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Table of Contents

 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2020

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

COMMISSION FILE NUMBER: 001-35608 

Natural Grocers by Vitamin Cottage, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

45-5034161

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

 

  

12612 West Alameda Parkway

80228

Lakewood, Colorado

(Address of principal executive offices)

(Zip code)

 

(303) 986-4600

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading symbol 

Name of each exchange on which registered

Common Stock, $0.001 par value

NGVC

New York Stock Exchange

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

 

Accelerated filer

Non –accelerated filer ☐

 

Smaller reporting company

  

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ☒

 

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of August 3, 2020 was 22,524,341.

 

 

 

 

 

Natural Grocers by Vitamin Cottage, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended June 30, 2020

 

Table of Contents

 

   

Page

Number

     
 

PART I. Financial Information

 
     

Item 1.

Financial Statements

4

 

Consolidated Balance Sheets as of June 30, 2020 (unaudited) and September 30, 2019

4

 

Consolidated Statements of Income for the three and nine months ended June 30, 2020 and 2019 (unaudited)

5

 

Consolidated Statements of Cash Flows for the nine months ended June 30, 2020 and 2019 (unaudited)

6

 

Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended June 30, 2020 and 2019 (unaudited)

7

 

Notes to Unaudited Interim Consolidated Financial Statements

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

30

Item 4.

Controls and Procedures

30

     
 

PART II. Other Information

 

Item 1.

Legal Proceedings

31

Item 1A.

Risk Factors

31

     

Item 5.

Other Information

32

Item 6.

Exhibits

33

     

SIGNATURES

34

 

 

2

 

 

Except where the context otherwise requires or where otherwise indicated: (i) all references herein to we,” “us, our,” “Natural Grocers and theCompany refer collectively to Natural Grocers by Vitamin Cottage, Inc. and its consolidated subsidiaries and (ii) all references to a fiscal year” refer to a year beginning on October 1 of the previous year and ending on September 30 of such year (for example, “fiscal year 2020” refers to the year from October 1, 2019 to September 30, 2020).

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q (this Form 10-Q) includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 in addition to historical information. These forward-looking statements are included throughout this Form 10-Q, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All statements that are not statements of historical fact, including those that relate to matters such as our industry, business strategy, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources, future growth, pending legal proceedings and other financial and operating information, are forward looking statements. We may use the words “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “future,” “target” and similar terms and phrases to identify forward-looking statements in this Form 10-Q.

 

The forward-looking statements contained in this Form 10-Q are based on management’s current expectations and are subject to uncertainty and changes in circumstances. We cannot assure you that future developments affecting us will be those we have anticipated. Actual results may differ materially from these expectations due to changes in global, regional or local political, economic, business, competitive, market, regulatory and other factors, many of which are beyond our control. In addition, our actual results could differ materially from the forward-looking statements in this Form 10-Q due to risks and challenges related to the COVID-19 pandemic and the resulting government mandates, including: the length of time that the pandemic continues; the inability of customers to shop due to illness or quarantine, isolation or stay-at-home orders; shifts in demand to more online shopping or to lower-priced or other perceived value offerings; the temporary inability of our employees to work due to illness; temporary store closures due to infections at our stores or government mandates; stay-at-home measures, safety directives and operating requirements imposed by local, state or federal governmental authorities; the extent and duration of the economic recession resulting from the COVID-19 pandemic and government mandates, including its impact on consumer spending, the unemployment rate, interest rates and inflationary and deflationary trends; disruptions in the production of the products we sell; disruptions in the delivery of products to our stores; increased operating costs; and the extent and effectiveness of any COVID-19-related stimulus packages implemented by the federal and state governments.

 

In addition to the foregoing, we believe the factors that could cause our actual results to differ materially from the forward-looking statements in this Form 10-Q include those referenced in Item 1A - “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019 (the Form 10-K) and Part II, Item 1A - “Risk Factors” in this Form 10-Q. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, our actual results may vary in material respects from those projected in these forward-looking statements.

 

Any forward-looking statement made by us in this Form 10-Q speaks only as of the date of this report. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by applicable securities laws. You are advised, however, to consult any disclosures we may make in our future reports filed with the Securities and Exchange Commission (the SEC). Our reports and other filings with the SEC are available at the SEC’s website at www.sec.gov. Our reports and other filings with the SEC are also available, free of charge, through our website at www.naturalgrocers.com.

 

3

 

 

PART I. Financial Information

Item 1. Financial Statements

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Balance Sheets

(Dollars in thousands, except per share data)

 

  

June 30,

2020

  

September 30,

2019

 

 

 

(unaudited)

     
Assets       

Current assets:

        

Cash and cash equivalents

 $29,855   6,214 

Accounts receivable, net

  5,174   5,059 

Merchandise inventory

  96,347   96,179 

Prepaid expenses and other current assets

  4,688   7,728 

Total current assets

  136,064   115,180 

Property and equipment, net

  151,927   201,635 

Operating lease assets, net

  341,848    

Finance lease assets, net

  34,598    

Deposits and other assets

  634   1,638 

Goodwill and other intangible assets, net

  10,278   8,644 

Deferred financing costs, net

  34   17 

Total assets

 $675,383   327,114 
         

Liabilities and Stockholders’ Equity

        

Current liabilities:

        

Accounts payable

 $69,558   63,162 

Accrued expenses

  24,467   19,061 

Capital and financing lease obligations, current portion

     1,045 

Operating lease obligations, current portion

  31,940    

Finance lease obligations, current portion

  2,617    

Total current liabilities

  128,582   83,268 

Long-term liabilities:

        

Capital and financing lease obligations, net of current portion

     51,475 

Operating lease obligations, net of current portion

  328,390    

Finance lease obligations, net of current portion

  33,812    

Revolving credit facility

     5,692 

Deferred income tax liabilities, net

  13,969   10,420 

Deferred rent

     11,393 

Leasehold incentives

     7,960 

Total long-term liabilities

  376,171   86,940 

Total liabilities

  504,753   170,208 

Commitments (Note 13)

          

Stockholders’ equity:

        

Common stock, $0.001 par value, 50,000,000 shares authorized, 22,524,341 and 22,510,279 shares issued at June 30, 2020 and September 30, 2019, respectively and 22,524,341 and 22,463,057 outstanding at June 30, 2020 and September 30, 2019, respectively

  23   23 

Additional paid-in capital

  56,472   56,319 

Retained earnings

  114,135   100,923 

Common stock in treasury at cost, 0 and 47,222 shares, at June 30, 2020 and September 30, 2019, respectively

     (359

)

Total stockholders’ equity

  170,630   156,906 

Total liabilities and stockholders’ equity

 $675,383   327,114 

 

See accompanying notes to unaudited interim consolidated financial statements.

 

4

 

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Statements of Income

(Unaudited)

(Dollars in thousands, except per share data)

 

   

Three months ended
June 30,

   

Nine months ended
June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Net sales

  $ 265,110       224,411       772,664       676,373  

Cost of goods sold and occupancy costs

    192,729       165,986       561,936       496,588  

Gross profit

    72,381       58,425       210,728       179,785  

Store expenses

    58,577       48,424       166,882       147,722  

Administrative expenses

    6,818       5,953       19,675       17,029  

Pre-opening and relocation expenses

    300       213       1,380       1,042  

Operating income

    6,686       3,835       22,791       13,992  

Interest expense, net

    (505

)

    (1,256

)

    (1,557

)

    (3,791

)

Income before income taxes

    6,181       2,579       21,234       10,201  

Provision for income taxes

    (1,490

)

    (581

)

    (4,957

)

    (2,146

)

Net income

  $ 4,691       1,998       16,277       8,055  
                                 

Net income per common share:

                               

Basic

  $ 0.21       0.09       0.72       0.36  

Diluted

  $ 0.21       0.09       0.72       0.36  

Weighted average number of shares of common stock outstanding:

                               

Basic

    22,510,987       22,438,657       22,491,818       22,412,662  

Diluted

    22,641,255       22,525,287       22,552,933       22,564,705  

 

 

See accompanying notes to unaudited interim consolidated financial statements.

