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MarketScreener Homepage  >  Equities  >  Nyse  >  Natural Grocers by Vitamin Cottage Inc    NGVC

NATURAL GROCERS BY VITAMIN COTTAGE INC (NGVC)
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NATURAL GROCERS BY VITAMIN COTTAGE : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-K)

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12/06/2018 | 09:20pm CET
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations (MD&A) should be read in conjunction with our consolidated
financial statements and notes thereto and "Selected Financial Data," which are
included elsewhere in this Form 10-K. This MD&A contains forward-looking
statements. Refer to "Forward-Looking Statements" at the beginning of this Form
10-K 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 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 September 30, 2018, we operated 148 stores in 19 states,
including Colorado, Arizona, Arkansas, Idaho, Iowa, Kansas, 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 Colorado.



We offer a variety of natural and organic groceries and dietary supplements that
meet our strict quality guidelines. The size of our stores varies from
approximately 5,000 to 16,000 selling square feet. For the year ended September
30, 2018, our new stores averaged approximately 10,000 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. Over the last five fiscal years, our store base has grown
at a compound annual growth rate of 15.5%, including eight, 14 and 23 new stores
in fiscal years 2018, 2017 and 2016, respectively. We relocated three existing
stores in fiscal year 2018. We plan to open seven to nine new stores and
relocate five to six stores in fiscal year 2019. Between September 30, 2018 and
the date of this Form 10-K, we have opened four new stores (in Colorado, Iowa,
Oregon and Texas) and relocated one store (in New Mexico). As of the date of
this report, we also have signed leases for an additional three new store
locations expected to open in fiscal years 2019 and beyond.



Performance Highlights



Key highlights of our recent performance are discussed briefly below and are
discussed in further detail throughout this MD&A. Key financial metrics,
including, but not limited to, comparable store sales, daily average comparable
store sales, mature store sales and daily average mature store sales are defined
under the caption "Key Financial Metrics in Our Business," presented later in
this MD&A.


? Net sales. Net sales were $849.0 million for the year ended September 30,

2018, an increase of $80.0 million, or 10.4%, compared to net sales of $769.0

    million for the year ended September 30, 2017.



? Comparable store sales and daily average comparable store sales. Comparable

store sales and daily average comparable store sales for the year ended

September 30, 2018 each increased 5.8% from the year ended September 30, 2017.

? Mature store sales and daily average mature store sales. Mature store sales

and daily average mature store sales for the year ended September 30, 2018

each increased 3.0% from the year ended September 30, 2017. For fiscal year

2018, mature stores include all stores open during or before fiscal year 2013.

? Net income. Net income was $12.7 million for the year ended September 30,

2018, an increase of $5.8 million, or 83.7%, compared to net income of $6.9

    million for the year ended September 30, 2017.



? EBITDA. EBITDA was $44.5 million in the year ended September 30, 2018, an

increase of $0.9 million, or 2.0%, compared to EBITDA of $43.6 million for the

year ended September 30, 2017. EBITDA is not a measure of financial

performance under GAAP. Refer to the "Selected Financial Data" section of this

Form 10-K for a definition of EBITDA and a reconciliation of the Company's net

    income to EBITDA.




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? Adjusted EBITDA. Adjusted EBITDA was $45.1 million in the year ended September

30, 2018, an increase of $1.5 million, or 3.3%, compared to Adjusted EBITDA of

$43.6 million for the year ended September 30, 2017. Adjusted EBITDA is not a

measure of financial performance under GAAP. Refer to the "Selected Financial

Data" section of this Form 10-K for a definition of Adjusted EBITDA and a

reconciliation of the Company's net income to Adjusted EBITDA.

? Liquidity. As of September 30, 2018, cash and cash equivalents was $9.4

million. As of September 30, 2018, $13.2 million was outstanding and $35.8

million was available for borrowing under our $50.0 million Credit Facility.

As of September 30, 2018, the Company had outstanding letters of credit of

$1.0 million, which amount was reserved against the amount available for

    borrowing under the terms of our Credit Facility.



? New store growth. We opened 76 new stores between the beginning of fiscal year

2014 and the end of fiscal year 2018, with 148 stores open as of September 30,

    2018. We opened eight new stores in fiscal year 2018.



? Store Relocations and Remodels. We relocated three existing stores in fiscal

    year 2018.




Industry Trends and Economics



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

? Impact of broader economic trends. The grocery industry and our sales are

affected by general economic conditions, including, but not limited to,

consumer spending, the level of disposable consumer income, consumer debt,

interest rates, the price of commodities, the political environment and

consumer confidence. In this regard, we believe our financial results for the

year ended September 30, 2018 reflected improvement in the oil and gas markets

we serve, although they generally continue to lag behind our non-oil and gas

    markets.




  ? Opportunities in the growing natural and organic grocery and dietary

supplements industry. Our industry, which includes organic and natural foods

and dietary supplements, continues to experience growth driven primarily by

increased public interest in health and nutrition. Capitalizing on this

opportunity, we continue to open new stores and enter new markets. As we open

new stores, our results of operations have been and may continue to be

materially adversely affected based on the timing and number of new stores we

open, their initial sales and new lease costs. The length of time it takes for

a new store to become profitable can vary depending on a number of factors,

including location, competition, a new market versus an existing market, the

strength of store management and general economic conditions. Once a new store

is open, it typically grows at a faster rate than mature stores for several

years. Mature stores are stores that have been open for any part of five

    fiscal years or longer.




As we expand across the United States and enter markets where consumers may not
be as familiar with our brand, we seek to secure prime real estate locations for
our stores to establish greater visibility with consumers in those markets. This
strategy has resulted in higher lease costs, and we anticipate these increased
costs will continue into the foreseeable future. Our financial results for the
year ended September 30, 2018 reflect the effects of these factors, and we
anticipate future periods will be similarly impacted.



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



? Increased Competition. The grocery and dietary supplement retail business is a

large, fragmented and highly competitive industry, with few barriers to entry.

