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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with our consolidated financial statements and notes thereto 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, 2021, we operated 162 stores in 20 states, including Colorado, Arizona, Arkansas, Idaho, Iowa, Kansas, Louisiana, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Washington and Wyoming. We also operate a bulk food repackaging facility and distribution center in 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, 2021, 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 5.2%. We opened three new stores and relocated/remodeled five existing stores in fiscal year 2021. We plan to open four to six new stores and relocate/remodel three to four stores in fiscal year 2022. As of the date of this report, we also have signed leases or acquired property for an additional five new stores and four relocations/remodels that we plan to open in fiscal years 2022 and beyond. Between October 1, 2021 and the date of this Form 10-K, we did not open any new stores or relocate/remodel any stores.

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, daily average comparable store sales, are defined under the caption “Key Financial Metrics in Our Business,” presented later in this MD&A.

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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:

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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, a convenient, clean, and shopper-friendly retail environment, and our focus on high-quality, affordable natural and organic groceries and dietary supplements.

We expect the rate of new store unit growth in the foreseeable future to be dependent upon economic and business conditions and other factors, including the impact of the COVID-19 pandemic and related government mandates.

Over the long term, we believe there are opportunities for us to continue to expand our store base, expand profitability and increase comparable store sales. However, future sales growth, including comparable store sales, and our profitability could vary due to increasing competitive conditions in the natural and organic grocery and dietary supplement industry and regional and general economic conditions. In the future, we believe there are opportunities for increased leverage of costs and increased economies of scale in sourcing products. However, due to the fixed nature of certain of our costs (in particular, our rent obligations and related occupancy costs), our ability to leverage costs may be limited.

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:

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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, third-party delivery fees 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 net sales typically decrease as new stores mature and sales increase. Rent payments for leases classified as finance lease obligations are not recorded in cost of goods sold and occupancy costs. Rather, these rent payments are recognized as a reduction of the related obligations and as interest expense.

Gross profit and gross margin

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

Store expenses

Store expenses consist of store-level expenses, such as salary and benefits, share-based compensation, supplies, utilities, depreciation, advertising, bank credit card charges and other related costs associated with operations and purchasing support. Depreciation expense included in store expenses relates to depreciation for assets directly used at the stores, including depreciation on land improvements, leasehold improvements, fixtures and equipment and technology. Depreciation expenses on the right-of-use assets related to the finance leases of the stores are also considered store expenses. Additionally, store expenses include any gain or loss recorded on the disposal of fixed assets, primarily related to store relocations, as well as store closure and lease termination costs. Store expenses also include long-lived asset impairment charges. The majority of store expenses consist of labor-related expenses, which we closely manage and which trend closely with sales. Labor-related expenses as a percentage of net sales tend to be higher at new stores compared to comparable stores, as new stores require a minimum level of staffing in order to maintain adequate levels of customer service combined with lower sales. As new stores increase their sales, labor-related expenses as a percentage of net 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 regulations applicable to publicly traded companies, and other general and administrative expenses. Depreciation expense included in administrative expenses relates to depreciation for assets directly used at the home office including depreciation on land improvements, leasehold improvements, fixtures and equipment and computer hardware and software.

Pre-opening expenses

Pre-opening expenses for new stores and relocations/remodels 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 finance leases, we recognize pre-opening interest expense. 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 costs are expensed as incurred. Pre-opening expenses for remodels are incurred if the store is required to be closed due to the remodel.

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Interest expense, net

Interest expense consists of the interest associated with finance lease obligations net of capitalized interest and our Credit Facility.

Income tax expense

Income taxes are accounted for in accordance with the provisions of Income Taxes (ASC 740). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are remeasured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) was signed into law. Intended to provide economic relief to those impacted by the COVID-19 pandemic, the CARES Act, among other things, includes provisions addressing the carryback of net operating losses for specific periods, temporary modifications to the limitations placed on the tax deductibility of net interest expenses, and technical amendments for qualified improvement property (QIP).

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,

Statements of Income Data:*

Cost of goods sold and occupancy costs 72.3 72.7 73.6

Administrative expenses 2.7 2.6 2.5

Pre-opening expenses 0.1 0.1 0.2

Interest expense, net (0.2 ) (0.2 ) (0.5 )

Income before income taxes 2.5 2.5 1.3

Provision for income taxes (0.5 ) (0.5 ) (0.3 )

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*Figures may not sum due to rounding.

Other Operating Data (Unaudited):

Store unit count increase period over period 1.9 % 3.9 3.4

Change in daily average comparable store sales 0.7 % 12.0 3.1

Number of stores opened during the period 3 6 6

Number of stores relocated and remodeled during the period 5 2 5

(1) Gross square footage and selling square footage at the end of the period include the square footage for all stores that were open as of the end of the period presented.

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Year ended September 30, 2021 compared to Year ended September 30, 2020

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

Statements of Income Data:

Net sales

Net sales increased $18.7 million, or 1.8%, to $1,055.5 million for the year ended September 30, 2021 compared to $1,036.8 million for the year ended September 30, 2020, primarily due to a $4.2 million increase in comparable store sales, and a $14.5 million increase in new store sales. Daily average comparable store sales increased 0.7% for the year ended September 30, 2021 compared to an increase of 12.0% for the year ended September 30, 2020. The daily average comparable store sales increase in fiscal year 2021 resulted from a 4.7% increase in average transaction size, partially offset by a 3.8% decrease in daily average transaction count. In the year ended September 30, 2021, customers reduced their frequency of shopping trips in response to the COVID-19 pandemic and related government mandates, but increased their overall basket size per shopping trip. Comparable store average transaction size was $44.24 for the year ended September 30, 2021. The increase in net sales during the year ended September 30, 2021 is attributable to our customers’ response to the COVID-19 pandemic and related government mandates, inflationary pressure on our retail prices, marketing initiatives, promotional campaigns and increased membership in and usage of the {N}power® customer loyalty program.

Gross profit

Gross profit increased $9.0 million, or 3.2%, to $292.2 million for the year ended September 30, 2021 compared to $283.1 million for the year ended September 30, 2020, primarily driven by the increased sales volumes resulting from the COVID-19 pandemic and related government mandates. Gross profit reflects earnings after product and occupancy costs. Gross margin increased to 27.7% for the year ended September 30, 2021 from 27.3% for the year ended September 30, 2020. The increase in gross margin during the year ended September 30, 2021 was primarily driven by improved product margin, and lower shrink and store occupancy expenses as a percentage of net sales.

Store expenses

Store expenses increased $7.5 million, or 3.3%, to $234.6 million in the year ended September 30, 2021 compared to $227.1 million in the year ended September 30, 2020. Store expenses as a percentage of net sales were 22.2% and 21.9% for the years ended September 30, 2021 and 2020, respectively. Store expenses as a percentage of net sales increased during the year ended September 30, 2021 due to higher labor-related expenses in the first half of the year. Store expenses included long-lived asset impairment charges and lease termination costs of $1.5 million in fiscal year 2021 and long-lived asset impairment charges of $0.6 million in fiscal year 2020.

Administrative expenses

Administrative expenses increased $1.6 million, or 5.9%, to $28.4 million for the year ended September 30, 2021 compared to $26.8 million for the year ended September 30, 2020. Administrative expenses as a percentage of net sales were 2.7% and 2.6% for the years ended September 30, 2021 and 2020, respectively.

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Pre-opening expenses

Pre-opening expenses decreased $0.6 million, or 40.4%, to $0.9 million for the year ended September 30, 2021 compared to $1.5 million for the year ended September 30, 2020. The change in pre-opening expenses was primarily due to the impact of the number and timing of new store openings and relocations/remodels. The numbers of stores opened and relocated/remodeled were as follows for the periods presented:

Year ended September 30,

New stores 3 6

Relocated/remodeled stores 5 2

Interest expense, net

Interest expense, net of capitalized interest, increased $0.2 million, or 10.9%, in the year ended September 30, 2021 compared to the year ended September 30, 2020.

Income taxes

Provision for income taxes decreased $0.2 million to $5.5 million for the year ended September 30, 2021 compared to $5.7 million for the year ended September 30, 2020. The Company’s effective income tax rate was approximately 21.0% and 22.1% for the years ended September 30, 2021 and 2020, respectively.

