Good day, ladies and gentlemen. Welcome to the Natural Grocers Second Quarter Fiscal Year 2018 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the conference over to Mr. David Colson, Vice President and Treasurer for Natural Grocers. Mr. Colson, you may begin.

Good afternoon, everyone, and thank you for joining us for the Natural Grocers by Vitamin Cottage Second 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 Kemper.

Thank you, David, and good afternoon, everyone. I'm very pleased to report our fourth consecutive quarter of improving daily average comparable store sales. During the second quarter, we continued to build upon the positive momentum we have been developing over the last year, delivering a 7.1% increase in daily average comp store sales, and further improvement in mature store comps, which increased 4.3% during the quarter. The improvements were driven by the success of our marketing and promotional efforts, price investments and our unwavering focus on our core values. We remain pleased with the response to our direct mail efforts, continued leverage from our {N}power customer loyalty program promotions and our Health Hotline magazine. Over the past year, we have targeted our marketing and promotional initiatives toward driving traffic into our stores. In the second quarter, as planned, we executed more on focused pricing and promotional efforts, which led to moderation of our gross margin investment compared to the first quarter. We will continue to be targeted and focused with our pricing and promotional efforts as we invest in traffic-driving initiatives. These efforts generated a 5% increase in daily average transaction count during the second quarter, while driving a 2% increase in average basket size. Both represented a sequential improvement over the first quarter. We believe, we are more effectively communicating our differentiations in leadership and product quality, while also enhancing our everyday affordable pricing principles. With that, let me turn the call over to Todd to discuss our financial results.

Thank you very much, Kemper, and good afternoon, everyone. During the second quarter of fiscal 2018 net sales increased 12.3% to $215.9 million, and daily average comparable store sales increased 7.1%. The daily average comp increased during the second quarter was driven by a 5.0% increase in daily average transaction count and a 2.0% increase in average transaction size. The positive momentum in daily average mature store sales continued increasing 4.3%. Our improving comp store sales reflects our marketing and promotional pricing initiatives, reduced internal and external new competition and continued improvement in our oil and gas markets. As Kemper mentioned, we are very pleased with the continued improvement in traffic, which drove positive expense leverage and improved profit trends. Our efforts to refine and focus our promotions during the second quarter contributed to a 2% increase in average basket compared to a 0.1% decrease in average basket during the first quarter. We also believe the continued acceleration of comps, even as we become more targeted with promotions, is demonstrating our ability to retain our traffic and basket gains, while moderating our investment in gross margin. Gross profit margin declined approximately 120 basis points to 27.0%, primarily due to a lower product margin. Product margin was impacted by our promotional pricing initiatives to drive traffic. However, the year-over-year decline in gross margin improved significantly compared to the 215 basis points decline, we experienced during the first quarter. Recall that, we generate a higher gross margin in supplements and body care than in grocery, and our promotional and pricing efforts have been focused primarily on grocery, which has impacted our sales mix and thus our gross margin. Gross margin was also negatively impacted by higher occupancy cost as a percentage of sales, however, the impact on gross margin due to higher…

Thank you, Todd. During the second quarter, we opened three new stores. Thus far during the third quarter of fiscal 2018, we have opened one new store in Oregon. We have signed leases for eight additional new stores to open in fiscal 2018 and beyond. We're continuing to monitor new stores performance and remain comfortable with our targeted store openings. Our fiscal 2018 outlook has been adjusted to reflect the strength of our first half comps and a narrowing of our diluted earnings per share guidance. During fiscal 2018, we expect to open 8 to 10 new stores, resulting in 6% to 7% unit growth; relocate three to four stores; achieve daily average comparable store sales growth of 3.5% to 4.5% compared to a prior outlook for 1% to 3% growth; achieve net income margin of 1% to 1.3% or 0.6% to 0.9% exclusive of the deferred tax benefit recognized during the first quarter; achieve diluted earnings per share between $0.43 and $0.50 or a range of between $0.24 and $0.31 exclusive of the deferred tax benefit recognized during the first quarter. We expect capital expenditures for fiscal 2018 in the range of $25 million to $30 million. In addition, our share repurchase program has been extended by two years. As a result of that extension, the program will now terminate on May 4, 2020. We are very pleased with the continued sales momentum and improved earnings during the second quarter. We remain focused on refining our promotions to deliver continued improvements to our bottom line, while continuing to build momentum during the remainder of fiscal 2018. We are confident in the core strategies that drive us and will continue to focus on the core beliefs that set us apart from the competition. We do not just sell products simply because they sell. Every product we sell must meet our strict quality standards. We remain focused on our 5 founding principles and our commitment to our strong relationship with our customers, vendors and good4u crews, while providing quality products such as pasture-based dairy, free-range eggs and only organic products that we offer at affordable prices, while providing free nutrition education to our customers. In line with this commitment, we recently announced an increase in our minimum wage to $11 per hour and we're continuing to provide $1 per hour in vitamin bucks to all our crew members. It is this focus that continues to drive growth and will create value for our shareholders. Now I would like to open the line up for questions. Thank you.