 

5

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

   

Nine months ended June 30,

 
   

2020

   

2019

 

Operating activities:

               

Net income

  $ 16,277       8,055  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    23,508       21,783  

Gain on disposal of property and equipment

          (158

)

Share-based compensation

    751       920  

Deferred income tax expense (benefit)

    3,283       (1,400

)

Non-cash interest expense

    9       10  

Changes in operating assets and liabilities

               

(Increase) decrease in:

               

Accounts receivable, net

    (115

)

    782  

Merchandise inventory

    (169

)

    (1,864

)

Prepaid expenses and other assets

    (906

)

    (430

)

Income tax receivable

    3,971       (298

)

Operating lease asset

    22,562        

(Decrease) increase in:

               

Operating lease liability

    (23,124

)

     

Accounts payable

    10,005       767  

Accrued expenses

    5,405       1,352  

Deferred compensation

          (688

)

Deferred rent and leasehold incentives

          (536

)

Net cash provided by operating activities

    61,457       28,295  

Investing activities:

               

Acquisition of property and equipment

    (23,277

)

    (20,817

)

Acquisition of other intangibles

    (2,218

)

    (2,036

)

Proceeds from sale of property and equipment

          833  

Proceeds from property insurance settlements

    27       32  

Net cash used in investing activities

    (25,468

)

    (21,988

)

Financing activities:

               

Borrowings under credit facility

    228,900       297,900  

Repayments under credit facility

    (234,592

)

    (301,000

)

Capital and financing lease obligation payments

          (566

)

Finance lease obligation payments

    (1,669

)

     

Dividend to shareholders

    (4,725

)

     

Loan fees paid

    (25

)

     

Payments on withholding tax for restricted stock unit vesting

    (237

)

    (380

)

Net cash used in financing activities

    (12,348

)

    (4,046

)

Net increase in cash and cash equivalents

    23,641       2,261  

Cash and cash equivalents, beginning of period

    6,214       9,398  

Cash and cash equivalents, end of period

  $ 29,855       11,659  

Supplemental disclosures of cash flow information:

               

Cash paid for interest

  $ 347       603  

Cash paid for interest on finance or capital and financing lease obligations, net of capitalized interest of $88 and $117, respectively

    1,217       3,169  

Income taxes paid

    10       4,733  

Deferred compensation paid

          700  

Supplemental disclosures of non-cash investing and financing activities:

               

Acquisition of property and equipment not yet paid

  $ 2,679       4,408  

Property acquired through capital and financing lease obligations

          9,651  

Property acquired through operating lease obligations

    8,170        

Property acquired through finance lease obligations

    5,232        

 

See accompanying notes to unaudited interim consolidated financial statements.

 

6

 

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Statements of Changes in Stockholders’ Equity

For the Nine Months Ended June 30, 2020 and June 30, 2019

(Unaudited)

(Dollars in thousands, except per share data)

 

 

   

Common stock –$0.001 par

                                 
   

value

                                 
   

Shares

outstanding

   

Amount

   

Additional

paid-in

capital

   

Retained

earnings

   

 

Treasury

stock

   

Total

stockholders’

equity

 

Balances September 30, 2019

    22,463,057     $ 23     $ 56,319     $ 100,923     $ (359

)

  $ 156,906  

Net income

                      1,868             1,868  

Cash dividends

                      (1,573

)

          (1,573

)

Share-based compensation

    12,661             135             96       231  

Topic 842 transition impact

                      1,660             1,660  

Balances December 31, 2019

    22,475,718       23       56,454       102,878       (263

)

    159,092  

Net income

                      9,718             9,718  

Cash dividends

                      (1,574

)

          (1,574

)

Share-based compensation

    28,092             (15

)

          214       199  

Balances March 31, 2020

    22,503,810       23       56,439       111,022       (49

)

    167,435  

Net income

                      4,691             4,691  

Issuance of common stock..

    14,062                                

Cash dividends

                      (1,578

)

          (1,578

)

Share-based compensation

    6,469             33             49       82  

Balances June 30, 2020

    22,524,341     $ 23     $ 56,472     $ 114,135     $     $ 170,630  

 

 

   

Common stock –$0.001 par

                                 
   

value

                                 
   

Shares

outstanding

   

Amount

   

Additional

paid-in

capital

   

Retained

earnings

   

 

Treasury

stock

   

Total

stockholders’

equity

 

Balances September 30, 2018

    22,373,382     $ 23     $ 56,236     $ 91,507     $ (1,040

)

  $ 146,726  

Net income

                      2,197             2,197  

Share-based compensation

    18,928             101             144       245  

Balances December 31, 2018

    22,392,310       23       56,337       93,704       (896

)

    149,168  

Net income

                      3,860             3,860  

Share-based compensation

    39,243             (145

)

          298       153  

Balances March 31, 2019

    22,431,553       23       56,192       97,564       (598

)

    153,181  

Net income

                      1,998             1,998  

Share-based compensation

    22,652             (30

)

          172       142  

Balances June 30, 2019

    22,454,205     $ 23     $ 56,162     $ 99,562     $ (426

)

  $ 155,321  

 

See accompanying notes to unaudited interim consolidated financial statements.

 

7

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements

 

June 30, 2020 and 2019

 

 

1. Organization

 

Nature of Business

 

Natural Grocers by Vitamin Cottage, Inc. (Natural Grocers or the holding company) and its consolidated subsidiaries (collectively, the Company) operate retail stores that specialize in natural and organic groceries, body care products and dietary supplements. The Company operates its retail stores under its trademark Natural Grocers by Vitamin Cottage®. As of June 30, 2020, the Company operated 159 stores in 20 states. The Company also has a bulk food repackaging facility and distribution center in Golden, Colorado. The Company had 153 stores in 19 states as of September 30, 2019.

 

 

2. Basis of Presentation and Summary of Significant Accounting Policies

 

Consolidated Financial Statements

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial statements and are in the form prescribed by Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements. The information included in this Form 10-Q should be read in conjunction with Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included in the Form 10-K. The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the Company’s financial results. Interim results are not necessarily indicative of results for any other interim period or for a full fiscal year. The Company reports its results of operations on a fiscal year ending September 30.

 

The accompanying unaudited consolidated financial statements include all the accounts of the holding company’s wholly owned subsidiaries, Vitamin Cottage Natural Food Markets, Inc. (the operating company) and Vitamin Cottage Two Ltd. Liability Company (VC2). All significant intercompany balances and transactions have been eliminated in consolidation.

 

The Company has one reporting segment: natural and organic retail stores. Sales from the Company’s natural and organic retail stores are derived from sales of the following product categories, which are presented as a percentage of sales for the three and nine months ended June 30, 2020 and 2019, as follows:

 

  

Three months ended

June 30,

  

Nine months ended

June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Grocery

  72

%

  69   69   68 

Dietary supplements

  18   21   21   21 

Other

  10   10   10   11 
   100

%

  100   100   100 

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (including the fair value of assets acquired and liabilities assumed in a business combination), the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management reviews its estimates on an ongoing basis, including those related to: allowances for self-insurance reserves; valuation of inventories; useful lives of property and equipment for depreciation and amortization; impairment of finite-lived intangible assets, long-lived assets, and goodwill; lease assumptions; and litigation based on currently available information. Changes in facts and circumstances may result in revised estimates and actual results could differ from those estimates.

