Good day, ladies and gentlemen. Welcome to the Natural Grocers' Fourth Quarter Fiscal Year 2016 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. Todd Dissinger, Vice President and Treasurer for Natural Grocers. Mr. Dissinger, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage fourth quarter and fiscal year 2016 earnings conference call. On the call with me today are Kemper Isely, our Co-President and Sandra Buffa, our 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. Our press release is available on our website and a recording of this call will be available on our website at investors.naturalgrocers.com. Now, I will turn the call over to our Co-President, Kemper Isely.

Thank you, Todd. Good afternoon, everyone. On today’s call I would like to review our fourth quarter and fiscal 2016 results, our strategies and initiatives and provide our initial outlook for fiscal 2017. Fiscal 2016 was a challenging year for National Grocers. During the year we faced heightened levels of competitive pressure from both our traditional competitors and from the entrance of non-traditional competitors into the natural and organic food segment, as well as regional and macro-economic factors. Of course, this growing competition reflects the continued rapid growth of the natural and organic food sector. As more people recognize the benefits of healthier eating habits, more players have moved into a space that we have been serving for more than 60 years. So while we must navigate competition, we are clearly in the right space. Following quarter two we revised our guidance downward in recognition of the changing environment. Subsequent to quarter two our team reassessed our business practices and focused on operating initiatives that would allow us to operate successfully within the parameters of our revised guidance. I am pleased to report that we were able to achieve our revised sales expectations for the back half of the year and successfully execute on our operating initiatives. I would like to walk you through our fiscal 2016 accomplishments and share my perspective on the opportunities that fiscal 2017 present. However before we get started I want to recognize the hard work and accomplishments of our crew who embraced the challenge and developed and executed on our plan in fiscal 2016. As a result of our crews’ efforts I believe the company is well positioned to meet the task ahead of us in fiscal 2017. First, let me start with sales. We achieved an 11.5% sales increase in the fourth quarter.…

Thank you, Kemper. Good afternoon everyone. During the fourth quarter trends remained relatively consistent with the trends we experienced over the previous two quarters. I am pleased to report that we achieved results in line with the updated guidance we provided after the second quarter. As Kemper mentioned, we have responded to the recent challenges in natural and organic food retailing and are navigating the current environment. Let me provide some detail on the fourth quarter results. During the fourth quarter of fiscal 2016 net sales increased 11.5% to $181 million and comparable store sales increased 0.34%. The fourth quarter comparable store sales growth compares to a 0.7% daily average comparable store sales growth during the third quarter. However on a two years stacked basis daily average two year comps were in line with the third quarter trend at 6.5%. The comparable store sales growth during the fourth quarter was driven by a 1% increase in average transaction size, partially offset by a 0.7% decrease in average transaction count. Daily average mature store sales decreased 1.8% primarily reflecting the increased internal competition and regional economic pressures. Gross margin declined approximately 70 basis points to 28.1% primarily due to an approximate 90 basis point increase in occupancy costs as a percent of sales which was partially offset by higher product margin. The increase in occupancy cost as a percent of sales was primarily due to higher average lease expense at newer and relocated stores and also reflects the decrease in mature store sales and the fixed nature of rent obligation and related occupancy expenses. Store expenses increased 17.9% to $41.4 million in the fourth quarter. As a percent of sales store expenses rose approximately 130 basis points to 22.9% during the fourth quarter compared to the prior year comparable period. The…

So far during quarter one of fiscal 2017 we have opened one additional store in Missouri. We have signed leases for 19 new stores to open in 2017 and 2018. Now let me introduce our fiscal 2017 outlook. During fiscal 2017 we expect to open 15 to 20 new stores, resulting in 12% to 16% unit growth, achieve daily average comparable store sales growth of negative 1% to 1%, achieve net income margin of 1.4% to 1.6% and achieve diluted earnings per share of between $0.50 and $0.58, and deliver EBITDA margin of 6.4% to 6.8%. I would like to point out that our guidance incorporates improving quarterly comparable store sales growth rates as the year progresses, as our year over year comparable store sales growth rates will be more favorable later in the year relative to current trends. We expect capital expenditures for fiscal 2017 in the range of $40 million to $48 million. Our new store opening range provides flexibility to adapt to the operating environment throughout the fiscal year. We anticipate cash on hand, cash generated from operations and availability under our credit facility will be sufficient to support our capital requirements and any contemplated share purchases under our two year $10 million share repurchase program. We remain confident with our core strategies and positioning. Our founding principles remain the core driver of our industry leading quality standards focused on nutrition education and value positioning, all differentiating us from the competition. Our small format stores provide convenience to our customers and allow us tremendous flexibility with our real estate strategy and the range of markets we can enter. We are optimistic about the growth opportunities that lie ahead. Now I would like to open the lines up for questions. Thank you.