Net income

Net income for the year ended September 30, 2021 was $20.6 million, or $0.91 in diluted earnings per share compared to $20.0 million, or $0.89 in diluted earnings per share, in the year ended September 30, 2020.

Year ended September 30, 2020 compared to Year ended September 30, 2019

A comparative discussion of our results of operations and other operating data for the years ended September 30, 2020 and September 30, 2019 is set out in our Annual Report on Form 10-K for the year ended September 30, 2020 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations - Year ended September 30, 2020 compared to Year ended September 30, 2019.”

Non-GAAP financial measures

EBITDA and Adjusted EBITDA

Management believes some investors’ understanding of our performance is enhanced by including EBITDA and Adjusted EBITDA, which are non-GAAP financial measures. EBITDA is defined as earnings before interest, taxes, depreciation and amortization. Adjusted EBITDA is defined 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 such as share-based compensation, impairment charges, store closing costs and non-recurring items. EBITDA and Adjusted EBITDA are not measures of financial performance under GAAP. 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 our 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 investors’ understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. Commencing with its financial reporting for fiscal year 2021, the Company has revised its definition of Adjusted EBITDA to exclude share-based compensation expense. The Company’s historical presentation of Adjusted EBITDA, including for fiscal year 2020, did not exclude share-based compensation expense. However, Adjusted EBITDA for fiscal year 2020, as presented in this report, has been recast to exclude share-based compensation expense to enhance the comparability of this measure between fiscal year 2020 and fiscal year 2021. Management believes that excluding share-based compensation expense from Adjusted EBITDA will enhance investors’ ability to assess period-to-period comparisons of the Company’s operating performance and make more meaningful comparisons between our operating performance and the operating performance of our competitors.

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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 EBITDA and Adjusted EBITDA 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 analytical tools, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of the limitations are:

Due to these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA and Adjusted EBITDA as supplemental information.

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

Year ended September 30,

Impairment of long-lived assets and store closing costs 1,455 612

(1) Adjusted EBITDA for fiscal year 2020, as presented, has been recast to exclude share-based compensation expense to enhance the comparability of this measure between fiscal year 2020 and fiscal year 2021.

Year ended September 30, 2021 compared to Year ended September 30, 2020

EBITDA decreased 1.7% to $58.0 million in the year ended September 30, 2021 compared to $58.9 million in the year ended September 30, 2020. EBITDA as a percentage of net sales was 5.5% and 5.7% for the years ended September 30, 2021 and 2020, respectively.

Adjusted EBITDA decreased 0.6% to $60.3 million in the year ended September 30, 2021 compared to $60.7 million in the year ended September 30, 2020. Adjusted EBITDA as a percentage of net sales was 5.7% and 5.9% for the years ended September 30, 2021 and 2020, respectively.

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Year ended September 30, 2020 compared to Year ended September 30, 2019

A comparative discussion of EBITDA and Adjusted EBITDA for the years ended September 30, 2020 and September 30, 2019 is set out in our Annual Report on Form 10-K for the year ended September 30, 2020 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP financial measures – EBITDA and Adjusted EBITDA.”

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 Revolving 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, 2021, we had $23.7 million in cash and cash equivalents and $49.0 million available for borrowing under our Revolving Facility. On November 18, 2020, we entered into a $35.0 million Term Loan Facility maturing November 13, 2024, which was used to partially fund the special cash dividend paid in December 2020.

In May 2016, our Board authorized a two-year share repurchase program pursuant to which the Company may repurchase up to $10.0 million in shares of the Company’s common stock. Our Board subsequently extended the share repurchase program, which will terminate on May 31, 2022. We did not repurchase any shares during the year ended September 30, 2021. Between October 1, 2021 and December 6, 2021 (the latest practicable date for making the determination), we did not repurchase any additional shares of our common stock. The dollar value of the shares of the Company’s common stock that may yet be repurchased under the share repurchase program is $8.3 million. Potential future share repurchases under the share repurchase program could be funded by operating cash flow, excess cash balances or borrowings under our Revolving Facility. The timing and the number of shares repurchased, if any, will be dictated by our capital needs and stock market conditions.

We paid a quarterly cash dividend of $0.07 per share of common stock during each quarter of fiscal year 2021 and we paid a special cash dividend of $2.00 per share of common stock in December 2020. On November 18, 2021, our Board approved a quarterly cash dividend of $0.10 per share, which will be paid on December 15, 2021 to stockholders of record as of the close of business on November 29, 2021.

We plan to continue to open new stores in the future, which may require us to borrow additional amounts under our Revolving Facility from time to time. We believe that cash and cash equivalents, together with the cash generated from operations and the borrowing availability under our Revolving Facility will be sufficient to meet our working capital needs and planned capital expenditures, including capital expenditures related to new store needs, repayment of debt, stock repurchases and dividends for the next 12 months and the foreseeable future. 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,

Net cash provided by operating activities $ 53,880 66,503

Net cash used in investing activities (27,755 ) (29,557 )

Net cash used in financing activities (30,981 ) (14,626 )

Net (decrease) increase in cash and cash equivalents (4,856 ) 22,320

Cash and cash equivalents, beginning of year 28,534 6,214

Cash and cash equivalents, end of year $ 23,678 28,534

Year ended September 30, 2021 compared to Year ended September 30, 2020

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 decreased $12.6 million, or 19.0%, to $53.9 million in the year ended September 30, 2021, from $66.5 million in the year ended September 30, 2020. The decrease in cash provided by operating activities was primarily due to a decrease in cash provided by working capital and a decrease in net income adjusted for non-cash items.

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Investing Activities

Net cash used in investing activities consists primarily of capital expenditures. Net cash used in investing activities decreased $1.8 million, or 6.1%, to $27.8 million in the year ended September 30, 2021 compared to $29.6 million in the year ended September 30, 2020. Cash paid for capital expenditures decreased $0.4 million in the year ended September 30, 2021 compared to the year ended September 30, 2020, driven by the number and the timing of new store openings and store relocations.

During the year ended September 30, 2021, we opened three new stores, relocated three stores and remodeled two stores, compared to opening six new stores, relocating one store and remodeling one store during the year ended September 30, 2020. We plan to spend approximately $28 million to $35 million on capital expenditures during fiscal year 2022 in connection with the opening of four to six planned new stores and three to four store relocations. We anticipate that our new stores will require, on average, an upfront capital investment of approximately $2.2 million per store.

Acquisition of property and equipment not yet paid increased $2.4 million to $4.8 million in fiscal year 2021 compared to $2.4 million in fiscal year 2020 due to the timing of payments related to new store openings and relocations.

Financing Activities

Net cash used in financing activities consists primarily of borrowings and repayments under our Credit Facility, payments of finance lease obligations, and dividends paid to shareholders. Net cash used in financing activities was $31.0 million for the year ended September 30, 2021 compared to $14.6 million for the year ended September 30, 2020. The increase in cash used in financing activities for the year ended September 30, 2021 was primarily due to dividends paid to shareholders of $51.5 million partially offset by net incremental borrowing under our Credit Facility of $23.7 million during the year ended September 30, 2021, compared to net incremental repayments of $5.7 million during the year ended September 30, 2020.

Year ended September 30, 2020 compared to Year ended September 30, 2019

A comparative discussion of operating, investing and financing activities for the years ended September 30, 2020 and September 30, 2019 is set out in our Annual Report on Form 10-K for the year ended September 30, 2020 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

Credit Facility

The revolving commitment amount under the Revolving Facility is $50.0 million, including a $5.0 million sub-limit for standby letters of credit. We borrowed $35.0 million under the Term Loan Facility in December 2020. 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 without premium or penalty. On November 13, 2019, the Company amended the Credit Facility to extend the maturity date to November 13, 2024 and permit the operating company to pay cash dividends to Natural Grocers in an amount sufficient to allow Natural Grocers to repurchase shares of common stock and pay dividends on its common stock in an aggregate amount not to exceed $10.0 million during any fiscal year. On November 18, 2020, we entered into the Fourth Amendment to the Credit Facility (the Fourth Amendment) to provide for the Term Loan Facility and to permit payment of a one-time dividend of up to $50.0 million no later than December 31, 2020.

