Q2 2022 North West Company Inc Earnings Call

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Welcome to the Northwest Company Inc. 2nd Quarter Resolve 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 at Sitka, Alaska where we just concluded our board meetings 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 at 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.

Second quarter resultswe 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.

increased 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 seams for 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 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 well 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 continued to cycle through the 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-source sales are up 16.3% with food up 16.2% and general merchandise up 17.1% for 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 177 basis points in the quarter, mainly due to the impact of a higher fuel-related freight and merchandise cost inflation. It 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 Seazel 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.

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 of 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 C-Lit 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 center store grocery and court categories such as transportation, home furnishings and appliances.

We do have some pockets of inventory and apparel in other seasonal categories. They were watching closely as we approached this holiday season.

Below the gross profit line, our operating expenses increased 5.1%, and the quarter-endness is largely due to inflationary cost pressures and the impact of the new stores.

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 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 an overview of the consulted results for the quarter. Let me just take a moment now to provide some additional colour 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 that our.

to point out that all of our sales are down compared to, very short.

It's a question 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.

It provides a perspective on this. Shitty fuel costs increase. It was around 60% compared to Q2 last year. This increased stroke top line sales as we've been taking steps to pass through these costs 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 sales is a pass-through cost, so at a deflationary impact on our gross profit rate.

The increase in jet fuel costs 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 BVI, which mitigated softer sales performance as we cycled through the impact of income support payments from the American Rescue Plant last year.

While the impact of an increase in tourism was a positive factor in the PVI and to some extent in Alaska, we did see the impact of lower travel and other Caribbean markets.

I will also point out that we do not have sales of USDA Farmers to Families Food Box 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.

Alright, so to wrap up, let me just say that looking forward to the second half of the year, we're 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 than last year, but meaningful above pre-pandemic levels.

In international operations, the TFD 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 around supply chain management, including controls on cost, inventory, 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 customers' 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 put your hands set before making your selection.

If you have a question, please press star 1 on your device's keypad.

You can 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.

Questions from Michael Van Aelst from TD Securities. Please go ahead.

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...

And if you see that changing much more going forward, do you see it getting back to 2019 or somewhere in between?

Okay, Michael, you know what, you cut out, could you just repeat the beginning of your question please?

Yeah, so I'm trying to understand where the out of community spending is relative to pre-pandemic levels.

Okay.

Bye.

Okay, so to pre-pandemic levels, well, 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...

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 the...

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.

Yeah.

Okay, and can you...

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 this is 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 it term 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 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, you know, 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 US. 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, um,

you know, 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. Right.

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.

I have a DA excluding stock based comp. Store and stock Extr adventure with up to 1 to thedeep s Or P

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.

somewhat better. Stocks in the potential. Yeah.

Yeah, I think maybe I'll jump in Michael. In terms of the quarters, 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, and the latter part of the-

finally when you talked about gross margin

and not fully passing on the higher costs. You talked about.

you know, trying to balance the pass through with the competitive activity and whatnot. Can you just, there's a little bit more color, so 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 but I would say that it's more so it's cost inflation has been happening at such a rapid pace.

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 discontinuous of different products that you might be offering or now it's just up to us to adjust to the new times. We're looking at other ways to maintain and and our margins and that's through making substitutions with other lower cost products.

keeping our gross profit dollars in rate.

improve the situation from where we are today. But 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 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. 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 increase?

It's not as much see them, but it's maybe reacting to them.

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 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 in your retail pricing but again it's not I would it's not it's not the the leading cause of our margin erosion. you

Okay, thank you.

Thank you. As a reminder, you may press star 1 if you have a question. The next question is from Steven 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 on just when we think about gross margin Lots of good color around some of the price or sort of cost increases that are coming through Sounds like you'll see some pressures in the back half of this year But do you see any sort of lights 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, 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, we had nearly doubled our business obviously during COVID-19 on an earnings perspective. It was expected but it's still never easy to take.

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, yep. 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 further 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. I don't feel that we're in a toughest position going on into the third and fourth quarter this year on our general merchandise.

Right, okay great. Thanks Dan. I just wanted to ask John , I'm 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. It does fluctuate around based upon the earnings across the different jurisdictions that we're in. Really, that's it. We always have some non-taxable items and things like that.

