Good day, ladies and gentlemen. Welcome to the Natural Grocers Second Quarter Fiscal Year 2026 Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we'll conduct a question-and-answer section, and instruction will be given at that time. As a reminder, today's call is being recorded. I would now like to turn the conference over to Ms. Jessica Thiessen, Vice President, Treasurer for Natural Grocers. Ms. Thiessen, you may begin.
Good afternoon, thank you for joining us for the Natural Grocers by Vitamin Cottage second quarter fiscal year 2026 earnings conference call. On the call with me today are Kemper Isely, Co-President, and Richard Hallé, Chief Financial Officer. As a reminder, certain information provided during this conference call, including the company's outlook for fiscal 2026, contains forward-looking statements based on current expectations and assumptions and 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 and uncertainties detailed in the company's most recently filed Forms 10-Q and 10-K. The company undertakes no obligation to update forward-looking statements. Our remarks today include references to adjusted EBITDA, which is a non-GAAP measure. Please see our earnings release for a reconciliation of adjusted EBITDA to net income.
Today's earnings release will be available on the company's website, and a recording of this call will be available on the website at investors.naturalgrocers.com. Now, I will turn the call over to Kemper.
Thank you, Jessica, and good afternoon, everyone. During today's call, I will provide an overview of our financial results and highlight progress on initiatives driving long-term value creation. Rich will discuss the second quarter results in greater detail and review our fiscal year guidance. We performed well in a challenging environment driven by strong store-level execution and disciplined expense management, delivering diluted earnings per share growth of 3.6%. There are a few underlying trends I want to highlight. In the second quarter, comparable store sales increased 0.5% while cycling an 8.9% comp last year. On a two-year basis, comps of 9.4% continue to demonstrate solid growth relative to the broader grocery retail industry. We believe the second quarter sales trends reflected continued economic uncertainty and value-seeking consumer spending behaviors observed broadly across the grocery retail sector.
Furthermore, in the second quarter, we continued to see strong membership gains in our {N}power Rewards program. Net sales penetration increased 3 percentage points to 84%, highlighting our customers appreciation for the program's value and benefits. {N}power remains an effective tool for optimizing promotional activity and strengthening customer engagement. Natural Grocers is the value option in natural and organic grocery retail. Our marketing and communications continue to feature our always affordable prices, including the Even More Affordable campaign, which highlights a rotating assortment of staples, including our Natural Grocers brand products. We believe the consumer prioritization of health and wellness, including food and nutrition, is growing and enduring. Our differentiated natural and organic offering, supported by rigorous standards and our always affordable pricing strategy, continues to deliver strong value and reinforce our competitive positioning. Next, I will highlight an important milestone which is consistent with management's long-term focus.
During the second quarter, we successfully completed a major upgrade to our enterprise resource planning system. The ERP platform supports the majority of our functional areas, making this the most comprehensive systems implementation the company has undertaken to date. The successful execution reflects the dedication and cross-functional collaboration of our teams. The upgraded system enhances operational efficiency, improves data visibility, and provides a scalable foundation to support future growth and expand functionality, including data analytics and operational efficiencies, leveraging business intelligence tools. We've also made progress on store development as another lever driving our long-term value. During the second quarter, we opened one new store, and subsequent to the quarter, we relocated one store and opened an additional store. We're encouraged by the productivity of our new stores and relocations. We are on track to open six to eight new stores in fiscal 2026.
We believe we have significant opportunities to expand our store footprint and are targeting a 4%- 5% annual new store unit growth rate for the foreseeable future. Finally, I would like to express my appreciation to our crew for their continued commitment to delivering an exceptional shopping experience. The best-in-class customer service provided by our good4u Crew is a key element of our differentiated offering. Now I will turn our call over to Rich to discuss our financial results in greater detail and our fiscal 2026 guidance.
Thank you, Kemper. Good afternoon. Second quarter net sales increased 0.5% from the prior year period to $337.4 million. Daily average comparable store sales increased 0.5%, comprised of a 1.6% increase in basket size and a 1.1% decrease in transaction count. The basket comp included a decline of less than a half an item per basket. We continued to see the highest sales growth in dairy, produce and meat, which are some of our most differentiated offerings. Our Natural Grocers brand penetration was 9.8% of total sales, up 120 basis points from a year ago.
Gross margin increased 10 basis points to 30.4%, driven by lower store occupancy costs as a percentage of net sales and stable product margin, including inventory shrink. Store expenses decreased 1.6%, primarily driven by expense management. Administrative expenses increased 10%, primarily driven by higher technology expenses, including expenses related to the completion of the ERP upgrade project. Net income increased 2.5% to $13.4 million, and diluted earnings per share increased 3.6% to $0.58 in the second quarter. Adjusted EBITDA increased 4% to $27.4 million. Turning to the balance sheet and cash flow.
We ended the second quarter in a strong liquidity position, including $20.7 million in cash and cash equivalents, no outstanding borrowings, and $67.6 million available for borrowing on our revolving credit facility. During the first six- months of fiscal 2026, we generated cash from operations of $43.8 million and invested $30.3 million in net capital expenditures, primarily for new and relocated stores and real property acquisitions, resulting in free cash flow of $13.5 million. Subsequent to the second quarter, we received a $2 million recovery from our insurance carrier for business interruption related to the June 2025 cybersecurity incident that temporarily impacted our main distributor's ability to fulfill orders and distribute products to our stores, resulting in product shortages and lost sales in June and July.
