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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2013;

OR

COMMISSION FILE NUMBER: 001-35608

Natural Grocers by Vitamin Cottage, Inc.

(Exact name of registrant as specified in its charter)

12612 West Alameda Parkway

Lakewood, Colorado 80228

(Address of principal executive offices)

(303) 986-4600

(Registrants telephone number, including area code)

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

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

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

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of May 7, 2013 was 22,401,924.

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Natural Grocers by Vitamin Cottage, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2013

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

Forward Looking Statements

This Form 10-Q includes forward-looking statements in addition to historical information. These forward-looking statements are included throughout this Form 10-Q, including in the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and relate to matters such as our industry, business strategy, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources and other financial and operating information. We have used the words “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “future” and similar terms and phrases to identify forward-looking statements in this 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 that we have anticipated. Actual results may differ materially from these expectations due to changes in global, regional or local political, economic, business, competitive, market, regulatory and other factors, many of which are beyond our control. We believe that these factors include those referenced in “Risk Factors” in our Form 10-K for the year ended September 30, 2012, as amended (our “Form 10-K”). Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, our actual results may vary in material respects from those projected in these forward-looking statements.

Any forward-looking statement made by us in this Form 10-Q speaks only as of the date on which we make it. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable securities laws. You are advised, however, to consult any further disclosures we may make in our future reports to the Securities and Exchange Commission, on our website or otherwise.

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PART I. Financial Information

Item 1.  Financial Statements

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Balance Sheets

(Unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Income

(Unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Comprehensive Income

(Unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Notes to Unaudited Interim Consolidated Financial Statements

March 31, 2013

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 and dietary supplements. The Company operates its retail stores under its trademark Natural Grocers by Vitamin Cottage® with 65 stores as of March 31, 2013, including 31 stores in Colorado, 12 in Texas, four in New Mexico, three in each of Kansas, Arizona and Montana, two in each of Wyoming and Nebraska, and one in each of the following states: Utah, Oklahoma, Missouri, Idaho and Oregon.  The Company’s bulk food repackaging facility and distribution center is located in Colorado. The Company had 53 stores as of March 31, 2012.

2. Basis of Presentation and Recent Accounting Pronouncements

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 the Securities and Exchange Commission in Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in our Form 10-K. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation.  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 holding company was incorporated in Delaware on April 9, 2012. The accompanying consolidated financial statements include all the accounts of the Company’s wholly owned subsidiaries, Vitamin Cottage Natural Food Markets, Inc. (the operating company), Vitamin Cottage Two Ltd. Liability Company (VC2) and Natural Systems, LLC. The operating company formed the holding company in order to facilitate the purchase of the remaining noncontrolling interest in Boulder Vitamin Cottage Group, LLC (BVC) and consummation of the initial public offering (IPO).  Prior to the Company’s IPO on July 25, 2012, the Company had a majority 55% ownership of BVC.  Immediately prior to the IPO, the Company issued 670,056 shares of stock in the holding company and paid $10,050,880 in cash to purchase the remaining 45% noncontrolling interest in BVC.  Effective October 31, 2012, BVC merged with and into the operating company and ceased to exist.  Prior to the merger, BVC owned five of the Company’s retail stores, which were managed by the operating company.  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 products which are presented as a percentage of sales for the three and six months ended March 31, 2013 and 2012 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, the disclosure of contingent assets and liabilities at the balance sheet date and reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

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Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standard Update, or ASU, No. 2013-02 “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU No. 2013-02 supersedes the presentation requirements for reclassifications out of accumulated other comprehensive income in both ASU No. 2011-12 and 2011-05.  ASU No. 2013-02 requires an entity to disaggregate the total change of each component of other comprehensive income either on the face of the income statement or as a separate disclosure in the notes. Amounts that are not required to be reclassified in their entirety to net income must be cross-referenced to other disclosures that provide additional detail. This update is effective for the Company beginning in the first quarter of fiscal 2014. The Company does not expect the adoption of this update will have a material effect on its consolidated financial statements.