 

8

 

Recently Adopted Accounting Pronouncements

 

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, “Leases (Topic 842)” in February 2016 and subsequently issued related ASUs in 2018 and 2019 (collectively, ASC 842). ASC 842 requires lessees to recognize a right-of-use asset and corresponding lease liability for all leases with terms greater than 12 months. Under ASC 842, recognition, measurement and presentation of lease expenses depend on whether the lease is classified as a finance or operating lease.

 

The Company adopted ASC 842 on October 1, 2019, the first day of fiscal year 2020, using the modified retrospective transition approach. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which, among other things, permits companies not to reassess prior conclusions on lease identification, lease classification and initial direct costs. The Company did not elect the hindsight practical expedient.

 

The adoption of ASC 842 resulted in the recognition of operating lease assets and operating lease liabilities of $359.6 million and $377.8 million, respectively, as of October 1, 2019. Included in the measurement of the new lease assets is the reclassification of certain balances, including those historically recorded as deferred rent and leasehold incentives. 

 

Additionally, the Company recognized a cumulative effect adjustment, which increased retained earnings by $1.7 million for the nine months ended June 30, 2020. These adjustments were primarily driven by the derecognition of $41.9 million of lease obligations and $40.2 million of net assets related to leases that had been classified as capital financing lease obligations under the former failed-sale leaseback guidance. These leases were reclassified as operating or finance leases as of October 1, 2019, the transition date. See Note 7 for additional information related to the Company’s lease accounting policy.

 

In June 2018, the FASB issued ASU 2018-07, “Compensation-Stock Compensation,” Topic 718, “Improvements to Nonemployee Share-Based Payment Accounting” (ASU 2018-07) as part of its simplification initiative to reduce complexity when accounting for share-based payments to non-employees. ASU 2018-07 expands the scope of Topic 718 to more closely align share-based payment transactions for acquiring goods and services from non-employees with the accounting for share-based payments to employees, with certain exceptions. The provisions of ASU 2018-07 are effective for the Company’s first quarter of the fiscal year ending September 30, 2020, with early adoption permitted. This ASU did not have an impact on the Company’s consolidated financial statements for the three or nine months ended June 30, 2020.

 

Recent Accounting Pronouncements 

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses,” Topic 326, “Measurement of Credit Losses on Financial Instruments” (ASU 2016-13), subsequently amended by various standard updates. ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information when determining credit loss estimates. ASU 2016-13 also requires financial assets to be measured net of expected credit losses at the time of initial recognition. ASU 2019-10, issued in November 2019, delayed the effective date of ASU 2016-13 for smaller reporting companies such as the Company. The provisions of ASU 2016-13 will be effective for the Company’s first quarter of the fiscal year ending September 30, 2024. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of these provisions will have on its consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” Topic 350, “Intangibles – Goodwill and Other” (ASU 2017-04). The amendments in ASU 2017-04 simplify the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in the current two-step impairment test. An impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value should be recognized; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments should be applied on a prospective basis. ASU 2019-10 delayed the effective date of this ASU to align with the effective date of ASU 2016-13 (referred to above). Because the Company is a smaller reporting company, the provisions of ASU 2017-04 will be effective for the Company’s first quarter of the fiscal year ending September 30, 2024. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of these provisions will have on its consolidated financial statements.

 

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform,” Topic 848, “Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (ASU 2020-04). The new guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The guidance applies only to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The interest rate currently payable under the Company’s Credit Facility is based on LIBOR, but recent amendments have incorporated alternative reference rates. As such, the Company does not anticipate that the adoption of these provisions will have a material impact on its consolidated financial statements.

 

 

 

3. Revenue Recognition

 

The nature of the goods the Company transfers to customers at the point of sale consists of merchandise purchased for resale. In these transactions, the Company acts as a principal and recognizes revenue (net sales) from the sale of goods when control of the promised goods is transferred to the customer. Control refers to the ability of the customer to direct the use of, and obtain substantially all the remaining benefits from, the transferred goods.

 

The Company’s performance obligations are satisfied upon the transfer of goods to the customer (at the point of sale), and payment from the customer is also due at that time. Transaction prices are considered fixed. Discounts provided to customers at the point of sale are recognized as a reduction in revenue as the goods are sold. Revenue excludes sales and usage-based taxes collected.

 

Proceeds from the sale of gift cards are recorded as a liability at the time of sale and recognized as revenue when the gift cards are redeemed by the customer and the performance obligation is satisfied by the Company. The Company also recognizes revenue for a portion of gift card values that is not expected to be redeemed (breakage). The estimated breakage takes into consideration several factors, including the laws and regulations applicable to each jurisdiction. The Company determines the amount of breakage income to be recognized on gift cards using historical experience to estimate amounts that will ultimately not be redeemed. The Company recognizes such breakage income in proportion to redemption rates of the overall population of gift cards.

 

The balance of contract liabilities related to unredeemed gift cards was $1.1 million and $1.0 million as of June 30, 2020 and September 30, 2019, respectively. Revenue for the three months ended June 30, 2020 and 2019 includes $0 million and $0.1 million, respectively, that was included in the contract liability balance of unredeemed gift cards at September 30, 2019 and 2018, respectively. Revenue for the nine months ended June 30, 2020 and 2019 includes approximately $0.8 million and $0.6 million, respectively, that was included in the contract liability balance of unredeemed gift cards at September 30, 2019 and 2018, respectively.

 

The following table disaggregates our revenue by product category for the three months and nine months ended June 30, 2020 and 2019, dollars in thousands:

 

  

Three months ended

June 30,

  

Nine months ended

June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Grocery

 $190,114   154,383   534,220   463,486 

Dietary supplements

  49,355   46,240   161,225   141,724 

Other

  25,641   23,788   77,219   71,163 
  $265,110   224,411   772,664   676,373 

 

 

4. Earnings Per Share

 

Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted EPS reflects the potential dilution that could occur if the Company’s granted but unvested restricted stock units (RSUs) were to vest, resulting in the issuance of common stock that would then share in the Company’s earnings.

 

Presented below are basic and diluted EPS for the three and nine months ended June 30, 2020 and 2019, dollars in thousands, except per share data:

 

  

Three months ended
June 30,

  

Nine months ended
June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Net income

 $4,691   1,998   16,277   8,055 
                 

Weighted average number of shares of common stock outstanding

  22,510,987   22,438,657   22,491,818   22,412,662 

Effect of dilutive securities

  130,268   86,630   61,115   152,043 

Weighted average number of shares of common stock outstanding including effect of dilutive securities

  22,641,255   22,525,287   22,552,933   22,564,705 
                 

Basic earnings per share

 $0.21   0.09   0.72   0.36 

Diluted earnings per share

 $0.21   0.09   0.72   0.36 

 

10

 

There were 14,973 and 135,147 non-vested RSUs for the three and nine months ended June 30, 2020, respectively, excluded from the calculation of diluted EPS as they are antidilutive. There were 124,102 and 42,584 non-vested RSUs for the three and nine months ended June 30, 2019, respectively, excluded from the calculation of diluted EPS as they are antidilutive.

 

The Company paid a dividend of $0.07 per share of common stock in each of the first three quarters of fiscal year 2020. The Company did not declare any dividends during the three or nine months ended June 30, 2019.

 

 

5. Debt

 

Credit Facility 

 

On January 28, 2016, the Company entered into a credit facility (the Credit Facility). The operating company is the borrower under the Credit Facility and its obligations under the Credit Facility are guaranteed by the holding company and VC2. The Credit Facility is secured by a lien on substantially all of the Company’s assets. The amount available for borrowing under the Credit Facility is $50.0 million, including a $5.0 million sublimit for standby letters of credit. The Company has the right to borrow, prepay and re-borrow amounts under the Credit Facility at any time prior to the maturity date. The Credit Facility matures on November 13, 2024. For floating rate borrowings under the Credit Facility, interest is determined by the lender’s administrative agent based on the most recent compliance certificate of the operating company and stated at the base rate less the lender spread based upon certain financial measures. For fixed rate borrowings under the Credit Facility, interest is determined by quoted LIBOR rates for the interest period plus the lender spread based upon certain financial measures. The unused commitment fee is based upon certain financial measures.