[Operator Instructions] The first question comes from David Magee with Sun Trust.

I just had a couple of questions. One, you mentioned that the impact of new competition may have moderated a bit, and I'm curious, if you look out over the next several months, do you have a sense for does it stay the same, or does it improve further from here?

I think for the first half of this year it will definitely stay very similar.

Okay. And then secondly, with regard to the marketing, you talked about the messaging the content of it. I'm curious what you think would be the most effective way to put that out there. What vehicle would be most effective for your messaging?

We believe that there are a lot of great variety of modalities that work well for us. We're experimenting quite a bit with social media right now, because we think that, that is -- you have to get into the conversation via the social media to really get your message out there. We're revising our help hotline to a magazine format that will allow us to also make it a digital help hotline so that we can distribute it to millions of people rather than just a smaller number of people. We also will have billboards which we think will be very effective and we will be having an aggressive radio campaigns in the first half of next year -- in the calendar year next year.

Kemper, what percent of -- or do you anticipate marketing costs to be a higher percent of sales this year than last year?

No, we budgeted on that at a similar percentage bill for last year.

The next question comes from Rupesh Parikh with Oppenheimer.

Thanks for taking my question. First, Kemper, I want to start, is it possible to get the quarter-to-date comp trends, or what you're seeing the start this quarter?

Well they are trending at the low end of our range that we gave for full year guidance. We've definitely seen some softness in sales since the election. And we're hoping that that moderate here shortly. We normally wouldn’t disclose that but because of the new sales after the election we thought we would mention -- we would disclose that today.

And as you look at that softening, is it any specific category, or are you just seeing less traffic? Is there any more color to that –

We just saw less traffic for a period of time, we seem to pick it back up this week.

And then going back to all your commentary on your real estate plans this year, what's the expectation in terms of competitors opening up new locations near the new location that you plan to open?

I'm trying to -- actually I think we're opening more in our competitors’ backyards than they're opening in our backyard as of this moment over the next year. Although we are opening in some new markets that don't have established competitors and over the next year and during last year and so there's always the potential for those -- for stores to open in those new markets that we go into that don't have Sprouts or Whole Foods. Most of our store openings are going in markets that already have a Sprouts, Whole Foods or Trader Joe's. And as I said earlier we think this new competition will stay about the same as it was in 2016.

And my last question maybe for Sandra. On the gross margin and SG&A line what type of comp do you need to leverage both of those line items?

I think we’ve historically said it’s a number somewhere around 3% where it was easier -- given where we were running expense wise before. As we discussed, however, we are focusing on some initiatives that we are seeing positive results in for reducing shrink and we're also focusing on a sales to labor hour grid and both of those should help to bring that number down.

The next question comes from Bill Kirk with RBC Capital Markets.

Thanks for taking the question. I think the tier stack has stayed relatively flat the last few quarters, yet you're guiding to a significant two-year deceleration. Can you help us understand why that would be?

Well last year our first quarter was fairly -- well it wasn't great but it was a lot better than the rest of the year. And so we believe that we'll have our weakest quarter, this quarter because of that. And so it's just been the trend and then we'll be coming -- going into more favorable -- we have less smaller comps in the following three quarters, last year and we will be going in comping against them in those quarters but it's still -- right now the way current economic trends are going and the way sales are going it’s difficult to project a higher comp in those upcoming quarters than what we’ve given you in the guidance.

Sure. And a slightly different question, maybe for Sandra. I think you said operating cash flow would largely fund next year's unit expansion. Does that imply there is some other source of funding needed to meet the unit count goals?

Well, it really depends so much on how many stores we open and we're going to be managing that as we watch how the year progresses. If we -- it could be $2 million to $3 million that we would need additional but the revolver is available for that, just depends on timing.

Our ongoing goal, Bill, is to finance all of our growth via cash flow rather than through borrowings. And so we will be very prudent in how many stores we open this year and in upcoming years so that we can kind of match our cash flow to our cash needs.

The next question comes from Chris Mandeville with Jefferies.

Hey good afternoon. So Kemper, you mentioned less internal competition, if you will, during the quarter. I know you guys are lapping probably one of your high volume stores having hit one of your own in early June. Can you just provide us with what type of cannibalization you actually experienced in Q4 itself and what your expectations are for 2017?

Well in Q2 we indicated that cannibalization impacted our comp by about 200 basis points and in Q3 we saw some moderation off of that number and we’ve seen a small moderation off of Q3. We had strong store in the Denver market anniversary in late Q3 and that's going to help.

