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Natural Grocers by Vitamin Cottage Inc  (NYSE:NGVC)
Q1 2019 Earnings Conference Call
Feb. 07, 2019, 4:30 p.m. ET

Contents:

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Natural Grocers First Quarter Fiscal Year 2019 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 now like to turn the conference over to Mr. David Colson, Vice President and Treasurer for Natural Grocers. Mr. Colson, you may begin.

David Colson -- Vice President and Treasurer

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage first quarter fiscal year 2019 earnings conference call. On the call with me today are Kemper Isely, Co-President; and Todd Dissinger, Chief Financial Officer.

As a reminder, all statements made on 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 due to a variety of factors, including the risks 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 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, Director and Co-President

Thank you, David, and good afternoon everyone. I am excited to report a strong start to fiscal 2019. Our founding principles continue to drive our business forward with our unsurpassed quality standards, always affordable prices, nutritional education, our commitment to our communities and our good4u Crew, all of which differentiate us from our competition. We believe our first quarter results show, we are telling this story better than we ever have in the past. We continue to build upon the momentum we achieved in fiscal 2018 and are pleased to report our seventh consecutive quarter of positive daily average comparable store sales, with comps up 5.5% and mature store comps up 3.6%. We generated an improved gross margin this quarter, which increased 40 basis points over the prior year. This improvement primarily reflects the more targeted promotion and pricing strategies, we implemented throughout fiscal 2018. And we are now beginning to anniversary the increased price investments we made throughout fiscal 2018.

In the first quarter, we continued to expand and refine our marketing efforts. These efforts included continued leverage of our NPower Loyalty program, which is contributing to the traffic of basket gains. NPower continues to be an effective resource for our enhanced and targeted marketing and promotion efforts. We were also pleased with the holiday selling period, including improved Turkey sales ahead of Thanksgiving and a strong performance throughout the Christmas holiday.

Over the last several quarters, our marketing and promotion efforts have been focused on Natural Grocers differentiation from the competition, and we are realizing positive momentum from that message. We are also focused on building brand awareness and have seen continued positive results from our social media and digital advertising campaigns.

Last quarter, we described our initial marketing efforts to support the expansion of our Natural Grocers brand product offerings. We continued to see strong sales in category penetration of our Natural Grocers branded introductions in the first quarter, and have approximately 50 new products scheduled to launch during fiscal 2019.

We plan to continue to drive the growth through a balance of new store openings and comp gains that will allow us to focus on improving our existing store's productivity and generate positive cash flow. We will continue to strategically invest in pricing, promotion and marketing to drive brand awareness and traffic, while focusing on continued profit improvement.

With that, let me turn the call over to Todd to discuss our financial results.

Todd Dissinger -- Chief Financial Officer

Thank you very much, Kemper, and good afternoon everyone. During the first quarter of fiscal 2019, net sales increased by 9.4%, to $221.5 million. And as Kemper mentioned, daily average comparable store sales increased by 5.5%. The comp increase was driven by a 2.3% increase in daily average transaction count, and a 3.2% increase in average transaction size. We are very pleased that we have been able to continue to maintain our traffic and basket gains, while moderating our gross margin investment on a year-over-year basis.

Gross margin increased by approximately 40 basis points to 26.7% during the first quarter. The improvement primarily reflects higher product margin driven by more focused promotional pricing campaigns, partially offset by the continued negative impact of a sales mix shift, as our promotions continue to drive strong comps in grocery.

As you know, we generate a higher gross margin in dietary supplements and body care than we do in grocery. It is worth noting that both dietary supplements and body care, continue to deliver comp gains along with grocery. Additionally, we also generated modest leverage on our occupancy expense. Store expenses, as a percentage of sales decreased approximately 10 basis points to 22.2% during the first quarter, compared to the prior year period.

The decrease in store expenses as a percentage of sales was primarily driven by expense leverage on comparable store sales growth, including decreases in depreciation, utilities, marketing and labor-related expenses, partially offset by an increase in other store expenses, all as a percentage of sales. We have been able to leverage our labor-related expenses, while at the same time responding to the pressures of a tight labor market. Pre-opening and relocation expenses increased approximately $130,000 year-over-year. We opened four new stores and relocated one store during the first quarter of fiscal 2019, compared to opening two new stores and one relocation in the first quarter of fiscal 2018.

The sales leverage on store and administrative expenses, along with the improved gross margin led to a 70 basis point improvement in operating margin. Our effective tax rate for federal and state income taxes for the first quarter of fiscal 2019 was 21%. We had an income tax benefit of $4.1 million in the first quarter of fiscal 2018.