3. Earnings Per Share

Basic earnings per share (EPS) excludes dilution and is computed by dividing net income attributable to Natural Grocers by Vitamin Cottage, Inc. stockholders by the weighted average shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, resulting in the issuance of common stock that would then share in the earnings of the Company. Presented below is basic and diluted EPS for the three and six months ended March 31, 2013 and 2012:

The Company did not declare any dividends in the three and six months ended March 31, 2013 and 2012.

As of March 31, 2013, the Company had 50,000,000 shares of common stock authorized and 22,401,924 shares outstanding as well as 10,000,000 shares of preferred common stock authorized with none outstanding.

4. Stock-based Compensation

The Company adopted an Omnibus Incentive Plan (the Plan) on July 17, 2012.  As of March 31, 2013, the Company had issued restricted stock unit (RSU) awards to its Chief Financial Officer and the two independent members of the Board of Directors.

The RSU grant to the Chief Financial Officer (CFO Award) was in accordance with the terms of her employment agreement that was signed in June 2008 which stated she was entitled to receive a grant of RSUs equal to 1.2% of the fully diluted shares of the Company in connection with an IPO.  Two thirds of the CFO Award vested immediately upon completion of the IPO and was settled in a combination of common stock and cash.  The remaining one third (89,221 shares) has been, or will be, settled 100% in shares of common stock and has vested, or will vest, in three equal parts over a six, 12 and 18 month period following the IPO.  In January 2013, the first portion vested, and accordingly the Company issued 29,740 shares.

Each independent member of the Company’s Board of Directors is granted a number of RSUs under the Plan each year equal to the number of shares of common stock having a value of $50,000 based on the closing price of common stock on the New York Stock Exchange (NYSE) on the date of grant. All of these RSUs are granted on the date of the Company’s annual meeting of stockholders or, in the case of a mid-year appointment, a pro rata portion is granted at the time of appointment. In either case, the RSUs vest over a twelve month period and are expensed over that period.  The Company held its annual meeting of stockholders on March 6, 2013, and each independent member of the Company’s Board of Directors received 2,428 RSUs based on the $20.59 closing price of common stock on the NYSE on that date.

Total stock-based compensation expense before income taxes recognized in the three and six months ended March 31, 2013

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was $26,000 and $46,000, respectively.  No stock-based compensation expense was recorded in the three and six months ended March 31, 2012. Stock-based compensation expense was included in the administrative expenses line item of the consolidated statements of income for the three and six months ended March 31, 2013.

As of March 31, 2013, there was approximately $125,000 of unrecognized stock-based compensation expense related to 67,161 shares of nonvested RSUs with a weighted average grant date fair value of $3.53.  The Company anticipates that this expense will be recognized over a weighted average period of approximately one year.

5. Long-Term Debt

The Company has a credit facility consisting of a revolving credit facility and a term loan that was fully repaid in fiscal year 2012.  The amount previously available under the revolving credit facility, which matures on June 30, 2014, was $21.0 million. On October 31, 2012, the Company signed an amendment to the credit facility to reduce the amount available for borrowing to $15.0 million and to reduce the unused commitment fee from 0.375% to 0.20%. The Company had no amounts outstanding on the revolving credit facility as of March 31, 2013 and September 30, 2012.

From time to time, the Company enters into lease agreements with developers for build-to-suit locations. Upon lease execution, the Company analyzes its involvement during the construction period with respect to Accounting Standards Codification, or ASC, Topic 840, Leases.  As a result of defined forms of lessee involvement, the Company could be deemed the “owner” for accounting purposes during the construction period, and may be required to capitalize the project costs on its balance sheet.  If the project costs were capitalized, the Company performs a sale-leaseback analysis upon completion of construction pursuant to ASC Topic 840, Leases, to determine if the Company can remove the assets from its balance sheet.  If the asset cannot be removed from the balance sheet, the fair market value of the building remains recognized as an asset on the balance sheet along with a corresponding capital lease finance obligation equal to the fair market value of the building less the amount the Company contributed towards construction.

The Company has five opened stores reflected in capital lease finance obligations totaling $11.2 million as of March 31, 2013, two of which were opened as of September 30, 2012.

The Company does not record rent expense for capitalized real estate leases, but rather rental payments are recognized as a reduction of the capital lease finance obligation and as interest expense.  Depreciation expense for the related capitalized real estate leases for build-to-suit stores is included in store expenses in the consolidated statements of income.