Okay, that's helpful. And then just kind of looking at the actual mature store comps themselves, I believe you mentioned that they have declined 1.8%. I'm just trying to square the two comments and now internal competition has actually moderated a bit but then I think Sandra had mentioned that the decline itself was largely driven by internal competition.

Well, we still have some serious internal competition, it moderated mildly, didn’t moderate a lot. We had our Tennyson store open, I think it was November of last year. And so we won't -- that store had some – it really damaged some of our existing stores sales when it opened and that won't moderate until after this quarter.

And you had mentioned that you are doing your price checks -- checking on your competition as it relates to some of the conventional products that they're selling relative to what type of premium you may be requiring on your organic side. Are there any specific categories or departments to which you're seeing greater disparity or more meaningful change of late versus what you've seen historically?

No, I'd say eggs are a prime example. Eggs are pretty expensive in conventional stores a year ago and they’ve dropped down to under a dollar a dozen or even less right now. So that would be -- one in particular I mean chicken -- conventional chicken has gotten really cheap, conventional beef has gotten really cheap.

And then the last one for me, I believe on the last call you had mentioned that {N} Power is just over about 200,000 users with nearly half of them actually using the program on a weekly basis. I was hoping to just kind of get an update there. And I guess maybe longer term when you expect to be able to truly leverage what data you're amassing behind the scenes to perform some more targeted marketing?

Yeah. Currently we have 260,000 plus registered members of {N} Power. As far as long term marketing we're doing a lot of demographic studies in regards to who are the members and who is spending the most money so that we can more intelligently target our social media toward those demographics better. And we should be able to start doing that sometime in the beginning of next year. We've also gotten a lot better at the way that we're targeting our current members to get better sales responses from our {N} Power members. And we’ve learned quite a bit in the last year about how to better message to those members and not have as much of an expense to our company through just counting -- through our messaging.

The next question comes from Scott Mushkin with Wolfe Research.

Hey guys. Thanks for taking my question. So I was wondering what percentage of your stores that compete with Kroger? Do you have that handy?

I would say 80% of them do. Kroger, one of their – I don’t have it exact but my guess is at least 80% of our – I mean in Denver, we have King Soopers, in Dallas you have Kroger and in Arizona, you’ve got the Fry's, in Oregon and Washington you’ve got Fred Meyers, and Dillons in the Kansas area et cetera.

I mean so I guess what makes me a little nervous about the numbers that you guys are reporting and the outlook is Kroger in some divisions has been getting much more aggressive on -- forget the delta between conventional – getting much more aggressive on organic prices. We've seen that in their Harris Teeter division clearly. I mean how prepared are you guys to see a big competitor like that start getting significantly more competitive on price and what would you do about it?

Well, we've been competing with the conventional, Safeway got into our space in 1977. And they had a store across -- back then we only had a couple stores and they got a store just across the street from us back then, we competed quite well with them back then. I agree that it's definitely a concern when a big company like Kroger becomes very price competitive but Costco and Wal-Mart are as price competitive as Kroger and they've been doing it for a long time also, I mean more competitive than Kroger has. And so we have to market to our -- what differentiates us which is we sell only organic produce, we only sell products that do not -- our grocery products don't contain artificial flavours, colors, preservatives et cetera. And we have our egg standard which is free range eggs compared to whatever Kraft, they sell at Kroger and our dairy standard is one of pasture based and Kroger will sell anything as long as it sells. So we intend to really push our quality differences versus Kroger over the next six months so that that becomes known to the consumers particularly in our stronger markets such as Denver.

So the other question –

I mean we're not going to be able to compete price for price with them but we do compete pretty favorably on a lot of our things. For instance in our bulk department we outprice Kroger by at least 10% to 15% to 20% on almost every item. And so we do have places where we're extremely better priced than they are already. And in produce we're pretty close to their price except for when they run a ridiculous sale.

Right. So then the second question, Kemper, is if Thrive Market just got a big round of funding. They're pushing kind of a natural organic, most dry grocery –

I wonder how much money -- yeah I'm serious about how much money they're willing to lose and keep on losing.

I have no doubt about that. I think you're right on that one. But do you think you feel them at this stage, do you think that they're having an impact or –

Every new competitor has a small impact. So I mean you have to be nimble and you have to keep on innovating to survive. And that's what we intend to do. At some point in time Thrive, their business model as far as I can see isn’t one that will ever make money and so they'll go out of business unless they get bought by somebody else for some ridiculous reason.

Maybe Kroger will buy them and put it together with their VITACOST. Then my final question --

VITACOST never made any money either, so.

My final question is on the store expense side and labor.

I mean we haven’t made money, so we can't compete with people that did have a business model and not making money.

Yes, very very difficult. Labor expense is going up, we see signs all over the place Help Wanted in some of your markets, even bonuses being offered. How much are you feeling that strain and then I'll yield and just wish you guys good luck and thank you for taking my questions.