The $2 million recovery equates to approximately $6.5 of diluted earnings per share, impacting our expectations for Q3, and that's been incorporated into our updated guidance that follows. Today, we are refining the company's fiscal year outlook to reflect our second quarter results and the significant opportunities we see in our differentiated market position while remaining thoughtful about the evolving consumer environment. Our outlook includes the following: Open six to eight new stores and relocate or remodel two to three existing stores. Achieve daily average comparable store sales growth between 1.5% and 2.5% compared to our prior outlook of between 1.5% and 4%. Diluted earnings per share between $2.07 and $2.15 compared to our prior outlook of between $2.00 and $2.15.
Capital expenditures of $45 million-$50 million compared to our prior outlook of $50 million-$55 million. Capital expenditures primarily support growth initiatives such as new and relocated stores and include maintenance CapEx of approximately 75 basis points of net sales. In addition, our current expectation is that sales comps will be 2%-4% in the second half of fiscal 2026 at the lower end of our outlook range in the third quarter as we cycle strong comps in the prior year and increasing slightly in the fourth quarter as we cycle moderated comps. Additionally, the comp range reflects consumer uncertainty in the current macro environment. We expect modest inflation throughout the year in line with current trends. Our outlook anticipates that year-over-year gross margin will be relatively flat, primarily depending on the level of promotional activity.
We expect that year-over-year store expenses as a percentage of net sales will be relatively flat to slightly lower. Our outlook anticipates that year-over-year administrative expenses as a percentage of net sales will be relatively flat in the second half, excluding the impact of the insurance recovery. Lastly, in fiscal 2026, we have incremental investment of approximately $0.09 of diluted earnings per share in new store openings, primarily through higher pre-opening expenses and store expenses. We'd like to open the line for questions. Thank you.
Thank you. We will now begin the question and answer session. The first question comes from Aaron Grey with Alliance Global Partners.
Hi, good evening, and thank you very much for the questions here. The first question I wanna ask about is the margin profile, which was good for you guys this quarter. I wanna think about how that is going forward, particularly given utilizing the ERP to drive some cost savings. You know, you seem to have had, you know, one of the higher gross margins in a couple years. As we think about efficiencies going forward, do you reinvest those back into the business, given the softer consumer environment, let that drop to the bottom line? Just how we think about the profit versus sales growth as we reinvest potentially those cost savings. Thanks.
I would say that the cost savings immediately from our investment in ERP are going to be minimal. It'll take a little while to get efficiencies from the new system and to work out bugs in the new system. Any cost savings that we do see, we usually reinvest in competitive pricing. You know, we look at every item that we sell and compare it to our competitors and decide where we should be in pricing, and we like to be on the leading edge of affordable pricing.
Appreciate that commentary. Second question for me, as we think about the comps, I know a lot of the commentary in terms of the trends has been based off, you know, the two-year stack and some of the softer comps you're gonna see in the back half of the year. You know, maybe outside of just thinking of a two-year stack, you know, anything that you're seeing to get more comfortability in terms of that stack starting to improve in the back half of the year as you know, as you go into fiscal year 2027?
Yeah. I mean, the, the first two quarters of this year were particularly difficult to comp well against last year because they were we had such strong comps last year. Starting in June of this year, our comps were substantially softer for the last four- months of the year of our fiscal year. We're pretty confident that we will see sales similar to what we have been seeing currently through those months, which gives us confidence that we will have substantially better comps from June through September of this year.
Okay, great. Thanks for the color. I'll go and jump back in the queue.
Thank you. The next question comes from Chuck Cerankosky with Northcoast Research.
Good afternoon, everyone. I was wondering how you would describe the consumer behavior in the most recently reported quarter to what you saw a year earlier, how things have changed since war in Iraq broke out and how it's been trending since then?
March was a particularly difficult month. I think that the conflict in Iran was not helpful to the consumer sentiment in March. April was much better than March. I think as we get further away from the conflict, the consumer sentiment will improve. As compared to last year, definitely there was more robust consumer enthusiasm last year at this time.
How did that, call it consumer distress, manifest itself? Was it, fewer items, fewer trips, more price sensitivity? Any insight on that?
As we reported, there was a 0.3%. Wasn't it 0.3%?
0.3% Items.
Yeah, 0.3% items per basket that we lost, which works out to about 3% of comp sales. There was definitely on the on our less loyal customers, definitely some pullback from those consumers. Our loyal customers shopped as normal.
We continue to see very good growth from that customer base. You know, as you know, our {N}power now makes up 84% of revenue, just continuing to see great success. We had really good numbers out of that. As Kemp said, our less loyal customers we're seeing really kind of a slowdown.
Great. Thank you.
Just to add on, as we're starting a program where we're working on really getting the penetration of our {N}power sales higher and also the number of customers the 30% of customers that aren't currently {N}power members enrolled in {N}power. I think we'll have some really good results towards our goals in regards to that issue starting in June.
Thanks.
Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Kemper Isely for any closing remarks.
Thank you for joining us. We are committed to maximizing value for our stockholders. We believe that our offering of high quality, natural and organic products supported by rigorous product standard and always affordable prices is differentiated and will support growing consumer demand over the long term. Continued investment in store development, people, processes, and system supports, operational discipline, and long-term value creation. Thank you and have a great day. Goodbye.
Thank you. The conference call is now concluded. Thank you for attending the Natural Grocers second quarter fiscal year 2026 earnings conference call. You may now disconnect. Thank you.