Capital lease finance obligations as of March 31, 2013 and September 30, 2012 are summarized as follows:

Capital lease obligations include the present value of the minimum lease payments for two stores that opened in the second quarter of fiscal year 2013.  Per ASC Topic 840, Leases, these leases were deemed to be capital leases, and accordingly the Company capitalized the present value of the minimum lease payments and recorded a related capital lease obligation.

Capital lease obligations as of March 31, 2013 are summarized as follows:

The Company incurred gross interest expense of $393,000 and $155,000 in the three months ended March 31, 2013 and

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2012, respectively, as well as $8,000 and $10,000 in amortization of deferred financing costs in the three months ended March 31, 2013 and 2012, respectively.  The Company had capitalized interest of $9,000 in the three months ended March 31, 2012.  The Company did not capitalize any interest in the three months ended March 31, 2013.

The Company incurred gross interest expense of $626,000 and $323,000 in the six months ended March 31, 2013 and 2012, respectively, as well as $31,000 and $22,000 in amortization of deferred financing costs in the six months ended March 31, 2013 and 2012, respectively.  The Company had capitalized interest of $15,000 in the six months ended March 31, 2012.  The Company did not capitalize any interest in the six months ended March 31, 2013.

6. Property and Equipment

The Company had the following property and equipment balances as of March 31, 2013 and September 30, 2012:

Construction in process included $1.9 million as of September 30, 2012 related to construction costs for build-to-suit leases in process related to two stores that opened in the first quarter of fiscal year 2013.

Capitalized real estate leases for build-to-suit stores include the assets for five stores that were open as of March 31, 2013, two of which were opened as of September 30, 2012, and are depreciated over a 40 year useful life.

Capitalized real estate leases include the present value of the minimum lease payments for two stores that opened in the second quarter of fiscal year 2013 and are being depreciated over a 15 year useful life which represents the lease terms.  Per ASC Topic 840, Leases, these leases were deemed to be capital leases, and accordingly the Company capitalized the present value of the minimum lease payments and recorded a related capital lease obligation.

During the three months ended March 31, 2013 and 2012, the Company recorded depreciation and amortization expense of $3.2 million and $2.4 million, respectively.  During the six months ended March 31, 2013 and 2012, the Company recorded depreciation and amortization expense of $6.2 million and $4.7 million, respectively.

The American Taxpayer Relief Act of 2012 was enacted in January 2013.  The impact of the new law has been recognized in the period of enactment.  The primary impact affecting the Company is the extension of the 50% bonus depreciation on qualifying assets and the special 15 year depreciation life for qualified leasehold property and qualified retail improvement property for property acquired from January 1, 2013 through December 31, 2013.  The Company may also benefit by the extension of the Work Opportunity Tax Credit through December 31, 2013.

7. Supplementary Balance Sheet Information

Restricted Cash

Restricted cash was $500,000 as of March 31, 2013 and represented cash that was pledged in February 2013 as collateral for a standby letter of credit related to our workers’ compensation insurance. The Company elected to pledge this cash as collateral for the letter of credit to reduce costs associated with our workers’ compensation insurance.

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Accrued Expenses

The composition of accrued expenses is summarized as follows as of March 31, 2013 and September 30, 2012:

8.  Investments

The Company had money market fund investments that are classified as cash and cash equivalents of $176,000 and $246,000 as of March 31, 2013 and September 30, 2012, respectively.  The Company also had available-for-sale securities, generally consisting of certificates of deposit, corporate bonds and municipal bonds, totaling $1.8 million as of March 31, 2013 and September 30, 2012, respectively, of which $1.8 million and $777,000 were classified as short-term as of March 31, 2013 and September 30, 2012, respectively. At March 31, 2013, the average effective maturity of the Company’s short-term investments was approximately eight months. At September 30, 2012, the average effective maturities of the Company’s short-term and long-term investments were approximately eight and 17 months, respectively. During the three and six months ended March 31, 2013, the Company recorded interest income of $9,600 and $19,300, respectively, and recorded expense related to amortized premiums paid of $7,300 and $14,800, respectively.