Base rate borrowings under the Credit Facility bear interest at a fluctuating base rate as determined by the lenders’ administrative agent based on the most recent compliance certificate of the operating company and stated at the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate, and (iii) the Eurodollar rate plus 1.00%, less the lender spread based upon the Company’s consolidated leverage ratio. Eurodollar rate borrowings under the Credit Facility bear interest based on the London Interbank Offered Rate, or its successor rate (LIBOR), for the interest period plus the lender spread based upon the Company’s consolidated leverage ratio. The unused commitment fee is also based upon the Company’s consolidated leverage ratio. At the Company’s election, the Credit Facility currently bears interest at the Eurodollar rate. The Company will repay principal amounts outstanding under the Term Loan Facility in equal quarterly installments of approximately $0.4 million commencing on the last day of each fiscal quarter commencing on March 31, 2021 and ending on September 30, 2024. Amounts repaid on the Term Loan Facility may not be reborrowed.

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The Credit Facility requires compliance with certain customary operational and financial covenants, including a consolidated leverage ratio. The Credit Facility also contains certain other customary limitations on the Company’s ability to incur additional debt, guarantee other obligations, grant liens on assets and make investments or acquisitions, among other limitations. Additionally, the Credit Facility prohibits the payment of cash dividends to the holding company from the operating company without the required lenders’ consent, provided 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 in an amount sufficient to allow the holding company to: (i) pay various audit, accounting, tax, securities, indemnification, reimbursement, insurance and other reasonable expenses incurred in the ordinary course of business and (ii) repurchase shares of common stock and pay dividends on our common stock in an aggregate amount not to exceed $10.0 million during any fiscal year.

We had no amounts outstanding under the Revolving Facility as of September 30, 2021 and 2020. We had $23.7 million of outstanding borrowings under the Term Loan Facility as of September 30, 2021. As of September 30, 2021 and September 30, 2020, we had undrawn, issued and outstanding letters of credit of $1.0 million and $1.3 million, respectively, which were reserved against the amount available for borrowing under the terms of the Revolving Facility. We had $49.0 million and $48.7 million available for borrowing under the Credit Facility as of September 30, 2021 and September 30, 2020, respectively.

As of each of September 30, 2021 and September 30, 2020, the Company was in compliance with the debt covenants under the Credit Facility.

Recent Accounting Pronouncements

For a description of new applicable accounting pronouncements, including those recently adopted, see Note 2, Basis of Presentation and Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

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, revenue, 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.

We have chosen accounting policies 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 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.

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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. In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” Topic 350, “Intangibles – Goodwill and Other” (ASU 2017-04). Early adoption is permitted and the Company early adopted for the year ended September 30, 2020. 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. 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.As of September 30, 2021, the Company has recorded no impairment charges related to goodwill.

Impairment of Long-Lived Assets and Store Closing Costs

We assess our long-lived assets, principally property and equipment and lease right of use assets, for possible impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. These events or changes primarily include a significant change in current period performance combined with a history of losses and a projection of continuing losses, or a decision to close or relocate a store. The Company assesses the recoverability of the assets at an individual 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 such assets over their respective remaining lives is not recoverable through projected undiscounted future cash flows, impairment is recognized for any excess of the carrying value over the estimated fair value of the asset group. The fair value of the asset group is estimated based on either: (i) discounted future cash flows using a market participant’s discount rate; or (ii) an appropriate third-party market appraisal or other valuation technique.

Our judgment regarding events or changes in circumstances that indicate the assets 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.

Leases

We lease retail stores, a bulk food repackaging facility and distribution center, land and administrative offices under long-term operating leases or finance 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 finance lease.

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, “Leases (Topic 842)” in February 2016 and subsequently issued related ASUs in 2018 and 2019 (collectively, “ASC 842”). ASC 842 requires lessees to recognize a right-of-use asset and corresponding lease liability for all leases with terms greater than 12 months. Under ASC 842, recognition, measurement and presentation of lease expenses depend on whether the lease is classified as a finance or operating lease.

We adopted ASC 842 on October 1, 2019, the first day of fiscal year 2020, using the modified retrospective transition approach. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which, among other things, permits companies not to reassess prior conclusions on lease identification, lease classification and initial direct costs. We did not elect the hindsight practical expedient.

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Most leases include one or more options to renew, with renewal terms normally expressed in periods of five-year increments. The exercise of lease renewal options is at the Company’s sole discretion. The lease term includes the initial contractual term as well as any options to extend the lease when it is reasonably certain that the Company will exercise that option.

As most of the Company’s lease agreements do not provide an implicit discount rate, the Company uses an estimated incremental borrowing rate, which is derived from third-party lenders, to determine the present value of lease payments. We use other observable market data to evaluate the appropriateness of the rate derived from the lenders. The estimated incremental borrowing rate is based on the borrowing rate for a secured loan with a term similar to the expected term of the lease.

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

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

We are exposed to interest rate changes of our long-term debt. We do not use financial instruments for trading or other speculative purposes.

Interest Rate Risk

Our principal exposure to market risk relates to changes in interest rates with respect to our Credit Facility. As of September 30, 2021, no amounts were outstanding under our Revolving Facility and $23.7 million was outstanding under our Term Loan Facility. Our Credit Facility carries floating interest rates that are tied to the Eurodollar rate, and therefore, our statements of income and our cash flows are exposed to changes in interest rates. Based upon a sensitivity analysis at September 30, 2021, a hypothetical 100 basis point change in interest rates would change our annual interest expense by $0.3 million in the year ended September 30, 2021.

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Item 8. Financial Statements and Supplementary Data.

Natural Grocers by Vitamin Cottage, Inc.

Index to Consolidated Financial Statements

Page Number

Reports of Independent Registered Public Accounting Firm 57

Consolidated Balance Sheets as of September 30, 2021 and 2020 59

Notes to Consolidated Financial Statements 63

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Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

Natural Grocers by Vitamin Cottage, Inc.:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Natural Grocers by Vitamin Cottage, Inc. and subsidiaries (the Company) as of September 30, 2021 and 2020, the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended September 30, 2021, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2021, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of September 30, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated December 9, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Change in Accounting Principle

As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases as of October 1, 2019 due to the adoption of ASU 2016-02, Leases.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Impairment of Long-Lived Assets

As discussed in Notes 2 and 7 to the consolidated financial statements, the Company reviews its long-lived assets for possible impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of the assets at an asset group level (with each store representing an individual asset group) by determining whether the carrying value of such assets can be recovered through projected undiscounted future cash flows over the assets’ respective remaining lives. As of September 30, 2021, the Company’s long-lived assets included property and equipment, operating lease assets, and finance lease assets of $151.4 million, $316.4 million, and $39.4 million, respectively.

We identified the assessment of the recoverability of long-lived assets associated with certain store locations, including property and equipment, operating lease assets, and finance lease assets, as a critical audit matter. A high degree of auditor judgment was applied in evaluating certain inputs to the assessment. These inputs included forecasted sales and forecasted operating expenses as a percentage of forecasted sales attributable to individual asset groups, for which there was limited observable market information.

The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s process to assess the recoverability of long-lived assets, including controls related to development of the inputs of forecasted sales and forecasted operating expenses as a percentage of forecasted sales. We performed sensitivity analyses to assess the impact of changes in forecasted sales and forecasted operating expenses as a percentage of forecasted sales on the recoverability analysis. We evaluated management’s ability to effectively forecast sales and operating expenses as a percentage of sales by comparing actual results to management’s historical forecasts. We evaluated the reasonableness of forecasted sales and forecasted operating expenses as a percentage of forecasted sales by comparing the inputs to available industry reports, historical financial data, and budgets.

/s/ KPMG LLP

We have served as the Company’s auditor since 2010.