 

The Credit Facility requires compliance with certain customary operational and financial covenants, including a leverage ratio. The Credit Facility also contains certain other customary limitations on the Company’s ability to incur additional debt, guarantee other obligations, grant liens on assets and make investments or acquisitions, among other limitations. Additionally, the Credit Facility prohibits the payment of cash dividends to the holding company from the operating company without the administrative agent’s consent, provided that so long as no default or event of default exists or would arise as a result thereof, the operating company may pay cash dividends to the holding company in an amount sufficient to allow the holding company to: (i) pay various audit, accounting, tax, securities, indemnification, reimbursement, insurance and other reasonable expenses incurred in the ordinary course of business and (ii) repurchase shares of common stock and pay dividends on the Company’s common stock in an aggregate amount not to exceed $10.0 million during any fiscal year.

 

The Company had $0 and $5.7 million outstanding under the Credit Facility as of June 30, 2020 and September 30, 2019, respectively. As of June 30, 2020 and September 30, 2019, the Company had undrawn, issued and outstanding letters of credit of $1.3 million and $1.0 million, respectively, which were reserved against the amount available for borrowing under the terms of the Credit Facility. The Company had $48.7 million and $43.3 million available for borrowing under the Credit Facility as of June 30, 2020 and September 30, 2019, respectively.

 

As of June 30, 2020 and September 30, 2019, the Company was in compliance with the financial covenants under the Credit Facility.

 

Lease Obligations 

 

As of September 30, 2019, 23 leases were classified as capital and financing lease obligations (see Note 7). As a result of the Company’s adoption, effective October 1, 2019, of the new lease standard set out in ASC 842: (i) the Company’s previous capital financing lease obligations were derecognized and reclassified as operating or finance leases and (ii) the Company’s previous capital lease obligations were classified as finance leases. As of June 30, 2020, the Company had 17 leases that were classified as finance leases. No rent expense is recorded for these finance leases (previously classified as capital and financing lease obligations); rather, rental payments under such leases are recognized as a reduction of the lease obligation and as interest expense. The interest rate on finance lease obligations, and legacy capital and financing lease obligations, is determined at the inception of the lease.

 

Interest

 

The Company incurred gross interest expense of approximately $0.5 million and $1.3 million for the three months ended June 30, 2020 and 2019, respectively, and approximately $1.7 million and $3.9 million for the nine months ended June 30, 2020 and 2019, respectively. Interest expense for the three and nine months ended June 30, 2020 and 2019 relates primarily to interest on capital and financing lease obligations. The Company capitalized interest of less than $0.1 million for each of the three months ended June 30, 2020 and 2019 and approximately $0.1 million for each of the nine months ended June 30, 2020 and 2019.

 

 

 

6. Stockholders’ Equity

 

Share Repurchases

 

In May 2016, the Board of Directors (the Board) authorized a two-year share repurchase program pursuant to which the Company may repurchase up to $10.0 million in shares of the Company’s common stock. The Board subsequently extended the share repurchase program, which will terminate on May 31, 2022. Repurchases under the Company’s share repurchase program are made from time to time at management’s discretion on the open market or through privately negotiated transactions in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the Exchange Act), subject to market conditions, applicable legal requirements and other relevant factors. Repurchases of common stock may also be made under a Rule 10b5-1 plan, which permits common stock to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The share repurchase program does not obligate the Company to purchase any particular amount of common stock and may be suspended, modified or discontinued by the Company without prior notice.

 

Prior to October 1, 2018, the Company repurchased 199,543 shares under the share repurchase program. The Company did not repurchase any shares between October 1, 2018 and June 30, 2020. The dollar value of the shares of the Company’s common stock that may yet be repurchased under the share repurchase program is $8.3 million.

 

Prior to October 1, 2019, the Company reissued 152,321 treasury shares at a cost of $1.3 million to satisfy the issuance of common stock pursuant to the vesting of certain RSUs and the award of common stock grants. During the three and nine months ended June 30, 2020, the Company reissued 6,469 treasury shares at a cost of less than $0.1 million and 47,222 treasury shares at a cost of approximately $0.4 million, respectively, to satisfy the issuance of common stock pursuant to the vesting of certain RSUs and the award of common stock grants. During the three and nine months ended June 30, 2019, the Company reissued 22,652 treasury shares at a cost of approximately $0.2 million and 80,823 treasury shares at a cost of approximately $0.6 million, respectively, to satisfy the issuance of common stock pursuant to the vesting of certain RSUs and the award of common stock grants. At June 30, 2020 and September 30, 2019, the Company held in treasury 0 shares and 47,222 shares, respectively, totaling $0 and $0.4 million, respectively.

 

 

7. Lease Obligations

 

The Company leases most of its stores, a bulk food repackaging facility and distribution center and its administrative offices. The Company determines if an arrangement is a lease or contains a lease at inception. Lease terms generally range from 10 to 25 years, with scheduled increases in minimum rent payments.

 

Operating lease liabilities represent the present value of lease payments not yet paid. Operating lease assets represent the Company’s right to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives and impairment of operating lease assets.

 

Most leases include one or more options to renew, with renewal terms normally expressed in periods of five year increments. The exercise of lease renewal options is at the Company’s sole discretion. The lease term includes the initial contractual term as well as any options to extend the lease when it is reasonably certain that the Company will exercise that option.

 

Variable payments related to pass-through costs for maintenance, taxes and insurance or adjustments based on an index such as Consumer Price Index are not included in the measurement of the lease liability or asset and are expensed as incurred.

 

As most of the Company’s lease agreements do not provide an implicit discount rate, the Company uses an estimated incremental borrowing rate, which is derived from third-party lenders, to determine the present value of lease payments. We use other observable market data to evaluate the appropriateness of the rate derived from the lenders. The estimated incremental borrowing rate is based on the borrowing rate for a secured loan with a term similar to the expected term of the lease.

 

Leases are recorded at the commencement date (the date the underlying asset becomes available for use) for the present value of lease payments, less tenant improvement allowances received or receivable. Leases with a term of 12 months or less (“short-term leases”) are not presented on the balance sheet. The Company’s short-term leases relate primarily to embedded leases. The Company has elected to account for the lease and non-lease components as a single lease component for all current classes of leases.

 

The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.  

 

12

 

The Company subleases certain real estate or portions thereof to third parties. Such subleases have all been classified as operating leases. Remaining lease terms extend through fiscal year 2030. Although some sublease arrangements provide renewal options, the exercise of sublease renewal options is at the sole discretion of the subtenant. The Company recognizes sublease income on a straight-line basis.

 

The Company has five operating leases with Chalet Properties, LLC (Chalet), one operating lease with the Isely Family Land Trust LLC (Land Trust) and one operating lease with FTVC, LLC, each of which is a related party (see Note 12). The leases began at various times with the earliest commencing in November 1999, continue for various terms through February 2027 and include various options to renew. These leases account for $7.0 million of right-of-use assets and $7.3 million of lease liabilities included in the disclosures below. Lease expense is recognized on a straight-line basis and was $0.3 million and $1.0 million for the three months and nine months ended June 30, 2020, respectively.

