Good day, ladies and gentlemen. Welcome to the Natural Grocers' First Quarter Fiscal Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only-mode. Later we will conduct the 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. John Fischer, General Counsel for Natural Grocers. Mr. Fischer, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers Vitamin Cottage first quarter fiscal year 2018 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 a recording of this call will be available on the website at investors.naturalgrocers.com. Now I will turn the call over to Mr. Kemper Isely.

Thank you, John, and good afternoon, everyone. I am pleased to share with you our continued improvement in sales trends during the first quarter, which were driven by our marketing and promotional efforts, as well as the benefits of our moderated new store growth, and reduced competitive openings across our store base. During the first quarter, we continue to build upon the momentum we've reported last quarter, delivering a 4.7% increase in daily average comp store sales. The comp store increase was comprised of a 4.8% increase in daily average transaction count and a 0.1% decrease in average transaction size. This included further improvement in mature store comps, which increased 1.6% during the quarter. We are very pleased with our success driving traffic with our marketing activities, which included direct mail, continued leverage of our Npower promotions, our new Health Hotline Magazine, local store marketing and company-wide events. Along with our marketing efforts, our store operations team has been focused on leadership and training efforts. We are pleased with the success of these marketing and operational initiatives and the momentum they have created. During the quarter, we also invested in price to drive customer count. While we have seen and will continue to see impact of these price investments in our gross margin percentage, we understand the trade-offs between driving traffic and the impact to our margins. As we move forward, we have an opportunity to be more effective with our promotional offers. We will look to further refine our promotional activity as the year progresses. In addition, given the recently enacted reductions in the federal corporate tax rate, we plan to reinvest the expected savings from these reductions in support of our investments in price and traffic-generating initiatives. Finally, as a result of the improved sales and traffic, we were able to leverage our store expenses. And most of you know, in December, we announced the appointment of Todd Dissinger as Chief Financial Officer. We are pleased to have Todd as part of our executive team. He will be an invaluable asset as the company continues to grow. With that, let me turn the call over to Todd to discuss our financial results.

Thank you very much, Kemper, and good afternoon, everyone. It is a privilege to speak with you today. And I'm excited about my new role, and look forward to continuing the dialogue with all of you in the future. During the first quarter of fiscal 2018, net sales increased 10.3% to $202.5 million, and daily average comparable store sales increased 4.7%. The daily average comparable store sales increase during the first quarter was driven by a 4.8% increase in daily average transaction count, partially offset by a 0.1% decrease in average transaction size. This was our third consecutive quarter of improving daily average comps. Daily average mature store sales returned to positive during the quarter, increasing 1.6%, reflecting our marketing and promotional initiatives, reduced internal and external new competition and continued improvement in the oil and gas markets. As Kemper mentioned, we are pleased with the improved traffic, and we believe our initiatives have positioned us well for continued positive sales trends, as well as created an opportunity to improve profit conversion of these enhanced sales. Gross profit margin declined approximately 220 basis points to 26.3%, primarily due to a lower product margin as a result of both our targeted promotions to drive traffic and, to a lesser extent, a shift in sales mix. Gross margin percentage was also negatively impacted by higher occupancy cost as a percentage of sales. However, the impact of gross margin percentage, as a result of higher occupancy cost year-over-year, was more modest this quarter than prior quarters, given the stronger comps. Store expenses as a percent of sales declined approximately 50 basis points to 22.3% during the first quarter compared to the prior-year period. The decrease in store expenses as a percentage of sales was primarily driven by leverage as a result of the…

Thank you, Todd. During the first quarter, we opened two new stores and relocated one store. Thus far, during the second quarter of fiscal 2018, we have opened one store in Texas and have an additional store in Texas scheduled to open next week. We have signed leases for nine additional new stores to open in fiscal 2018 and beyond. We continue to monitor new store performance, have budgeted a continued moderation of new unit growth in fiscal 2018 and will remain flexible with new unit development plans going forward in order to adapt to the competitive environment, as necessary. Our fiscal 2018 outlook has been adjusted to reflect the impact of the non-cash re-measurement of our deferred income tax assets and liabilities during the first quarter. During fiscal 2018, we expect to open 8 to 10 new stores, resulting in 6% to 7% unit growth; relocate 3 to 4 stores; achieve daily average comparable store sales growth of 1% to 3%; achieve net income margin of 1% to 1.3% or 0.6% to 0.9% exclusive of the first quarter deferred tax benefit; achieve diluted earnings per share of between $0.40 and $0.50 or a range of between $0.21 and $0.31 exclusive of the first quarter non-cash re-measurement to our deferred tax assets and liabilities, and we expect capital expenditures for fiscal 2018 in the range of $25 million to $30 million. 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 further share repurchases under our 2-year $10 million share repurchase program. We are encouraged by the sales momentum we continue to build during the first quarter, and plan to focus on refining our promotions to deliver an improved bottom line during the remainder of fiscal 2018. We remain confident in the core strategies that drive us, and we are focused on the core beliefs that set us apart from the competition. We pride ourselves on our strong relationships with our customers and vendors, while providing quality products at affordable prices with outstanding service and free nutritional education. Remember, every product we sell is good for you. We do not just sell products because they sell. It is our commitment to these principles that continues to drive growth and create value for our shareholders. Now I would like to open the lines up for questions. Thank you.

[Operator Instructions] And our first question comes from Bill Kirk of RBC. Please go ahead.

Hi. Thanks for taking the question. Using your tax and reinvestment commentary, I come up with about $0.05 of EPS that would be going back behind price and promotion. Is that right or about right? And how much price promotional spend does that equate to as a percentage of sales?

So I think you're a little bit high, Bill. It's probably more like $0.03. If you think about the tax rate, it's lower by about 12%. And depending on what you're calculating the pretax income at, we're more around 3% - or $0.03 a share.

And does that $0.03 equal about 20 basis points behind price and promo? What does that equal?

I think you're a little bit high on the 20 basis points.

Okay, okay. So, I guess, more theoretically, what do you think the return on that type of commercial spend is? And why are those dollars most appropriate to go there today?

Well, the reason that it's important to spend on price is to build customer accounts at our stores, so that we can remain vital and viable in the future. Without price promotion, you can do all the marketing you want to do, but it isn't going to drive customers into your store. And so we need to get our customer accounts going up, and we believe that the targeted price promotion on stable goods will continue to increase our customer accounts favorably over the coming year.

Okay. Thank you. That's it from me.

Thanks, Bill.

Our next question comes from Rupesh Parikh of Oppenheimer. Please go ahead.

Thanks for taking my question. So I want to start out first. Is there any color you can provide in terms of how your quarter-to-date comps are trending thus far?

They're trending quite a bit better than last quarter.

Okay, okay. So would you - okay. So if they're trending better than last quarter, your guidance would imply - you only took up your comp rates very slightly. Is that just your conservatism at this point or are you expecting potentially moderating comps as you may pull back on some of the promotions?

Well, we - yes, we'll be going against positive comps coming up in the second half of the year. As you know, last year, during the first quarter, we had our worst comp quarter in a long time. And so we're going against substantially negative comps this quarter. So, of course, they would be probably higher than the previous quarter just because of that.

Okay, great. And then just going back to your commentary on the gross margin. So it sounds like you're planning to make adjustments going forward to - I guess, to mitigate some of the margin degradation. I was curious, how quickly can you make tweaks to your promotional activity? And are these adjustments where you may reduce suppliers, pull back on price? If you can just help us understand and what type of weeks.

Well, during - even during the quarter, we pulled back on price promotion. And by December, we had moderated our degradation in margin, substantially from October and November. And so we saw better results going into December as compared to October and November, and we have made similar adjustments here in January.

Okay. I guess, my last question. Is it fair to say that, that improvement in margins has continued so far quarter-to-date?

Yes.

Okay, great. Thank you.

Our next question comes from Chris Mandeville of Jefferies. Please go ahead.

Thanks for taking my questions. Kemper, can we just talk about the - or maybe Todd, it doesn't matter. The 215 basis points-or-so of gross margin erosion, can you help us buck it back a little bit or break that down? What was actually self-inflicted from the incremental price investment and promotion versus anything that may have been competitive or cost related?

It is about 90%.

Okay. And then with regards to realizing higher occupancy. You're stating that you actually still - you've been having put up a 4.7% comp did not leverage that line item?

Well, we've put up 4.7% comp, but we were only 1.6% of the mature comp. We need to get our mature comp up to over 3% to leverage our occupancy cost.

Okay, got that. And then with regards to the promotions themselves, I'm just trying to better understand how you plan or intend on weaning customers off of the elevated level of value that you've been conveying in recent months. You mentioned that you've parried back a little bit in December and done so even further in January. From what you've seen thus far, how confident do you feel that you could stop sacrificing gross margin, but you have retained the benefit on the top line to ensure that you're actually realizing greater returns on a go-forward basis?

Well, one of the ways that we've done that is we've made some of our pricing exclusive to our Npower members. And that means the half - you get to put the price up in your store and say, it's a member-only price, and yet only half of the customers were taking advantage of that price.

Okay. That's helpful. And then lastly, just thinking about competition itself, I think it's been well-reported that, hopefully, it's maybe seeing some issues when it comes to managing their own inventory of late. So just wondering if you feel as though maybe you're seeing any type of benefit to the detriment of them? And then maybe more broadly, how would you characterize the grocery landscape today versus maybe the last 6 to 12 months?

Well, the opening of new competitors has moderated significantly compared to 18 months ago. So I think everybody's pulled back a little bit on their expansion plans. In regards to Whole Foods, as the quarter progressed, we saw the comp at our stores better competing with Whole Foods, improve more than our overall comp. So I think it's possible that we are receiving from the benefit of their inventory issues.

And I'm sorry just to circle back really quickly. Todd, on the margin itself or of late, have you been realizing anything in terms of incremental freight costs that would also have been pressuring the gross margin? Or should we expect that on a go-forward basis?

We could see a slight uptick in freight costs.

Thank you very much, guys.

Sure, Chris.

Thanks.

Our next question comes from Shane Higgins of Deutsche Bank. Please go ahead.

Hey, good afternoon guys. Thanks for taking the questions. Obviously, price investments promotions are key focus for you guys. How do you guys feel about your relative price and value positioning today versus maybe where you were 3 or 6 months ago? And the fact that you guys are going to reinvest a lot of the tax savings, are you guys also anticipating competitors doing the same?

No, I can't anticipate what competitors are going to do, but I can tell you that in our price surveys that we have become substantially more competitive since we started our investment in price.

And any color you guys can give on the merchandise mix? I think you said that was a bit of a headwind to the margin just in terms of grocery versus vitamin supplements and fresh body care and other?

We lost a slight amount of mixed margin in HABA and in supplements. Their sales did not grow quite as fast during the quarter as our overall sales did. They were pretty close to the same overall sales, but they were slightly negative - in the whole basket.

Okay. Thanks for that. And it looks like - just going through here. Your inventories actually came down quite a bit. You guys have been managing that real well. Any color on what you guys are doing on that front, and maybe on the shrink expense and how that's impacting your margin?

Well, we're on - we've put a lot of focus into our inventory management systems and replenishment systems. And that is definitely helping to bring inventory down at our store - at our existing stores. And as always, we're looking at our new stores and weaning out things that haven't sold in the past and not bringing them in, which will help our shrink in the long run substantially.

Great. And then just the last one for me is, just any color on your store labor productivity initiatives, what you guys are doing there, and whether that - what kind of impacts you're expecting for the rest of this year?

So we had improvement year-over-year during the quarter, and we expect to continue having year-over-year improvement as the year goes along. Good sales will definitely help that issue, and the sales trends in January are positive. So I think we'll have - I mean, if they continue through this quarter, we'll have a good result in that area also.

Are you guys seeing any labor or wage pressures as, obviously, that labor market continues to tighten?