Denver, Colorado

December 9, 2021

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Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

Natural Grocers by Vitamin Cottage, Inc.:

Opinion on Internal Control Over Financial Reporting

We have audited Natural Grocers by Vitamin Cottage, Inc. and subsidiaries' (the Company) internal control over financial reporting as of September 30, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of September 30, 2021 and 2020, the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended September 30, 2021, and the related notes (collectively, the consolidated financial statements), and our report dated December 9, 2021 expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ KPMG LLP

Denver, Colorado

December 9, 2021

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Balance Sheets

(Dollars in thousands, except per share data)

September 30,

Assets

Current assets:

Prepaid expenses and other current assets 2,914 6,185

Other assets:

Deposits and other assets 530 616

Goodwill and other intangible assets, net 11,768 10,499

Liabilities and Stockholders’ Equity

Current liabilities:

Term loan facility, current portion 1,750 —

Operating lease obligations, current portion 33,308 32,156

Finance lease obligations, current portion 3,176 2,836

Long-term liabilities:

Term loan facility, net of current portion 21,938 —

Operating lease obligations, net of current portion 301,895 325,641

Finance lease obligations, net of current portion 39,450 39,506

Commitments (Notes 11 and 18)

Stockholders’ equity:

See accompanying notes to consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Income

(Dollars in thousands, except per share data)

Year ended September 30,

Net income per share of common stock:

Weighted average number of shares of common stock outstanding:

See accompanying notes to consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Cash Flows

(Dollars in thousands)

Year ended September 30,

Operating activities:

Impairment of long-lived assets and store closing costs 1,155 612 380

Loss (gain) on disposal of property and equipment 209 (42 ) (131 )

Non-cash interest expense 24 12 13

Changes in operating assets and liabilities

Decrease (increase) in:

Prepaid expenses and other assets (141 ) (762 ) 42

(Decrease) increase in:

Deferred compensation — — (688 )

Deferred rent and leasehold incentives — — (580 )

Investing activities:

Proceeds from sale of property and equipment 89 — 836

Proceeds from property insurance settlements 443 27 32

Financing activities:

Borrowings under term loan facility 35,000 — —

Repayments under term loan facility (11,313 ) — —

Capital and financing lease obligations payments — — (780 )

Finance lease obligation payments (2,823 ) (2,271 ) —

Dividends to shareholders (51,453 ) (6,301 ) —

Loan fees paid (52 ) (25 ) —

Net (decrease) increase in cash and cash equivalents (4,856 ) 22,320 (3,184 )

Supplemental disclosures of cash flow information:

Deferred compensation paid — — 700

Supplemental disclosures of non-cash investing and financing activities:

Acquisition of property and equipment not yet paid $ 4,770 2,407 6,289

Acquisition of other intangibles not yet paid 319 255 476

Proceeds from sale of property and equipment not yet received — 42 6

Property acquired through operating lease obligations 9,216 13,204 —

Property acquired through finance lease obligations 3,025 11,625 —

See accompanying notes to consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE, INC.

Consolidated Statements of Changes in Stockholders’ Equity

Fiscal Years Ended September 30, 2021, 2020 and 2019

(Dollars in thousands, except per share data)

Common stock –$0.001 par

value Additional Total

Issuance of common stock 36,486 — — — — —

Share-based compensation — — 537 — — 537

Issuance of common stock 73,652 — — — — —

See accompanying notes to consolidated financial statements.

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NATURAL GROCERS BY VITAMIN COTTAGE,INC.

Notes to Consolidated Financial Statements

September 30, 2021 and 2020

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 162 stores as of September 30, 2021, including 41 stores in Colorado, 25 in Texas, 14 in Oregon, 12 in Arizona, nine in Utah, eight in Kansas, seven in Missouri, six each in Iowa, New Mexico and Oklahoma, four each in Idaho, Montana and Washington, three each in Arkansas, Nebraska, Nevada and North Dakota, two in Wyoming, and one in Minnesota and Louisiana. The Company also has a bulk food repackaging facility and distribution center in Colorado. The Company had 162 and 159 stores as of September 30, 2021 and 2020, respectively.

2. Basis of Presentation and Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying consolidated financial statements include all the accounts of the holding company’s wholly owned subsidiaries, Vitamin Cottage Natural Food Markets, Inc. (the operating company) and Vitamin Cottage Two Ltd. Liability Company (VC2). All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America (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 date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management reviews its estimates on an ongoing basis, including those related to valuation of inventories, useful lives of long-lived assets for depreciation and amortization, impairment of finite-lived intangible, long-lived assets, and goodwill, lease assumptions, allowances for self-insurance reserves, deferred tax assets and liabilities and litigation based on currently available information. Changes in facts and circumstances may result in revised estimates and actual results could differ from those estimates.

Segment Information

The Company has one reporting segment, natural and organic retail stores.

Other Comprehensive Income

The Company has no other comprehensive income.

Cash and Cash Equivalents

Cash and cash equivalents include currency on hand, demand deposits with banks, money market funds and credit and debit card transactions which typically settle within three business days. The Company considers all highly liquid investments with a remaining maturity of 90 days or less when acquired to be cash equivalents.

Accounts Receivable

Accounts receivable consists primarily of receivables from vendors for certain promotional programs, magazine advertising and other miscellaneous receivables and are presented net of any allowances for doubtful accounts. Accounts receivable also includes receivables from Landlords for tenant improvement allowances. Vendor receivable balances are generally presented on a gross basis separate from any related payable due. Allowance for doubtful accounts is calculated based on historical experience and application of the specific identification method. Allowance for doubtful accounts totaled $0.1 million as of each of September 30, 2021 and 2020.

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Concentration of Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist primarily of investments in cash and cash equivalents. The Company’s cash and cash equivalent account balances, which are held in major financial institutions, exceeded the Federal Deposit Insurance Corporation’s federally insured limits by approximately $22.6 million as of September 30, 2021.

Vendor Concentration

For the years ended September 30, 2021 and 2020, purchases from the Company’s largest vendor and its subsidiaries represented approximately 67% and 66%, respectively, of all product purchases made during such periods. However, the Company believes that, if necessary, alternate vendors could supply similar products in adequate quantities to avoid material disruptions to operations.

Merchandise Inventory

Merchandise inventory consists of goods held for sale. The cost of inventory includes certain costs associated with the preparation of inventory for sale, including inventory overhead costs. Merchandise inventory is carried at the lower of cost or net realizable value. Cost is determined using the weighted average cost method.

Long-Lived Assets

Depreciable long-lived assets primarily consist of leasehold and building improvements, which are stated at historical cost less accumulated depreciation. Depreciation is provided using the straight-line method over the useful life of the relevant asset. For land improvements and leasehold and building improvements, depreciation is recorded over the shorter of the assets’ useful lives or the lease terms. Maintenance, repairs and renewals that neither add to the value of the property nor appreciably prolong its life are charged to expense as incurred. Gains and losses on disposition of property and equipment are included in store expenses in the year of disposition, and primarily relate to store relocations.

The Company capitalizes interest, if applicable, as part of the historical costs of buildings and leasehold and building improvements.

Impairment of Finite-Lived Intangible and Long-Lived Assets

We assess our long-lived assets, principally property and equipment, lease right of use assets and purchased intangible assets subject to amortization, for possible impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. These events or changes primarily include a significant change in current period performance combined with a history of losses and a projection of continuing losses, or a decision to close or relocate a store. If the carrying value of such assets over their respective remaining lives is not recoverable through projected undiscounted future cash flows, impairment is recognized for any excess of the carrying value over the estimated fair value of the asset group. The fair value of the asset group is estimated based on either: (i) discounted future cash flows using a market participant’s discount rate; or (ii) an appropriate third-party market appraisal or other valuation technique.

The Company considers factors such as historic and forecasted operating results, trends and future prospects, current market value, significant industry trends and other economic and regulatory factors in performing these analyses. As of September 30, 2021 and 2020, the Company had property and equipment assets of $151.4 million and $147.9 million, respectively, operating lease assets of $316.4 million and $339.2 million, respectively, finance lease assets of $39.4 million and $40.1 million, respectively, and purchased intangible assets subject to amortization of $6.1 million and $4.9 million, respectively. The Company recorded impairment charges related to long-lived assets of $1.1 million, $0.6 million and $0.4 million in fiscal years 2021,2020 and 2019, respectively.

Goodwill and Intangible Assets

Intangible assets primarily consist of goodwill and trademarks. Goodwill and the Vitamin Cottage trademark have indefinite lives and are not amortized; rather, they are tested for impairment at least annually. Intangible assets with definite lives are amortized over their estimated useful lives. The Company evaluates the reasonableness of the useful lives of these intangibles 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. In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” Topic 350, “Intangibles – Goodwill and Other” (ASU 2017-04). Early adoption is permitted and the Company early adopted for the year ended September 30, 2020. 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. As of September 30, 2021, the Company has recorded no impairment charges related to goodwill.