That's all I would comment on on that.

Okay, that's great. Thanks guys, appreciate it.

Thanks, Steven.

Thank you.

There are no further questions registered at this time. I would like to turn the meeting backward to Mr. McConnell.

Thank you very much and appreciate 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 thank you for your participation.

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We thank conference court sent feren feren cour compteen court conferen IC that Ning the comp cour conferen C national office be court actually re cour the by we 19 in cour state ation Act cour not teen and cour Please the fact courar resu continue sales conm cond ition of the cour the cour two point zero zero two million twent increase end the two years cour 19 ated cour ions ated trave ions case the trren Sal continue cy years ated cour last cour nine continue be Act pressu increases teen sent two year resu continue the compared the ES sales and ared two thousand 19 resul cour Sul the ud ms sales second cour SEs increase two point cour percent five hundred nine the international operions Sal ES sales cour point percent COVID-19 related the su sales two years compared two thousand nineteenin leve sales 16 point percent 16 twent percent teen 1% cour gener trans from the previous cour continue the court contomers to the the court ation cour pro se in court the Act related related ation also change sales il's case prev courarters teen increascases sales and CLO PE leve increase some the PR? ciions the just cost teen pring and con ations Al pressu courions ters Vels ated the C courar the cour teen ation sum cour coun the ions cost court cour theincre the court coun trans ation and we were CLO sent increase five point percent cour in ation pressu and the Act the cour the con Sul increase Ning court thir ty two point cour ill compared point cour ill last year just con ation cour last year just thir teen point M 60% compared in the court two thousand 19 the the results court ition international operations per ation 300 twent ill last year reven ated Sal the cour in ation continue the gener think cour sales ared cour sales related sales years cour sales percent ared sales and the cour two thousand 19 terms the courions years re increase trictions increasees cour cour pected increase 60% ared 2, two last year the increase point sales two increases the years the in ation ated increase sales the cost ation increase also exam Act Co cour international sales increase 1% hundred 9, nine ill the Act the T ared to lastyear ated Sal cour cy the cour last year increase the Act other be not SEs year national operations Act sent preious say cour to the year still cour 19 related Act last year pected cy the this year we expect in the year cour last year mean leve international operation the the thirty two ls last year Act theincrease en in the cour last year ortt teen including ation tomers continue to cour in ation we serv the contom ions. Thank, Thank you ions. Question the four question the six question one the question the sent questionions. Question cour spend to leve cour two thousand leve teen the question the end Ing to pre leve pre levels sales still con ID ly that were pre levels expect the re this year going going to think Ing two thousand 19 obviously last two years people because theincrease increasees people for pro the mar two thousand 19 I think be mean two thousand 19 obviously ID ly last two years. Then cy through the this year expect lels ly two one two two 20 20, three because some about the prev call will be the market, some the ions UE C think the the ill. So end the also the P going to to y cour also ES ated going to CRE ular cour leves that be law en's the the not increase last year the cour terms CT we ment expected the year the last year cour the coun the other we the cour cour ment coun contin UE cour be case that the cour, the con were tal in the international operationsions vious the the .ation we the cour last year were the then still expected the second twent be law the second 20 the expected the would say think's going be around the expected be around the cour some some year thecourt last year continue last year the ment teen coun the cour cy ments we some stru last year we really to the cour cour the cy for think last year some cour trave retrictions that think the court So really be the the end the year that the cy tal Ross marg not tal the not ars part that cour the would say that it cost in ation been case just really obviously of the going to the continue product be O it just to just the other 19 marg twoations Co products obvly Ross. We think going pro the situation we it I would end the pet to the increasees the law the experi when the' going think going for around on PE fact cour's would law cour year the cost coures not may Act it's not the fact be 20 5%, 20% the Ning that and just the been in product increases some 60% ation. It's the some su that question but not would's's not the the leading mar question Thank. one question question the the that one to the cour tal the King national cour. 