Natural Grocers by Vitamin Cottage, Inc. - Quarter Report: 2020 June (Form 10-Q)

r

 

 

 

 

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.

 

 

---

Table of Contents

Except where the context otherwise requires or where otherwise indicated: (i) 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 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.

PART I. Financial Information

Item 1. Financial Statements

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Balance Sheets

(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 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.

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)

See accompanying notes to unaudited interim consolidated financial statements.

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:

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.

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:

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:

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.  

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:

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:

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.

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

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:

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:

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:

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:

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:

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:

10. Accrued Expenses

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

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.

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.

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

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 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.

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.

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:

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.

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, 2020 compared to the three months ended June 30, 2019

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

Net sales

Net sales increased $40.7 million, or 18.1%, to $265.1 million for the three months ended June 30, 2020 compared to $224.4 million for the three months ended June 30, 2019, primarily due to a $34.7 million increase in comparable store sales and a $6.0 million increase in new store sales. Daily average comparable store sales increased 15.5% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The daily average comparable store sales increase resulted from a 31.5% increase in daily average transaction size, partially offset by a 12.2% decrease in average transaction count. During the quarter, customers reduced their frequency of shopping trips as a result of social distancing practices, but increased their overall basket size per shopping trip. Comparable store average transaction size was $47.15 for the three months ended June 30, 2020. Daily average mature store sales increased 12.5% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The increase in comparable store sales during the three months ended June 30, 2020 was primarily driven by increased net sales as a result of our customers’ response to the COVID-19 pandemic and government mandates. Also contributing to the increase in comparable store sales during the three months ended June 30, 2020 were marketing initiatives, a moderated level of promotional pricing and increased membership in and usage of the {N}power customer loyalty program.

Gross profit

Gross profit increased $14.0 million, or 23.9%, to $72.4 million for the three months ended June 30, 2020 compared to $58.4 million for the three months ended June 30, 2019, primarily driven by the increased sales volumes resulting from the COVID-19 pandemic and government mandates. To a lesser extent, the increase in gross profit reflected an increase in the number of stores. Gross margin increased to 27.3% for the three months ended June 30, 2020 compared to 26.0% for the three months ended June 30, 2019. The increase in gross margin during the three months ended June 30, 2020 was primarily driven by a decrease in store occupancy expense, as a percentage of sales, and an improved product margin.

We had 22 store leases that were classified as capital and financing lease obligations for the three months ended June 30, 2019. As of September 30, 2019, 23 leases were classified as capital and financing lease obligations. As a result of our adoption of ASC 842 effective October 1, 2019: (i) eight previous capital financing lease obligations were derecognized and reclassified as operating leases; (ii) 10 previous capital finance leases were classified as finance leases; and (iii) five previous capital lease obligations were classified as finance leases. As of June 30, 2020, we had 17 leases that were classified as finance leases. The leases that were reclassified to operating leases now generate rent expense, which is recorded as occupancy expense, rather than a reduction of the lease obligation and as interest expense.

Store expenses

Store expenses increased $10.2 million, or 21.0%, to $58.6 million for the three months ended June 30, 2020 compared to $48.4 million for the three months ended June 30, 2019. The increase in store expenses during the three months ended June 30, 2020 was due primarily to increased labor related expenses. Store expenses as a percentage of sales were 22.1% and 21.6% for the three months ended June 30, 2020 and 2019, respectively. The increase in store expenses as a percentage of sales was primarily attributable to increases in labor related expenses and the adoption of ASC 842, partially offset by lower marketing expenses.

Administrative expenses

Administrative expenses increased $0.9 million, or 14.5%, to $6.8 million for the three months ended June 30, 2020 compared to $6.0 million for the three months ended June 30, 2019. The increase in administrative expenses during the three months ended June 30, 2020 was primarily driven by higher compensation and an increase in hardware, software and communications expenses. Administrative expenses as a percentage of sales were 2.6% and 2.7% for the three months ended June 30, 2020 and 2019, respectively.

Pre-opening and relocation expenses

Pre-opening and relocation expenses increased $0.1 million, or 40.8%, to $0.3 million for the three months ended June 30, 2020 compared to $0.2 million for the three months ended June 30, 2019, due to the impact of the number and timing of new store openings and relocations. We opened two new stores during the three months ended June 30, 2020 compared to opening no new stores and relocating two stores during the three months ended June 30, 2019. Pre-opening and relocation expenses as a percentage of sales were 0.1% for each of the three months ended June 30, 2020 and 2019.

Interest expense, net

Interest expense, net of capitalized interest, decreased $0.8 million, or 59.8%, for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The decrease in interest expense is primarily due to a decrease in the number of finance leases (formerly classified as capital and financing leases) during the three months ended June 30, 2020, as well as a decrease in the average outstanding balance under our Credit Facility. The decrease in interest expense attributable to the lower number of finance leases is consistent with the increase in occupancy costs referred to above given the number of derecognized previous capital finance leases that have been reclassified as operating leases and that now generate straight-line rent expense rather than reduction of the lease obligation and interest expense.

Income taxes

Income tax expense increased $0.9 million for the three months ended June 30, 2020 to $1.5 million compared to $0.6 million for the three months ended June 30, 2019. The Company’s effective income tax rate was approximately 24.1% and 22.5% for the three months ended June 30, 2020 and 2019, respectively.

Net income

Net income was $4.7 million, or $0.21 diluted earnings per share, for the three months ended June 30, 2020 compared to $2.0 million, or $0.09 diluted earnings per share, for the three months ended June 30, 2019. The increase in net income during the three months ended June 30, 2020 was primarily attributable to the significant growth in net sales and margin improvement.