Our competition varies by market and includes conventional supermarkets such

as Kroger and Safeway, mass or discount retailers such as Wal-Mart and Target,

natural and gourmet markets such as Whole Foods and The Fresh Market,

foreign-based discount retailers such as Aldi and Lidl, specialty food

retailers such as Sprouts and Trader Joe's, warehouse clubs such as Sam's Club

and Costco, independent health food stores, dietary supplement retailers, drug

stores, farmers' markets, food co-ops, online retailers such as Amazon, meal

delivery services such as Blue Apron and multi-level marketers. Competition in

the grocery industry is likely to intensify, and shopping dynamics may shift,

as a result of, among other things, Amazon's acquisition of Whole Foods in

August 2017, the plans of Aldi and Lidl to expand their presence in the United

States and the expanding availability of grocery ordering, pick-up and

delivery options. These businesses compete with us on the basis of price,

selection, quality, customer service, shopping experience, ease of ordering

and delivery or any combination of these or other factors. They also compete

with us for products and locations. In addition, some of our competitors are

expanding to offer a greater range of natural and organic foods. We believe

our commitment to carrying only carefully vetted, affordably priced and

high-quality natural and organic products and dietary supplements, as well as

our focus on providing nutritional education, differentiate us in the industry

and provide a competitive advantage. In addition, we face internally generated

    competition when we open new stores in markets we already serve.




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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, 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. The rate of new store growth in the foreseeable future is expected
to continue to moderate compared to years prior to fiscal year 2017, depending
on economic and business conditions and other factors. During the past few
years, we have enhanced our infrastructure to enable us to support our continued
growth. In addition, in recent years we believe we have enhanced customer
loyalty and increased customer engagement by expanding our digital and social
media presence and further developing the {N}power customer loyalty program. In
September 2018, we launched a new website (www.naturalgrocers.com) which was
designed to offer a more personalized and convenient online experience for our
customers. The new website features more advanced ecommerce capabilities,
enhanced product and recipe search interfaces and improved functionality with
mobile and tablet devices.



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. As we
continue to expand our store base, 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 our
commitment to providing high-quality products at affordable prices and increased
competition, such sourcing economies and efficiencies at our bulk food
repackaging facility and distribution center may not be reflected in our gross
margin in the near term. In addition, our ability to leverage costs may be
limited due to the fixed nature of our rent obligations and related occupancy
expenses.


Our operating results may be affected by a variety of internal and external factors and trends, which are described more fully in the section entitled "Risk Factors" appearing elsewhere in this 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,
returns and allowances. In comparing net sales between periods we monitor the
following:


? Change in comparable store sales. We begin to include sales from a store in

comparable store sales on the first day of the thirteenth full month following

the store's opening. We monitor the percentage change in comparable store

sales by comparing sales from all stores in our comparable store base for a

reporting period against sales from the same stores for the same number of

operating months in the comparable reporting period of the prior year. When a

store that is included in comparable store sales is remodeled or relocated, we

continue to consider sales from that store to be comparable store sales. Our

comparable store sales data may not be presented on the same basis as our

competitors. We use the term "new stores" to refer to stores that have been

    open for less than thirteen months.



? Change in daily average comparable store sales. Daily average comparable store

sales are comparable store sales divided by the number of selling days in each

period. We use this metric to remove the effect of differences in the number

of selling days we are open during the comparable periods (for example, as a

    result of leap years or the Easter holiday shift between quarters).




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? Change in mature store sales. We begin to include sales from a store in mature

store sales after the store has been open for any part of five fiscal years

(for example, our mature stores for fiscal year 2018 are stores that opened

during or before fiscal year 2013). We monitor the percentage change in mature

store sales by comparing sales from all stores in our mature store base for a

reporting period against sales from the same stores for the same number of

operating months in the comparable reporting period of the prior year. When a

store that is included in mature store sales is remodeled or relocated, we

continue to consider sales from that store to be mature store sales. Our

    mature store sales data may not be presented on the same basis as our
    competitors.



? Change in daily average mature store sales. Daily average mature store sales

are mature store sales divided by the number of selling days in each period.

We use this metric to remove the effect of differences in the number of

selling days during the comparable periods (for example, as a result of leap

    years or the Easter holiday shift between quarters).



? Transaction count. Transaction count represents the number of transactions

reported at our stores during the period and includes transactions that are

    voided, return transactions and exchange transactions.




  ? Average transaction size. Average transaction size, or basket size, is

calculated by dividing net sales by transaction count for a given time period.

We use this metric to track the trends in average dollars spent in our stores

    per customer transaction.



Cost of goods sold and occupancy costs




Our cost of goods sold and occupancy costs include the cost of inventory sold
during the period (net of discounts and allowances), shipping and handling
costs, distribution and supply chain costs (including the costs of our bulk food
repackaging facility), buying costs, shrink expense and store occupancy costs.
Store occupancy costs include rent, common area maintenance and real estate
taxes. Depreciation expense included in cost of goods sold relates to
depreciation of assets directly used at our bulk food repackaging facility. The
components of our cost of goods sold and occupancy costs may not be identical to
those of our competitors, and as a result, our cost of goods sold and occupancy
costs data included in this Form 10-K 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 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. 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 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
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, any long-lived asset impairment charges
and store closing expenses. The majority of store expenses are comprised of
salary-related expenses which we closely manage and which trend closely with
sales. Labor-related expenses as a percentage of sales tend to be higher at new
stores compared to comparable stores, as new stores require a certain level of
staffing in order to maintain adequate levels of customer service combined with
lower sales. As new stores increase their sales, labor-related expenses as a
percentage of sales typically decrease.



Administrative expenses



Administrative expenses consist of home office-related expenses, such as salary
and benefits, share-based compensation, office supplies, hardware and software
expenses, depreciation and amortization expense, occupancy costs (including
rent, common area maintenance, real estate taxes and utilities), professional
services expenses, expenses associated with our Board, 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.



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



Income tax expense



On December 22, 2017, the legislation commonly referred to as the Tax Cuts and
Jobs Act (the Tax Reform Act) was enacted into law. The Tax Reform Act changes
various corporate income tax provisions within the existing Internal Revenue
Code. Substantially all the provisions of the Tax Reform Act are effective for
taxable years beginning after December 31, 2017. The most significant change
that impacts us is the reduction in the corporate federal income tax rate from
35% to 21%.



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:



                                                     Year ended September 30,
                                                   2018         2017        2016
Statements of Income Data:*
Net sales                                            100.0 %     100.0       100.0
Cost of goods sold and occupancy costs                73.4        72.4        71.4
Gross profit                                          26.6        27.6        28.6
Store expenses                                        22.0        22.7        22.1
Administrative expenses                                2.5         2.6         2.7
Pre-opening and relocation expenses                    0.3         0.5         0.8
Operating income                                       1.8         1.8         2.9
Interest expense, net                                 (0.5 )      (0.5 )      (0.4 )
Income before income taxes                             1.2         1.3         2.5
Benefit from (provision for) income taxes              0.3        (0.4 )      (0.8 )
Net income                                             1.5 %       0.9      

1.6

__________________________

*Figures may not sum due to rounding.


Other Operating Data:
Number of stores at end of period                      148         140      

126

Store unit count increase period over period           5.7 %      11.1      

22.3

Change in comparable store sales                       5.8 %      (0.2 )    

1.7

Change in daily average comparable store sales 5.8 % 0.1

1.4

Change in mature store sales                           3.0 %      (1.9 )      (0.7 )
Change in daily average mature store sales             3.0 %      (1.6 )      (1.0 )




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Year ended September 30, 2018 compared to Year ended September 30, 2017

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



                                              Year ended September 30,               Change in
                                                2018              2017         Dollars       Percent
Statements of Income Data:
Net sales                                   $     849,042         769,030        80,012          10.4 %
Cost of goods sold and occupancy costs            623,469         556,694        66,775          12.0
Gross profit                                      225,573         212,336        13,237           6.2
Store expenses                                    186,741         174,350        12,391           7.1
Administrative expenses                            21,506          20,089         1,417           7.1
Pre-opening and relocation expenses                 2,273           3,799        (1,526 )       (40.2 )
Operating income                                   15,053          14,098           955           6.8
Interest expense, net                              (4,560 )        (3,793 )        (767 )        20.2
Income before income taxes                         10,493          10,305           188           1.8
Benefit from (provision for) income taxes           2,168          (3,414 )       5,582        (163.5 )
Net income                                  $      12,661           6,891         5,770          83.7




Net sales



Net sales increased $80.0 million, or 10.4%, to $849.0 million for the year
ended September 30, 2018 compared to $769.0 million for the year ended September
30, 2017, primarily due to a $44.7 million, or 5.8%, increase in comparable
store sales, and a $35.4 million increase in new store sales. Comparable store
sales increased 5.8% for the year ended September 30, 2018 compared to a
decrease of 0.2% for the year ended September 30, 2017. Daily average comparable
store sales increased 5.8% for the year ended September 30, 2018 compared to an
increase of 0.1% for the year ended September 30, 2017. The daily average
comparable store sales increase in fiscal year 2018 resulted from a 1.4%
increase in average transaction size and a 4.4% increase in daily average
transaction count. Comparable store average transaction size was $35.35 for the
year ended September 30, 2018. Daily average mature store sales increased 3.0%
for the year ended September 30, 2018 compared to a decrease of 1.6% for the
year ended September 30, 2017.



Gross profit



Gross profit increased $13.2 million, or 6.2%, to $225.6 million for the year
ended September 30, 2018 compared to $212.3 million for the year ended September
30, 2017, primarily driven by an increase in the number of comparable stores.
Gross margin decreased to 26.6% for the year ended September 30, 2018 from 27.6%
for the year ended September 30, 2017. Gross margin for the year ended September
30, 2018 was negatively impacted by our promotional pricing campaigns, a shift
in sales to lower margin products and a slight increase in occupancy expense as
a percentage of sales.



For the years ended September 30, 2018 and 2017, the Company had 20 and 17
leases, respectively, for stores which were classified as capital and financing
lease obligations. 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 each of
the years ended September 30, 2018 and 2017 would have been approximately 55
basis points higher for each period.



Store expenses



Store expenses increased $12.4 million, or 7.1%, to $186.7 million in the year
ended September 30, 2018 from $174.4 million in the year ended September 30,
2017. Store expenses as a percentage of sales were 22.0% and 22.7% for the years
ended September 30, 2018 and 2017, respectively. The decrease in store expenses
as a percentage of sales was primarily due to decreases in marketing,
depreciation and labor-related expenses, partially offset by an increase in
other expenses, all as a percentage of sales. Other expenses included long-lived
asset impairment charges and store closing expenses totaling approximately $0.6
million.



Administrative expenses



Administrative expenses increased $1.4 million, or 7.1%, to $21.5 million for
the year ended September 30, 2018 compared to $20.1 million for the year ended
September 30, 2017. Administrative expenses as a percentage of sales were 2.5%
and 2.6% for the years ended September 30, 2018 and 2017, respectively. The
increase in administrative expenses was due primarily to compensation, legal,
and software-related expenses.



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Pre-opening and relocation expenses




Pre-opening and relocation expenses decreased $1.5 million, or 40.2%, to $2.3
million for the year ended September 30, 2018 compared to $3.8 million for the
year ended September 30, 2017. The decrease in pre-opening and relocation
expenses was primarily due to the impact of the number and timing of new store
openings and relocations. Pre-opening and relocation expenses as a percentage of
sales were 0.3% and 0.5% for the years ended September 30, 2018 and 2017,
respectively. The numbers of stores opened and relocated were as follows for the
periods presented:



                     Year ended September 30,
                      2018               2017
New stores                  8                 14
Relocated stores            3                  2
                           11                 16




Interest expense, net



Interest expense, net of capitalized interest, increased $0.8 million, or 20.2%,
in the year ended September 30, 2018 compared to the year ended September 30,
2017. The increase in interest expense is primarily due to an increase in the
number of capital leases, a decrease in capitalized interest and higher interest
rates under our Credit Facility during the year ended September 30, 2018. If our
capital and financing lease obligations had qualified as operating leases,
interest expense as a percentage of sales for the years ended September 30, 2018
and 2017 would have been approximately 45 basis points lower during each period.



Income taxes



Provision for income taxes decreased $5.6 million, or 163.5%, for year ended
September 30, 2018 compared to the year ended September 30, 2017, primarily due
to a non-cash benefit of approximately $4.3 million arising from the
remeasurement of certain deferred tax assets and liabilities under the Tax
Reform Act. Exclusive of the adjustment to deferred tax assets and liabilities,
the Company's effective income tax rate for the year ended September 30, 2018
was approximately 20.7% as compared to 33.1% for the year ended September 30,
2017. The decrease in the effective income tax rate for the year ended September
30, 2018 is primarily the result of the Tax Reform Act.



Net income


Net income in the year ended September 30, 2018 was $12.7 million, or $0.56 in diluted earnings per share compared to $6.9 million, or $0.31 in diluted earnings per share, in the year ended September 30, 2017.

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Year ended September 30, 2017 compared to Year ended September 30, 2016

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



                                             Year ended September 30,               Change in
                                               2017              2016         Dollars       Percent
Statements of Income Data:
Net sales                                  $     769,030         705,499        63,531            9.0 %
Cost of goods sold and occupancy costs           556,694         503,727        52,967           10.5
Gross profit                                     212,336         201,772        10,564            5.2
Store expenses                                   174,350         156,158        18,192           11.6
Administrative expenses                           20,089          19,242           847            4.4
Pre-opening and relocation expenses                3,799           5,993        (2,194 )        (36.6 )
Operating income                                  14,098          20,379        (6,281 )        (30.8 )
Interest expense, net                             (3,793 )        (3,044 )        (749 )         24.6
Income before income taxes                        10,305          17,335        (7,030 )        (40.6 )
Provision for income taxes                        (3,414 )        (5,864 )       2,450          (41.8 )
Net income                                 $       6,891          11,471        (4,580 )        (39.9 )




Net sales



Net sales increased $63.5 million, or 9.0%, to $769.0 million for the year ended
September 30, 2017 compared to $705.5 million for the year ended September 30,
2016, primarily due to a $65.1 million increase in new store sales, partially
offset by a $1.6 million, or 0.2%, decrease in comparable store sales. Our 0.2%
decrease in comparable store sales in fiscal year 2017 compared to a 1.7%
increase in comparable store sales in fiscal year 2016. The decline in
comparable store sales during the year ended September 30, 2017 was due to the
impact of increased competition in the natural and organic sector, one less
selling day due to the occurrence of leap year in fiscal year 2016, internally
generated competition due to opening new stores in our existing markets, general
economic uncertainty and the lingering impact of depressed oil and natural gas
prices, although the negative impact of depressed oil and natural gas prices
moderated during the fourth quarter of fiscal year 2017.



Daily average comparable store sales increased 0.1% for the year ended September
30, 2017 compared to an increase of 1.4% for the year ended September 30, 2016.
The daily average comparable store sales increase in fiscal year 2017 resulted
from a 0.4% increase in average transaction size, partially offset by a 0.3%
decrease in daily average transaction count. Comparable store average
transaction size was $35.38 for the year ended September 30, 2017. Daily average
mature store sales decreased 1.6% for the year ended September 30, 2017 compared
to a decrease of 1.0% for the year ended September 30, 2016.



Gross profit



Gross profit increased $10.6 million, or 5.2%, to $212.3 million for the year
ended September 30, 2017 compared to $201.8 million for the year ended September
30, 2016, primarily driven by an increase in the number of comparable stores.
Gross margin decreased to 27.6% for the year ended September 30, 2017 from 28.6%
for the year ended September 30, 2016. Gross margin for the year ended September
30, 2017 was negatively impacted by an increase in occupancy costs as a
percentage of sales, primarily due to the higher average lease expenses
experienced at newer format stores opened since fiscal year 2012 and at
relocated stores. The increase in occupancy cost as a percentage of sales also
reflects the decrease in average mature store sales combined with the fixed
nature of our rent obligations and related occupancy expenses. Additionally,
product margin as a percentage of sales during fiscal year 2017 decreased
slightly due to our promotional pricing campaigns and, to a lesser extent, a
shift to lower margin products.



For the years ended September 30, 2017 and 2016, the Company had 17 and 16
leases, respectively, for stores which were classified as capital and financing
lease obligations. 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 for the years
ended September 30, 2017 and 2016 would have been approximately 55 basis points
higher during each period.



Store expenses



Store expenses increased $18.2 million, or 11.6%, to $174.4 million in the year
ended September 30, 2017 from $156.2 million in the year ended September 30,
2016. Store expenses as a percentage of sales were 22.7% and 22.1% for the years
ended September 30, 2017 and 2016, respectively. The increase in store expenses
as a percentage of sales in fiscal year 2017 was primarily due to increases in
labor-related expenses, depreciation, utilities and other store expenses.



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Administrative expenses



Administrative expenses increased $0.8 million, or 4.4%, to $20.1 million for
the year ended September 30, 2017 compared to $19.2 million for the year ended
September 30, 2016. The increase in administrative expenses was due to increased
public company costs related to compliance with the requirements of
Sarbanes-Oxley and increased technology and communication costs. Administrative
expenses as a percentage of sales were 2.6% and 2.7% for the years ended
September 30, 2017 and 2016, respectively.



Pre-opening and relocation expenses




Pre-opening and relocation expenses decreased $2.2 million, or 36.6%, to $3.8
million for the year ended September 30, 2017 compared to $6.0 million for the
year ended September 30, 2016. The decrease in pre-opening and relocation
expenses was primarily due to the impact of the number and timing of new store
openings and relocations. Pre-opening and relocation expenses as a percentage of
sales were 0.5% and 0.8% for the years ended September 30, 2017 and 2016,
respectively. The numbers of stores opened, relocated and remodeled were as
follows for the periods presented:



                     Year ended September 30,
                      2017               2016
New stores                 14                 23
Relocated stores            2                  4
Remodeled stores            0                  1
                           16                 28




Interest expense, net



Interest expense, net of capitalized interest, increased $0.7 million, or 24.6%,
in the year ended September 30, 2017 compared to the year ended September 30,
2016, primarily due to higher average borrowings under our Credit Facility and
an increase in the number of capital leases during the year ended September 30,
2017. If our capital and financing lease obligations had qualified as operating
leases, interest expense as a percent of sales would have been approximately 45
and 50 basis points lower than as reported in each of the years ended September
30, 2017 and 2016, respectively.



Income taxes



Provision for income taxes decreased $2.5 million, or 41.8%, in the year ended
September 30, 2017 compared to the year ended September 30, 2016, primarily due
to a $7.0 million decrease in income before income taxes and a decrease in the
estimated annual tax rate in the year ended September 30, 2017. Our effective
tax rate decreased from 33.9% in the year ended September 30, 2016 to 33.1% in
the year ended September 30, 2017, primarily due to higher federal tax credits
for the year ended September 30, 2017. For the year ended September 30, 2017,
the federal tax rate remained at 35.0% for our deferred tax assets and
liabilities.



Net income



Net income was $6.9 million, or $0.31 in diluted earnings per share, in the year
ended September 30, 2017 compared to $11.5 million, or $0.51 in diluted earnings
per share, in the year ended September 30, 2016.