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The Company capitalizes certain costs incurred with developing or obtaining internal-use software. Capitalized software costs are included in intangible assets in the consolidated balance sheets and are amortized over the estimated useful lives of the software. Software costs that do not meet capitalization criteria are expensed as incurred.

Deferred Financing Costs

Certain costs incurred with borrowings or establishment of credit facilities are deferred. These costs are amortized over the life of the credit facility using the straight-line method.

Leases

The Company leases retail stores, a bulk food repackaging facility and distribution center and administrative offices under long-term operating or finance leases. These leases include scheduled increases in minimum rents and renewal provisions at the option of the Company. The lease term for accounting purposes commences with the date the Company takes possession of the space and ends on the later of the primary lease term or the expiration of any renewal periods that are deemed to be reasonably assured at the inception of the lease.

The Company adopted ASC 842 on October 1, 2019, the first day of fiscal year 2020, using the modified retrospective transition approach.

Operating Leases

Operating lease liabilities represent the present value of lease payments not yet paid. Operating lease assets represent the Company’s right to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives and impairment of operating lease assets. The rent payment pursuant to the lease agreement is recorded as a reduction in the operating lease liability and as a reduction in the right of use asset and as single lease expense over the term of the remaining lease.

Finance Leases

Finance lease liabilities represent the present value of lease payments not yet paid. Finance lease assets represent the Company’s right to use an underlying asset and are based upon the lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives and impairment of lease assets. The Company does not record single lease expense for the rental payments under finance leases, but rather payments under the finance lease obligations are recognized as a reduction of the finance lease obligation and as interest expense. The right of use asset is depreciated over the term of the related lease.

Leases –prior to adoption of ASC 842

Operating Leases

Prior to the adoption of ASC 842 in fiscal year 2020, the Company accounted for operating leases with rent holidays and escalating payment terms by recognizing the associated expense on a straight-line basis over the lease term, and the difference between the average rental amount charged to expense and amounts payable under the leases are included in deferred rent. For certain leases, the Company has received cash from landlords to compensate for costs incurred by the Company in making the store locations ready for operation (leasehold incentives). Leasehold incentives received from a landlord were deferred and recognized on a straight-line basis as a reduction to rent expense over the lease term.

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Capital Financing Leases

From time to time, the Company enters into leases with developers for build-to-suit store locations. Upon lease execution, the Company analyzed its involvement during the construction period.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 performed a sale-leaseback analysis upon completion of the constructionto determine if the Company should remove the assets from its balance sheet. If the asset should not be removed from the balance sheet, the fair market value of the building remained recognized as an asset on the balance sheet, along with a corresponding capital lease financing obligation equal to the fair market value of the building less any amount the Company contributed towards construction. The Company did not record rent expense for the rental payments under capital financing leases, but rather payments under the capital financing lease obligations were recognized as a reduction of the capital lease financing obligation and as interest expense. The capital financing lease assets were depreciated on a straight-line basis over the estimated useful life of the asset.

Capital Leases

Occasionally, the Company entered into leases that were deemed to be capital leases. For these leases, the Company capitalized the lower of the present value of the minimum lease payments or the fair value of the leased asset at inception and recorded a corresponding capital lease obligation. The Company did not record rent expense for the rental payments under capital leases, but rather payments under the capital lease obligations were recognized as a reduction of the capital lease obligation and as interest expense. The capital lease asset was depreciated on a straight-line basis over the term of the related lease.

Self-Insurance

The Company is self-insured for certain losses relating to employee medical and dental benefits and workers compensation. Stop-loss coverage has been purchased to limit exposure to any significant level of claims. Self-insured losses are accrued based upon the Company’s estimates of the aggregate claims incurred but not reported using historical experience. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from historical trends.

Revenue Recognition

Revenue is recognized at the point of sale, net of in-house coupons, discounts and returns. Sales taxes are not included in sales. The Company charges sales tax on all taxable customer purchases and remits these taxes monthly to the appropriate taxing jurisdiction. The Company records a contract liability within accrued expenses when it sells the Company’s gift cards and records a sale when a customer redeems the gift card.

Cost of Goods Sold and Occupancy Costs

Cost of goods sold and occupancy costs includes the cost of inventory sold during the period net of discounts and allowances, as well as, distribution, shipping and handling costs, store occupancy costs and costs of the bulk food repackaging facility and distribution center. The amount shown is net of various rebates from third-party vendors in the form of quantity discounts and payments. Vendor consideration associated with product discounts is recorded as a reduction in the cost of the product. Store occupancy costs include rent, common area maintenance and real estate taxes. Store occupancy costs do not include any rent amounts for the store leases classified as finance leases (previously classified as capital and financing lease obligations).

Store Expenses

Store expenses consist of store-level expenses such as salaries, benefits and share-based compensation, supplies, utilities, depreciation, gain or loss on disposal of assets, long-lived asset impairment charges, store closing costs and other related expenses associated with operations support. Store expenses also include purchasing support services and advertising and marketing costs.

Administrative Expenses

Administrative expenses consist of salaries, benefits and share-based compensation, occupancy costs, depreciation, office supplies, hardware and software expenses, professional services expenses and other general and administrative expenses.

Pre-Opening Expenses

Costs associated with the opening of new stores or relocating/remodeling existing stores are expensed as incurred.

Advertising and Marketing

Advertising and marketing costs are expensed as incurred and are included in store expenses and pre-opening expenses in the consolidated statements of income. Total advertising and marketing expenses for the years ended September 30, 2021, 2020 and 2019 were $6.3 million, $6.6 million and $8.2 million, respectively, net of vendor reimbursements of $5.4 million, $4.5 million and $4.6 million for the years ended September 30, 2021, 2020 and 2019, respectively.

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Share-Based Compensation

The Company adopted the 2012 Omnibus Incentive Plan in connection with its initial public offering on July 25, 2012. Restricted stock units are granted at the market price of the Company’s common stock on the date of grant and expensed over the applicable vesting period.

The excess tax benefits for recognized compensation costs are reported as a credit to income tax expense and as operating cash outflows when such excess tax benefits are realized by a reduction to current taxes payable.

Income Taxes

The Company accounts 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 the Company’s assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates in the respective jurisdictions in which the Company operates.

The Company considers the need to establish valuation allowances to reduce deferred income tax assets to the amounts the Company believes are more likely than not to be recovered.

The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. 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. Although the Company believes that its estimates are reasonable, actual results could differ from these estimates. In addition, the Company is subject to periodic audits and examinations by the Internal Revenue Service (IRS) and other state and local taxing authorities.

Any interest or penalties incurred related to income taxes are expensed as incurred and treated as permanent differences for tax purposes.

U.S. Tax Reform

As a result of the technical amendments made by the CARES Act to QIP, the Company accelerated tax depreciation expenses of approximately $9.3 million for the year ended September 30, 2019, representing primarily temporary book-to-tax timing differences for income tax purposes. The impacts of the CARES Act are recorded as components within the Company’s deferred income tax liabilities and income tax receivable on the Company’s consolidated balance sheets.

Recently Adopted Accounting Pronouncements

The Company adopted ASC 842 on October 1, 2019, the first day of fiscal year 2020, using the modified retrospective transition approach. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which, among other things, permits companies not to reassess prior conclusions on lease identification, lease classification and initial direct costs. The Company did not elect the hindsight practical expedient.

The adoption of ASC 842 resulted in the recognition of operating lease assets and operating lease liabilities of $359.6 million and $377.8 million, respectively, as of October 1, 2019. Included in the measurement of the new lease assets is the reclassification of certain balances, including those historically recorded as deferred rent and leasehold incentives.

Additionally, the Company recognized a cumulative effect adjustment, which increased retained earnings by $1.7 million for the year ended September 30, 2020. This adjustment was primarily driven by the derecognition of $41.9 million of lease obligations and $40.2 million of net assets related to leases that had been classified as capital financing lease obligations under the former failed-sale leaseback guidance. These leases were reclassified as operating or finance leases as of October 1, 2019, the transition date. See Note 11 for additional information related to the Company’s lease accounting policy.

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In June 2018, the FASB issued ASU 2018-07, “Compensation-Stock Compensation,” Topic 718, “Improvements to Non-employee 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 were effective for the Company’s first quarter of the fiscal year ending September 30, 2020, with early adoption permitted. The adoption of this ASU did not have an impact on the Company’s consolidated financial statements for the year ended September 30, 2020.

In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” Topic 350, “Intangibles – Goodwill and Other” (ASU 2017-04). The amendments in ASU 2017-04 simplify the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in the current two-step impairment test. An impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value should be recognized; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments should be applied on a prospective basis. ASU 2019-10 delayed the effective date of this ASU to align with the effective date of ASU 2016-13 (referred to above). Because the Company is a smaller reporting company, the provisions of ASU 2017-04 will be effective for the Company’s first quarter of the fiscal year ending September 30, 2024. Early adoption is permitted and the Company early adopted for the year ended September 30, 2020. ASU 2017-04 did not have an impact on the Company’s consolidated financial statements for the year ended September 30, 2020.

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 replaced most existing revenue recognition guidance in GAAP. ASU 2014-09’s core principle is that a company recognizes 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. The Company adopted this ASU and related amendments on October 1, 2018, using the modified retrospective approach. Additionally, upon adoption of this ASU, the Company elected the following practical expedients:

The adoption of ASU 2014-09 did not have a material impact on the Company’s consolidated financial statements for the year ended September 30, 2019.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses,” Topic 326, “Measurement of Credit Losses on Financial Instruments” (ASU 2016-13), subsequently amended by various standard updates. ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information when determining credit loss estimates. ASU 2016-13 also requires financial assets to be measured net of expected credit losses at the time of initial recognition. ASU 2019-10, issued in November 2019, delayed the effective date of ASU 2016-13 for smaller reporting companies such as the Company. The provisions of ASU 2016-13 will be effective for the Company’s first quarter of the fiscal year ending September 30, 2024. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of these provisions will have on its consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, “Income Taxes,” Topic 740, “Simplifying the Accounting for Income Taxes” (ASU 2019-12). The new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles and also simplifies areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The provisions of ASU 2019-12 will be effective for the Company’s first quarter of the fiscal year ending September 30, 2022 with early adoption permitted. The Company does not anticipate that the adoption of these provisions will have a material impact on its consolidated financial statements.

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In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform,” Topic 848, “Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (ASU 2020-04). The new guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The guidance applies only to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The interest rate currently payable under the Company’s Credit Facility is based on LIBOR, but recent amendments provide for a LIBOR successor rate once LIBOR is discontinued. The amendments in this update only apply to modifications made prior to December 31, 2022. The Company does not anticipate that this ASU will have a material impact on its consolidated financial statements.

3. Revenue Recognition

The nature of the goods the Company transfers to customers at the point of sale consists of merchandise purchased for resale. In these transactions, the Company acts as a principal and recognizes revenue (net sales) from the sale of goods when control of the promised goods is transferred to the customer. Control refers to the ability of the customer to direct the use of, and obtain substantially all the remaining benefits from, the transferred goods.

The Company’s performance obligations are satisfied upon the transfer of goods to the customer (at the point of sale), and payment from the customer is also due at that time. Transaction prices are considered fixed. Discounts provided to customers at the point of sale are recognized as a reduction in revenue as the goods are sold. Revenue excludes sales and usage-based taxes collected.

Proceeds from the sales of the Company’s gift cards are recorded as a liability at the time of sale and recognized as revenue when the gift cards are redeemed by the customer and the performance obligation is satisfied by the Company.

As of each September 30, 2021 and September 30, 2020, the balance of contract liabilities related to unredeemed gift cards was $1.5 million and $1.3 million, respectively. Revenue for the fiscal year ended September 30, 2021 includes $0.7 million that was included in the contract liability balance of unredeemed gift cards at September 30, 2020.

The following table disaggregates the Company’s revenue by product category for the fiscal years ended September 30, 2021, 2020 and 2019, dollars in thousands:

Year ended September 30,

4. Earnings Per Share

Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if the Company’s granted but unvested restricted stock units were to vest, resulting in the issuance of common stock that would then share in the earnings of the Company. The following table presents the Company’s basic and diluted earnings per share for the years ended September 30, 2021, 2020 and 2019, dollars in thousands, except per share data:

Year ended September 30,

There were 166,362, 94,497 and 56,510 non-vested restricted stock units for the years ended September 30, 2021, 2020 and 2019, respectively, excluded from the calculation as they are antidilutive.

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The Company paid a quarterly cash dividend of $0.07 per share of common stock in each quarter of fiscal year 2021 and 2020. The Company paid a special cash dividend of $2.00 per share of common stock in December 2020. The Company did not declare or pay any dividends in the year ended September 30, 2019.

As of September 30, 2021, the Company had 50,000,000 shares of common stock authorized, of which 22,620,417 shares were issued and outstanding, as well as 10,000,000 shares of preferred common stock authorized, of which none was issued and outstanding.

5. Fair Value Measurements

The Company records its financial assets and liabilities at fair value in accordance with the framework for measuring fair value. The framework establishes a fair value hierarchy that distinguishes between assumptions based on market data (observable inputs) and market participant’s assumptions (unobservable inputs). Non-financial assets, such as goodwill and long-lived assets, are accounted for at fair value on a non-recurring basis. These items are tested for impairment on the occurrence of a triggering event or, in the case of goodwill, at least on an annual basis.

During fiscal year 2021, long-lived assets, including Right of Use Assets, with a carrying value of $3.3 million were written down to their fair value of $2.1 million, resulting in asset impairment charges of $1.1 million. During fiscal year 2020, long-lived assets with a carrying value of $1.1 million were written down to their fair value of $0.5 million, resulting in asset impairment charges of $0.6 million. During fiscal year 2019, long-lived assets with a carrying value of $0.8 million were written down to their fair value of $0.4 million, resulting in asset impairment charges of $0.4 million. The carrying amounts of the Company’s financial assets and liabilities, including cash and cash equivalents, accounts receivable, accounts payable and other accrued expenses, approximate fair value because of the short maturity of those assets and liabilities.

6. Property and Equipment

The Company had the following property and equipment balances as of September 30, 2021 and 2020, dollars in thousands:

Useful lives As of September 30,

Construction in process n/a $ 2,268 6,717

Less accumulated depreciation and amortization (223,866 ) (205,516 )

Total costs capitalized for qualifying construction projects of leasehold and building improvements included $0.5 million and $0.4 million the years ended September 30, 2021 and 2020, respectively, related to internal staff compensation. Depreciation expense related to capitalized internal staff compensation was $0.6 million for each of the years ended September 30, 2021, 2020, and 2019. Interest costs of $0.2 million, $0.1 million and $0.3 million were capitalized for the years ended September 30, 2021, 2020 and 2019, respectively.

Depreciation and amortization expense for the years ended September 30, 2021, 2020 and 2019 is summarized as follows, dollars in thousands:

Year ended September 30,

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7. Impairment of Long-Lived Assets

Long-lived assets, such as property and equipment, lease right of use assets and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of the assets at an individual 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 such assets over their respective remaining lives is not recoverable through projected undiscounted future cash flows, impairment is recognized. The amount of impairment is measured based on projected discounted future cash flows using a market participant’s discount rate . The Company considers factors such as historic and forecasted operating results, trends and future prospects, current market value, significant industry trends and other economic and regulatory factors in performing these analyses.

As of September 30, 2021 and 2020, the Company had property and equipment assets of $151.4 million and $147.9, respectively, and lease right-of-use assets of $355.8 million and $379.3, respectively. In the fourth quarter of fiscal years 2021 and 2020, the Company concluded, as a result of its review of potential long-lived asset impairment, that certain long-lived assets were impaired. The Company recorded impairments of $1.1 million, $0.6 million and $0.4 million for the years ended September 30, 2021, 2020 and 2019, respectively. Such charges are reflected within store expenses on the consolidated statement of income for the years ended September 30, 2021 and 2020.

8. Goodwill and Other Intangible Assets

Goodwill and other intangible assets as of September 30, 2021 and 2020, are summarized as follows, dollars in thousands:

Useful lives As of September 30,

Amortizable intangible assets:

Less accumulated amortization (3,139 ) (2,378 )

Amortizable intangible assets, net 615 1,256

Deferred financing costs, net (1) 59 31

Total goodwill and other intangibles, net $ 11,768 10,499

(1) Certain prior year amounts have been reclassified for consistency with current year presentation.

Amortization expense was $0.8, $0.8 and $0.5 million for the years ended September 30, 2021, 2020 and 2019, respectively.

Capitalized costs for internal-use software development were $2.0 million and $2.6 million for the years ended September 30, 2021 and 2020, respectively, primarily due to capitalization of expenses related to external consultants.

9. Accrued Expenses

The composition of accrued expenses as of September 30, 2021 and 2020, is summarized as follows, dollars in thousands:

As of September 30,

Payroll and employee-related expenses $ 13,243 13,569

Accrued property, sales and use tax payable 8,322 7,912

Accrued marketing expenses 713 407

Deferred revenue related to gift card sales 2,157 1,819

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10. Long-Term Debt

Credit Facility

The Company is a party to a Credit Facility, entered into on January 28, 2016 and subsequently amended, consisting of a $50.0 million revolving loan facility (the Revolving Facility) and a $35.0 million term loan facility (the Term Loan Facility, and together with the Revolving Facility, the Credit Facility). The operating company is the borrower under the Credit Facility and its obligations under the Credit Facility are guaranteed by the holding company and VC2. The Credit Facility is secured by a lien on substantially all of the Company’s assets. The revolving commitment amount under the Revolving Facility is $50.0 million, including a $5.0 million sublimit for standby letters of credit. The Company has the right to borrow, prepay and re-borrow amounts under the Revolving Facility at any time prior to the maturity date without premium or penalty. The Credit Facility matures on November 13, 2024. Base rate loans under the Credit Facility bear interest at a fluctuating base rate, as determined by the lenders’ administrative agent based on the most recent compliance certificate of the operating company and stated at the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate, and (iii) the Eurodollar rate plus 1.00%, less the lender spread based upon the Company’s consolidated leverage ratio. Eurodollar rate borrowings under the Credit Facility bear interest based on the London Interbank Offered Rate, or its successor (LIBOR), for the interest period plus the lender spread based upon the Company’s consolidated leverage ratio. The unused commitment fee is based upon the Company’s consolidated leverage ratio. The Company will repay principal amounts outstanding under the Term Loan Facility in equal installments of approximately $0.4 million on the last day of each fiscal quarter, beginning on March 31, 2021 and ending on September 30, 2024, with the remaining principal amount payable on the maturity date. Amounts repaid on the Term Loan Facility may not be reborrowed.

The Credit Facility requires compliance with certain customary operational and financial covenants, including a leverage ratio. The Credit Facility also contains certain other customary limitations on the Company’s ability to incur additional debt, guarantee other obligations, grant liens on assets and make investments or acquisitions, among other limitations. Additionally, the Credit Facility prohibits the payment of cash dividends to the holding company from the operating company without the administrative agent’s consent, provided that so long as no default or event of default exists or would arise as a result thereof, the operating company may pay cash dividends to the holding company in an amount sufficient to allow the holding company to: (i) pay various audit, accounting, tax, securities, indemnification, reimbursement, insurance and other reasonable expenses incurred in the ordinary course of business and (ii) repurchase shares of common stock and pay dividends on the Company’s common stock in an aggregate amount not to exceed $10.0 million during any fiscal year.

The Company had no amounts outstanding under the Revolving Facility as of September 30, 2021 and 2020. The Company had $23.7 million of outstanding borrowings under the Term Loan Facility as of September 30, 2021. As of September 30, 2021 and September 30, 2020, the Company had undrawn, issued and outstanding letters of credit of $1.0 million and $1.3 million, respectively, which were reserved against the amount available for borrowing under the terms of the Revolving Facility. The Company had $49.0 million and $48.7 million available for borrowing under the Revolving Facility as of September 30, 2021 and September 30, 2020, respectively.

On November 13, 2019, the Company amended the Credit Facility to extend the maturity date to November 13, 2024 and permit the operating company to pay cash dividends to Natural Grocers in an amount sufficient to allow Natural Grocers to repurchase shares of common stock and pay dividends on its common stock in an aggregate amount not to exceed $10.0 million during any fiscal year. On November 18, 2020, the Company entered into the Fourth Amendment to the Credit Facility to provide for the Term Loan Facility and to permit payment of a one-time dividend of up to $50.0 million no later than December 31, 2020.

Lease Obligations

The Company had 20 and 19 leases that were classified as finance leases as of September 30, 2021 and 2020, respectively. No rent expense is recorded for these finance leases; rather, rental payments under such leases are recognized as a reduction of the lease obligation and as interest expense. The interest rate on finance lease obligations is determined at the inception of the lease.

Interest

The Company incurred gross interest expense of $2.5 million, $2.2 million and $5.2 million in the years ended September 30, 2021, 2020 and 2019, respectively. Interest expense for the year ended September 30, 2021 and 2020 relates primarily to interest on finance lease obligations. Interest expense for the years ended September 30, 2019 relates primarily to interest on capital and financing lease obligations. The Company capitalized interest of $0.2 million, $0.1 million and $0.3 million for the years ended September 30, 2021, 2020 and 2019, respectively.

11. Lease Commitments

The Company leases most of its stores, a bulk food repackaging facility and distribution center and its administrative offices. The Company determines if an arrangement is a lease or contains a lease at inception. Lease terms generally range from 10 to 25 years, with scheduled increases in minimum rent payments.

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The FASB issued ASU 2016-02, “Leases (Topic 842)” in February 2016 and subsequently issued related ASUs in 2018 and 2019 (collectively, “ASC 842”). ASC 842 requires lessees to recognize a right-of-use asset and corresponding lease liability for all leases with terms greater than 12 months. Under ASC 842, recognition, measurement and presentation of lease expenses depend on whether the lease is classified as a finance or operating lease. The Company adopted ASC 842 on October 1, 2019, the first day of fiscal year 2020, using the modified retrospective transition approach.

Variable payments related to pass-through costs for maintenance, taxes and insurance or adjustments based on an index such as Consumer Price Index are not included in the measurement of the lease liability or asset and are expensed as incurred.

Leases are recorded at the commencement date (the date the underlying asset becomes available for use) for the present value of lease payments, less tenant improvement allowances received or receivable. Leases with a term of 12 months or less (short-term leases) are not presented on the balance sheet. The Company’s short-term leases relate primarily to embedded leases. The Company has elected to account for the lease and non-lease components as a single lease component for all current classes of leases.

The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company subleases certain real estate or portions thereof to third parties. Such subleases have all been classified as operating leases. Remaining lease terms extend through fiscal year 2030. Although some sublease arrangements provide renewal options, the exercise of sublease renewal options is at the sole discretion of the subtenant. The Company recognizes sublease income on a straight-line basis.

The Company has four operating leases and one finance lease with Chalet Properties, LLC (Chalet), one operating lease with the Isely Family Land Trust LLC (Land Trust) and one operating lease with FTVC, LLC, each of which is a related party (see Note 14). The leases began at various times with the earliest commencing in November 1999, continue for various terms through July 2040 and include various options to renew. The terms and rental rates of these leases are similar to leases that would be entered into with nonrelated parties and are at prevailing market rental rates. These leases account for $7.6 million of right-of-use assets and $7.9 million of lease liabilities included in the disclosures below. Cash rent paid pursuant to the related party leases was $1.3 million, $1.3 million and $1.5 million for the years ended September 30, 2021, 2020 and 2019, respectively.

The components of total lease cost for the year ended September 30, 2021 and 2020 are as follows, dollars in thousands:

Year ended September 30,

Operating lease cost:

Cost of goods sold and occupancy costs $ 42,652 42,634

Administrative expenses 305 311

Finance lease cost:

Depreciation of right-of-use assets Store expenses(1) 3,686 3,139

Interest on lease liabilities Interest expense, net (1) 1,953 1,698

Short-term lease cost Store expenses 326 2,016

Variable lease cost Cost of goods sold and occupancy costs(2) 5,611 5,367

Sublease income Store expenses (313 ) (368 )

1 Immaterial balances related to stores not yet open are included in pre-opening expenses.

2 Immaterial balances related to the corporate headquarters and distribution center are included in administrative expenses and store expenses, respectively.