As of March 31, 2013, available-for-sale securities totaling $1.8 million were in unrealized loss positions with $366 recorded in accumulated other comprehensive income for temporary declines in fair value, consisting of five securities in gain positions and eight securities in loss positions due to the amortization of premiums paid to acquire the securities.  As of September 30, 2012, available-for-sale securities totaling $1.8 million were in unrealized loss positions with $3,696 recorded in accumulated other comprehensive income for temporary declines in fair value, consisting of three securities in gain positions and nine securities in loss positions due to the amortization of premiums paid to acquire the securities.  There was no other than temporary impairment on available-for-sale securities as of March 31, 2013 or September 30, 2012.

9. Fair Value Measurements

The Company records its financial assets and liabilities at fair value in accordance with the framework for measuring fair value in authoritative guidance. The framework establishes a fair value hierarchy that distinguishes between assumptions based on market data (observable inputs) and the Company’s own assumptions (unobservable inputs).

As of March 31, 2013 and September 30, 2012, the Company had the following financial assets that were subject to fair value measurements according to the fair value hierarchy:

The money market fund and available-for-sale securities are carried at fair value. During the three and six months ended March 31, 2013, the Company purchased $245,000 and $426,000, respectively, in available-for-sale securities, resulting in a decrease in the money market fund (level 1) and an increase in available-for-sale securities (level 2).  During the three months ended March 31, 2013, available-for-sale securities of $340,000 matured, resulting in an increase in the money market fund (level 1) and a decrease in available-for-securities (level 2). Transfers between levels of the fair value hierarchy are deemed to have occurred when amounts from the money market fund are invested in available-for-sale securities and vice versa.  The transfer is deemed to have occurred as of the

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date of the event or transfer.  See Note 8, Investments, for additional disclosures.

The Company believes that the carrying values approximate fair values of note payable — related party because stated interest rates approximate market rates. The carrying amounts of other financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and other accrued expenses approximate fair value because of the short maturity of those instruments.

10. Related Party Transactions

The Company has seven leases with Chalet Properties, LLC (Chalet), one lease with the Isely Family Land Trust LLC (Land Trust) and one lease with 3801 East Second Avenue LLC, all related parties.

Chalet:  Rent paid to Chalet was approximately $324,000 for each of the three months ended March 31, 2013 and 2012, respectively, and $648,000 and $642,000 for the six months ended March 31, 2013 and 2012, respectively.

Land Trust:  Rent paid to the Land Trust was approximately $76,500 and $153,000 for each of the three and six months ended March 31, 2013 and 2012, respectively.

3801 East Second Avenue, LLC:  Rent paid to 3801 East Second Avenue LLC was approximately $12,000 and $24,000 for each of the three and six months ended March 31, 2013 and 2012, respectively.

11. Commitments and Contingencies

Legal

The Company is periodically involved in various legal proceedings that are incidental to the conduct of its business, including but not limited to employment discrimination claims and customer injury claims. 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 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.

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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 should be read in conjunction with our unaudited consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and in conjunction with our Form 10-K. To the extent that the following Management’s Discussion and Analysis contains statements which are not of a historical nature, such statements are forward-looking statements which involve risks and uncertainties. These risks and uncertainties include, but are not limited to, those discussed in our Form 10-K. Such forward-looking statements are often identified with such words as “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “future” or similar words concerning future events. Actual results could differ materially from these forward- looking statements. All references to a “fiscal year” refer to a year beginning on October 1 of the previous year, and ending on September 30 of such year (for example “fiscal year 2013” refers to the year from October 1, 2012 to September 30, 2013).

Company Overview

We operate natural and organic grocery and dietary supplement stores that are focused on providing high quality products at affordable prices, exceptional customer service, nutrition education and community outreach. We believe we have been at the forefront of the natural and organic foods movement since our founding. We are headquartered in Lakewood, Colorado, and as of March 31, 2013, we operated 65 stores in 13 states, including Colorado, Arizona, Idaho, Kansas, Missouri, Montana, Nebraska, New Mexico, Oklahoma, Oregon, Texas, Utah and Wyoming, as well as a bulk food repackaging facility and distribution center in Colorado.

