advertising initiatives to address this.

Additionally, our operational excellence continues to be a priority. We continue to be the leader in high-quality standards to further distinguish ourselves from our competitors. This quarter we changed our chicken supplier to selling non-GMO and organic chickens at a better price than before. The lower price on chickens impacted our daily average comp sales by 15 basis points during the quarter. Additionally, our updated dairy standards continue to receive very positive feedback and our customers appreciate our commitment to quality standards.

Now, I will turn the call over to Sandra to highlight our financial results.

Thank you, Kemper. And good afternoon, everyone. We are pleased to report net sales increased in the third quarter of fiscal 2014 to $134 million or 18.4% over the same period in fiscal 2013. Comparable store sales increased 2% quarter-over-quarter. Daily average comparable store sales increased 3.1% quarter-over-quarter driven by a 1.3% increase in daily average transaction count and a 1.8% increase in average transaction size.

Daily average mature store sales increased 1.6% quarter-over-quarter. Gross profit during the third quarter of fiscal 2014 increased 18.5% to $38.6 million driven by an increase in the number of new stores. Gross profit was negatively impacted in the third -- in the 3 months ended June 30, 2014 by one less selling day for the occurrence of Easter in April of 2014 versus March of 2013.

Gross margin was consistent quarter-over-quarter due to increases in product margins across almost all departments, as well as operating efficiencies at the bulk food repackaging facility, offset by an increase in occupancy cost as a percent of sales. The increases in product margin were partially offset by a shift in sales mix.

The stores that were accounted for as capital leases, rather than being reflected as operating leases, increased gross margin as a percent of sales by approximately 55 basis points in the third quarter of fiscal 2013 and 2014. Store expenses increased 50 basis points to 21% of sales during the quarter. This was driven by an increase in salary related expenses, depreciation, and advertising expenses and to a lesser extent, an increase in utilities, all as an percent of sales.

Administrative expenses as a percent of sales decreased 20 basis points quarter-over-quarter as a result of the Company's continued ability to support sales growth without proportionate investments in overhead. During the third quarter of fiscal year 2014 both store and administrative expenses were favorably impacted by lower incentive compensation and other discretionary benefits expense reflecting our pay-for-performance philosophy.

During the quarter net income increased 16.6% to $3.4 million with diluted earnings per share of $0.15. EBITDA increased 22% to $10.6 million or 7.9% of sales in the third quarter. The stores that were accounted for as capital leases rather than being reflected as operating leases increased EBITDA as a percent of sales by approximately 55 basis points in the third quarter of both fiscal 2014 and 2013.

Turning briefly on to our year-to-date results net sales increased 22% including a 6.3% increase in daily average comparable store sales. Net income increased 23.6% to $10.3 million with diluted earnings per share of $0.46 year-to-date fiscal 2014.

Balance sheet and liquidity highlights are as follows; as of June 30, 2014 we had $6.6 million in cash and cash equivalents with no amounts outstanding on our revolving credit facility. Year-to-date fiscal 2014 we generated $23.5 million in cash from operations and we invested $26.9 million in property and equipment, primarily on new stores.

Now, I will turn the call back to Kemper to discuss our new store growth and updated outlook for the remainder of fiscal 2014.

Thank you, Sandra. As I mentioned at the beginning of the call we continue to invest into new store growth opening 12 new stores year-to-date, bringing our total count to 84 stores in 14 states. We have signed leases for the remaining 3 stores planned to open in fiscal 2014 and have 7 signed leases with stores planned to open after fiscal 2014 which include 2 new states Arkansas and Nevada. By the end of fiscal 2015 we expect our geographic presence will expand to at least 16 states west of the Mississippi.

We are pleased to announce that during the quarter with substantially completed the implementation of our new Human Resource Information System continuing our strategic initiatives to support future growth. We are consistently focused on managing and controlling our growth and we see this as a positive step to support and enhance our ability to onboard, train, and communicate with our employees.

Moving now to our updated outlook for fiscal year 2014 we remain confident in our previous guidance and are narrowing two ranges based on our third quarter results and expectations for the remainder of the fiscal year. Specifically, we are updating our daily average comparable store sales outlook for fiscal 2014 to 5.5% to 6% and updating our diluted earnings per share outlook for fiscal year 2014 to $0.58 to $0.61. Our fiscal 2014 guidance for net income and EBITDA margins and CapEx will remain unchanged. We have clear direction on how we intend to manage expenses and margin going forward while we work on various initiatives to increase sales.