 

The components of total lease cost for the three and nine months ended June 30, 2020 were as follows, dollars in thousands:

 

Lease cost

Classification 

Three months

ended June 30,

2020

  

Nine months

ended June 30,

2020

 

Operating lease cost:

         
 Cost of goods sold and occupancy costs $10,677  $31,929 
 Store expenses  80   239 
 Administrative expenses  76   235 
 Pre-opening and relocation expenses  32   154 

Finance lease cost:

         

Depreciation of right-of-use assets

Store expenses(1)  797   2,284 

Interest on lease liabilities

Interest expense, net (1)  431   1,234 

Short-term lease cost

Store expenses  626   1,154 

Variable lease cost

Cost of goods sold and occupancy costs(2)  1,407   4,012 

Sublease income

Store expenses  (91

)

  (276)

Total lease cost

 $14,035   40,965 

 

1 Immaterial balances related to stores not yet open are included in pre-opening and relocation expenses.

 

2 Immaterial balances related to corporate headquarters and distribution center are included in administrative expenses and store expenses, respectively.

 

Additional information related to the Company’s leases for the three and nine months ended June 30, 2020 was as follows, dollars in thousands:

 

  

Three months ended

June 30, 2020

  

Nine months ended

June 30, 2020

 

Cash paid for amounts included in the measurement of lease liabilities:

        

Operating cash flows from operating leases

 $11,114   33,118 

Operating cash flows from finance leases

  456   1,305 

Financing cash flows from finance leases

  587   1,669 

Right-of-use assets obtained in exchange for new lease liabilities:

        

Operating leases

     7,230 

Finance leases

     5,232 
         

Weighted-average remaining lease term (in years):

        

Operating leases

  11.8     

Finance leases

  11.8     

Weighted-average discount rate:

        

Operating leases

  3.6

%

    

Finance leases

  4.9

%

    

 

In addition, during the nine months ended June 30, 2020, the Company purchased one store building that had previously been leased. This resulted in: (i) a $2.5 million reduction in operating lease liability and (ii) the reclassification of $2.4 million of corresponding operating right-of-use asset to property and equipment.

 

13

 

Future lease payments under non-cancellable leases as of June 30, 2020 were as follows, dollars in thousands:

 

Fiscal Year

 

Operating

leases

  

Finance

leases

  

Total

 

Remainder of 2020

 $11,162   1,089   12,251 

2021

  44,151   4,367   48,518 

2022

  43,444   4,389   47,833 

2023

  42,561   4,433   46,994 

2024

  40,458   4,499   44,957 

Thereafter

  265,949   30,580   296,529 

Total future undiscounted lease payments

  447,725   49,357   497,082 

Less tenant improvement allowance receivable from landlord

         

Less imputed interest

  (87,395

)

  (12,928

)

  (100,323

)

Total reported lease liability

  360,330   36,429   396,759 

Less current portion

  (31,940

)

  (2,617

)

  (34,557

)

Noncurrent lease liability

 $328,390   33,812   362,202 

 

The table above excludes $10.7 million of legally binding minimum lease payments for leases that had been executed as of June 30, 2020 but whose terms had not yet commenced.

 

Prior to the Company’s adoption of ASC 842, the Company’s leases were designated as either capital, financing or operating. Consistent with the guidance provided in ASC 842, previously designated capital lease obligations are now classified as finance leases, while previously designated capital lease finance obligations have been derecognized and reclassified as operating or finance leases. The designation of operating leases remains substantially unchanged under ASC 842. The future minimum lease payments by fiscal year, as determined prior to the adoption of ASC 842 under the Company’s previously designated capital, capital financing and operating leases (as disclosed in the Form 10-K) are presented below.

 

Minimum rental commitments and sublease rental income under the terms of the Company’s operating leases as of September 30, 2019 were as follows, dollars in thousands:

 

 

Fiscal Year

 

Third
parties

  

Related
parties

  

Sublease

rental

income

  

Total

operating
leases

 

2020

 $41,646   1,081   (422

)

  42,305 

2021

  41,484   1,058   (418

)

  42,124 

2022

  41,081   1,056   (424

)

  41,713 

2023

  40,175   1,056   (413

)

  40,818 

2024

  38,012   1,056   (257

)

  38,811 

Thereafter

  262,086   2,062   (772

)

  263,376 

Total payments

 $464,484   7,369   (2,706

)

  469,147 

 

14

 

Future payments under the terms of the leases for opened stores included in capital lease finance obligations and capital lease obligations as of September 30, 2019 were as follows, dollars in thousands:

 

Fiscal Year

 

Interest
expense on
capital lease
finance
obligations

  

Principal
payments on
capital lease
finance
obligations

  

 

Interest
expense on
capital lease
obligations

  

 

Principal

payments on
capital lease
obligations

  

Total future
payments on

capital lease

finance and capital

lease obligations

 

2020

 $3,871   569   605   333   5,378 

2021

  3,816   656   570   368   5,410 

2022

  3,751   747   532   407   5,437 

2023

  3,675   880   488   460   5,503 

2024

  3,578   1,095   439   515   5,627 

Thereafter

  15,088   8,244   2,142   3,889   29,363 

Non-cash derecognition of capital lease finance obligations at end of lease term

     27,367         27,367 

Total future payments

 $33,779   39,558   4,776   5,972   84,085 

 

Future payments under the terms of the leases for the store locations at which construction was in progress as of September 30, 2019, based on the two stores’ planned opening date in fiscal year 2020, were as follows, dollars in thousands:

 

Fiscal Year

 

Interest expense on

capital lease finance obligations for assets

under construction

  

Principal payments

on capital lease

finance obligations

for assets under

construction

  

Interest
expense on
capital lease
obligations
for assets

under construction

  

Principal payments

on capital lease
obligations
for

assets under

construction

 

2020

 $118   18   237   123 

2021

  161   26   236   132 

2022

  160   28   228   139 

2023

  158   30   221   147 

2024

  155   33   213   155 

Thereafter

  1,368   756   1,827   3,944 

Non-cash derecognition of capital lease finance obligations at end of lease term

     1,459       

Total future payments

 $2,120   2,350   2,962   4,640 

 

 

8. Property and Equipment 

 

The Company had the following property and equipment balances as of June 30, 2020 and September 30, 2019, dollars in thousands:

 

      

As of

 
  

Useful lives

(in years)

 

June 30,

2020

  

September 30,

2019

 

Construction in process

  n/a  $5,418   15,145 

Capitalized real estate leases for build-to-suit stores, including unamortized land of $0 and $617, respectively

  40      42,320 

Capitalized real estate leases

  15      7,241 

Land

  n/a   1,390   1,230 

Buildings

  40   26,732   23,571 

Land improvements

 5 –24  1,572   1,498 

Leasehold and building improvements

 1 –25  155,139   144,318 

Fixtures and equipment

 5 –7  139,076   131,491 

Computer hardware and software

 3 –5  23,450   21,672 
       352,777   388,486 

Less accumulated depreciation and amortization

      (200,850

)

  (186,851

)

Property and equipment, net

     $151,927   201,635 

 

15

 

Prior to the Company’s adoption of ASC 842 effective October 1, 2019, capitalized real estate leases included the Company’s buildings under both capital lease and capital lease finance obligations. Effective upon the Company’s adoption of ASC 842, right-of-use assets for both operating and finance leases are presented as discrete line items outside of property and equipment (see Note 7).