We offer a variety of natural and organic groceries and dietary supplements that meet our strict quality guidelines. The size of our stores vary from approximately 5,000 selling square feet to 16,000 selling square feet, with a typical store average of approximately 9,800 selling square feet.  During the trailing twelve months prior to March 31, 2013, our new stores averaged approximately 10,700 selling square feet.

The growth in the organic and natural foods industry and growing consumer interest in health and nutrition has enabled us to continue to open new stores and enter new markets. In each of fiscal years 2012 and 2011, we opened ten new stores, and in each of fiscal years 2010 and 2009, we opened six new stores. We currently plan to open 13 new stores in fiscal year 2013, six of which we opened in the six months ended March 31, 2013 in Helena and Missoula, Montana; Omaha, Nebraska; Medford, Oregon and Denton and Lubbock, Texas. We have opened one store since March 31, 2013 in Kalispell, Montana.  We have signed leases for six new store locations that we plan to open in fiscal year 2013 and four new store locations that we plan to open in fiscal year 2014 in Idaho Falls, Idaho; Shawnee and Topeka, Kansas; Omaha, Nebraska; Tulsa, Oklahoma; Beaverton, Bend, Gresham and Salem, Oregon and Wichita Falls, Texas.  Additionally, we plan to remodel two existing stores and relocate one existing store in the remainder of fiscal year 2013.

Industry Trends and Economics

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

·                  Opportunities in the growing natural and organic grocery and dietary supplements industry.  Our industry, which includes organic and natural foods and dietary supplements, has had significant growth over the last several years, driven in large part by increased public interest in health and nutrition. Our results of operations have been and may continue to be materially and adversely affected by the timing and number of new store openings. 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. New stores generally have lower sales compared to mature stores, but typically grow at a faster rate than mature stores for several years after their opening date. Mature stores refer to stores that have been open for any part of five fiscal years or longer.

·                  Position within the broader grocery industry.  The grocery industry is highly competitive. Our competition varies by market and includes conventional, natural, gourmet and specialty food markets, mass and discount retailers, warehouse clubs, independent health food stores, dietary supplement retailers, drug stores, farmers markets, mail order and online retailers, and multi-level marketers. Customer shopping preferences are based on a number of factors, including price, selection, quality, customer service, shopping environment, location or any combination of these factors. Natural and organic groceries and dietary supplements continue to be some of the fastest growing segments in grocery retailing, which we believe has led our competitors to increase their focus and advertising on natural and organic selections. The growth in the market has also driven our competitors to open new stores and enter new markets, which has had and may continue to have an impact on our results of operations for any given period.

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·                  Impact of broader economic trends.  The grocery industry and our sales are affected by general economic conditions. A number of factors can affect the level of consumer spending, including economic conditions, the level of disposable consumer income, consumer debt, interest rates, the price of commodities, the political environment and consumer confidence. Our sales were affected by the economic recession in fiscal years 2009 and 2010.  In the twelve months ended September 30, 2009, 2010, 2011 and 2012 our comparable store sales grew 2.6%, 2.1%, 4.9% and 11.6%, respectively.  Removing the effect of the 2012 leap year in the twelve months ended September 30, 2012, our daily average comparable store sales grew 11.3% over the prior fiscal year.

Performance Highlights

Key highlights of our recent performance are discussed briefly below and are discussed in further detail throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

·                  Net sales.  We reported net sales of $106.5 million for the three months ended March 31, 2013, which is a 25.4% increase compared to net sales of $84.9 million for the three months ended March 31, 2012.  We reported net sales of $202.3 million for the six months ended March 31, 2013, which is a 26.6% increase compared to net sales of $159.7 million for the six months ended March 31, 2012.

·                  Comparable store sales.  Our comparable store sales for the three and six months ended March 31, 2013 increased 8.1% and 10.4%, respectively, over the three and six months ended March 31, 2012.  As of March 31, 2013, we have had over 45 quarters of consecutive growth in comparable store sales.

·                  Daily average comparable store sales. Daily average comparable store sales, removes the effect of the loss of two selling days for leap year and the occurrence of Easter in March of 2013, rather than April of 2012. Daily average comparable store sales for the three and six months ended March 31, 2013 increased 10.6% and 11.6%, respectively, over the three and six months ended March 31, 2012.

