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NGVC > SEC Filings for NGVC > Form 10-Q on 1-May-2014All Recent SEC Filings

Show all filings for NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Form 10-Q for NATURAL GROCERS BY VITAMIN COTTAGE, INC.


1-May-2014

Quarterly Report


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 report on Form 10-Q and with our Form 10-K. This discussion and analysis contains forward-looking statements. Refer to Forward-Looking Statements at the beginning of this report for an explanation of these types of statements. 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 2014" refers to the year from October 1, 2013 to September 30, 2014). 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 believe we have been at the forefront of the natural and organic foods movement since our founding. We are headquartered in Lakewood, Colorado, and as of March 31, 2014, we operated 81 stores in 13 states, including Colorado, Arizona, Idaho, Kansas, Missouri, Montana, Nebraska, New Mexico, Oklahoma, Oregon, Texas, Utah and Wyoming, as well as a bulk food repackaging facility and distribution center in Colorado.

We offer a variety of natural and organic groceries and dietary supplements that meet our strict quality standards. We regularly review and update these standards. During the three months ended March 31, 2014, for example, we updated our dairy standards and, as a result, plan by April 2015 to sell only pasture-raised, non-confinement dairy products.

The size of our stores varies from 5,000 to 16,000 selling square feet. During the twelve months ended March 31, 2014, our new stores averaged approximately 11,500 selling square feet.

The growth in the organic and natural foods industry and growing consumer interest in health and nutrition has enabled us to continue to open new stores and enter new markets. During the five fiscal years ended September 30, 2013, we grew at a compound annual growth rate of 21.7%. In fiscal year 2013, we opened 13 new stores, and we currently plan to open 15 new stores in fiscal year 2014, nine of which we opened during the six months ended March 31, 2014. Since March 31, 2014 and as of the date of this report, we have opened two additional new store locations, signed leases for the remaining four new store locations expected to open in the remainder of fiscal year 2014 in Kansas, Oklahoma, Oregon and Washington, and have signed leases for four new store locations expected to open in fiscal year 2015 in Colorado, Kansas, Nevada and Oklahoma. Additionally, we completed the remodel of one existing store location in the six months ended March 31, 2014 and plan to remodel one additional existing store in fiscal year 2014.

Performance Highlights

Key highlights of our recent performance are discussed briefly below and are discussed 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 $130.3 million for the three months ended March 31, 2014, which is an increase of $23.9 million, or 22.4%, compared to net sales of $106.5 million for the three months ended March 31, 2013. We reported net sales of $250.9 million for the six months ended March 31, 2014, which is an increase of $48.6 million, or 24.0%, compared to net sales of $202.3 million for the six months ended March 31, 2013.

Comparable store sales. Comparable store sales for the three and six months ended March 31, 2014 increased 6.9% and 8.7%, respectively, over the three and six months ended March 31, 2013.

Daily average comparable store sales. Daily average comparable store sales, which removes the effect of the additional one selling day for the occurrence of Easter in March of 2013, increased 5.7% and 8.1%, respectively in the three and six months ended March 31, 2014 over the three and six months ended March 31, 2013.

Mature store sales. Mature store sales for the three and six months ended March 31, 2014 increased 4.9% and 5.9%, respectively, over the three and six months ended March 31, 2013.

Daily average mature store sales. Daily average mature store sales, which removes the effect of the additional one selling day for the occurrence of Easter in March of 2013, increased 3.7% and 5.3%, respectively, in the three and six months ended


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March 31, 2014 over the three and six months ended March 31, 2013.

Net income. Net income was $4.0 million for the three months ended March 31, 2014, which increased $0.8 million, or 24.3%, when compared to net income of $3.2 million for the three months ended March 31, 2013. We reported net income of $6.9 million for the six months ended March 31, 2014, which increased $1.5 million, or 27.3%, when compared to net income of $5.4 million for the six months ended March 31, 2013.

EBITDA. Earnings before interest, taxes, depreciation and amortization (EBITDA) was $11.2 million in the three months ended March 31, 2014, which increased $2.5 million, or 28.4%, from $8.8 million in the three months ended March 31, 2013. We generated EBITDA of $20.6 million in the six months ended March 31, 2014, which increased $5.1 million, or 32.6%, from $15.5 million in the six months ended March 31, 2013. EBITDA is not a measure of financial performance under GAAP. Refer to the end of this MD&A for a definition of EBITDA and a reconciliation of net income to EBITDA.

Liquidity. As of March 31, 2014, cash and cash equivalents was $7.8 million, available-for-sale securities, consisting of certificates of deposit, was $0.1 million, and there was $14.3 million available under our $15.0 million amended and restated revolving credit facility. As of March 31, 2014, the Company had an outstanding letter of credit of $0.7 million which was reserved against the amount available for borrowing under the terms of our revolving credit facility. The Company had no amounts outstanding on the revolving credit facility as of March 31, 2014.

New store growth. We opened five new stores during the three months ended March 31, 2014, and opened nine new stores during the six months ended March 31, 2014. We operated a total of 81 stores as of March 31, 2014. We plan to open a total of 15 new stores in fiscal year 2014, which will result in an annual new store growth rate of 20.8% for fiscal year 2014 compared to fiscal year 2013.

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:

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 continued to open new stores and 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 after its opening date. Mature stores are stores that have been open for any part of five fiscal years or longer.

As we expand across the U.S. 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 continuing into the foreseeable future. Our financial results for the three and six months ended March 31, 2014 reflect the effects of these factors, and we anticipate future periods will be impacted likewise.

Impact of broader economic trends. The grocery industry and our sales are affected by general economic conditions, including, but not limited to, consumer spending, economic conditions, the level of disposable consumer income, consumer debt, interest rates, the price of commodities, the political environment and consumer confidence.

Outlook

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

We plan for the foreseeable future to continue opening new stores and entering new markets at or above recent levels of growth. During the past few years, we have successfully expanded our infrastructure to enable us to support our continued growth. This has included successfully implementing our enterprise resource planning system, hiring key personnel and developing efficient,


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effective new store opening, construction and operations processes and relocating and expanding our bulk food repackaging facility and distribution center in September 2012. We will complete the implementation of a human resources information and learning management system in the third quarter of fiscal year 2014 which we believe will allow us to more efficiently and effectively onboard and train our employees at all locations.

We believe there are attractive opportunities for us to continue to expand our store base and focus on increasing comparable store sales. As we continue to expand our store base, we believe there are opportunities for increased leverage in fixed costs, such as administrative expenses, as well as increased economies of scale in sourcing products. However, due to our commitment to providing high-quality products at affordable prices, such sourcing economies may not be reflected in our gross margin in the near term. Additionally, higher fixed costs of our bulk food repackaging facility and distribution center resulting from the September 2012 relocation and expansion may not be offset by retail price changes or volume increases in the near term.

Our operating results may be affected by a variety of internal and external factors and trends described more fully in the section "Risk Factors" contained in our Form 10-K, as amended by Part II, Item 1A of this report on Form 10-Q.

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, 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.

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 2014 are stores that opened during or before fiscal year 2009). 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.

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

Average transaction size. Average transaction 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 and store occupancy costs. Store occupancy costs include rent, common area maintenance and real estate


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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 report on 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. We do not record straight-line rent expense in cost of goods sold and occupancy costs for the leases classified as capital and financing lease obligations, but rather rent payments are recognized as a reduction of the related obligations and as interest expense. Additionally, depreciation expense related to the capitalized asset is recorded in store expenses.

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 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 capitalized real estate leases, land improvements, leasehold improvements, fixtures and equipment and computer hardware and software. Additionally, store expenses include any gain or loss recorded on the disposal of fixed assets, primarily related to store relocations. The majority of store expenses are comprised of salary 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 certain 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.

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 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.

Operating income

Operating income consists of gross profit less store expenses, administrative expenses and pre-opening and relocation expenses. Operating income can be impacted by a number of factors, including the timing of new store openings and store relocations, whether or not a store lease is classified as an operating or a capital or financing lease, as well as increases in store expenses and administrative expenses. The amount of time it takes for new stores 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, general economic conditions and the amount of time it takes a new store to become mature.

Interest expense

Interest expense consists of the interest associated with capital and financing lease obligations. Interest expense also includes interest we pay on our outstanding indebtedness, which includes our revolving credit facility.


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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       Six months ended
                                               March 31,               March 31,
                                           2014         2013        2014        2013
Statements of Income Data:*
Net sales                                    100.0 %      100.0      100.0       100.0
Cost of goods sold and occupancy costs        70.3         70.1       70.5        70.5
Gross profit                                  29.7         29.9       29.5        29.5
Store expenses                                20.6         20.8       20.7        20.9
Administrative expenses                        2.7          3.1        3.0         3.3
Pre-opening and relocation expenses            0.9          0.7        0.8         0.7
Operating income                               5.5          5.2        5.0         4.6
Interest expense                              (0.5 )       (0.4 )     (0.6 )      (0.3 )
Income before income taxes                     4.9          4.8        4.4         4.3
Provision for income taxes                    (1.9 )       (1.8 )     (1.7 )      (1.6 )
Net income                                     3.1 %        3.0        2.8         2.7


*Figures may not sum due to rounding.