Additionally, I would like to give some color to our initial outlook for fiscal 2015. In fiscal 2015 we anticipate unit growth of 20.7% or 18 new stores. Sales growth is approximately 20%, EBITDA growth of approximately 8% to 12% and net income growth of a proximally 6% to 9%. Our fiscal 2015 outlook for EBITDA and net income growth reflects the Company's goal to grow our store base at 20% and also find incentive compensation and other discretionary benefits above the fiscal 2014 level to recognize the important contribution our employees make to the Company's growth and success.

Over the 3 years following fiscal [2015] we expect our EBITDA and net income growth to average 20%. Based on or initiatives to drive sales growth we believe we will return to the growth levels I just outlined. These opportunities include reviewing online delivery opportunities, redesigning our website, and more fully utilizing our demonstration kitchens. We are confident in these future growth opportunities and believe the demand for natural and organic food is only expanding. We are encouraged by our demonstrated ability to expand our presence geographically while expanding the top and bottom line. We remain true to our 5 founding principles and continue to focus on what differentiates us, offering unique natural and organic products at affordable prices. We continue to gain trust and loyalty from our customers through our high quality standards and nutrition education.

I have a few additional items to highlight. First and foremost we remain committed to our 20% unit growth rate with plans to open 18 new stores in fiscal 2015. We are also continuing to update our older stores and have plans to remodel two stores next year and relocate 3 stores, all of which are over 15 years old. We expect to continue to remodel and relocate stores in further years. Second, we will more fully utilize our demonstration kitchens. We recently expanded the Nutritional Health Coach job description to include hosting cooking and educational events. We have already seen an increase in the number of events and plan to see this continue. We are also implementing more community events, these are relationship-building opportunities, these events include doctors, practitioners, nutritionists, healthy living bloggers and authors, cooks and activist living in our communities. This is a great way for us to engage with the community, increase awareness around our high-quality standards, and help educate our customers. Third, we continue to be the leader in high-quality standards with our updated dairy standards and non-GMO chicken offerings. Fourth, we have various sales initiatives in place which include improving and updating the signage in our stores to clearly emphasize our standards and help educate our customers.

We are currently redesigning our website to help simplify and create a more user-friendly environment. We are also currently vetting partners for digital coupons and home delivery options. Additionally, we have recently tested extended hours at certain stores in response to customer requests and have already seen positive results.

And lastly, we remain focused on our employees. Our fiscal 2015 outlook includes our plan, if performance and financial goals are met, to fund incentive compensation and other discretionary benefits above the fiscal 2014 levels. Our employees are a huge contribution to our growth and success and it is very important to recognize them.

One final point I would like to make is that one of our greatest strengths is that we have a plan to grow our Company at a rapid pace. And we have the infrastructure in place to implement this plan.

Now, I would look like to open the lines up for questions. Thank you.

Ladies and gentlemen, at this time we will open the call for questions. (Operator Instructions). Our first question today comes from David Magee from SunTrust. Please go ahead with your question.

Hi, everybody. My first question just has to do with the rate of EBIT growth that you're forecasting for next year being what below that is a anticipated sales gain. I'm coming up with a number, a differential of maybe about $3.5 million as for the extra costs that may be on the [P Note] next year. Is that all related to the discretionary expenses or items that you referred to?

It is primarily related to that, that is correct.

Is the thought that folks haven't been compensated fairly for the last year or so, and this is a catch-up effort in that regard?

We believe everybody has been compensated fairly but we believe that we need to have discretionary incentive compensation available in our budget. So we decided that we needed to include that in the budget to keep our employees engaged and motivated.

So, this doesn't reflect any change in your thinking about how the stores are performing?

No.

And do you still anticipate a step down in terms of the competitive headwind, the new headwinds?

Yes, in about the middle of next year we expect the headwinds to decrease substantially.

Do you mean the middle of calendar --

Of our fiscal year next year.

Your, fiscal year. Okay.

We expect it to be at the 28% of our store base with new competition as compared to 53.7% at the end of quarter 3.

And do you think your stores will respond in line with your expectations as the competition has lessened?

In the past they have definitely responded. A year after competition opens our stores tend to respond very well with new growth.

Okay. Great job, thank you.

Thanks.

And our next question comes from Sean Naughton from Piper Jaffray. Please go ahead with your question.

Hi, thanks for taking my questions.

Hi, Sean.

Hi, Kemper. When we just look at the categories you guys are competing in, the grocery sales, supplement sales, other sales, it looked like supplements took another step down in growth. Was there anything specific there or was that more -- are you seeing anything in the basket that would lead you to believe that there may be some slowdown in that category? Or is it more a function of just the transactions being a little bit more challenged in the stores?

Well, the growth for the category for the quarter was around 13% and overall our sales were up 18% so that is the loss in the category as a total part of our sales. I think as a percentage it is trending similar to how it has all year. It has been about -- growing at about 75% of what our overall growth has been. And so because our overall growth slowed a little bit, it slowed a little bit to the quarter. Does that make sense to you?

It does, that is helpful. And then when we -- talking a little bit more about 2015, when I am looking at the guidance, I think you have got a 20%, approximate 20% top line growth number in there. Do you guys have a comp that you are thinking about that would match up with that 20% number?

It will be fairly similar to what we had in 2014.

Okay. And then anything on your -- you were talking a little bit about some additional -- or maybe not additional but some more remodeling and some potentially more spending on some of those stores. Any idea on where CapEx shakes out for next year or are we still a little early on that number at this point?

At this point we're a little bit early on that number. I mean, it would be proportionately larger to what it was this year essentially. I mean, we have 20% more growth so it will be about 20% greater than it was this year.

Okay. That is helpful. And then one last question just on the, in the quarter it looked like some pretty nice product margin gains offset by some negative mix shifts there. Any way to kind of bucket the impact from, you know, gains on rate gains on like products versus the decline in occupancy? Just looking for orders of magnitude here?

Ashley do you want to answer that questions?

Hi, Sean. Basically in the quarter since external margin remains flat, it really was the product margin increase and then the occupancy cost decreased at the same rate.

Okay. So those were kind of the two big ones?

Yes.

Okay. Thank you.

Thanks, Sean.

And our next question comes from Mark Miller from William Blair. Please go ahead with your question.

Hi, everyone. I am looking for a little bit more color on the incentive comp and the discretionary benefits. Roughly how much of a benefit was that on the expense line, perhaps in basis points? And are you anticipating a similar reduction in the fiscal fourth quarter? And I'm trying to make the connection between this year and next, so if that is going to be an added cost year-on-year, does that basically represent you going back to normal and that fiscal 2014 is just lower?

Answering your last question first, it would be going back to normal in fiscal 2015 and fiscal 2014 would've just been lower. The exact number of basis points, I really don't want to get into.

Is the right way to think about it, Kemper, the difference between the sales growth and the profit growth next year you are saying is mostly incentive compensation. So if we calculate that drag on profitability that is basically the amount by which it is going down in 2014?

Correct.

It includes the other discretionary.

Yes, and it includes other discretionary benefits.

Okay. And then in terms of sales driving initiatives, in your mind, which of these are most impactful and have the most immediacy to them? And then specifically on the demonstration kitchens, maybe you just could bring us up to date on to what extent those are being leveraged and where have you had the greatest success with that? Thanks.

On our sales building initiatives the greatest impact that we are seeing right now is actually coming from some Living Social coupons that we did in June which were driving customer counts significantly in one of our markets. It is longer-term when you build the sales leverage at the demonstration kitchens because what you do is you get the community -- how do you say it?

Involvement.

The community involvement, the community, the people that are the most active in the community into your stores and then the word of mouth starts to build your store's business substantially because of that. The number of demonstrations that we are having in the kitchens is increasing substantially. It has more than doubled since we started really the focus on it and will probably, my guess, it will double again by this time next year. So that we will have -- be utilizing those kitchens on a much more consistent basis.

Maybe just one follow-up on that, thanks, it is helpful. Is, I assume that -- is that having a linear impact to sales then? Whatever sales come out of that by quadrupling that, do you expect a similar impact on sales? And as you think about that relative to the operating cost from that, is this viewed as a high margin activity or is it just important to drive traffic? Thanks

It is not really -- it is not a high margin activity but what it does is it educates the customer about the products in our stores and how to use the products in our stores. And so it exponentially drives sales and average ticket because then the customers that go to those events buy substantially more product in the stores after those events.

Okay. Thanks, Kemper.

And our next question comes from Scott Van Winkle from Canaccord Genuity. Please go ahead with your question.

The 3 locations you mentioned, Kemper, for next year, is that incremental to the 18? So, you know, a gross new opening of 21, net 18? Or is that 18 gross, net 15?

The 3 that we mentioned that are upcoming are opening in this quarter. So we have 2 stores opening here in August, one in Olathe, Kansas, one in Oklahoma City, Oklahoma. And then in September we have our Eugene, Oregon store opening. And we only are planning on opening 18 stores in 2015. We are planning on moving 3 of our existing locations in 2015 and we're planning on remodeling 2 of our existing locations in 2015.

Great. I wrote them down reverse, thank you very much. And then if you look at your comps here in the third quarter, if you look at a two-year comp, just rough numbers, it went from 25 in Q1, to 17 in Q2, to 14 in Q3, and your guidance is, you know, kind of low end of the range is the 14 level. So (inaudible) to assume that maybe we can correlate that with the percentage of your stores that have new competition that 53% number you threw out is the peak before we trend down towards 28% next year?

Correct.

Great. Thank you.

Our next question comes from Kate Wendt from Wells Fargo Securities. Please go ahead with your questions.

Yes, thanks. So, I am still, I guess, pretty confused about this incentive comp situation next year. If you are going to have similar rates of revenue growth why your incentive comp budget would need to go up so much and really pressure your earnage growth so significantly next year? And maybe you could help also provide -- in the past when you have done actually really extraordinary performance you have still been able to get really good leverage on your different expense lines. I don't understand, a piece of that is from higher sales flow-through, but I would imagine that there should be some sort of balance internally between the amount that you pay in incentive comp and the amount of growth that you are going to deliver on the bottom line. So if you can just kind of help us further understand the philosophy there? And then perhaps, what the dollar amounts of incentive compensation have been over the past couple of years versus what they are expected to be in 2015? Thanks.

Essentially what has happened this year is that incentive comp has been funded at about a quarter of what it normally has been running. Next year we are budgeting incentive comp and other discretionary benefits. And next year we think that it is very important to keep our employees engaged to increase the amount of incentive comp funding in the budget as long as our sales and financial goals are met. If we don't meet our sales and financial goals then, of course, those incentive comp and discretionary benefits won't be funded again next year. But we took this year's budget and then added those two next year so that we could get some funding into there. And that is the reason why there was a drop in our projected earnings growth and EBITDA growth.

Okay. So do you not have -- do you just set top line growth targets internally and not bottom line targets?

We do set them internal -- both we set all 3 internally, and, as I said, we made a decision that we would, for one year, not try to achieve the higher bottom line numbers so that we could afford to fund incentive comp because of how important it is to the employees at our company. If we don't have happy employees we are not going to be able to achieve our long-term goals. And our long-term goals are growth on the top line and bottom line, but short term sometimes you have to look at what your long-term goal is. As far as the dollar amounts, which was in your previous question, I think that David Magee was pretty accurate in his number that he threw out there.

Okay. And then obviously one of the main issues in terms of competition has been in your home state of Colorado. And if you could just talk at all to how trends have been since the grand openings of some of those stores that opened against you in Colorado.

Six months after opening we are noticing positive sales trends at many of the stores that were affected by those openings here in Colorado. Which is typical of what happens in the cycle. Usually it takes about a year for sales trends to reverse themselves and our stores to start gaining traction again after a new competitor opens.

Okay. That is good to hear but just on your fourth quarter guidance doesn't really seem to imply any improvement, in fact, maybe a little bit of further deceleration. So are there other events that are going on in other areas? Or perhaps is there a slowdown in comps outside of stores with new competition that is also occurring?

Or third quarter stores that didn't have competition were up around 11% which is 2 percentage points lower than it was earlier in the year but it is still in double digits so we are still doing pretty well with stores that didn't have additional competition. I think there was a little bit of deceleration in the quarter because a lot of our customers are independent, they own independent businesses and they probably ended up having to pay a lot of extra taxes on April 15 because of the new taxes that went into effect in 2013; and so that, I think, had a little bit of a negative impact on sales in the quarter.

Okay. Got it. Thanks so much.

Our next question comes from Joe Edelstein from Stephens Incorporated. Please go ahead with your question.

Hi, good afternoon. Thanks for taking my question.

Sure. How are you doing today?

Doing great, thank you. Can you just help us better understand on this incentive comp what level of the organization it is really targeted at? Is this a broad-based incentive plan all of the way down to the store level or is this mostly directed at corporate?

Our incentive comp program is comprehensive to everybody that works at the Company. So if you work here depending on your length of service, et cetera, you are included in the plan.