[Operator Instructions] And the first question comes from Bill Kirk from RBC Capital Markets. Please go ahead.

Thank you for taking the question. So, as I have a question about new store openings and as they've slowed, how much has that impacted self cannibalization, I mean, less new stores, less self cannibalization. How big of an impact has that been?

Trying to not open stores in markets, adding new stores to cannibalize existing sales. So, yes, I mean, in our current pipeline, I don't see that there is, we have 1 store opening in Tigard, Tigard in October -- Tigard, Oregon in October of this year might have a slight cannibalization effect on our Beaverton, Oregon store. But other than that I don't think that we have stores in the pipeline that should have a material impact on cannibalizing our sales of the kind of new stores.

Okay. And on the announcement today of the extension of the share repurchase authorization, that just sound clear, that's just extending the time to conduct it, it didn't change the amount, did it?

That's correct.

Okay, that is it from me. I will jump back in queue if there is anything else.

And the next question comes from Rupesh Parikh from Oppenheimer.

Hello, congrats on a nice quarter. So my first two questions are to do with your comps. As we look at your guidance for the full year, it implied the deceleration at back half of the year. Is that -- is there something you're seeing right now? Or is that just conservative -- conservatism?

Well, we lost some comp this quarter already because of the shift of Easter to April 1. We think we lost about 30 basis points of sales in April because of that. And then we also are going up against higher comps, positive comps in the fourth quarter in June. And so we think that it will be harder to hit as higher comp as we had in the first half of the year.

Okay. If you look at your quarter-to-date comp performance, excluding that Easter shift, are trends running in line to what you just saw, or are they running -- or any color you can provide on, on where you're seeing quarter-to-date?

Well, they're running, they will run so that we meet our guidance.

Okay. Okay. And then from a -- as we look at your gross margins for the back half of the year, do you expect to see continued improvement versus what we saw in the first half?

The improvement will moderate somewhat because we -- depending on the competitive situation, we may need to be more promotional.

Okay. And then I guess, my final question just as you look at the promotional environment. Are you guys seeing any changes versus recent quarters? Or is it fairly consistent?

It's been fairly consistent. I mean, the heavy promotions that we did in the first quarter and second quarter really did help to drive customer turns into our stores. And if we see moderation in that then we'll have to accelerate those promotions again.

Okay, great thank you.

And the next question comes from Chris Mandeville from Jefferies.

Kemper, on the pricing and the investment strategy, can you just dig into that a little bit more deeply, where have you been predominantly focused, what's helping you in terms of use of data to direct that spend and I suppose they're being spent there possibly?

Being promotional on consumer staple goods is what drives customer accounts into your stores, and then promoting it properly does the same thing. We use our {N}power program to really drive the data to see what works and what doesn't work. And we're able to moderate or accelerate our promotions based on what we see from that data. It's pretty quick than we can analyze that data actually. We e-mail out to almost 600,000 people three times a week promotions and we do see what works and what doesn't work because of that.

Okay. But you're predominantly focusing on the staples category like eggs and milk and what have you?

Yes, correct.

Okay. And then, thinking about inflation, obviously, have been very tough from last 24 hours here. What does that look like for you guys given your quality of products sold and what's your outlook for the rest of the year? And then I guess, secondarily, do you have any concern that if conventional goods do slip back into deflation that you might be a bit impacted by a growing price disparity, that would impact, compel you to be a little bit more promotional versus what your implied guidance may have currently?

I would say that from an inflation standpoint, so far, we're not seeing a lot of commodity inflation right now. As a matter of fact, I think it's pretty flat, really haven't seen, nut prices have stayed pretty flat, the egg prices have stayed pretty flat to down. Produce prices, avocado prices has come down nicely this year so far. So, I would say that commodity prices have stayed pretty flat. As far as if there is deflation in the conventional market, there is always a concern that people might trade down, but our customers are pretty committed to buying organic and high-quality products, and so they're willing to pay a price differential for those high-quality products. So I don't see that as a huge threat to our pricing strategy.

Okay, now I will leave it that and let someone else ask some questions thanks.

And the next question comes from Ryan Gilligan from Barclays. Please go ahead.

Can you talk about where you see gross margins shaking out at the end of this period of margin investment? So how much further lower do you see margins going forward?

Todd, do you want to answer that one?

Yes. So we -- as you can see, we had 120 basis points denigration in our gross margin in Q3 and that was substantially better than the 215 basis points that we experienced in Q1. So like year-over-year comparison, we expect to narrow in Q3 and further in Q4. I don't think we're going to give guidance on our gross margin percentage, but we can see a trend of improvement there.

Okay. Got it. And then just on the minimum wage investment. Is there any way to size that and give some more color on the timing up?

That was effective at the beginning of April. It'll cost us approximately $0.01 in earnings for the rest of the year.

Got it. So about $0.02 on an annualized basis, is that fair?

That would be fair, yes.

Okay. And then just labor scheduling, is there an update on that? I think you guys talked about a pilot rolling out in March?

We've rolled out, we call it hot schedules to all of our stores and they are using it as of right now.

Are you seeing an improvement in labor as a percent of sale or sales per labor hour?

Ryan, I think it's a bit early to tell, you go from a little bit busier period of time to a less busy of time, April 15 is a shift in our business from selling a lot of supplements to more groceries. And so we have a little decline in sales. So it's a little bit hard to see as of this moment whether we're seeing the benefits, but we do expect to see the benefits by the end of the quarter.

Got it that is helpful thank you.

And our next question comes from Scott Mushkin from Wolfe Research.

So I wanted to poke at the long-term outlook for margins a little bit more. I guess you're seeing success in discount in the pasturing items, but you know, I do know rent runs through that GM line. And I'm just trying to construct with the cost pressures on wages and generally do business going up, and it will be, need to invest on the gross margin line. Can you give us a feel for what you think, can we stabilize margins just generally give us an exact percentage, but is it going to be possible to stabilize your margins without seeing sales consistently above 4% or 5%?

I think that we'll stabilize margins by the end of the year for sure.

Even if comps run in that 3% range?

Yes. By the end of the year, we will be able to stabilize. And in a year, next year, we should see pretty -- be able to pretty much track to what we did this year.

Okay. I wanted to ask, I mean, obviously, the comp is incredibly strong, but you guys tend to bend toward the kind of a wellness vitamin side of things given -- obviously, given the company's name. How much do you think the real significant flu season and cold season, how much of an impact do you think it had on your sales?

We probably had about a 25 basis point impact.

So not too much. All right. And then my final question is you made -- you alluded to, Kemper, in some of your comments that may be the promotional environment might get a little more difficult in the back half of the year. What are you seeing at competitors right now, do you believe the environment is stable or deteriorating a little bit, improving a little bit, so if I can hear what your thoughts are?

I think at the moment, it's pretty stable. But, I mean, one of our major competitors kind of had softer sales and they had been having this last quarter, and I can see them being a little bit more price competitive because of that. And then Kroger is definitely aggressive on pricing and you got Amazon. I'm not sure what they're doing with Whole Foods, it doesn't seem like they've done much as far as pricing goes, at Whole Foods, they haven't become better on their pricing.

Perfect. Thanks for taking my questions.

And the next question comes from Alvin Concepcion from Citi. Please go ahead.

It's actually Garrett on for Alan. Thanks for taking the question. So wondering if you could just kind of walk us through the monthly cadence of the comps in the quarter. And also talk about kind of the month-by-month promotional spend, was it pretty consistent across all three months? Or does it increase or decrease as the quarter wind? Any color there would be helpful.