·                  Mature store sales.  Our mature store sales for the three and six months ended March 31, 2013 increased 3.5% and 5.7%, respectively, over the three and six months ended March 31, 2012.  For fiscal year 2013, mature store sales include all stores open during or before fiscal year 2008.

·                  Daily average mature store sales. Daily average mature store sales, removes the effect of the loss of two selling days for leap year and the occurrence of Easter in March of 2013, rather than April of 2012. Daily average mature store sales for the three and six months ended March 31, 2013 increased 5.8% and 6.9%, respectively, over the three and six months ended March 31, 2012.  For fiscal year 2013, daily average mature store sales include all stores open during or before fiscal year 2008.

·                  Net income.  We reported net income of $3.2 million for the three months ended March 31, 2013 which increased $440,000, or 15.8%, compared to net income of $2.8 million for the three months ended March 31, 2012.  We reported net income of $5.4 million for the six months ended March 31, 2013 which increased $1.4 million, or 34.7%, compared to net income of $4.0 million for the six months ended March 31, 2012.

·                  Net income attributable to Natural Grocers by Vitamin Cottage, Inc.  We reported net income attributable to Natural Grocers by Vitamin Cottage, Inc. of $3.2 million for the three months ended March 31, 2013 which increased $732,000, or 29.5%, compared to net income attributable to Natural Grocers by Vitamin Cottage, Inc. of $2.5 million for the three months ended March 31, 2012.  We reported net income attributable to Natural Grocers by Vitamin Cottage, Inc. of $5.4 million for the six months ended March 31, 2013 which increased $2.0 million, or 56.5%, compared to $3.5 million for the six months ended March 31, 2012.

·                  EBITDA.  We generated EBITDA of $8.8 million in the three months ended March 31, 2013, which increased $1.9 million, or 28.3%, from $6.8 million in the three months ended March 31, 2012.  We generated EBITDA of $15.5 million in the six months ended March 31, 2013, which increased $4.4 million, or 39.6%, from $11.1 million in the six months ended March 31, 2012. EBITDA is not a measure of financial performance under GAAP. Items excluded from EBITDA are significant components in understanding and assessing our financial performance. Refer to the end of this Management’s Discussion and Analysis of Financial Condition and Results of Operations for a reconciliation of net income attributable to Natural Grocers by Vitamin Cottage, Inc. to EBITDA.

·                  Liquidity.  We had $9.5 million in cash and cash equivalents, $500,000 in restricted cash and $1.8 million in available-

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for-sale securities as of March 31, 2013, as well as $15.0 million available under our revolving credit facility.

·                  New store growth.  Our new store growth was 18.2%, 25.6% and 20.4% in the years ended September 30, 2010, 2011 and 2012, respectively.  We opened four and six new stores during the three and six months ended March 31, 2013, respectively, compared to two and four new stores during the three and six months ended March 31, 2012, respectively.  We plan to open 13 new stores in fiscal year 2013, six of which we had opened as of March 31, 2013, which will result in an annual new store growth rate of 22.0%.

Outlook

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

We plan for the foreseeable future to continue opening new stores and entering new markets at recent levels of growth. During the past few years, we have successfully expanded our infrastructure to enable us to support our continued growth. This has included successfully implementing an enterprise resource planning, or ERP, system in fiscal year 2010, hiring key personnel and developing efficient, effective new store opening construction and operations processes and relocating and expanding our bulk food repackaging facility and distribution center in September 2012. We believe there are attractive opportunities for us to continue to expand our store base and focus on increasing comparable store sales. As we continue to expand our store base, we believe there are opportunities for increased leverage in fixed costs, such as administrative expenses, as well as increased economies of scale in sourcing products.  However, due to our commitment to providing high-quality products at affordable prices, such sourcing economies may not be reflected in our gross margin in the near term. This opportunity for increased leverage will be slightly offset by higher administrative expenses that we have incurred and will continue to incur as a result of being a public company.  Additionally, higher costs of our bulk food repackaging facility and distribution center as a result of the recent relocation and expansion may not be offset by retail price changes in the near term.

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 terms “new stores” and “non-comparable stores” to refer to stores that have been open for less than thirteen months.

