Natural Grocers by Vitamin Cottage, Inc. - Quarter Report: 2015 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2015;

OR

COMMISSION FILE NUMBER: 001-35608

Natural Grocers by Vitamin Cottage, Inc.

(Exact name of registrant as specified in its charter)

(303) 986-4600

(Registrant’s telephone number, including area code)

Indicate by checkmark 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 checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ☒ No ☐

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

Indicate by checkmark 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 May 4, 2015 was 22,491,158.

Natural Grocers by Vitamin Cottage, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2015

Table of Contents

Except where the context otherwise requires or where otherwise indicated, all references herein to ‘‘we,’’ ‘‘us,’’ ‘‘our,’’ ‘‘Natural Grocers,’’ and the ‘‘Company’’ refer collectively to Natural Grocers by Vitamin Cottage, Inc. and its consolidated subsidiaries.

Forward-Looking Statements

This report on 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 report on 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 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” and similar terms and phrases to identify forward-looking statements in this report on Form 10-Q.

The forward-looking statements contained in this report on 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 that 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. We believe that these factors include those referenced in “Risk Factors” in our report on Form 10-K for the fiscal year ended September 30, 2014 (our Form 10-K). 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 report on 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 any applicable securities laws. You are advised, however, to consult any further disclosures we may make in our future reports filed with the Securities and Exchange Commission (the SEC). Such reports may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 and may also be accessed on the SEC’s website at www.sec.gov. Our filings with the SEC are also available, free of charge, through our website at www.naturalgrocers.com.

PART I. Financial Information

Item 1. Financial Statements

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Balance Sheets

(Unaudited)

(Dollars in thousands, except share data)

See accompanying notes to unaudited interim consolidated financial statements.

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Income

(Unaudited)

(Dollars in thousands, except per share data)

See accompanying notes to unaudited interim consolidated financial statements.

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Cash Flows 

(Unaudited)

(Dollars in thousands) 

See accompanying notes to unaudited interim consolidated financial statements.

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Notes to Unaudited Interim Consolidated Financial Statements

March 31, 2015 and 2014

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 on Form 10-Q 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 2015” refers to the fiscal year from October 1, 2014 to September 30, 2015). 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. As of March 31, 2015, we operated 95 stores in 16 states, including Colorado, Arizona, Arkansas, Idaho, Kansas, Missouri, Montana, Nebraska, Nevada, New Mexico, Oklahoma, Oregon, Texas, Utah, Washington and Wyoming. We also operate 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.

The size of our stores varies from 5,000 to 16,000 selling square feet. During the twelve months ended March 31, 2015, 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 have enabled us to continue to open new stores and enter new markets. During the five fiscal years ended September 30, 2014, we increased our store count at a compound annual growth rate of 21.4%. In fiscal year 2014, we opened 15 new stores, and we currently plan to open 18 new stores in fiscal year 2015, eight of which we opened during the six months ended March 31, 2015. As of the date of this report, we have a total of 12 signed leases for new stores, eight of which we plan to open in fiscal year 2015 in Arizona, Colorado, Kansas, Minnesota, North Dakota and Oklahoma. Additionally, we plan to remodel two existing store locations and relocate one existing store location in fiscal year 2015.

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.

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:

As we continue to 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 for the foreseeable future. Our financial results for the three and six months ended March 31, 2015 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, reduced or changed consumer choices and the cost of these products. Our store offerings are comprised of natural and organic products and dietary supplements. A change in consumer preferences away from our offerings, including as a result of reductions or changes in our offerings, would have a material adverse effect on our business. Reduced or changed consumer choices may result from the implementation of our requirements for dairy products that satisfy our pasture-based, non-confinement standards. Additionally, negative publicity regarding natural and organic products or dietary supplements, or upgraded standards that reduce or change consumer choices, may adversely affect demand for our products and could result in lower consumer traffic, sales and results of operations.

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 ERP system, hiring key personnel and developing efficient new store opening processes and relocating and expanding our bulk food repackaging facility and distribution center. In fiscal year 2014, we substantially completed the implementation of a human resources information and learning management system, which we believe will allow us to more efficiently and effectively onboard and train our employees at all locations. In fiscal year 2015, we redesigned our website to enhance functionality and create a more engaging user experience and began home delivery services in select markets. In addition, we are exploring options to include additional services through other digital platforms, such as digital coupons and a loyalty program.