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Non-GAAP financial measures



EBITDA and Adjusted EBITDA



EBITDA and Adjusted EBITDA are not measures of financial performance under GAAP.
We define EBITDA as net income before interest expense, provision for income
taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA as
adjusted to exclude the effects of certain income and expense items that
management believes make it more difficult to assess the Company's actual
operating performance, including certain items that are generally non-recurring,
such as impairment charges and store closing costs. The adjustments to EBITDA in
the year ended September 30, 2018 related to impairment of long-lived assets
charges and store closing costs. There were no adjustments to EBITDA in the
years ended September 30, 2017 and 2016.



The following table reconciles net income to EBITDA and Adjusted EBITDA, dollars
in thousands:



                                                      Year ended September 30,
                                              2018              2017              2016
Net income                                $      12,661             6,891            11,471
Interest expense, net                             4,560             3,793             3,044
(Benefit from) provision for income
taxes                                            (2,168 )           3,414             5,864
Depreciation and amortization                    29,430            29,511            25,533
EBITDA                                           44,483            43,609            45,912
Impairment of long-lived assets and
store closing costs                                 585                 -                 -
Adjusted EBITDA                           $      45,068            43,609            45,912



--------------------------------------------------------------------------------
EBITDA increased 2.0% to $44.5 million in the year ended September 30, 2018
compared to $43.6 million in the year ended September 30, 2017. EBITDA as a
percentage of sales was 5.2% and 5.7% for the years ended September 30, 2018 and
2017, respectively. The stores with leases that are classified as capital and
financing lease obligations, rather than being reflected as operating leases,
increased EBITDA as a percentage of sales for the years ended September 30, 2018
and 2017 by approximately 55 basis points in each period, 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 date if these leases had been accounted for as operating leases.



Adjusted EBITDA increased 3.3% to $45.1 million in the year ended September 30,
2018 compared to $43.6 million in the year ended September 30, 2017. Adjusted
EBITDA as a percentage of sales was 5.2% and 5.7% for the years ended September
30, 2018 and 2017, respectively.



EBITDA and Adjusted EBITDA decreased 5.0% to $43.6 million in the year ended
September 30, 2017 compared to $45.9 million in the year ended September 30,
2016. EBITDA and Adjusted EBITDA as a percentage of sales were 5.7% and 6.5% for
the years ended September 30, 2017 and 2016, respectively. The stores with
leases that are classified as capital and financing lease obligations, rather
than being reflected as operating leases, increased EBITDA and Adjusted EBITDA
as a percentage of sales by approximately 55 basis points for each of the years
ended September 30, 2017 and 2016 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 date if these
leases had been accounted for as operating leases.



Management believes that some investors' understanding of our performance is
enhanced by including EBITDA and Adjusted EBITDA, each of which is a non-GAAP
financial measure. We believe EBITDA and Adjusted EBITDA provide additional
information about: (i) our operating performance, because they assist us in
comparing the operating performance of our stores on a consistent basis, as they
remove 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 component of a measure in our
financial covenants under the Credit Facility.



Furthermore, management believes some investors use EBITDA and Adjusted EBITDA
as supplemental measures to evaluate the overall operating performance of
companies in our industry. Management believes that some investors'
understanding of our performance is enhanced by including these non-GAAP
financial measures as a reasonable basis for comparing our ongoing results of
operations. By providing these non-GAAP financial measures, together with a
reconciliation from net income, we believe we are enhancing analysts' and
investors' understanding of our business and our results of operations, as well
as assisting analysts and investors in evaluating how well we are executing our
strategic initiatives.



Our competitors may define EBITDA and Adjusted EBITDA differently, and as a
result, our measure of EBITDA and Adjusted EBITDA may not be directly comparable
to those of other companies. Items excluded from EBITDA and Adjusted EBITDA are
significant components in understanding and assessing financial performance.
EBITDA and Adjusted EBITDA are supplemental measures of operating performance
that do 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 the consolidated financial statements as indicators of financial
performance. EBITDA and Adjusted EBITDA have limitations as an analytical tool,
and should not be considered in isolation, or as an alternative to, or as a
substitute for, analysis of our results as reported under GAAP. For additional
discussion of our use of EBITDA and Adjusted EBITDA, and some of their
limitations, please refer to the "Selected Financial Data" section of this Form
10-K.



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Liquidity and Capital Resources




Our ongoing 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,
relocating and remodeling stores, debt service and corporate taxes. As of
September 30, 2018, we had $9.4 million in cash and cash equivalents and $35.8
million available for borrowing under our Credit Facility.



On May 4, 2016, our Board authorized a two-year share repurchase program
pursuant to which the Company may expend up to $10.0 million to repurchase
shares of the Company's common stock. On May 2, 2018, our Board of Directors
authorized a two-year extension of the share repurchase program. As a result of
such extension, the share repurchase program will terminate on May 4, 2020.
During the year ended September 30, 2018, we repurchased 101,573 shares of our
common stock for approximately $0.6 million (an average price of $5.72 per
share) under the share repurchase program. During the year ended September 30,
2017, we repurchased 30,000 shares of our common stock for approximately $0.3
million (an average price of $8.71 per share) under the share repurchase
program. We expect funding of share repurchases will come from operating cash
flow, excess cash and/or borrowings under the Credit Facility. The timing and
the number of shares purchased will be dictated by our capital needs and stock
market 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 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.


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



                                                      Year ended September 30,
                                              2018              2017              2016

Net cash provided by operating
activities                                $      42,863            40,849   

28,827

Net cash used in investing activities           (23,543 )         (38,499 )         (53,740 )
Net cash (used in) provided by
financing activities                            (16,443 )             154   

26,015

Net increase in cash and cash
equivalents                                       2,877             2,504   

1,102

Cash and cash equivalents, beginning of
year                                              6,521             4,017   

2,915

Cash and cash equivalents, end of year    $       9,398             6,521             4,017




Operating Activities



Net cash provided by operating activities consists primarily of net income
adjusted for non-cash items, including depreciation and amortization and changes
in deferred taxes, and the effect of working capital changes. Net cash provided
by operating activities increased $2.0 million, or 4.9%, to $42.9 million in the
year ended September 30, 2018, from $40.8 million in the year ended September
30, 2017. The increase in cash provided by operating activities was primarily
due to an increase in working capital from net income and accrued expenses and
other purchases, partially offset by deferred tax benefit. Our working capital
requirements for inventory will likely increase as we continue to open new
stores.