 

Depreciation and amortization expense for the three and nine months ended June 30, 2020 and 2019 is summarized as follows, dollars in thousands:

 

  

Three months ended
June 30,

  

Nine months ended
June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Depreciation and amortization expense included in cost of goods sold and occupancy costs

 $204   184   587   551 

Depreciation and amortization expense included in store expenses

  7,411   6,626   22,044   20,316 

Depreciation and amortization expense included in administrative expenses

  298   397   877   916 

Total depreciation and amortization expense

 $7,913   7,207   23,508   21,783 

 

 

9. Goodwill and Other Intangible Assets

 

The Company had the following goodwill and other intangible asset balances as of June 30, 2020 and September 30, 2019, dollars in thousands:

 

      

As of

 
  

Useful lives

(in years)

 

June 30,

2020

  

September 30,

2019

 

Amortizable intangible assets:

            

Other intangibles

 0.5-3 $3,540   2,677 

Amortizable intangible assets

      3,540   2,677 

Less accumulated amortization

      (2,176

)

  (1,592

)

Amortizable intangible assets, net

      1,364   1,085 

Other intangibles in process

      3,327   1,972 

Trademark

 

Indefinite

  389   389 

Total other intangibles, net

      5,080   3,446 

Goodwill

 

Indefinite

  5,198   5,198 

Total goodwill and other intangibles, net

     $10,278   8,644 

 

 

10. Accrued Expenses

 

The composition of accrued expenses as of June 30, 2020 and September 30, 2019 is summarized as follows, dollars in thousands:

 

  

As of

 
  

June 30,

  

September 30,

 
  

2020

  

2019

 

Payroll and employee-related expenses

 $15,147   8,447 

Accrued property, sales and use tax payable

  6,246   7,761 

Accrued marketing expenses

  699   477 

Deferred revenue related to gift card sales

  1,438   1,410 

Other

  937   966 

Total accrued expenses

 $24,467   19,061 

 

 

11. Income Taxes

 

Income taxes are accounted for in accordance with the provisions of ASC 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are remeasured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized.

 

16

 

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) was signed into law. Intended to provide economic relief to those impacted by the COVID-19 pandemic, the CARES Act, among other things, includes provisions addressing the carryback of net operating losses for specific periods, temporary modifications to the limitations placed on the tax deductibility of net interest expenses, and technical amendments for qualified improvement property (QIP).

 

As a result of the technical amendments made by the CARES Act to QIP, the Company accelerated tax depreciation expenses of approximately $4.0 million representing primarily temporary book-to-tax timing differences for income tax purposes (and will therefore have no effective tax rate impact) and are recorded as components within the Company’s deferred income tax liabilities and income tax receivable on the Company’s consolidated balance sheets. The Company will record the permanent benefit of addressing the carryback of net operating losses related to the accelerated depreciation expenses in the quarter ending September 30, 2020. However, this benefit will not have a material impact on the Company’s consolidated financial statements.

 

 

12. Related Party Transactions

 

The Company has ongoing relationships with related entities as noted below:

 

Chalet Properties, LLC: The Company has five operating leases with Chalet Properties, LLC (Chalet). Chalet is owned by the Company’s four non-independent Board members: Kemper Isely, Zephyr Isely, Heather Isely and Elizabeth Isely, and other related family members. Rent paid to Chalet was approximately $0.2 million and $0.3 million for the three months ended June 30, 2020 and 2019, respectively. Rent paid to Chalet was approximately $0.7 million and $0.9 million for the nine months ended June 30, 2020 and 2019, respectively.

 

Isely Family Land Trust LLC: The Company has one operating lease with the Isely Family Land Trust LLC (the Land Trust). The Land Trust is owned by the Isely Children’s Trust and by the Margaret A. Isely Family Trust. Rent paid to the Land Trust was approximately $0.1 million for each of the three months ended June 30, 2020 and 2019. Rent paid to the Land Trust was approximately $0.2 million for each of the nine months ended June 30, 2020 and 2019.

 

FTVC LLC: The Company has one operating lease for a store location with FTVC LLC, which is owned by the Company’s four non-independent Board members and other related family members. Rent paid to FTVC LLC was less than $0.1 million for each of the three months ended June 30, 2020 and 2019. Rent paid to FTVC LLC was less than $0.1 million for each of the nine months ended June 30, 2020 and 2019.

 

 

13. Commitments and Contingencies

 

The Company is periodically involved in various legal proceedings that are incidental to the conduct of its business, including but not limited to employment-related claims, customer injury claims and investigations. When the potential liability from a matter can be estimated and the loss is considered probable, the Company records the estimated loss. Due to uncertainties related to the resolution of lawsuits, investigations and claims, the ultimate outcome may differ from the estimates. Although the Company cannot predict with certainty the ultimate resolution of any lawsuits, investigations and claims asserted against it, management does not believe any currently pending legal proceeding to which the Company is a party will have a material adverse effect on its business, prospects, financial condition, cash flows or results of operations.

 

 

14. Subsequent Event

 

On August 5, 2020, the Board approved the payment of a cash dividend of $0.07 per share of common stock to be paid on September 15, 2020 to stockholders of record as of the close of business on August 31, 2020.

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with our unaudited consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and with the audited consolidated financial statements and notes thereto in our Form 10-K. This MD&A contains forward-looking statements. Refer to “Forward-Looking Statements at the beginning of this Form 10-Q for an explanation of these types of statements. Summarized numbers included in this section, and corresponding percentage or basis point changes, may not sum due to the effects of rounding.

 

Company Overview

 

We operate natural and organic grocery and dietary supplement stores that are focused on providing high-quality products at affordable prices, exceptional customer service, nutrition education and community outreach. We offer a variety of natural and organic groceries, body care products and dietary supplements that meet our strict quality standards. We believe we have been at the forefront of the natural and organic foods movement since our founding. We are headquartered in Lakewood, Colorado. As of June 30, 2020, we operated 159 stores in 20 states, including Colorado, Arkansas, Arizona, Idaho, Iowa, Kansas, Louisiana, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Washington and Wyoming. We also operate a bulk food repackaging facility and distribution center in Golden, Colorado. Our stores range from approximately 5,000 to 16,000 selling square feet, and average approximately 11,000 selling square feet.

 

The growth in the organic and natural foods industry and growing consumer interest in health and nutrition have enabled us to continue to open new stores and enter new markets. During the five fiscal years ended September 30, 2019, we increased our store count at a compound annual growth rate of 12%. In fiscal year 2019, we opened six new stores. We plan to open seven new stores in fiscal year 2020, six of which opened during the nine months ended June 30, 2020. No new stores were opened between June 30, 2020 and the date of this Form 10-Q. As of the date of this report, we have signed leases for two additional new stores that we plan to open subsequent to fiscal year 2020. We have also purchased the property for one additional new store. We plan to relocate one store in fiscal year 2020. We have not relocated any stores to date in fiscal year 2020.

 

Performance Highlights

 

Key highlights of our performance for the three and nine months ended June 30, 2020 are discussed briefly below and in further detail throughout this MD&A. Key financial metrics, including, but not limited to, comparable store sales, daily average comparable store sales, mature store sales and daily average mature store sales are defined under the caption “Key Financial Metrics in Our Business,” presented later in this MD&A.

 

 

Net sales. Net sales were $265.1 million for the three months ended June 30, 2020, an increase of $40.7 million, or 18.1%, compared to net sales of $224.4 million for the three months ended June 30, 2019. Net sales were $772.7 million for the nine months ended June 30, 2020, an increase of $96.3 million, or 14.2%, compared to net sales of $676.4 million for the nine months ended June 30, 2019.

 

 

Comparable store sales and daily average comparable store sales. Comparable store sales and daily average comparable store sales for the three months ended June 30, 2020 each increased 15.5% compared to the three months ended June 30, 2019. Comparable store sales and daily average comparable store sales for the nine months ended June 30, 2020 increased 12.0% and 11.6%, respectively, compared to the nine months ended June 30, 2019.

 

 

Mature store sales and daily average mature store sales. Mature store sales and daily average mature store sales for the three months ended June 30, 2020 each increased 12.5% compared to the three months ended June 30, 2019. Mature store sales and daily average mature store sales for the nine months ended June 30, 2020 increased 10.0% and 9.6%, respectively, compared to the nine months ended June 30, 2019.

 

 

Net income. Net income was $4.7 million for the three months ended June 30, 2020, an increase of $2.7 million, or 134.8%, compared to net income of $2.0 million for the three months ended June 30, 2019. Net income was $16.3 million for the nine months ended June 30, 2020, an increase of $8.2 million, or 102.1%, compared to net income of $8.1 million for the nine months ended June 30, 2019.