We believe there are opportunities for us to continue to expand our store base and focus on increasing comparable store sales. Future sales growth, including comparable store sales, could vary due to increasing competitive conditions in the natural and organic grocery and dietary supplement industry. As we continue to expand our store base, we believe there are opportunities for increased leverage in costs as a percentage of sales, 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 and increased competition, such sourcing economies and efficiencies at our bulk food repacking facility and distribution center may not be reflected in our gross margin 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.

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. In comparing net sales between periods we monitor the following:

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 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, deferred 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 and the strength of store management.

Interest expense

Interest expense consists of the interest associated with capital and financing lease obligations, net of capitalized interest. Interest expense also includes interest we pay on our outstanding indebtedness, including under our Credit Facility.

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 March 31, 2015 compared to the three months ended March 31, 2014

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

Net sales

Net sales increased $27.4 million, or 21.0%, to $157.7 million for the three months ended March 31, 2015 compared to $130.3 million for the three months ended March 31, 2014, primarily due to a $20.2 million increase in sales from new stores and a $7.2 million, or 5.6%, increase in comparable store sales. The comparable store sales increase was primarily driven by a 3.2% increase in daily average transaction count and a 2.2% increase in average transaction size. Comparable store average transaction size was $36.69 in the three months ended March 31, 2015. Mature store sales increased 2.6% in the three months ended March 31, 2015 as compared to the three months ended March 31, 2014.

Gross profit

Gross profit increased $8.1 million, or 20.9%, to $46.9 million for the three months ended March 31, 2015 compared to $38.8 million for the three months ended March 31, 2014, primarily driven by positive comparable store sales and an increase in the number of stores. Gross margin was 29.7% for each of the three months ended March 31, 2015 and 2014. Gross margin in the three months ended March 31, 2015 was positively impacted by an increase in product gross margin, offset by an increase in occupancy costs as a percentage of sales for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014. The positive impact in product margin is due to increases in product margin across most departments, in the three months ended March 31, 2015 as compared to the three months ended March 31, 2014. Occupancy costs as a percentage of sales increased in the quarter ended March 31, 2015 as compared to the quarter ended March 31, 2014, primarily due to increased average lease expenses at newer stores and the fixed nature of occupancy costs per store. Gross margin has also been positively impacted by the nature of new store openings and a reduction in our new store growth rate during the three months ended March 31, 2015 compared to the three months ended March 31, 2014.

The Company had 11 and nine leases for stores which were classified as capital and financing lease obligations for the three months ended March 31, 2015 and 2014, 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, 2015 and 2014 would have been approximately 55 and 60 basis points higher, respectively, than as reported, all as a percentage of sales.

Store expenses

Store expenses increased $5.6 million, or 20.8%, to $32.5 million in the three months ended March 31, 2015 from $26.9 million in the three months ended March 31, 2014, primarily due to increases in salary related expenses, depreciation, bank credit card charges and other store expenses. Store expenses as a percentage of sales were 20.6% for each of the three months ended March 31, 2015 and 2014. Store expenses as a percentage of sales have been positively impacted by a change in the timing and nature of new store openings and a reduction in our new store growth rate during the three months ended March 31, 2015 compared to the three months ended March 31, 2014.

Administrative expenses

Administrative expenses increased $0.6 million, or 17.1%, to $4.2 million for the three months ended March 31, 2015 compared to $3.5 million for the three months ended March 31, 2014, primarily due to the addition of general and administrative positions to support our store growth, in addition to increases in depreciation, various professional fees and other administrative expenses. Administrative expenses as a percentage of sales were 2.6% and 2.7% for the three months ended March 31, 2015 and 2014, respectively. The decrease in administrative expenses as a percentage of sales was a result of our ability to support additional store investment and sales without proportionate investments in overhead.

Pre-opening and relocation expenses

Pre-opening and relocation expenses decreased $0.3 million, or 28.2%, in the three months ended March 31, 2015 to $0.9 million compared to $1.2 million for the three months ended March 31, 2014, due to the impact of the number and the timing of the new store openings. We opened four and five new stores in the three months ended March 31, 2015 and 2014, respectively. Pre-opening and relocation expenses as a percentage of sales were 0.6% and 0.9% for the three months ended March 31, 2015 and 2014, respectively.   