Labor costs are going up and several of the states that we do business in passed new minimum wage laws. And they will have – we’ve factored those into our guidance for the year. Fortunately for us we have always paid above minimum wage already and so most of those new minimum wage laws won't affect us this coming year. I guess that would be what we have to say about that.

The next question comes from Shane Higgins with Deutsche Bank.

Yeah thanks taking my questions. Guys, I just wanted to circle back on the competitive environment. Are you seeing, Kemper, any kind of significant price investments or hot promotions from some of your specialty guys? I know there has been a lot of talk about Sprouts and Whole Foods. But just curious if you saw any of that in any of your markets during the quarter.

I would say that Sprouts and Whole Foods have invested a lot of price into their conventional product. To an extent Sprouts invests a little bit in the organic produce market but otherwise I haven't seen any more than normal from them.

All right. Thanks for that color. How about your comp trends in more energy dependent states Texas, Oklahoma, even Colorado versus the ones that haven't been as impacted by the slowdown in the energy market?

Our comp trends in those states have been negative and our comp trends in the states that don't have an energy impact have been positive.

Are you seeing that delta narrow at all?

It has narrowed a little bit during the last quarter.

Okay, thanks. And just a quick one on sales by category. How are the dietary supplements doing for you guys?

Dietary supplements are doing very well. They almost gained market share last year as a percentage of sales, they are essentially flat for the year, so that was very positive.

And in terms of new unit growth cadence how should we think about modeling that for 2017?

Well right now we have five scheduled to open this quarter, four for next quarter and then we will be dynamic for the next two quarters after that.

And then just one more for me on your inventories. I notice that inventories per store were down about 6%, you finished it pretty lean. Can just talk about kind of how you're thinking about managing inventories into next year and working capital in general?

We believe that we have room to decrease our inventories by at least another 5%.

The next question comes from Ryan Gilligan with Barclays.

Hi thanks for taking the question. Just a quick follow-up on the quarter-to-date trends. I know they were bad for the last week after the election, but can you give us a sense for how they trended for the first five weeks of this quarter?

They were not as strong as the previous quarter.

Okay. Is there anything in your data that could suggest what's driving that softness, other than just the stepped-up competition at some --?

No, we were pretty surprised by that because September -- in the last quarter September was our strongest month by far and so we thought we had a lot of momentum going for September and October.

And on the new labor grid, can you give us a sense for where sales per labor hour are now?

Can I just go back to that one?

Yes.

I think there is a lot -- I think that the divisiveness of the election was really harmful to the mood of the consumer in October and I think that could have been part of the problem.

Got it. That makes sense. And I guess my next question, just on the new labor grid, can you give us a sense for where sales per labor hour are now and where they can go?

No, we can't really disclose that one. But we are aggressively managing our labor costs, much more aggressively than we did last year.

And I guess last question on upfront CapEx for the new stores, is there an opportunity to lower that over time?

We are working on a prototype designs for new stores that will -- we hope will substantially lower our per store costs.

The next question comes from Alvin Concepcion with Citi.

Great, thanks for taking my question. I'm not sure if you covered this. But I'm wondering what you’re seeing on inflation, and what's your outlook for next year? And more specifically what are you seeing on the produce side?

For inflation -- I mean the biggest winner so far for deflation is the nut category. The prices of almonds and walnuts and pecans et cetera has fallen almost in half from their peak. And so that's great for the consumer and great for us because we now have these products at a better price for our customers and they will be able to buy, purchase more. As far as other products, there really hasn't been a lot of inflation in – there hasn’t been either inflation or deflation in our category pretty much other than that nut category that I was just speaking of.

And on the discussion about your pricing gaps, I understand there is quality differences but are you maintaining your pricing gap to competitors, and what are those at this point?

Well it's impossible for us to maintain our pricing gap on a $0.99 egg compared to the quality of the egg that we sell. So what we've had to do is educate our customers about why our eggs is at a better price. And that seems to be pretty successful when we do that. We’re actually gaining market share. So we’re happy with that.

I am wondering if you could also talk about your private label opportunity, what that holds for you in the future?

We have partnered with Daimon to help us roll out private label at our stores and hopefully by the end of our next fiscal year we'll have many more SKUs of private label on our shelf. End of Q&A

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 very much for joining us to discuss our fourth quarter results. While 2016 was a challenging year we were able to adapt to the environment and maintain positive comparable store sales growth despite a highly competitive landscape. We are confident with our growth strategies and positioning as we enter -- we are confident with our growth strategies and positioning as we enter fiscal 2017. Thanks for being on the call today. Everyone have a nice afternoon. Bye.

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