 

 

EBITDA. Earnings before interest, taxes, depreciation and amortization (EBITDA) was $14.6 million for the three months ended June 30, 2020, an increase of $3.6 million, or 32.2%, compared to $11.0 million for the three months ended June 30, 2019. EBITDA was $46.3 million for the nine months ended June 30, 2020, an increase of $10.5 million, or 29.4%, compared to $35.8 million for the nine months ended June 30, 2019. EBITDA is not a measure of financial performance under GAAP. Refer to the “Non-GAAP Financial Measures” section in this MD&A for a definition of EBITDA and a reconciliation of net income to EBITDA.

 

 

Liquidity. As of June 30, 2020, cash and cash equivalents was $29.9 million, and there was $48.7 million available for borrowing under our Credit Facility, net of undrawn, issued and outstanding letters of credit of $1.3 million.

 

 

New store growth. We opened two new stores during the three months ended June 30, 2020. We opened six new stores during the nine months ended June 30, 2020. We operated a total of 159 stores as of June 30, 2020. We plan to open a total of seven new stores in fiscal year 2020, which would result in an annual new store growth rate of 4.6% for fiscal year 2020.

 

Store Relocations and Remodels. We did not relocate or remodel any stores during the nine months ended June 30, 2020.

 

18

 

Industry Trends and Economics

 

We have identified the following recent trends and factors that have impacted and may continue to impact our results of operations and financial condition:

 

 

Impact of broader economic trends. The grocery industry and our sales are affected by general economic conditions, including, but not limited to, consumer spending, the level of disposable consumer income, consumer debt, interest rates, the price of commodities (including oil prices), the political environment and consumer confidence. See “COVID-19 Pandemic” below for a discussion of the impact of the COVID-19 pandemic on the U.S. economy and our business.

 

 

Opportunities in the growing natural and organic grocery and dietary supplements industry. Our industry, which includes organic and natural foods and dietary supplements, continues to experience growth driven primarily by increased public interest in health and nutrition. Capitalizing on this opportunity, we continue to open new stores and enter new markets. As we open new stores, our results of operations have been and may continue to be materially adversely affected based on the timing and number of new stores we open, their initial sales and new lease costs. The length of time it takes for a new store to become profitable can vary depending on a number of factors, including location, competition, a new market versus an existing market, the strength of store management and general economic conditions. Once a new store is open, it typically grows at a faster rate than mature stores for several years. Mature stores are defined as stores that have been open for any part of five fiscal years or longer.

 

As we expand across the United States and enter markets where consumers may not be as familiar with our brand, we seek to secure prime real estate locations for our stores to establish greater visibility with consumers in those markets. This strategy has resulted in higher lease costs, and we anticipate these increased costs will continue into the foreseeable future. Our financial results for the three and nine months ended June 30, 2020 reflect the effects of these factors, and we anticipate future periods will be similarly impacted.

 

Our performance is also impacted by trends regarding natural and organic products, dietary supplements and at-home meal preparation. Consumer preferences towards dietary supplements or natural and organic food products might shift as a result of, among other things, economic conditions, food safety perceptions, changing consumer choices and the cost of these products. A change in consumer preferences away from our offerings, including those resulting from reductions or changes in our offerings, would have a material adverse effect on our business. Additionally, negative publicity regarding the safety of dietary supplements, product recalls or new or upgraded regulatory standards may adversely affect demand for the products we sell and could result in lower consumer traffic, sales and results of operations.

 

 

Increased Competition. The grocery and dietary supplement retail business is a large, fragmented and highly competitive industry, with few barriers to entry. Our competition varies by market and includes conventional supermarkets such as Kroger and Safeway; mass or discount retailers such as Wal-Mart and Target; natural and gourmet markets such as Whole Foods and The Fresh Market; foreign-based discount retailers such as Aldi and Lidl; specialty food retailers such as Sprouts and Trader Joe’s; warehouse clubs such as Sam’s Club and Costco; dietary supplement retailers such as GNC and The Vitamin Shoppe; online retailers such as Amazon; meal delivery services; independent health food stores; drug stores; farmers’ markets; food co-ops; and multi-level marketers. Competition in the grocery industry is likely to intensify, and shopping dynamics may shift, as a result of, among other things, industry consolidation, expansion by existing competitors, and the increasing availability of grocery ordering, pick-up and delivery options. These businesses compete with us on the basis of price, selection, quality, customer service, convenience, location, store format, shopping experience, ease of ordering and delivery or any combination of these or other factors. They also compete with us for products and locations. In addition, some of our competitors are expanding to offer a greater range of natural and organic foods. We also face internally generated competition when we open new stores in markets we already serve. We believe our commitment to carrying only carefully vetted, affordably priced and high-quality natural and organic products and dietary supplements, as well as our focus on providing nutritional education, differentiate us in the industry and provide a competitive advantage.

 

19

 

COVID-19 Pandemic

 

On March 11, 2020, the World Health Organization announced that COVID-19 infections had become a pandemic, and on March 13, 2020, the U.S. President announced a National Emergency relating to the disease. In response to the COVID-19 pandemic, national, state and local authorities have implemented a number of public health measures intended to prevent the spread of the virus, including social distancing, quarantine, wearing face coverings, and “stay-at-home” measures. While states have commenced efforts to reopen their economies, these public health measures have had an adverse impact on the U.S. economy and in early 2020, the U.S. entered a recession. The duration and severity of the recession are unknown at this time. The effectiveness of the U.S government’s economic stabilization efforts in response to the pandemic, including proposed government payments to affected citizens and industries, is uncertain.

 

To date, all of our stores have been deemed an “essential business” by relevant government authorities and have continued operating since the start of the COVID-19 pandemic. We believe we have acted proactively in response to the COVID-19 pandemic and the resulting government mandates. We have taken a number of actions to protect the health and wellbeing of our customers and employees (whom we refer to as the “good4u Crew” or “Crew”), including implementing robust health and safety measures in our stores, hiring additional good4u Crew members to handle increased operational demands at our stores, paying higher wages and bonuses to our Crew members during the pandemic, providing daily immune and stress support supplements to our Crew members at no cost, and expanding healthcare benefits and paid leave for our Crew members. We have experienced increased levels of net sales and average transaction size due to the COVID-19 pandemic as public health measures have been implemented by states across our footprint and customers have adjusted to these new circumstances. The COVID-19 pandemic and government mandates have also led to an increase in online orders for home delivery, which we offer at substantially all our stores in partnership with a third party. Since the COVID-19 outbreak, we have experienced shortages and delays in the delivery of certain products to our stores. We have taken steps to mitigate these disruptions to our supply chain and such disruptions have moderated, although certain products remain in relatively short supply or are unavailable.

 

While we are closely monitoring the economic impact of the COVID-19 pandemic and government mandates on our business, the long-term impact of the pandemic is unknown at this time. We expect the impact of the COVID-19 pandemic and government mandates on our financial condition, results of operations and cash flows will largely depend on the extent and duration of the pandemic, the governmental and public actions taken in response, and the effect the pandemic will have on the U.S. economy. Moreover, the COVID-19 pandemic and government mandates make it more challenging for management to estimate future performance of our business, particularly over the near term. See “The ongoing COVID-19 pandemic has impacted our operations and this or other future pandemics could materially impact our business, results of operations and financial condition” under “Item 1A.-Risk Factors.”

 

Additional information regarding the impact of the COVID-19 pandemic and government mandates on our business and results of operations is provided below in this MD&A.

 

Outlook

 

We believe there are several key factors that have contributed to our success and will enable us to increase our comparable store sales and continue to profitably expand. These factors include a loyal customer base, increasing basket size, reputation for cleanliness, growing consumer interest in nutrition and wellness, a differentiated shopping experience that focuses on customer service, nutrition education and a convenient and efficient shopper-friendly retail environment, and our focus on high quality, affordable natural and organic groceries and dietary supplements.