Net cash provided by operating activities increased $12.0 million, or 41.7%, to
$40.8 million in the year ended September 30, 2017, from $28.8 million in the
year ended September 30, 2016. The increase in cash provided by operating
activities was primarily due to a change in working capital driven by accrued
expenses, and other purchases, partially offset by a decrease in net income, as
adjusted for non-cash items such as depreciation and amortization resulting from
the addition of new stores and deferred tax expense.



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Investing Activities



Net cash used in investing activities consists primarily of capital
expenditures. Net cash used in investing activities decreased $15.0 million, or
38.8%, to $23.5 million in the year ended September 30, 2018 compared to $38.5
million in the year ended September 30, 2017. Cash paid for capital expenditures
decreased $17.5 million in the year ended September 30, 2018 compared to the
year ended September 30, 2017, driven by the number and the timing of new store
openings and store relocations.



During the year ended September 30, 2018, we opened eight new stores and
relocated three stores, compared to opening 14 new stores and relocating two
stores during the year ended September 30, 2017. We plan to spend approximately
$27 million to $32 million on capital expenditures during fiscal year 2019 in
connection with the opening of seven to nine planned new stores and five to six
store relocations. We anticipate that our new stores will require, on average,
an upfront capital investment of approximately $2.1 million per store.



Acquisition of property and equipment not yet paid increased $2.4 million to
$5.2 million in fiscal year 2018 compared to $2.8 million in fiscal year 2017
due to the timing of payments related to new store openings and relocations.



Net cash used in investing activities decreased $15.2 million, or 28.4%, to
$38.5 million in the year ended September 30, 2017 compared to $53.7 million in
the year ended September 30, 2016. Cash paid for capital expenditures decreased
$12.5 million in the year ended September 30, 2017 compared to the year ended
September 30, 2016, driven by the number and the timing of new store openings,
relocations and remodels.



Financing Activities



Net cash (used in) provided by financing activities consists primarily of
borrowings and repayments under our Credit Facility and payments of capital and
financing lease obligations. Net cash used in financing activities was $16.4
million for the year ended September 30, 2018, compared to cash provided by
financing activities of $0.2 million for the year ended September 30, 2017. The
decrease in cash provided by financing activities for the year ended September
30, 2018 was primarily due to net incremental repayments of $15.2 million under
our Credit Facility during the year ended September 30, 2018 compared to net
incremental borrowings of $1.0 million during the year ended September 30, 2017.



Net cash provided by financing activities was $0.2 million for the year ended
September 30, 2017, compared to cash provided by financing activities of $26.0
million for the year ended September 30, 2016. The decrease in cash provided by
financing activities for the year ended September 30, 2017 was primarily due to
lower net incremental borrowings of $1.0 million under our Credit Facility
during the year ended September 30, 2017 compared to net incremental borrowings
of $27.4 million during the year ended September 30, 2016.



Credit Facility



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 operating
company is the borrower under the Credit Facility and its obligations under the
Credit Facility are guaranteed by the holding company and Vitamin Cottage Two
Ltd. Liability Company (VC2). The Credit Facility is secured by a lien on
substantially all of the Company's assets. 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 January 31, 2021.



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, except that so long as no
default exists or would arise as a result thereof, the operating company may pay
cash dividends to the holding company for various audit, accounting, tax,
securities, indemnification, reimbursement, insurance and other reasonable
expenses incurred in the ordinary course of business, and for repurchases of
shares of common stock in an amount not to exceed $10.0 million.



We had $13.2 and $28.4 million outstanding under the Credit Facility as of
September 30, 2018 and September 30, 2017, respectively. As of each of September
30, 2018 and September 30, 2017, we had undrawn, issued and outstanding letters
of credit of $1.0 million, which were reserved against the amount available for
borrowing under the terms of the Credit Facility. We had $35.8 and $20.6 million
available for borrowing under the Credit Facility as of September 30, 2018 and
September 30, 2017, respectively.



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As of each of September 30, 2018 and September 30, 2017, the Company was in compliance with the debt covenants under the Credit Facility.

Off-Balance Sheet Arrangements




As of September 30, 2018, our off-balance sheet arrangements consisted of
operating leases and the undrawn portion of our Credit Facility. The majority of
our stores and facilities are leased, with varying terms and renewal options.
Currently, we own buildings in which six of our stores are located; those
buildings are located on land that is leased pursuant to a ground lease. As of
September 30, 2018, 20 store 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 effect
on our consolidated financial statements or financial condition.



Recent Accounting Pronouncements




In July 2015, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update (ASU) 2015-11, "Simplifying the Measurement of Inventory,"
Topic 330, "Inventory" (ASU 2015-11). The amendments in ASU 2015-11, which apply
to inventory that is measured using any method other than the last-in, first-out
(LIFO) or retail inventory method, require that entities measure inventory at
the lower of cost and net realizable value. The amendments in ASU 2015-11 should
be applied on a prospective basis. ASU 2015-11 is effective for fiscal years
beginning after December 15, 2016 and interim periods within those years. The
Company adopted the amendments of ASU 2015-11 effective October 1, 2017. The
adoption of this standard did not have a material impact on our consolidated
financial statements for the year ended September 30, 2018.



In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee
Share-Based Payment Accounting," Topic 718, "Compensation-Stock Compensation"
(ASU 2016-09). ASU 2016-09 includes provisions intended to simplify various
aspects related to how share-based payments are accounted for and presented in
the Company's financial statements, including income tax consequences,
forfeitures and classification on the statement of cash flows. Under previous
guidance, excess tax benefits and deficiencies from share-based compensation
arrangements were recorded in equity when the awards vested or were settled. ASU
2016-09 requires prospective recognition of excess tax benefits and deficiencies
in income tax expense, rather than paid-in-capital. The Company adopted the
amendments of ASU 2016-09 effective October 1, 2017. The adoption of this
standard did not have a material impact on the Company's consolidated statements
of income for the year ended September 30, 2018.



In addition, under ASU 2016-09, excess tax income tax benefits from share-based
compensation arrangements are classified as cash flow from operations, rather
than as cash flow from financing activities. For the year ended September 30,
2018, there were no excess income tax benefits.



The Company has elected to continue to estimate the number of share-based awards
expected to vest, as permitted by ASU 2016-09, rather than electing to account
for forfeitures as they occur.