I would say that the cadence was fairly -- no, January was the strongest month for comp, but I believe that was our weakest month last year for going up against. So that would make sense. That will be the strongest month for comp this year. As far as the promotional spend, it's pretty flat for each month for the quarter.

Okay. And then, so far in 3Q, is the promotional spend still pretty good, so what it was in 2Q?

So far, it's slightly down from what it was last quarter.

Okay. That's helpful. And then, I guess just kind of switching gears to digital, could you maybe talk about, give us an update on where you stand with delivery? And if that's kind of a major focus moving forward? And maybe kind of taking a step further back, where you see kind of online penetration for the industry, and then maybe for your company specifically?

Well, you know {N}power is pretty much a digital promotional platform for us. And as I mentioned earlier, we're sending out about 1.8 million e-mails a week to our customers via that, that particular program. So to our existing customers are pretty good, pretty good touch points via digital that way. And then we've really ramped up our digital promotions, I don't know what call you it, but via Facebook, Google et cetera. Paid placement of ads, and we actually ran a digital-only coupon for Easter, where we got a -- I think it cost us about a $1 -- $2.50 per customer that we attracted. We attracted like 2,000 to 4,000-some customers. So it was a pretty effective spend. Those customers spent on average $67 off of that promotion. So we've been experimenting with it and gradually ramping up digital-only promotions. And they've been pretty effective so far.

Okay. That's helpful. And then just last one, I guess, on delivery. Are you continuing the kind of applications with Instacart, and where do you kind of see that, that relationship going to the end of the year? And how has the customer been reacting to that?

Well, as Instacart rolls out to more markets where our stores are being added to those markets, the sales via Instacart have increased substantially over the previous year because of the expanded market reach. The sales at our stores that were existing are marginally with Instacart.

Okay great, thanks so much for the color.

And the next question comes from [indiscernible], private investor.

Hi, good afternoon, gentlemen. And thank you very much for taking my call. I am a third-generation Natural Grocers' customers, first generation investor. And my question today are probably a little bit less technical than the ones that have been asked previous to this. They are a little bit more ground level. The produce department, can you please provide me some information in terms of what's being done to increase the quality of the produce that's made available on that department. My observations in your home market of the Denver metro region over the last probably 36 months, usually show that, that produce is lacking in quality compared to the selection of the organic produce, not only at Whole Foods, but also at stores like King Soopers and the Kroger and Albertson, Safeway. I know this is anecdotal for whatever it's worth. But I'm, again, being a long-term customer, I'm speaking to other individuals that strongly support Natural Grocers. We all have to go to Whole Foods to purchase our produce. What's being done to better secure contracts for organic produce that are at higher quality and less produce that appears to more a B-grade quality. So that customers are coming to your stores and maybe purchasing things, and at the center of the store can also, you can retain your customers and have them purchasing and increasing produce?

I didn't get. What was your name?

Noaa. N-O-A-A.

Hi, Noaa. I'm disappointed that you have that opinion of our produce because we have the opposite opinion that you do. We only sell organic produce, number one. And number two, we -- I mean, every once in a while some organic produces isn't the best, but it doesn't look the best, but it usually taste the best. I'm also a shopper of our stores and only buy my produce from our stores, because I don't believe in giving support to stores that don't -- that sell things because they just want they sell, which is what our competitors do, including Whole Foods, Sprouts, King Soopers, et cetera. And so it's disappointing to me. If you want to tell me which stores in particular, you're not having a good produce experience, I'd like to know that. So that we can address it on a store-by-store basis, but up in our Boulder store, I know we're winning the battle for organic – selling organic produce up in Boulder, hands down and many of the other local markets we're winning it hands down. There are a couple of our stores that have slower sales that may have sometimes have difficult produce departments. But by and large, our produce departments are selling only Grade A produce and first quality produce. So I'm not – kind of taken back by your general comment.

And this concludes our question-and-answer session. I would like to turn the call back to Mr. Isely for any concluding remarks.

Thank you very much for joining us to discuss our second quarter results. We believe in Natural Grocers' 62-year history of successfully adapting to an ever-evolving natural products landscape, we are serving our customers and our community. 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.