 

We currently expect the rate of new store unit growth in the foreseeable future to depend on economic and business conditions and other factors, including the impact of the COVID-19 pandemic and government mandates. During the past few years, we have enhanced our infrastructure to enable us to support growth. In addition, in recent years we believe we have enhanced customer loyalty through our {N}power® customer loyalty program.

 

Over the long term, we believe there are opportunities for us to continue to expand our store base, expand profitability and increase comparable store sales. However, future sales growth, including comparable store sales, and our profitability could vary due to increasing competitive conditions in the natural and organic grocery and dietary supplement industry and regional and general economic conditions. In the future, we believe there are opportunities for increased leverage in costs, such as administrative expenses, as well as increased economies of scale in sourcing products. However, due to the fixed nature of certain of our costs (in particular, our rent obligations and related occupancy expenses), our ability to leverage costs may be limited.

 

Our operating results may be affected by the above-described factors as well as a variety of other internal and external factors and trends described more fully in Item 1A - “Risk Factors” in our Form 10-K and Part II, Item 1A – “Risk Factors” in this Form 10-Q.

 

20

 

Key Financial Metrics in Our Business

 

In assessing our performance, we consider a variety of performance and financial measures. The key measures are as follows:

 

Net sales

 

Our net sales are comprised of gross sales net of discounts, in-house coupons and returns and allowances. In comparing net sales between periods, we monitor the following:

 

 

Change in comparable store sales. We begin to include sales from a store in comparable store sales on the first day of the thirteenth full month following the store’s opening. We monitor the percentage change in comparable store sales by comparing sales from all stores in our comparable store base for a reporting period against sales from the same stores for the same number of operating months in the comparable reporting period of the prior year. When a store that is included in comparable store sales is remodeled or relocated, we continue to consider sales from that store to be comparable store sales. Our comparable store sales data may not be presented on the same basis as our competitors. We use the term “new stores” to refer to stores that have been open for less than thirteen months.

 

 

Change in daily average comparable store sales. Daily average comparable store sales are comparable store sales divided by the number of selling days in each period. We use this metric to remove the effect of differences in the number of selling days we are open during the comparable periods (for example, as a result of leap years or the Easter holiday shift between quarters).

 

 

Change in mature store sales. We begin to include sales from a store in mature store sales after the store has been open for any part of five fiscal years (for example, our mature stores for fiscal year 2020 are stores that opened during or before fiscal year 2015). We monitor the percentage change in mature store sales by comparing sales from all stores in our mature store base for a reporting period against sales from the same stores for the same number of operating months in the comparable reporting period of the prior year. When a store that is included in mature store sales is remodeled or relocated, we continue to consider sales from that store to be mature store sales. Our mature store sales data may not be presented on the same basis as our competitors.

 

 

Change in daily average mature store sales. Daily average mature store sales are mature store sales divided by the number of selling days in each period. We use this metric to remove the effect of differences in the number of selling days during the comparable periods (for example, as a result of leap years or the Easter holiday shift between quarters).

 

 

Transaction count. Transaction count represents the number of transactions reported at our stores during the period and includes transactions that are voided, return transactions and exchange transactions.

 

 

Average transaction size. Average transaction size, or basket size, is calculated by dividing net sales by transaction count for a given time period. We use this metric to track the trends in average dollars spent in our stores per customer transaction.

 

Cost of goods sold and occupancy costs

 

Our cost of goods sold and occupancy costs include the cost of inventory sold during the period (net of discounts and allowances), shipping and handling costs, distribution and supply chain costs (including the costs of our bulk food repackaging facility), buying costs, shrink expense and store occupancy costs. Store occupancy costs include rent, common area maintenance and real estate taxes. Depreciation expense included in cost of goods sold relates to depreciation of assets directly used at our bulk food repackaging facility. The components of our cost of goods sold and occupancy costs may not be identical to those of our competitors, and as a result, our cost of goods sold and occupancy costs data included in this Form 10-Q may not be identical to those of our competitors and may not be comparable to similar data made available by our competitors. Occupancy costs as a percentage of sales typically decrease as new stores mature and increase sales. Rent payments for leases classified as finance lease obligations (previously classified as capital and financing lease obligations) are not recorded in cost of goods sold and occupancy costs. Rather, these rent payments are recognized as a reduction of the related obligations and as interest expense.

 

Gross profit and gross margin

 

Gross profit is equal to our net sales less our cost of goods sold and occupancy costs. Gross margin is gross profit as a percentage of net sales. Gross margin is impacted by changes in retail prices, product costs, occupancy costs and the mix of products sold, as well as the rate at which we open new stores.

 

Store expenses

 

Store expenses consist of store-level expenses, such as salary and benefits, share-based compensation, supplies, utilities, depreciation, advertising, bank credit card charges and other related costs associated with operations and purchasing support. Depreciation expense included in store expenses relates to depreciation for assets directly used at the stores, including depreciation on land improvements, leasehold improvements, fixtures and equipment and computer hardware and software. Depreciation expenses on the right-of-use assets related to the finance leases of the stores are also considered store expenses. Additionally, store expenses include any gain or loss recorded on the disposal of fixed assets, generally related to store relocations. The majority of store expenses consist of labor-related expenses, which we closely manage and which trend closely with sales. Labor-related expenses as a percentage of sales tend to be higher at new stores compared to comparable stores, as new stores require a minimum level of staffing in order to maintain adequate levels of customer service combined with lower sales. As new stores increase their sales, labor-related expenses as a percentage of sales typically decrease.

 

21

 

Administrative expenses

 

Administrative expenses consist of home office-related expenses, such as salary and benefits, share-based compensation, office supplies, hardware and software expenses, depreciation and amortization expense, occupancy costs (including rent, common area maintenance, real estate taxes and utilities), professional services expenses, expenses associated with our Board, expenses related to compliance with the requirements of Sarbanes-Oxley, and other general and administrative expenses. Depreciation expense included in administrative expenses relates to depreciation for assets directly used at the home office including depreciation on land improvements, leasehold improvements, fixtures and equipment and computer hardware and software.

 

Pre-opening and relocation expenses

 

Pre-opening and relocation expenses may include rent expense, salaries, advertising, supplies and other miscellaneous costs incurred prior to the store opening. Rent expense is generally incurred from one to four months prior to a store’s opening date for store leases classified as operating. For store leases classified as capital or financing leases, no pre-opening rent expense is recognized. Other pre-opening and relocation expenses are generally incurred in the 60 days prior to the store opening. Certain advertising and promotional costs associated with opening a new store may be incurred both before and after the store opens. All pre-opening and relocation costs are expensed as incurred.

 

Interest expense, net

 

Interest expense consists of the interest associated with finance lease obligations (previously classified as capital and financing lease obligations) and our Credit Facility, net of capitalized interest and interest income.

 

 

Results of Operations

 

The following table presents key components of our results of operations expressed as a percentage of net sales for the periods presented:

 

   

Three months ended
June 30,

   

Nine months ended
June 30,

 
   

2020

   

2019

   

2020

   

2019

 

Statements of Income Data:*

                               

Net sales

    100.0

%

    100.0       100.0       100.0  

Cost of goods sold and occupancy costs

    72.7       74.0       72.7       73.4  

Gross profit

    27.3       26.0       27.3       26.6  

Store expenses

    22.1       21.6       21.6       21.8  

Administrative expenses

    2.6       2.7       2.5       2.5  

Pre-opening and relocation expenses

    0.1       0.1       0.2       0.2  

Operating income

    2.5       1.7       2.9       2.1  

Interest expense, net

    (0.2

)

    (0.6

)

    (0.2

)

    (0.6

)

Income before income taxes

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