ASU 2016-09 requires excess tax benefits and deficiencies to be prospectively excluded from assumed future proceeds in the calculation of diluted shares, resulting in an immaterial decrease in diluted weighted average shares outstanding for the year ended September 30, 2018.




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. Early adoption is permitted for annual and interim goodwill
impairment testing dates after January 1, 2017, and the ASU is effective for the
Company's first quarter of the fiscal year ending September 30, 2020. The
Company is currently evaluating the impact that the adoption of these provisions
will have on its consolidated financial statements.



In February 2016, the FASB issued ASU 2016-02, "Leases," Topic 842, "Leases"
(ASU 2016-02). ASU No. 2016-02 requires lessees to recognize a right-of-use
asset and corresponding lease liability for all leases with terms of more than
12 months. Recognition, measurement and presentation of expenses will depend on
classification as a finance or operating lease. ASU 2016-02 also requires
certain quantitative and qualitative disclosures. The provisions of ASU 2016-02
are effective for the Company's first quarter of the fiscal year ending
September 30, 2020, with early adoption permitted. The Company will apply the
transition provisions of ASU 2016-02 at its adoption date, rather than the
earliest comparative period presented in the financial statements, as permitted
by ASU 2018-11, "Leases," Topic 842, "Targeted Improvements," released in July
2018.



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The adoption of ASU 2016-02 will result in a material increase to the Company's
consolidated balance sheets for lease liabilities and right-of-use assets. The
Company is also performing a comprehensive review of its current processes to
determine and implement changes required to support the adoption of this
standard. As part of this review process, the Company is implementing new
software solutions to support the lease reporting upon adoption. The Company is
currently evaluating the other effects the adoption of ASU 2016-02 will have on
its consolidated financial statements.



In January 2018, the FASB issued ASU 2018-01, "Leases," Topic 842, "Land
Easement Practical Expedient for Transition to Topic 842" (ASU 2018-01). ASU
2018-01 permits an entity to elect a transition practical expedient to not
assess, under Accounting Standards Codification (ASC) 842, land easements that
exist or expired before the standard's effective date that were not previously
accounted for as leases under ASC 840. The Company plans to elect this practical
expedient in implementing ASU 2016-02.



In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with
Customers," Topic 606, "Revenue from Contracts with Customers" (ASU 2014-09).
ASU 2014-09 provides guidance for revenue recognition and will replace most
existing revenue recognition guidance in GAAP when it becomes effective. ASU
2014-09's core principle is that a company will recognize revenue when it
transfers promised goods or services to customers in an amount that reflects the
consideration to which the company expects to be entitled for the transfer of
those goods or services. ASU 2014-09 permits the use of either the retrospective
or cumulative effect transition method. Additionally, the amendments in this ASU
provide a practical expedient for entities to recognize the incremental costs of
obtaining a contract as an expense when incurred if the amortization period of
the asset that the entity otherwise would have recognized is one year or less,
The Company plans to elect this practical expedient upon adoption.



In July 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with
Customers - Deferral of the Effective Date." The FASB approved the deferral of
ASU 2014-09, by extending the new revenue recognition standard's mandatory
effective date by one year and permitting public companies to apply the new
revenue standard to annual reporting periods beginning after December 15, 2017.
The guidance in ASU 2014-09 will be effective for the Company in the first
quarter of the fiscal year ending September 30, 2019.



Further to ASU 2014-09 and ASU 2015-14, the FASB issued ASU 2016-08, "Revenue
from Contracts with Customers," Topic 606, "Principal versus Agent
Considerations (Reporting Revenue Gross versus Net)" (ASU 2016-08) in March
2016, ASU 2016-12, "Revenue from Contracts with Customers," Topic 606,
"Narrow-Scope Improvements and Practical Expedients" (ASU 2016-12) in May 2016
and ASU 2016-20, "Revenue from Contracts with Customers," Topic 606, "Technical
Corrections and Improvements" (ASU 2016-20) in December 2016. The amendments in
ASU 2016-08 clarify the implementation guidance on principal versus agent
considerations, including indicators to assist an entity in determining whether
it controls a specified good or service before it is transferred to the
customers. ASU 2016-12 addresses narrow-scope improvements to the guidance on
collectability, non-cash consideration, and completed contracts at transition.
Additionally, the amendments in this ASU provide a practical expedient for
contract modifications at transition and an accounting policy election related
to the presentation of sales taxes and other similar taxes collected from
customers. The Company plans to make such election. The Company also plans to
elect the practical expedient in ASU 2016-20 that provides entities do not need
to disclose the transaction price allocated to performance obligations when the
related contracts have a duration of one year or less. This includes loyalty
rewards, which can be redeemed in the month subsequent to the quarter earned,
and marketing promotions that cross accounting periods. Both of these classes of
transactions are currently immaterial to the Company. The effective date and
transition requirements for ASU 2016-08, ASU 2016-12 and ASU 2016-20 are the
same as for ASU 2014-09.



The Company does not plan to early adopt the new revenue recognition guidance;
adoption will be on the modified retrospective basis beginning in fiscal year
2019. The Company has substantially concluded its assessment of the impact of
the adoption of this standard on its consolidated financial statements. Most of
the Company's revenue is expected to continue to be generated from point-of-sale
transactions, which ASU 2014-09 treats generally consistent with current
accounting standards. The Company does not expect this standard will have a
material impact on the accounting for point-of-sale transactions or related
areas including the right of return, gift card breakage, and customer
incentives. Although the impact on the consolidated financial statements is not
expected to be material, additional disclosures will be required.



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.



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.



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We have chosen accounting policies that we believe are appropriate to report
accurately and fairly our operating results and financial position, and we apply
those accounting policies in a consistent manner. Refer to our consolidated
financial statements and related notes for a summary of our significant
accounting policies. We believe that the following accounting policies are the
most critical in the preparation of our consolidated financial statements
because they involve the most difficult, subjective or complex judgments about
the effect of matters that are inherently uncertain.



Income Taxes



We account for income taxes using the asset and liability method. This method
requires recognition of deferred tax assets and liabilities for expected future
tax consequences of temporary differences that currently exist between the tax
basis and financial reporting basis of our assets and liabilities. Deferred tax
assets and liabilities are measured using enacted tax rates in the respective
jurisdictions in which we operate. We consider the need to establish valuation
allowances to reduce deferred income tax assets to the amounts that we believe
are more likely than not to be recovered.