The income tax benefit for the first quarter 2018 was primarily the result of a $4.3 million non-cash remeasurement of the company's deferred income tax assets and liabilities, as a result of the federal tax reform in December 2017. Net income was $2.2 million with diluted earnings per share of $0.10 in the first quarter of fiscal 2019, compared to net income of $5.2 million and diluted earnings per share of $0.23 in the first quarter of last year.

The decrease in net income was driven by the impact of the $4.3 million non-cash remeasurement of the company's deferred income tax assets and liabilities as I just mentioned. Excluding this non-cash tax impact, net income for the first quarter of fiscal 2018 was $800,000 with diluted earnings per share of $0.04. EBITDA was $11.3 million in the first quarter of fiscal 2019, up 17.8% compared to $9.6 million in the first quarter of fiscal 2019. During the first quarter of fiscal 2019, we generated cash from operations of $7.5 million and invested $11.6 million in capital expenditures.

Now, I would like to turn the call back over to Kemper to discuss unit development and guidance.

Kemper Isely -- Chairman, Director and Co-President

Thank you, Todd. During the first quarter we opened four new stores, relocated one store and closed one store. Thus far, during the second quarter of fiscal 2019, we have opened one new store and relocated one store. We currently have signed leases for two additional new stores to open in fiscal 2019 and beyond. We continue to monitor new store performance and remain comfortable with our targeted store openings.

Now, let me review our 2019 outlook, which is unchanged from our initial 2019 outlook, we discussed on the fourth quarter call. During fiscal 2019, we expect to open seven to nine new stores, resulting in unit growth of 4.7% to 6.1%, relocate five to six stores, achieved daily average comparable store sales growth of 2% to 4%, achieved net income margin of 0.75% to 1%, achieved diluted earnings per share of between $0.33 and $0.40. And we expect capital expenditures for fiscal 2019 in the range of $27 million to $32 million.

We are very pleased with our strong start to fiscal 2019. Our founding principles continue to differentiate us and drive our business forward with our unsurpassed quality standards, always affordable prices, nutritional education, our commitment to our communities and our good4u Crew. We believe we are communicating the story better than we ever have in the past. We continue to work hard to achieve our objective of driving traffic, while enhancing profitability in delivering value for our shareholders.

Now I'd like to open the lines up for questions. Thank you.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions ) The first question comes from Renato Basanta with Barclays. Please go ahead.

Renato Basanta -- Barclays -- Analyst

Hi, good evening guys. Congrats on the nice quarter, and thanks for taking my questions. So first question on comps. Just wondering, if you could provide the cadence for the quarter and where we are quarter-to-date? And then just any color on how we should be thinking about the impact in 2Q from the later Easter, that would be helpful?

Kemper Isely -- Chairman, Director and Co-President

The quarter essentially, every month was essential -- it was essentially the same and we're pretty much 5 to 5.5 (technical difficulty) in every month. It was -- there was no real change month-to-month. As far as this quarter goes, January was a month that was a bit -- we're up against more challenging quarters a little bit -- we're coming in a little bit lower than we did last quarter so far.

Renato Basanta -- Barclays -- Analyst

Okay. And just any impact from Easter for 2Q?

Kemper Isely -- Chairman, Director and Co-President

There will be an impact which we've baked into our outlook, we'll have benefit next quarter and a little bit of sales this quarter.

Renato Basanta -- Barclays -- Analyst

Okay. And just to follow-up on maybe comment about January. Just on the guidance. So you posted a pretty strong first quarter, gross margins well into positive territory and certainly the compares get a little harder. But I think your prior guidance was based on flattish to potentially slightly lower margin. So I'm just wondering, if there's anything out there that you're sort of seeing that's keeping you within the same range for guidance for the year?

Kemper Isely -- Chairman, Director and Co-President

No. I would say that we're probably not going to be at the low-end of our comp guidance for the year. We'll certainly -- we think that our high-end is a realistic number.

Renato Basanta -- Barclays -- Analyst

Okay. And then just you are able to leverage labor, which was impressive in this environment. So just given you had some minimum wage increases and you also rolled out labor scheduling, potentially has an offset or benefit. How should we be thinking about that line item going forward? Should we expect continued leverage?

Kemper Isely -- Chairman, Director and Co-President

We think that it's going to be pretty flat for the year. We don't think, we're going to get any more leverage this year, as you said there's a lot of wage pressure right now, out there and even with higher productivity in our stores and higher -- it's going to be hard to yield leverage for the rest of the year because of the wage pressures.

Renato Basanta -- Barclays -- Analyst

Okay. And then just last one for me on delivery. I know it's still small part of your business, but just any update there. I think you -- in the past you've talked about the Instacart stores being flattish in terms of sales. So have you seen any improvement there? And then it'd be helpful if you could provide more details, just overall on the Instacart partnership maybe color on who gets the date of the fee structure? Just any thoughts on that would be much appreciated. Thank you.

Kemper Isely -- Chairman, Director and Co-President

You want to take that Todd?