Nine months ended June 30, 2020 compared to the nine months ended June 30, 2019

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

Net sales

Net sales increased $96.3 million, or 14.2%, to $772.7 million for the nine months ended June 30, 2020 compared to $676.4 million for the nine months ended June 30, 2019, primarily due to a $81.0 million increase in comparable store sales and a $15.5 million increase in new store sales, partially offset by a $0.2 million decrease in sales from one store that closed during the first quarter of fiscal 2019. Daily average comparable store sales increased 11.6% for the nine months ended June 30, 2020 compared to the nine months ended June 30, 2019. The daily average comparable store sales increase resulted from a 15.2% increase in average transaction size, partially offset by a 3.1% decrease in daily average transaction count. During the nine months ended June 30, 2020, customers reduced their frequency of shopping trips as a result of social distancing practices, but increased their overall basket size per shopping trip. Comparable store average transaction size was $41.82 for the nine months ended June 30, 2020. Daily average mature store sales increased 9.6% for the nine months ended June 30, 2020 compared to the nine months ended June 30, 2019. The increase in comparable store sales during the nine months ended June 30, 2020 was primarily driven by increased net sales starting in late February 2020 as a result of our customers’ response to the COVID-19 pandemic and government mandates. Also contributing to the increase in comparable store sales during the nine months ended June 30, 2020 were marketing initiatives, promotional pricing campaigns and increased membership in and usage of the {N}power customer loyalty program.

Gross profit

Gross profit increased $30.9 million, or 17.2%, to $210.7 million for the nine months ended June 30, 2020 compared to $179.8 million for the nine months ended June 30, 2019, primarily driven by the increased sales volumes resulting from the COVID-19 pandemic and government mandates. To a lesser extent, the increase in gross profit reflected an increase in the number of stores. Gross margin increased to 27.3% for the nine months ended June 30, 2020 from 26.6% for the nine months ended June 30, 2019. The increase in gross margin during the nine months ended June 30, 2020 was primarily driven by a decrease in store occupancy and shrink expenses, both as a percentage of sales, and an improved product margin.

We had 22 store leases that were classified as capital and financing lease obligations for the nine months ended June 30, 2019. As of September 30, 2019, 23 leases were classified as capital and financing lease obligations. As a result of our adoption of ASC 842 effective October 1, 2019: (i) eight previous capital financing lease obligations were derecognized and reclassified as operating leases; (ii) 10 previous capital finance leases were classified as finance leases; and (iii) five previous capital lease obligations were classified as finance leases. As of June 30, 2020, we had 17 leases that were classified as finance leases. The leases that were reclassified to operating leases now generate rent expense, which is recorded as occupancy expense, rather than a reduction of the lease obligation and as interest expense.

Store expenses

Store expenses increased $19.2 million, or 13.0%, to $166.9 million for the nine months ended June 30, 2020 compared to $147.7 million for the nine months ended June 30, 2019. The increase in store expenses during the nine months ended June 30, 2020 was due primarily to increased labor related expenses. Store expenses as a percentage of sales were 21.6% and 21.8% for the nine months ended June 30, 2020 and 2019, respectively. The decrease in store expenses as a percentage of sales was primarily attributable to enhanced leverage of store expenses due to the increased sales volumes resulting from the the COVID-19 pandemic and government mandates, partially offset by the adoption of ASC 842.

Administrative expenses

Administrative expenses increased $2.6 million, or 15.5%, to $19.7 million for the nine months ended June 30, 2020 compared to $17.0 million for the nine months ended June 30, 2019. The increase in administrative expenses during the nine months ended June 30, 2020 was primarily driven by higher compensation and an increase in hardware, software and communication expenses. Administrative expenses as a percentage of sales were 2.5% for each of the nine months ended June 30, 2020 and 2019.

Pre-opening and relocation expenses

Pre-opening and relocation expenses increased $0.3 million, or 32.4%, to $1.4 million for the nine months ended June 30, 2020 compared to $1.0 million for the nine months ended June 30, 2019, due to the impact of the number and timing of new store openings and relocations. We opened six new stores during the nine months ended June 30, 2020 compared to opening five new stores and relocating four stores during the nine months ended June 30, 2019. Pre-opening and relocation expenses as a percentage of sales were 0.2% for each of the nine months ended June 30, 2020 and 2019.

Interest expense

Interest expense, net of capitalized interest, decreased $2.2 million, or 58.9%, for the nine months ended June 30, 2020 compared to the nine months ended June 30, 2019. The decrease in interest expense is primarily due to a decrease in the number of finance leases (formerly classified as capital and financing leases) during the nine months ended June 30, 2020 as well as a decrease in the average outstanding balance under our Credit Facility. The decrease in interest expense attributable to the lower number of finance leases is consistent with the increase in occupancy costs referred to above given the number of derecognized previous capital finance leases that have been reclassified as operating leases and that now generate straight-line rent expense rather than reduction of the lease obligation and interest expense.

Income taxes

Income tax expense increased $2.8 million for the nine months ended June 30, 2020 to $5.0 million compared to $2.1 million for the nine months ended June 30, 2019. The Company’s effective income tax rate was approximately 23.3% and 21.0% for the nine months ended June 30, 2020 and 2019, respectively.

Net income

Net income was $16.3 million, or $0.72 diluted earnings per share, for the nine months ended June 30, 2020 compared to $8.1 million, or $0.36 diluted earnings per share, for the nine months ended June 30, 2019. The increase in net income during the nine months ended June 30, 2020 was primarily attributable to the significant growth in net sales and margin improvement.

Non-GAAP financial measures 

EBITDA

EBITDA is not a measure of financial performance under GAAP. We define EBITDA as net income before interest expense, provision for income taxes and depreciation and amortization. The following table reconciles net income to EBITDA for the periods presented, dollars in thousands: