The North West Company Inc. (OTCPK:NNWWF) Q2 2022 Earnings Conference Call September 8, 2022 11:00 AM ET
Company Participants
Dan McConnell – President & Chief Executive Officer
Amanda Sutton – Vice President, Legal & Corporate Secretary
John King – Chief Financial Officer
Conference Call Participants
Michael Van Aelst – TD Securities
Operator
All participants, thank you for standing by; the conference is ready to begin. Please be advised that this conference call is being recorded. Welcome to the North West 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.
Dan McConnell
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 and Corporate Secretary. Actually, we’re residing today over in Siclos [ph] where we just concluded our Board meetings; so it’s been a delight. And — but I’m going to start off by asking Amanda to read our disclosure statement.
Amanda Sutton
Thank you, Dan. Before we begin, I’ll remind you that certain information presented today may constitute forward-looking statements. Such statements reflect North West’s current expectations, estimates, projections and assumptions. These forward-looking statements are not guarantees of 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 North West’s annual information form and it’s MD&A under the heading Risk Factors.
Dan?
Dan McConnell
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 gains, which has been substantially eliminated as well as by travel restrictions that are no longer in place. This translated into softer same-store sales as we continue to cycle through the past two years of exceptional pandemic-related growth.
Since the last quarter, our bottom-line continues to be impacted by inflationary cost pressures, particularly with freight and general merchandise cost or merchandise cost 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 when compared to the pre-pandemic levels in both, sales and earnings gains compared to 2019. I’ll start by providing some color around our consolidated results before diving into our results by division, including the airline.
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 a same-store basis, sales were down 4.1% as we continue to cycle through COVID-19 related factors that resulted in significant sale 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% for the quarter. In general, the trends for in the previous quarter 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 177 basis points in the quarter, mainly due to the impact of a higher related — higher fuel-related freight and merchandise cost inflation, it was not only passed through on retail prices and been combined with the chill — sorry, chains in our sales plan [ph].
Like many other retailers, we have also had some higher markdowns in sales and general merchandise. As highlighted in previous quarters, our focus has remained on maintaining a balance between passing through these cost increases, keeping our momentum on sales, and closely monitoring competitive pricing levels; via 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 conversations with our vendors and freight carriers to help mitigate pressures on our 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 Sealift and Winter Road stores in Canada in order to maximize efficiencies on supply chain costs, as well as getting ahead of some prime shortages that still persist. As we noted in our report, a large portion of the increase in inventory is due to center-store grocery and core categories such as transportation, furnishings and appliances. We do have some targets of inventory in apparel on the 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 accordance 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 gained 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 an 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 for retail sales. Within the current time inflation environment, we continue to see consumers spending shift away from discretionary general merchandise and over to food [ph]. Again, I think it is important that our — to point out that all of our sales are down compared to — sorry, to claim 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 faster volumes as travel restriction has been lifted coupled with increases from fuel surcharge rates on both, cargo and the passengers. To provide some perspective on this; Jet A fuel cost increase was around 60% when compared to Q2 last year. This increase drove top line sales as we’ve been taking steps to pass through these cost increases the same way other air carriers in the industry have been doing this through this inflationary cycle. Having said that, this fuel-related increase in sale is a pass-through cost, so at a deflationary end on our gross profit rate. The increase in Jet A fuel cost is also an example of the impact that 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 BDI, which mitigated softer sales performance as we cycle through the impact of income support [indiscernible] last year. While the impact of an increase in tourism was a positive factor in the BDI [ph], and assuming at Alaska, we did see the impact of lower travel in other Caribbean markets. I will also note, that we do not have the sales of U.S.D.A Farmers [ph] and the Food-Box [ph] program 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.
All right, to wrap up, let me just say that looking forward to the second half of the year, we are still up against some COVID-19 related impact last year, which we 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 last year, but meaningful above pre-pandemic levels. In international operations, the PSD payment will be $3,200 compared to $1,100 last year, which will 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 around supply chain management, including controls on cost, inventory and pricing across the entire organization. Our customers and communities are continuing to adopt to lower income support and high inflation, and we are focused on ensuring our essential products and services offerings meet the customers’ needs.
With that, let me open it up for any questions that you might have. And, thank you.
Question-and-Answer Session
Operator
[Operator Instructions] Next question is from Michael Van Aelst from TD Securities. Please go ahead.
Michael Van Aelst
Thanks very much. I’m wondering if you could help us understand where out of community spending is roughly in Q2 relative to pandemic levels? And if you see that changing much more going forward like, are we — do you see it getting back to 2019 levels or somewhere in between?
Dan McConnell
Okay. Michael, you know what — you kind of — could you just repeat the beginning of your question, please?
Michael Van Aelst
Yes. So I’m trying to understand where the out of community spending is relative to pre-pandemic levels.
Dan McConnell
Okay. Well, okay. So to pre-pandemic levels; as you can see, our sales are still considerably higher than they were pre-pandemic levels. I expect that for the remainder of this year, we’re going to see some — 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 that for the remainder of this year, I expect that income levels will be considerably higher in — call it 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.
Michael Van Aelst
Okay. And can you remind us the magnitude of those settlement payments? I mean, how much of an impact it can have on the income?
Dan McConnell
Well, I would say there’s a couple out there. I think you probably want to — I mean this one of them — they’re in the billions. So depending on which one, there was a 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 the term on childcare — childcare payment that’s going to be issue again; and I think about Q2 of 2023 is what we’re predicting currently. But then also to do on a consolidated basis, as I indicated, there is going to be some incremental income, particularly in Alaska through the PFD, which is more than — almost tripled from what it’s been in the historical levels.
Michael Van Aelst
Okay. And you said that would be offset by lower SNAP benefits?
Dan McConnell
You got it.
Michael Van Aelst
What’s the magnitude of the offset?
John King
Michael, SNAP benefits were increased last year, and I don’t have the quantum in terms of the direct offset from the PFD. But if we look at the payments in total, we would expect the PSD 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 school children in the U.S. Certainly, in Canada, there was other — we saw the tail — I would say, 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 in addition to that, we also had the COVID payments from last year that we’re up against in Q3.
Michael Van Aelst
Great. 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?
Dan McConnell
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.
Michael Van Aelst
Sorry, somewhat better?
Dan McConnell
Yes.
John King
Yes. I think, maybe I’ll jump in, Michael. In terms of the quarter, if you look at — as Dan said, we’ll 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, but it won’t be until Q4 that we really start to — in the latter part of Q4, quite frankly, as we really start to see the cycle through. And even in Q4, if I think about last year, we had some more travel restrictions that came on, I think, later in the quarter with variants and so on; so it really will be to the end of the year that we take the cycle through this.
Michael Van Aelst
Got it. Okay. And then finally, when you talked about the gross margins and not passing on — fully passing on the higher cost, 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 price positioning or what?
Dan McConnell
There is a little bit of both, but I would say that it’s more so it’s cost inflation has been happening at such a rapid pace. It’s — to be frank, it’s just really trying to capture all those costs that you can pass on. And obviously, you can’t some of the times that when you’re going into this scenario, you just have to — if it will lead to the discontinuance of different products that you might be offering or now it’s just upto us to adjust to the new times. We’re looking at other ways to maintain and 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 that we’re going to improve the situation from where we are today. But it’s — so it’s both, but I wouldn’t say like at the end of the day, our competitors are going to be faced with the same increases and if it takes them a little longer to catch up, it’s a pretty eye-opening experience when they get their next invoice of inventory. So, I don’t think that is going to be a long-standing systemic issue at all. And if anything, I think it’s going to allow us to take further ground on our competitors. So, I — so — but it is a factor currently, but it’s not the biggest factor by any stretch.
Michael Van Aelst
Why would it be — why would you take a longer time for your competitors to see the cost increases?
Dan McConnell
It’s not as much to see them, but it’s maybe reacting to them. So that’s our — like I said, it’s not the biggest factor; it’s — it maybe 25% or 20% of it, but it’s a learning that comes quickly. And it’s just because — I mean, we have — there has been instances where you’ve had product increases of sometimes 60% over a very short duration of time. So it’s caused definitely some delays and just being able to react to some of those pressures and be able to reflect that in your retail pricing. But again, it’s not — I would — it’s not the leading cause of our margin erosion.
Michael Van Aelst
Okay. Thank you.
Operator
Thank you. [Operator Instructions] The next question is from Stephen [ph] from BMO Capital Markets. Please go ahead.
Unidentified Analyst
Yes, thank you. Good afternoon, guys or good morning. I just wanted to follow-up — just 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 was consolidated, but I just want to clarify that.
Dan McConnell
That’s right. No, you’re right, it’s consolidated.
Unidentified Analyst
Yes. Okay. Okay, great. Thank you. And then, just on — just wanted to think about gross margin, lots of good color around some of the price — or cost increases that are coming through; it sounds like you’ll see some pressures in the back half of this year. But do you see any sort of light at the end of the tunnel as you get into fiscal next fiscal year, sort of Q1, Q2 when you begin to cycle some of the declines from this year?
Dan McConnell
Absolutely. We’re — yes, we’re quite optimistic actually for some of the reasons that I mentioned previously. We do think that there’s going to be a — it will be a delightful experience as opposed to 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’re — 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.
Unidentified Analyst
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 hub wins as you comp against some of those income programs as well as gross margin headwinds in the back half of the year?
Dan McConnell
You got it. Yes.
Unidentified Analyst
Yes. Okay. Okay, great. Thank you. And then, just one final one. Thinking about the inventory composition; you gave some color in your prepared remarks. What — how much of that inventory is sort of seasonal product that you might have to face — you may have to put further markdowns on?
Dan McConnell
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, we — 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, we’re — I don’t feel that we’re in a tough position going on into the third and fourth quarter this year in our general merchandise.
Unidentified Analyst
Right. Okay. Okay, great. Thanks, Dan. And then, just one 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 parts [ph] of the year?
John King
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. You know, really that you’ve got — you always have some non-taxable items and things like that. But that — that’s all I would comment on on that.
Unidentified Analyst
Yes. Okay. Okay, that’s great. Thanks, guys. I appreciate it.
Dan McConnell
Thanks, Stephen.
Operator
Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. McConnell.
Dan McConnell
Thank you very much, and I appreciate the questions. And we look forward to speaking with you next quarter.
Operator
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.
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