Number of stores at end of period                      81     65     81     65
Number of stores opened during the period               5      4      9      6

Total store unit count increase period over period   24.6 % 22.6   24.6   22.6
Change in comparable store sales                      6.9    8.1    8.7   10.4
Change in daily average comparable store sales        5.7   10.6    8.1   11.6
Change in mature store sales                          4.9    3.5    5.9    5.7
Change in daily average mature store sales            3.7    5.8    5.3    6.9

Three months ended March 31, 2014 compared to the three months ended March 31, 2013

The following table summarizes our results of operations and other operating data for the periods presented, dollars in thousands:

                                          Three months ended
                                               March 31,          Increase (Decrease)
                                            2014        2013      Dollars      Percent
Statements of Income Data:
Net sales                                $   130,343   106,485      23,858         22.4 %
Cost of goods sold and occupancy costs        91,590    74,668      16,922         22.7
Gross profit                                  38,753    31,817       6,936         21.8
Store expenses                                26,877    22,163       4,714         21.3
Administrative expenses                        3,548     3,342         206          6.2
Pre-opening and relocation expenses            1,211       796         415         52.1
Operating income                               7,117     5,516       1,601         29.0
Other (expense) income:
Interest expense                                (704 )    (401 )      (303 )       75.6
Other income, net                                  1         2          (1 )      (50.0 )
Income before income taxes                     6,414     5,117       1,297         25.3
Provision for income taxes                    (2,415 )  (1,900 )      (515 )       27.1
Net income                               $     3,999     3,217         782         24.3

Net sales

Net sales increased $23.9 million, or 22.4%, to $130.3 million for the three months ended March 31, 2014 compared to $106.5 million for the three months ended March 31, 2013, primarily due to a $16.6 million increase in sales from new stores and a $7.3 million, or 6.9%, increase in comparable store sales. Daily average comparable store sales increased 5.7% for the three months


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ended March 31, 2014 as compared to the three months ended March 31, 2013. The daily average comparable store sales increase was primarily driven by a 2.0% increase in daily average transaction count and a 3.7% increase in average transaction size. Comparable store average transaction size was $36.76 in the three months ended March 31, 2014 compared to $36.37 in the three months ended March 31, 2013. Daily average mature store sales increased 3.7% in the three months ended March 31, 2014 as compared to three months ended March 31, 2013.

Gross profit

Gross profit increased $6.9 million, or 21.8%, to $38.8 million for the three months ended March 31, 2014 compared to $31.8 million for the three months ended March 31, 2013, primarily driven by positive comparable store sales and new store growth. Gross margin decreased slightly to 29.7% for the three months ended March 31, 2014 from 29.9% for the three months ended March 31, 2013 primarily due to an increase in occupancy costs as a percentage of sales for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, partially offset by an increase in product gross margin. The positive impact in product margin is due to increased product margin across most departments, offset by a shift in sales mix towards products with lower margin in the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. Gross margin benefited from operating efficiencies at the bulk food repackaging and distribution center in the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase in occupancy costs were primarily due to increased average lease expenses at new stores.

The Company had nine and seven leases for stores which were classified as capital and financing lease obligations for the three months ended March 31, 2014 and 2013, respectively. If these leases had qualified as operating leases, the straight-line rent expense would have been included in occupancy costs, and our costs of goods sold and occupancy costs as a percentage of sales during the three months ended March 31, 2014 and 2013 would have been approximately 60 and 40 basis points higher, respectively, than as reported.

Store expenses

Store expenses increased $4.7 million, or 21.3%, to $26.9 million in the three months ended March 31, 2014 from $22.2 million in the three months ended March 31, 2013. Store expenses as a percentage of sales were 20.6% and 20.8% for the three months ended March 31, 2014 and 2013, respectively. The decrease in store expenses as a percentage of sales was primarily due to a decrease in salaries, benefits and related expenses at comparable stores, as well as a decrease in advertising expenses, partially offset by increases in depreciation and, to a lesser extent, utilities expense. The decrease in salaries, benefits and related expenses at comparable stores was due to leverage from the increase in sales, as the increased salary related expenses required to support the sales growth was less than the increase in sales. The decrease in advertising expenses was primarily due to lower television advertising during the quarter.

Administrative expenses

Administrative expenses increased $0.2 million, or 6.2%, to $3.5 million for the three months ended March 31, 2014 compared to $3.3 million for the three months ended March 31, 2013, primarily due to the addition of general and administrative positions to support our store growth, as well as increased share-based compensation costs. Administrative expenses as a percentage of sales were 2.7% and 3.1% for the three months ended March 31, 2014 and 2013, respectively. The decrease in administrative expenses as a percentage of sales was a result of our ability to support additional store investments and sales without proportionate increases in overhead expenses. . . .

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