Okay.

Full-time, part-time, and the amount of comp depends on the level that you are at the Company too.

Okay. And you may have just answered a question in regards to Kate's question, but the consumer environment has been pretty choppy and so I was wondering if you could just sort of walk us through the cadence of your same-store sales. During the quarter it sounded like April got off to a rough start, but have we kind of stabilized from here?

I would say that we are looking better this month than we did during the last quarter.

And is that somewhat a result of running the summer hours? I understand they just went into place just a few weeks ago, only in a few select stores, but is that part of the driver? And then also, are you considering rolling those out to other stores, perhaps even keeping those hours beyond the summer months?

We will know the results of the initiative by the end of August. It is looking very promising right now that we will probably roll it out to all of our stores. It is our intention to open our new stores with the new hours.

Okay. And just maybe one last question from me if I can. We have been out visiting other companies in the natural, organic, retailing space and it certainly seems competitors have broadened, or in some cases planned to broaden their offering. I know that you adhere to very strict product standards but would you ever consider broadening your offering a bit? The health and wellness trend is certainly in place but do you feel like you are operating in just too small of a niche market today?

No, not at all. And as a matter of fact we believe that tightening our standards increases our customer loyalty and will increase our sales long-term at a greater rate. And that is why we introduced our pasture-based dairy standard. When we did that we had to get rid of 50% of our yogurt skews in our stores and it changed our yogurt make up substantially. We lost some unit volume but our overall sales volume was essentially flat after we did that. But it has increased the customer loyalty of our current customers substantially.

Great to hear. Thanks for taking my questions.

(Operator Instructions). Our next question comes from Philip Terpolilli from Longbow Research. Please go ahead with your question.

Hi, guys, good afternoon. Just a quick question. One of your competitors we spoke with yesterday had mentioned expanding and maybe changing some of their stores as they do their remodels, expanding freezers, some of the produce, a couple of your other competitors have had success in some of those areas. If you kind of looked across the store, maybe back to Sean's question earlier about supplements, maybe adjusting the mix a little bit at the store, whether more produce or some other categories. Or do you feel very comfortable where you are right now?

We feel that our new store model has the appropriate level of each item in it. It has an optimal level of each, you know, number of freezer doors, lineal feet of produce, number of grocery shelves, number of vitamin shelves, et cetera in it. And so when we remodel our stores we make those new stores similar in composition to our new store model. And so yes, there is definitely change of composition in stores because the older stores tended to have a greater emphasis on supplements than the new stores. But they still have 25% of their floor space are more devoted to the supplement section. And then also I would like to note that our [hava] department, since we changed the format to that department is actually gaining market share at our stores and year-over-year it is up in market share which is a real positive because that is a higher-margin department also.

Okay. Great. And then just one last thing, Kemper. I think you had mentioned before a percentage of stores without incremental competition, could you share that with us? I think you were referencing it.

The percentage of stores without incremental competition?

Yes, of the total base how many stores haven't seen any incremental competitors open nearby.

It would be about 45% of our stores.

Perfect, thank you.

Our next question comes from Mitch Pinheiro from Imperial Capital. Please go ahead with your question.

Just a quick question. Looking at the fourth quarter, I mean, am I calculating this right that the comps look like they would accelerate from the third quarter level? Is that implied in your guidance?

They will be slight -- we are estimating that they will be slightly higher than our third quarter level, yes.

Okay. All right. That is all I have, thank you.

And our final question comes from Rupesh Parikh from Oppenheimer. Please go ahead with your question.

Thanks for taking my question. I just want to delve a little further into your longer-term guidance. I know there has been a number of questions just on the incentive comp in 2015. But maybe you can help us understand what drives that reacceleration, maybe, in 2016 and beyond? Is it just that incentive comp being normalized or is there other factors that give you confidence that you will see a return to stronger growth in 2016 and beyond?

Number one, incentive comp would be normalized. And then number two, we are forecasting slightly higher comp store growth over 2015. Not a lot, but we are mid-single digit's.

Okay. If I can sneak in one quick one. Outside of new competitor openings in your market, are you guys seeing any other changes in the competitive environment from last quarter?

No, not really, no.

Okay. Thank you.

Thanks.

Ladies and gentlemen, at this time I am showing no additional questions. I would like to turn the conference call back over to management for any closing remarks.

I would like to thank everybody for being on the call today and for all of their questions. Thanks and have a very nice afternoon, bye.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.