There's definitely wage pressure out there. I mean, there's certain states like Oregon that have raised their minimum wage substantially, and we always pay higher than the minimum wage. So there's definitely some wage pressure out there. It's not a significant headwinds to our profits because we were already fairly, we compensated our good4u crews better than the minimum wage to start with. And so it's been - it's going to be a fairly minimal impact, but there is some impact.

Great, thanks.

Our next question comes from Ryan Gilligan of Barclays. Please go ahead.

Hi, thanks. So the comp is obviously impressive, but can you talk about what confidence you have that you'll be able to retain these new transactions once you pull back on promotion?

Well, as I've said before, we kind of already have pulled back on the promotions to an extent, and our traffic counts and the comp numbers have improved in January. And so I think that, because of our superior offerings at our stores and our superior customer service and our nutrition education aspects of our stores and the experience that our customers get at our stores, we'll be able to retain the customers that we've been pulling in with our promotional activity.

And we've been very successful at moving more customers into our Npower program. We added about 75,000 customers to the Npower membership. So our count is at about 480,000 members. And that's up about 200,000 in over a year ago. So we'll be able to market more effectively to that group.

That's helpful. Is there any way to size the level of improvement in gross margin degradation so far quarter-to-date?

In the second quarter?

Yes. Just is it still down, close to 200 basis points? Obviously, the comparison starts to get easier.

Yes. I don't think that we were able to discuss that as of yet. We have to wait until the next quarter's call.

Is there any way to break out the comp difference between the Npower members and non-members?

Because of the large increase in our Npower membership, it's difficult at this point in time to do that. We are studying what the people that were in the program spent last year as compared to what they're spending at the end this year. It does increase the longer they're members in our program, the Npower members.

Got it. And then just lastly on tax reform. Is reaccelerating store growth the potential outcome or it used up your saving?

No. We're going to keep our moderated store growth for the foreseeable future and the stores per year in 3 to 4 moves.

Sounds good. Thank you.

Our next question comes from Scott Mushkin of Wolfe Research. Please go ahead.

Hey, guys, thanks for taking my questions. So big earnings day, so I'm kind of bopping around. So I'm just trying to understand if I'm getting it, and it's probably me, not you guys, but I think you said your comps are running above the 4.7%, which you just put up, and that profits have been improving as you've pulled back on promos. Is that correct?

Our comps are running above the 4.7% substantially this - in January. And I said that, during the quarter, our profits improved substantially from October to December.

Okay. So I did get that right. So the number's actually trying to square that with the comments around tax and reinvesting tax, and it sounds like lower pricing. So can you just kind of square that for me? I'm a little confused on, if you're doing so well, why you would might use the money to do that. It seems like it could be just wasted. As you said, you're coming off promos, so that's kind of suggesting maybe you're going to be off promos? And I guess, that's where I'm a little confused. Maybe you can help me there.

Well, I would say that we - any tax savings that we're going to achieve during the year will probably go into promotional pricing.

So is your anticipation, you're kind of coming off promos right now, that you're going to ramp them back up as we go through this current year?

I think we'll be moderated as we go. We'll be similar to where we were in the second half of last year.

Okay, okay. That's it for me. And that will be regardless of what's happening in your markets? It's something you guys are going to lead the way? And then that's it for me.

Well, no. I mean, if we don't see - if we see competitive pressures moderating, then we will, of course, pull back on our promotional activity and in markets that we don't have to have this promotional activity, and we're not going to have that activity.

So I said that was my last one. So obviously, I just lied. But - so wait, are you seeing things ease up as the economy gets better? And...

Well, there are certain markets that don't require as much promotional activity as others. I mean, the big cities like Dallas and Denver and Phoenix and Tucson and Salt Lake City require more - and Kansas City require more promotional activity to generate customers and say - let me think of a city that might be less affected by, say, Lubbock, Texas.

Okay. I appreciate you taking my questions. Thanks.

Okay.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Kemper Isely for any closing remarks.

Thank you very much for joining us to discuss our first quarter results. We believe in Natural Grocers' 62 year history of successfully adapting to an ever evolving natural products landscape, while serving our customers and our communities. We look forward to speaking with you on our next call. Thank you.

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