Todd Dissinger -- Chief Financial Officer

Sure. So we're at about 136 stores now that are supported by Instacart. And the volume through Instacart, it's a good partnership, but it's not a significant driver of our sales, and we think it's a nice offering. We do incur some additional expense and fee sharing with Instacart. So we're sensitive to the profitability of that business.

Renato Basanta -- Barclays -- Analyst

Okay, thanks. Have a good night.

Operator

Okay. The next question comes from Scott Mushkin with Wolfe Research. Please go ahead.

Siddharth Dandekar -- Wolfe Research LLC -- Analyst

Hi, this is Sid down the car on for Scott. Thanks for taking my question.

Kemper Isely -- Chairman, Director and Co-President

Sure.

Siddharth Dandekar -- Wolfe Research LLC -- Analyst

You mentioned that dietary supplements and body care delivered comp gains. Do you foresee price investment shift a bit to these categories to further improve the product mix here, given your strong comp? I mean, the two year stat was pretty impressive here.

Kemper Isely -- Chairman, Director and Co-President

No, I don't think that we need to invest more in our pricing in dietary supplements, we're very competitively with price compared to traditional retailers on our dietary supplements already.

Siddharth Dandekar -- Wolfe Research LLC -- Analyst

Okay. And then related to the competitive environment. You mentioned last quarter, you're focused to track the incremental NPower member. Is that now becoming more challenging, as Whole Foods and Prime Now is expanding, is a overlap with NGVC increasing. So what are you doing to address that, if that's the case?

Kemper Isely -- Chairman, Director and Co-President

We have noticed that we are having a lot of issues with Prime members not shopping at our store. We've increased our NPower membership up to 800,000 members as of January. We're gaining about 30,000, 60,000 per month. So we're not having trouble to tracking them, but our membership doesn't cost money though, that's kind of a big benefit. We don't have to ship our product whereas the Amazon has to ship product and lose money every time they do ship product. I don't think it's a big benefit to the Whole Foods members either, Whole Foods is still having troubles with keeping their prices competitive.

Siddharth Dandekar -- Wolfe Research LLC -- Analyst

Okay. And then last one for me. Just in terms of the deflationary trends, so what are you seeing in the market in terms of that impacting your gross margins? And what's your outlook from here on out for the rest of the year?

Kemper Isely -- Chairman, Director and Co-President

Well, as we said in our guidance, we're looking at trying to keep our margins essentially flat for the rest of this year compared to 2018. And I think that we have a good opportunity to do that, as far as deflationary pricing and product categories, there's always a little bit of that because of competition, and commodity prices have been somewhat thoughts, so there's deflation in some of the commodity prices, which brings down prices on the retail and in the end, but it doesn't affect margin.

Siddharth Dandekar -- Wolfe Research LLC -- Analyst

Okay, great. Thanks.

Operator

Okay. And the next question comes from Greg Badishkanian with Citi. Please go ahead.

Garrett Klumpar -- Citigroup -- Analyst

Thanks, good afternoon. It's actually Garrett on for Greg. Just following up on the inflation I think previously you talked about being relatively stable over the last couple of quarters at about 1%. But just wondering, if design deviation of that is not in fiscal 1Q?

Kemper Isely -- Chairman, Director and Co-President

No, there's really not, it's not been any abnormal amounts of inflation so far. I think there is some inflation working its way through because of increased freight costs so on and so forth from our supplier. But commodity prices have been going down, so that's helping them to keep their prices more in check also I think.

Garrett Klumpar -- Citigroup -- Analyst

Okay, that's helpful. And then just on kind of the price investments. I'm wondering if you could talk about the level of price investments this quarter versus the ones you made in fiscal 4Q. And as we get to the year, do you foresee the magnitude of price investments decrease or increasing from what you did in the first quarter?

Kemper Isely -- Chairman, Director and Co-President

I think that our price investments are pretty much stabilized. So I think we'll be -- we had a little bit of gain in the first quarter compared to 2018's first quarter. And I think it'll be pretty flat through the rest of this year compared to 2018.

Garrett Klumpar -- Citigroup -- Analyst

All right. That's really helpful. Thanks so much.

Operator

Okay. Seeing no further questions. 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, Director and Co-President

Thank you very much for joining us to discuss our first quarter results. We look forward to speaking with you on our next call to review our second quarter 2019 results. Have a great day. Thank you.

Operator

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

Duration: 21 minutes

Call participants:

David Colson -- Vice President and Treasurer

Kemper Isely -- Chairman, Director and Co-President

Todd Dissinger -- Chief Financial Officer

Renato Basanta -- Barclays -- Analyst

Siddharth Dandekar -- Wolfe Research LLC -- Analyst

Garrett Klumpar -- Citigroup -- Analyst

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