We recognize the effect of income tax positions only if those positions are more
likely than not of being sustained by the relevant taxing authority. Recognized
income tax positions are measured at the largest amount that is greater than 50%
likely of being realized. Changes in recognition or measurement are reflected in
the period in which the change in judgment occurs.



Significant accounting judgment is required in determining the provision for
income taxes and related accruals, deferred tax assets and liabilities. In the
ordinary course of business, there are transactions and calculations where the
ultimate tax outcome is uncertain. In addition, we are subject to periodic
audits and examinations by the IRS and other state and local taxing authorities.
Although we believe that our estimates are reasonable, actual results could
differ from these estimates.



To the extent we prevail in matters for which reserves have been established, or
are required to pay amounts in excess of our reserves, our effective income tax
rate in a given financial statement period could be materially affected. An
unfavorable tax settlement would require the use of our cash and would result in
an increase in our effective income tax rate in the period of resolution. A
favorable tax settlement would be recognized as a reduction in our effective
income tax rate in the period of resolution.



Goodwill and Intangible Assets




We assess our goodwill and intangible assets primarily consisting of trademarks,
favorable operating leases and covenants-not-to-compete at least annually. The
Company's annual impairment testing of goodwill is performed as of July 1. In
performing the Company's analysis of goodwill, the Company first evaluates
qualitative factors, including relevant events and circumstances, to determine
whether it is more likely than not that the fair value of a reporting unit is
less than its carrying amount. If it is not more likely than not that the fair
value of a reporting unit is less than its carrying amount, the two-step
impairment test is not necessary. If it is determined that it is more likely
than not that the fair value of a reporting unit is less than its carrying
amount, then the Company performs the two-step impairment test. There are
significant judgments and estimates within the processes; it is therefore
possible that materially different amounts could be recorded if we used
different assumptions or if the underlying circumstances were to change.



Impairment of Long-Lived Assets and Store Closing Costs




We assess our long-lived assets, principally property and equipment, for
possible impairment at least annually, or whenever events or changes in
circumstances indicate the carrying amount of an asset may not be recoverable.
Recoverability is measured by a comparison of the carrying amount of the assets
to the future undiscounted cash flows expected to be generated by the assets. We
aggregate long-lived assets at the store level which we consider to be the
lowest level in the organization for which independent identifiable cash flows
are available. If the carrying value of the long-lived asset or asset group is
not recoverable on an undiscounted cash flow basis, impairment is recognized to
the extent the carrying value exceeds its fair value.



Our judgment regarding events or changes in circumstances that indicate an
asset's carrying value may not be recoverable is based on several factors such
as historical and forecasted operating results, significant industry trends and
other economic factors. Further, determining whether an impairment exists
requires that we use estimates and assumptions in calculating the future
undiscounted cash flows expected to be generated by the assets. These estimates
and assumptions look several years into the future and include assumptions on
future store revenue growth, potential impact of operational changes,
competitive factors, inflation and the economy. Application of alternative
assumptions could produce materially different results.



If the Company commits to a plan to dispose of a long-lived asset before the end
of its previously estimated useful life, estimated cash flows are revised
accordingly, and the Company may be required to record an asset impairment
write-down. Additionally, related liabilities arise, such as severance,
contractual obligations and other accruals associated with store closings from
decisions to dispose of assets. The Company estimates these liabilities based on
the facts and circumstances in existence for each restructuring decision. The
amounts the Company will ultimately realize or disburse could differ from the
amounts assumed in arriving at the asset impairment and restructuring charge
recorded.



                                       53

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  Table of Contents



Leases



We lease retail stores, a bulk food repackaging facility and distribution
center, land and administrative offices under long-term operating leases,
capital financing leases or capital leases. Accounting for leased properties
requires compliance with technical accounting rules and significant judgment by
management. Application of these accounting rules and assumptions made by
management will determine whether the lease is accounted for as an operating
lease, whether we are considered the owner for accounting purposes or whether
the lease is accounted for as a capital lease.



If the lease is classified as an operating lease, it is not recognized on our consolidated balance sheet, and rent expense, including rent holidays and escalating payment terms, is recognized on a straight-line basis over the expected lease term.




If we are determined to be the owner for accounting purposes, we record the fair
market value of the leased asset and a related capital lease finance obligation
on our consolidated balance sheet. The leased asset is then depreciated over the
estimated useful life of the asset. Rent payments for these properties are not
recorded as rent expense, but rather are recognized as a reduction of the
capital lease finance obligation and as interest expense.



If the lease is classified as a capital lease, we record the present value of
the minimum lease payments and a related capital lease obligation on our
consolidated balance sheet. The asset is then depreciated over the expected
lease term. Rent payments for these properties are not recorded as rent expense,
but rather are recognized as a reduction of the capital lease obligation and as
interest expense.


Significant accounting judgment and assumptions are required in determining the accounting for leases, including:

? fair market value of the leased asset, which is generally estimated based on

project costs or comparable market data. Fair market value is used as a factor

in determining whether the lease is accounted for as an operating or capital

lease, and is used for recording the leased asset when we are determined to be

    the owner for accounting purposes;



? minimum lease term that includes contractual lease periods, and may also

include the exercise of renewal options if the exercise of the option is

determined to be reasonably assured or where failure to exercise such options

would result in an economic penalty. The minimum lease term is used as a

factor in determining whether the lease is accounted for as an operating lease

or a capital lease and in determining the period over which to depreciate the

    capital lease asset; and



? incremental borrowing rate which is estimated based on treasury rates for debt

with maturities comparable to the minimum lease term and our credit spread and

other premiums. The incremental borrowing rate is used as a factor in

determining the present value of the minimum lease payments which is then used

in determining whether the lease is accounted for as an operating lease or

capital lease, as well as for allocating our rental payments on capital leases

between interest expense and a reduction of the outstanding obligation.

© Edgar Online, source Glimpses

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P/E ratio 2020 46,70
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Technical analysis trends NATURAL GROCERS BY VITAMIN
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Mean consensus HOLD
Number of Analysts 4
Average target price 19,3 $
Spread / Average Target 11%
EPS Revisions
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NameTitle
Kemper Isely Chairman & Co-President
Zephyr Isely Co-President & Director
Todd Dissinger Chief Financial Officer
Heather Capri Isely Secretary, Director & Executive Vice President
Elizabeth Isely Director & Executive Vice President
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