Interest expense

Interest expense, net of capitalized interest, increased less than $0.1 million, or 1.4%, in the three months ended March 31, 2015 compared to the three months ended March 31, 2014, primarily due to a $0.1 million increase in interest expense related to capital and financing lease obligations, partially offset by a $0.1 million increase in capitalized interest. If the capital and financing lease obligations had qualified as operating leases, interest expense as a percentage of sales would have been approximately 45 and 55 basis points lower than as reported in the three months ended March 31, 2015 and 2014, respectively.

Income taxes

Our effective income tax rate for each of the three months ended March 31, 2015 and 2014 was 37.7%.

Net income

Net income increased 35.1% to $5.4 million, or $0.24 diluted earnings per share, in the three months ended March 31, 2015 compared to $4.0 million, or $0.18 diluted earnings per share, in the three months ended March 31, 2014.

Six months ended March 31, 2015 compared to the six months ended March 31, 2014

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

Net sales

Net sales increased $52.7 million, or 21.0%, to $303.6 million for the six months ended March 31, 2015 compared to $250.9 million for the six months ended March 31, 2014, primarily due to a $38.1 million increase in sales from new stores and a $14.6 million, or 5.9%, increase in comparable store sales. The comparable store sales increase was primarily driven by a 3.3% increase in daily average transaction count and a 2.5% increase in average transaction size. Comparable store average transaction size was $36.73 in the six months ended March 31, 2015. Mature store sales increased 2.7% in the six months ended March 31, 2015 as compared to the six months ended March 31, 2014.

Gross profit

Gross profit increased $15.0 million, or 20.3%, to $89.2 million for the six months ended March 31, 2015 compared to $74.1 million for the six months ended March 31, 2014, primarily driven by positive comparable store sales and an increase in the number of stores. Gross margin decreased to 29.4% for the six months ended March 31, 2015 from 29.5% for the six months ended March 31, 2014. Gross margin in the six months ended March 31, 2015 was positively impacted by an increase in product gross margin, offset by an increase in occupancy costs as a percentage of sales for the six months ended March 31, 2015 as compared to the six months ended March 31, 2014. The positive impact in product margin is due to increases in product margin across most departments, in the six months ended March 31, 2015 as compared to the six months ended March 31, 2014. Occupancy costs as a percentage of sales increased in the quarter ended March 31, 2015 as compared to the quarter ended March 31, 2014 primarily due to increased average lease expenses at newer stores and the fixed nature of occupancy costs per store.    

The Company had 11 and nine leases for stores which were classified as capital and financing lease obligations for the six months ended March 31, 2015 and 2014, 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 six months ended March 31, 2015 and 2014 would have been approximately 55 and 60 basis points higher, respectively, than as reported, all as a percentage of sales.

Store expenses

Store expenses increased $11.5 million, or 22.0%, to $63.5 million in the six months ended March 31, 2015 from $52.1 million in the six months ended March 31, 2014. Store expenses as a percentage of sales were 20.9% and 20.7% for the six months ended March 31, 2015 and 2014, respectively. The increase in store expenses as a percentage of sales was primarily due to increases in depreciation and other store expenses, partially offset by decreases in salary related expenses.

Administrative expenses

Administrative expenses increased $0.9 million, or 12.7%, to $8.4 million for the six months ended March 31, 2015 compared to $7.4 million for the six months ended March 31, 2014, primarily due to the addition of general and administrative positions to support our store growth, in addition to increases in depreciation, various professional fees and other administrative expenses. Administrative expenses as a percentage of sales were 2.8% and 3.0% for the six months ended March 31, 2015 and 2014, respectively. The decrease in administrative expenses as a percentage of sales was a result of our ability to support additional store investment and sales without proportionate investments in overhead.

Pre-opening and relocation expenses

Pre-opening and relocation expenses decreased $0.7 million, or 31.1%, in the six months ended March 31, 2015 to $1.4 million compared to $2.1 million for the six months ended March 31, 2014, due to the impact of the timing, nature and location of the new store openings. We opened eight and nine new stores in the six months ended March 31, 2015 and 2014, respectively. Pre-opening and relocation expenses as a percentage of sales were 0.5% and 0.8% for the six months ended March 31, 2015 and 2014, respectively.

Interest expense

Interest expense, net of capitalized interest, increased less than $0.1 million, or 2.7%, in the six months ended March 31, 2015 compared to the six months ended March 31, 2014, primarily due to a $0.1 million increase in interest expense related to capital and financing lease obligations, partially offset by a $0.1 million increase in capitalized interest. If the capital and financing lease obligations had qualified as operating leases, interest expense as a percentage of sales would have been approximately 45 and 55 basis points lower than as reported in the six months ended March 31, 2015 and 2014, respectively.

Income taxes

Our effective income tax rate for the six months ended March 31, 2015 and 2014 was 37.6% and 37.9%, respectively. The decrease in our effective income tax rate was primarily due to a reduction in the blended state tax rate, tax benefits resulting from the extension of the Federal Enhanced Food Deduction (IRC Section 170(e)(3)(C)), and prior fiscal year tax benefits relating to the retroactive extension of the Federal Work Opportunity Tax Credit and Bonus Depreciation.

During the three months ended December 31, 2014, the Company experienced benefits from the American Taxpayer Relief Act of 2012, which extended the 50% bonus depreciation on qualifying assets and the special 15 year life for qualified leasehold property and qualified retail improvement property for property acquired from January 1, 2014 through December 31, 2014.

The Company also benefited from the extension of the Work Opportunity Tax Credit during the three months ended December 31, 2014 and 2013 and the extension of the Enhanced Food Deduction during the three months ended December 31, 2014.  As these provisions were retroactively extended through December 31, 2014, the Company has recognized tax benefits during the six months ended March 31, 2015. In addition, the Company has recognized a tax benefit relating to Work Opportunity Tax Credit relating to fiscal year 2014.

Net income

Net income increased 29.6% to $9.0 million, or $0.40 diluted earnings per share, in the six months ended March 31, 2015 compared to $6.9 million, or $0.31 diluted earnings per share, in the six months ended March 31, 2014.

Non-GAAP financial measures

EBITDA

EBITDA increased 29.4% to $14.5 million in the three months ended March 31, 2015 compared to $11.2 million in the three months ended March 31, 2014. EBITDA increased 26.0% to $26.0 million in the six months ended March 31, 2015 compared to $20.6 million in the six months ended March 31, 2014. EBITDA as a percentage of sales was 9.2% and 8.6% for the three months ended March 31, 2015 and 2014, respectively. EBITDA as a percentage of sales was 8.5% and 8.2% for the six months ended March 31, 2015 and 2014, respectively. The stores with leases that are classified as capital and financing lease obligations, rather than being classified as operating leases, increased EBITDA as a percentage of sales by approximately 55 and 60 basis points for the three months ended March 31, 2015 and 2014, respectively, and by approximately 55 and 60 basis points for the six months ended March 31, 2015 and 2014, respectively, due to the impact on cost of goods sold and occupancy costs as discussed above, as well as occupancy costs that would have been included in pre-opening expenses prior to the stores’ opening dates if these leases had been accounted for as operating leases.

EBITDA is not a measure of financial performance under GAAP. We define EBITDA as net income before interest expense, provision for income tax, depreciation and amortization. We believe EBITDA provides additional information about: (i) our operating performance, because it assists us in comparing the operating performance of our stores on a consistent basis, as it removes the impact of non-cash depreciation and amortization expense as well as items not directly resulting from our core operations such as interest expense and income taxes and (ii) our performance and the effectiveness of our operational strategies. Additionally, EBITDA is a measure in our debt covenants under our Credit Facility. In addition, EBITDA performance is one of the factors upon which funding of our incentive compensation plans is based.

Furthermore, management believes some investors use EBITDA as a supplemental measure to evaluate the overall operating performance of companies in our industry. Management believes that some investors’ understanding of our performance is enhanced by including this non-GAAP financial measure as a reasonable basis for comparing our ongoing results of operations. By providing this non-GAAP financial measure, together with a reconciliation from net income, we believe we are enhancing investors’ understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. Our competitors may define EBITDA differently, and as a result, our measure of EBITDA may not be directly comparable to EBITDA of other companies. Items excluded from EBITDA are significant components in understanding and assessing financial performance. EBITDA is a supplemental measure of operating performance that does not represent and should not be considered in isolation or as an alternative to, or substitute for net income or other financial statement data presented in our consolidated financial statements as indicators of financial performance. EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of the limitations are:

Due to these limitations, EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA as supplemental information. We further believe that our presentation of this non-GAAP financial measurement provides information that is useful to analysts and investors because it is an important indicator of the strength of our operations and the performance of our business.

The following table reconciles net income to EBITDA for the periods presented, dollars in thousands:

Liquidity and Capital Resources

Our primary sources of liquidity are cash generated from operations, current balances of cash and cash equivalents and borrowings under our Credit Facility.

Our primary uses of cash are for purchases of inventory, operating expenses, capital expenditures predominantly in connection with opening new stores and relocating and remodeling certain existing stores, debt service and corporate taxes. Additionally, in the six months ended March 31, 2015, our uses of cash include the purchase price for the Store Acquisition.

As of March 31, 2015, we had $7.2 million in cash and cash equivalents, letters of credit in the amount of $1.0 million which reduced the amount available for borrowing under the terms of our Credit Facility, on a dollar-for-dollar basis, and $14.0 million available under our Credit Facility.

We currently have a $15.0 million credit agreement with a maturity date of January 31, 2017. We have the right to request the issuance of letters of credit under our Credit Facility up to $3.0 million. We can increase the amount available under our Credit Facility up to an additional amount that may not exceed $10.0 million by obtaining an additional commitment or commitments. The unused commitment fee ranges from 0.15% to 0.35% based on certain conditions.

We plan to continue to open new stores, which has previously required, and may continue to require, us to borrow additional amounts under our Credit Facility in the future. We plan to spend approximately $25 million to $27 million on capital expenditures during the remaining six months of fiscal year 2015 in association with the 10 planned new stores and one relocation and two remodels. We believe that cash and cash equivalents, together with the cash generated from operations and the borrowing availability under our Credit Facility will be sufficient to meet our working capital needs and planned capital expenditures, including capital expenditures related to new store needs for at least the next twelve months. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within days from the related sale.

We anticipate that our new stores will require, on average, an upfront capital investment of approximately $2.2 million per store consisting of capital expenditures of approximately $1.7 million, net of tenant allowances, initial inventory of approximately $0.3 million, net of payables, and pre-opening expenses of approximately $0.2 million.   

Following is a summary of our operating, investing and financing activities for the periods presented, dollars in thousands:

Operating Activities

Cash provided by operating activities consists primarily of net income adjusted for non-cash items, including depreciation and changes in deferred taxes, and the effect of working capital changes. Cash provided by operating activities increased $8.7 million, or 55.5%, to $24.3 million in the six months ended March 31, 2015, compared to $15.6 million in the six months ended March 31, 2014. The increase in cash provided by operating activities was primarily due to an increase in net income, as adjusted for depreciation and amortization resulting from the addition of new stores, and changes in working capital driven by the timing of payment on inventory and other purchases. Our working capital requirements for inventory will likely continue to increase as we continue to open new stores.

Investing Activities

Cash used in investing activities increased $5.2 million, or 32.2%, to $21.6 million in the six months ended March 31, 2015 compared to $16.3 million in the six months ended March 31, 2014 due to the Store Acquisition. We paid $5.6 million during the three months ended December 31, 2014 related to the Store Acquisition. Cash paid for capital expenditures decreased $1.9 million in the six months ended March 31, 2015 compared to March 31, 2014, and is driven by the number and the timing of new store openings. In the six months ended March 31, 2014, we had proceeds from maturity of available-for-sale securities of $1.0 million and a reduction in our restricted cash balance of $0.5 million.

Financing Activities

Cash (used in) provided by financing activities consists primarily of borrowings and repayments under our Credit Facility, excess tax benefits on vested share-based compensation and payments of capital and financing lease obligations. Cash used in financing activities was $0.7 million for the six months ended March 31, 2015, compared to cash provided by financing activities of $0.3 million for the six months ended March 31, 2014. The decrease in cash provided by financing activities for the six months ended March 31, 2015 was primarily due to the payment of $0.5 million of contingent consideration related to the Store Acquisition and a $0.5 million decrease in the excess tax benefit from share-based compensation.    

Credit Facility

Credit Facility 

Our $15.0 million Credit Facility may be increased by up to $10.0 million, as described above in “Liquidity and Capital Resources.” The Operating Company is the borrower under our Credit Facility, and its obligations under our Credit Facility are guaranteed by the Holding Company.

As of March 31, 2015, we had no amounts outstanding on our Credit Facility, letters of credit in the amount of $1.0 million reserved against the amount available for borrowing under our Credit Facility, and $14.0 million available for borrowing under our Credit Facility. For floating rate borrowings under our Credit Facility, interest is determined by the lender’s administrative agent and is stated at the prime rate less the lender spread, subject to the Company meeting certain financial measures. For fixed rate borrowings under our Credit Facility, interest is determined by quoted LIBOR rates for the interest period plus the lender spread, subject to us meeting certain financial measures.

Our Credit Facility is secured by a lien on substantially all of our assets and requires compliance with certain operational and financial covenants (including a leverage ratio and a fixed charge coverage ratio). Our Credit Facility also contains certain other limitations on our ability to incur additional debt, guarantee other obligations, grant liens on assets and make investments or acquisitions as defined in the agreement. Additionally, our Credit Facility prohibits the payment of cash dividends to the Holding Company from the Operating Company, without the administrative agent’s consent except when no default or event of default exists. If no default or event of default exists, dividends are allowed for various audit, accounting, tax, securities, indemnification, reimbursement, insurance and other reasonable expenses in the ordinary course of business. We do not expect such restrictions to impact our ability to meet our cash obligations. The terms and conditions of the agreement for our Credit Facility and associated documents are customary and include, among other things, guarantees, security interest grants, pledges and subordinations. As of March 31, 2015, we were in compliance with the debt covenants of our Credit Facility.

Contractual Obligations 

The following table summarizes our contractual obligations as of March 31, 2015, dollars in thousands:

We periodically make other commitments and become subject to other contractual obligations that we believe to be routine in nature and incidental to the operation of the business. Management believes that such routine commitments and contractual obligations do not have a material impact on our business, financial condition or results of operations.

Off-Balance Sheet Arrangements

As of March 31, 2015, our off-balance sheet arrangements consisted of operating leases and the undrawn portion of our Credit Facility. All of our stores, bulk food repackaging facility and distribution center and administrative facilities are leased, and as of March 31, 2015, 11 leases were classified as capital and financing lease obligations, and the remaining leases were classified as operating leases in our consolidated financial statements. We have no other off-balance sheet arrangements that have had, or are reasonably likely to have, a material current or future effect on our consolidated financial statements or financial condition.

Recent Accounting Pronouncements

See Note 2 to the consolidated financial statements included in this report on Form 10-Q.

Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. Actual amounts may differ from these estimates. We base our estimates on historical experience and on various other assumptions and factors that we believe to be reasonable under the circumstances. We evaluate our accounting policies and resulting estimates on an ongoing basis to make adjustments we consider appropriate under the facts and circumstances. Critical accounting policies that affect our more significant judgments and estimates used in the preparation of our financial statements include, accounting for income taxes, accounting for impairment of long-lived assets and accounting for leases, which are discussed in more detail under the caption “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II of our Form 10-K.

Item 3. Qualitative and Quantitative Disclosures About Market Risk

We are exposed to interest rate changes of our long-term debt, and, to a limited extent, our revolving credit facility. We do not use financial instruments for trading or other speculative purposes. There have been no material changes regarding our market risk position from the information provided under Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” in our Form 10-K.

Item 4. Controls and Procedures 

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officers and principal financial and accounting officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on that evaluation, our principal executive officers and principal financial and accounting officer concluded that our disclosure controls and procedures were effective as of March 31, 2015.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. Other Information

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in Part I, Item 1A, of our Form 10-K.

Item 6. Exhibits

See Exhibit Index.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized on May 7, 2015.

EXHIBIT INDEX

† The certifications attached as Exhibit 32.1 that accompany this report on Form 10-Q, are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Natural Grocers by Vitamin Cottage, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

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