·                  Change in daily average comparable store sales.  Daily average comparable store sales are comparable store sales divided by the number of selling days in each period. We use this metric to remove the effect of differences in the number of selling days we are open during the comparable periods.

·                  Change in mature store sales.  We begin to include sales from a store in mature store sales after the store has been open for any part of five fiscal years (for example, our mature stores for fiscal year 2013 are stores that opened during or before fiscal year 2008).  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 we are open during the comparable periods.

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

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

Cost of goods sold and occupancy costs

Our cost of goods sold and occupancy costs include the cost of inventory sold during the period (net of discounts and allowances), shipping and handling costs, distribution and supply chain costs (including the costs of our bulk food repackaging facility), buying costs, shrink and store occupancy costs. Store occupancy costs include rent payments, common area maintenance and real estate taxes. Depreciation expense included in cost of goods sold relates to depreciation for 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. As a result, our cost of goods sold and occupancy costs data included in this Form 10-Q may not be comparable to similar data made available by our competitors. New stores whose leases are accounted for as operating leases typically have higher occupancy costs as a percentage of sales compared to comparable stores, as new stores generally experience lower sales combined with fixed occupancy costs. Occupancy costs as a percentage of sales typically decrease as new stores mature and increase sales.

Gross profit and gross margin

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

Store expenses

Store expenses consist of store level expenses, such as salary and benefits, supplies, utilities, depreciation, advertising, bank credit card charges and other related costs associated with operations and purchasing support. Depreciation expense included in store expenses relates to depreciation for assets directly used at the stores including depreciation on capitalized real estate leases, land improvements, leasehold improvements, fixtures and equipment and computer hardware and software.  Additionally, store expenses include any gain or loss recorded on the disposal of fixed assets, primarily related to store relocations. The majority of store expenses are composed 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, stock-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 of Directors 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.  We expect that our administrative expenses will increase in future periods due to additional legal, accounting, insurance, stock-based compensation and other expenses we have incurred and will continue to incur as a result of being a public company.

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 approximately two to four months prior to a store’s opening date. Other pre-opening and relocation expenses are generally incurred in the 60 days prior to the store opening. Pre-opening and relocation costs are expensed as incurred.

Operating income

Operating income consists of gross profit less store expenses, administrative expenses and pre-opening and relocation expenses. Operating income can be impacted by a number of factors, including the timing of new store openings and store relocations which impacts the level of pre-opening and relocation expenses period over period, as well as increases in store expenses and administrative expenses. The amount of time it takes for new stores to become profitable can vary depending on a number of factors, including location, competition and general economic conditions.

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Interest expense

Interest expense consists of the interest we pay on our outstanding indebtedness, which currently includes our revolving credit facility (which carries an interest rate on amounts outstanding as well as an unused commitment fee on available amounts) and related party note payable.  Interest expense also includes interest associated with capital lease finance obligations and capital lease obligations.

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:

* Figures may not sum due to rounding.

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

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

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Net sales

Net sales increased $21.6 million, or 25.4%, to $106.5 million for the three months ended March 31, 2013 compared to $84.9 million for the three months ended March 31, 2012, due to a $14.7 million increase in non-comparable store sales and a $6.9 million, or 8.1%, increase in comparable store sales. Daily average comparable store sales increased 10.6% for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The change in comparable store sales versus daily average comparable store sales is due to the loss of two selling days for leap year in 2012 and the occurrence of Easter in March of 2013, rather than April of 2012.  The daily average comparable sales increase was driven equally by increases in daily average transaction count and average transaction size at comparable stores. Comparable store average transaction size increased to $36.37 in the three months ended March 31, 2013 from $35.12 in the three months ended March 31, 2012.