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Please continue to stand by we the conference court sent conferen to feren cour companyteen court conferen Ing the propres officee year that the company second courar conferen the officee cour se Ing cour courard Ing the by 19 in ation. The T ation Act not teen con cour Please. The the the courar resu continue sales con M the contin ition of the cour court. The cour thousand 2000 twentteen increase last two years 19 cour ions ated ations TRS sales UE cy the years and related cour court UE be Act. su Co increases senten year resul UE the ared the sales ared 2000 19 resul cour resul. The ion uding the ms sales cour sales increase two point courfour cent hundred mill. The international operations. Ing sales coun ales cour point percent UE cy 19 related the resul sales. The two years Ing ared 19 CRE levees. Sales teen 0% 16 twent 2% gener teen 1% the court gener. The TRS vious cour continue to the second courar contomers. The cour ation pro the court to the the Act. The related related ation hundred ES. The also the change in sales cour il Sal and prev courters teen increases sales and compe PR ve crease. Some the pres ions teen the just teen ES pring and con ationations. Al su ions ms Vels cour the cour teening posation M ular cour coun the ation. St cour still cour cour the increase in two cour coun trans ation ions and some the were CLO. The sent increase point 1% cour inflation su the Act. The cour con ation resul crease in court thirty point cour mill compared ty two point four M ion last year. Just ation last just teen point two mill 60 point percent compared in the courar 2000 19. The su resul for courar around international operations operationations hundred two million last year reven ated re il salls the cour in ation UE ending the gener think cour sales ared sales related sales years cour sales percent ared sales and the cour 2000 19 terms the year years reven increase on the trictions increasees cour the pected increase 60% ared two last year increase point sales two increes the years the in ation. The related increase sales the ation increase two exam. The Act cost cour the international incre 1% hundred nine million the Act the cour the in ared to last the ated Sal cy the cour last year Act crease the the Act other sales year courpoint fact national operations. Act by the pro expsent prev ion say cour to the second theyear. Still cour 19 related Act last year expected the this year expect in the second year cour last year leve international operation. The ayment thirty two ers ared hundred last year. Act the increase en cour in the cour last year the T teen ud's Co in ation tomers continueing to court inflation we servic contom ations questionions Thank Thank question from question question question one The six question six one The questionion sent questionions ions questionions cur where end Ing to that levels back thousand ve the question ending to levels pre levels. Sales conid ly that were pre levels expect the re year going going to think going meaning 2000 19 obviously last last two years people because the increase increasees people for pro the market 2000 19 I think be Ing 2000 19 but obviously ly last two years then cy. The year expected that leve. Sid ly one two two 20 20 because the some tal the previous calls be to the mar. Some the ations backed think want the in the ill ending also the the P going to be to 20 also ES ated's to increment ular last cour. Le be by enef the the increase last year. The cour ms the ment expected the year the last year school cour. The coun the other. The cour ment coun contin the be in that the cour were the Inter national operationations. viously. The the that we the cour pments last year were the still expect the second 20 be the second 20. The the cour expect the would say think to be around the expected going be the same cour. Some some year. The cour year continue last year tal. The P ment the coun. The last cour TR. cy P ments some struct last year that we really to the cour cour cy for think last year. Some cour ave ictions think the courtter. So really will be the the the year that the cy tal Ross marg not talk the the not pressu. The ion cour the little that it Co case just those that obviously of the going to the the continue CT that be just just the the two 19 marg sub ions lawer Co products. Obviously pro we think the situation I say the the PE going to the increasees the law the the ex peri T to be su think's going allow cour competi cour. It not the law cour twoyear Co in crees not may re. Act said it's the fact be 20 5% 20% but the that qu ly just we been CT increases some 60% ation. It's CA that cour the of those su but's not not's not the the lead Ing marg ion Thank one question question that one to of the tal talking national just one Ross marg of the price crease proress back after year. The get to the year. The one two to cy some of the con in this year were the actually of ion previously think going to be be the experi. The cour viously the increes that peri was expected mean viously cour 19 exed. So expected still we 2000 19 going 2000 19. So the the say talking the back after year con ation just sales con some of those cour Ross in the back after of one one conposation or proct that the case we we actually to the we five courch ES. Just some of the two three we think that we we IP ated the bus the was inthemar. viously. Last year's never were cour gener 2000 20. So posation going to the cour Court this year gener one The of the year not cour cour the cross that really that that the conment Thank you cour question the Ing cour. Thank you the questionions cour to couryear thank the conference. The ation.