Gross profit

Gross profit totaled $31.8 million for the three months ended March 31, 2013, compared to $25.7 million for the three months ended March 31, 2012. Cost of goods sold and occupancy costs increased $15.4 million, or 26.1%, to $74.7 million for the three months ended March 31, 2013 compared to $59.2 million for the three months ended March 31, 2012, primarily due to an increase in cost of goods sold and occupancy costs from non-comparable stores. Gross margin decreased from 30.2% for the three months ended March 31, 2012 to 29.9% for the three months ended March 31, 2013.  The decrease in gross margin period over period was driven by a shift in mix of product sales towards products with slightly lower margins, partially offset by purchasing improvements.  Occupancy costs as a percentage of sales increased as a result of entering into more expensive leases.  In the three months ended March 31, 2012, all of the Company’s leases were accounted for as operating leases with rent expense included in occupancy costs.  In the three months ended March 31, 2013, five of the Company’s new stores were accounted for as capital lease finance obligations and two were accounted for as capital lease obligations. We do not record straight-line rent expense in costs of goods sold and occupancy costs for these leases, but rather rent payments are recognized as a reduction of the related obligations and as interest expense.  Additionally, depreciation expense related to the capitalized asset is recorded in store expenses.  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 would have been approximately 40 basis points higher in the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Store expenses

Store expenses increased $4.1 million, or 22.9%, to $22.2 million in the three months ended March 31, 2013 from $18.0 million in the three months ended March 31, 2012. Store expenses as a percentage of sales were 20.8% and 21.2% for the three months ended March 31, 2013 and 2012, respectively. The decrease in store expenses as a percentage of sales was primarily due to a decrease in salary related expenses as a percentage of sales at comparable stores, partially offset by an increase in salary related expenses and depreciation as a percentage of sales at non-comparable stores.  Store labor related expenses as a percentage of sales decreased 70 basis points for the three months ended March 31, 2013 compared to the same period in the prior year, due to leverage from the increase in comparable store sales, as the increased salary related expenses required to support the sales growth was less than the increase in sales.  Direct store advertising expense as a percentage of sales increased as a result of expanding our coverage in existing stores and entering new markets.

Administrative expenses

Administrative expenses increased $529,000, or 18.8%, to $3.3 million for the three months ended March 31, 2013 compared to $2.8 million in the three months ended March 31, 2012, due to the addition of general and administrative positions to support our store growth and increased costs as a result of being a public company. Administrative expenses as a percentage of sales were 3.1% and 3.3% for the three months ended March 31, 2013 and 2012, respectively. The decrease in administrative expenses as a percentage of sales was a result of our ability to support additional store investments and sales without proportionate investments in overhead.

Pre-opening and relocation expenses

Pre-opening and relocation expenses increased $370,000, or 86.6%, in the three months ended March 31, 2013 compared to the same period in the prior year due to the increased number of new store openings in 2013, as well as the timing of new store openings.  Pre-opening and relocation expenses as a percentage of sales were 0.7% and 0.5% for the three months ended March 31,

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2013 and 2012, respectively. The numbers of stores opened, relocated and remodeled were as follows for the periods presented:

Interest expense

Interest expense increased $246,000, or 159.1%, in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 as a result of interest related to five capital lease finance obligations and two capital lease obligations that resulted in $390,000 in interest expense in the three months ended March 31, 2013.  This increase was partially offset by a decrease in interest expense due to the payoff of all outstanding amounts under the term loan and revolving credit facility in July 2012.

Income taxes

Our effective income tax rate for the three months ended March 31, 2013 and 2012 was 37.1% and 34.9%, respectively. The increase in our effective income tax rate was due to owning 100% of BVC for the three months ended March 31, 2013, and therefore no longer having nontaxable net income attributable to noncontrolling interest.  Excluding the impact of BVC, our tax rate remained consistent with the comparable prior period.

The American Taxpayer Relief Act of 2012 extended the 50% bonus depreciation on qualifying assets and the special 15 year depreciation life for qualified leasehold property and qualified retail improvement property for property acquired from January 1, 2013 through December 31, 2013.  The Company may also benefit by the extension of the Work Opportunity Tax Credit through December 31, 2013.

Net income attributable to noncontrolling interest

Net income attributable to noncontrolling interest decreased $293,000 in the three months ended March 31, 2013 compared to the three months ended March 31, 2012, as a result of the purchase of the remaining noncontrolling interest in BVC in July 2012.  As a result of the purchase, we acquired 100% of the equity interests in BVC.  Effective October 31, 2012, BVC merged with and into our operating company and ceased to exist.

Six months ended March 31, 2013 compared to the six months ended March 31, 2012

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