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Additional information related to the Company’s leases for the year ended September 30, 2021 and 2020 are as follows, dollars in thousands:

Year ended September 30,

Cash paid for amounts included in the measurement of lease liabilities:

Operating cash flows from operating leases $ 44,473 44,281

Operating cash flows from finance leases 1,976 1,792

Financing cash flows from finance leases 2,823 2,271

Right-of-use assets obtained in exchange for new lease liabilities:

Additional information related to the Company’s leases as of September 30, 2021 and 2020 were as follows:

September 30,

Weighted-average remaining lease term (in years):

Weighted-average discount rate:

Operating leases 3.6 % 3.6

Finance leases 5.0 % 5.1

In addition, during the year ended September 30, 2020, the Company purchased one store building that had previously been leased. This resulted in: (i) a $2.5 million reduction in operating lease liability and (ii) the reclassification of $2.4 million of corresponding operating right-of-use asset to property and equipment.

Future lease payments under non-cancellable leases as of

September 30, 2021 were as follows, dollars in thousands:

Fiscal Year Operating leases Finance leases Total

The table above excludes $28.2 million of legally binding minimum lease payments for leases that had been executed as of September 30, 2021 but whose terms had not yet commenced.

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Future minimum rental commitments and sublease rental income under the terms of the Company’s operating and finance leases were as follows as of September 30, 2021, dollars in thousands:

Fiscal Year Third parties Related parties Sublease rental income Total leases

Future minimum rental commitments under the terms of the Company’s related party leases include $3.4 million pursuant to a finance lease and $5.7 million pursuant to operating leases as of September 30, 2021.

Prior to the Company’s adoption of ASC 842 as of October 1, 2019, the Company’s leases were designated as either capital, financing or operating. Consistent with the guidance provided in ASC 842, previously designated capital lease obligations are now classified as finance leases, while previously designated capital lease finance obligations have been derecognized and reclassified as operating or finance leases. The designation of operating leases remains substantially unchanged under ASC 842.

Total rent expense, including common area expenses and warehouse rent, for the years ended September 30, 2021, 2020, and 2019 totaled $55.3 million, $54.6 million and $51.6 million, respectively, which is included in cost of goods sold and occupancy costs and administrative expenses in the consolidated statements of income. In addition, $0.2 million, $0.2 million and $0.3 million is included in pre-opening expense associated with rent expense for stores prior to their opening date for the years ended September 30, 2021, 2020 and 2019, respectively.

12. Share-Based Compensation

The Company adopted the 2012 Omnibus Incentive Plan (as amended, the Plan) on July 17, 2012. Restricted stock unit awards granted pursuant to the Plan, if they vest, will be settled in new shares of the Company’s common stock or shares of common stock held in treasury. At the adoption of the Plan, there were 1,090,151 shares of common stock available for issuance or delivery under the Plan. In March 2019, the Company’s stockholders approved a proposal to amend the Plan to: (i) increase the number of shares of common stock reserved for issuance thereunder by 600,000 shares and (ii) extend its term by five years. As of September 30, 2021, 407,746 shares of common stock remain available for grants under the Plan. The Plan provides for awards of options, stock appreciation rights, stock grants, restricted stock units, other share-based awards and cash-based incentive awards to officers, members of the Board and certain employees who are not named executive officers and consultants. As of September 30, 2021, restricted stock units had been granted under the Plan, at no out-of-pocket cost to officers, Board members and key employees. These restricted stock units vest subject to requisite service requirements, immediately in part or annually in installments over a one-to-five-year period. The award recipients are not entitled to cash dividends or to vote with regard to non-vested restricted stock units, and the units are subject to forfeiture during the vesting period. Restricted stock units are granted at the market price of the Company’s stock on the date of grant and are expensed on a straight-line basis over the vesting period.

The shares of non-vested restricted stock units as of September 30, 2021 were as follows:

Shares Weighted average grant date fair value

During the year ended September 30, 2021, the Company awarded stock grants totaling 4,000 shares of the Company’s common stock to 40 employees who were not named executive officers. Such shares were fully vested on the grant date.

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Share-based compensation expense for restricted stock unit awards to certain employees who are not named executive officers was $0.5 million, $0.8 million and $0.8 million for the years ended September 30, 2021, 2020 and 2019, respectively. Share-based compensation expense for restricted stock unit awards to one named executive officer was $0.2 million, $0.2 million and $0.2 million for the years ended September 30, 2021, 2020 and 2019, respectively.

Each independent member of the Board receives an annual grant of restricted stock units equal to $60,000 (based on the closing price of common stock on the New York Stock Exchange on the date of grant). Such grants are made each year on the date of the Company’s annual meeting of stockholders, or on a pro rata basis in the case of a mid-year appointment. Share-based compensation expense for the Company’s awards to its Board members was $0.2 million for each of the years ended September 30, 2021, 2020 and 2019.

The Company recorded total share-based compensation expense before income taxes of $0.9 million, $1.1 million and $1.2 million in the years ended September 30, 2021, 2020 and 2019, respectively. The share-based compensation expense is included in cost of goods sold and occupancy costs, store expenses or administrative expenses in the consolidated statements of income consistent with the manner in which the applicable officer, Board member or key employee’s compensation expense is presented. The Company realized a tax benefit from share-based compensation of $0.1 million in the year ended September 30, 2021, and did not realize a tax benefit from share-based compensation expense in the years ended September 30, 2020 and 2019.

As of September 30, 2021, there was $2.5 million of unrecognized share-based compensation expense related to non-vested restricted stock units, net of estimated forfeitures, which the Company anticipates will be recognized over a weighted average period of approximately three years.

13. Stockholders’ Equity

Share Repurchases

In May 2016, the Board of Directors (the Board) authorized a two-year share repurchase program pursuant to which the Company may repurchase up to $10.0 million in shares of the Company’s common stock. The Board subsequently extended the share repurchase program, which will terminate on May 31, 2022. Repurchases under the Company’s share repurchase program may be made from time to time at management’s discretion on the open market or through privately negotiated transactions in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the Exchange Act), subject to market conditions, applicable legal requirements and other relevant factors. Repurchases of common stock may also be made under a Rule 10b5-1 plan, which permits common stock to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The share repurchase program does not obligate the Company to purchase any particular amount of common stock and may be suspended, modified or discontinued by the Company without prior notice.

The Company did not repurchase any shares during the years ended September 30, 2021 and 2020. The dollar value of the shares of the Company’s common stock that may yet be repurchased under the share repurchase program is $8.3 million.

During fiscal year 2021, the Company reissued no treasury shares. During fiscal year 2020, the Company reissued 47,222 treasury shares at a cost of $0.4 million to satisfy the issuance of common stock pursuant to the vesting of certain restricted stock unit awards and the award of stock grants. At September 30, 2021 and 2020 the Company held no shares in treasury.

14. Related Party Transactions

The Company has ongoing relationships with related parties as noted:

Chalet Properties, LLC: The Company has four operating leases and one finance lease (see Note 11) with Chalet. Chalet is owned by the Company’s four non-independent Board members, Kemper Isely, Zephyr Isely, Heather Isely and Elizabeth Isely, and other family members. Rent paid to Chalet was $1.0 million for the year ended September 30, 2021 and 2020, and $1.2 million for the year ended September 30, 2019.

Isely Family Land Trust LLC: The Company has one operating lease (see Note 11) with Land Trust. The Land Trust is owned by the Isely Children’s Trust and by the Margaret A. Isely Family Trust. Rent paid to the Land Trust was $0.3 million for each of the years ended September 30, 2021, 2020 and 2019.

FTVC LLC: The Company has one operating lease (see Note 11) for a store location with FTVC LLC, which is owned by the Company’s four non-independent Board members and other related family members. Rent paid to FTVC LLC was less than $0.1 million for each of the years ended September 30, 2021, 2020 and 2019.

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15. Income Taxes

The following are the components of the provision for income taxes as of September 30, 2021, 2020 and 2019, respectively, dollars in thousands:

Year ended September 30,

Current federal income tax expense (benefit) $ 3,859 1,317 (1,981 )

Total current income tax expense (benefit) 4,611 1,950 (1,575 )

Deferred state income tax expense 28 585 213

The differences between the United States federal statutory income tax rate and the Company’s effective tax rate are as follows:

Year ended September 30,

State income taxes, net of federal income tax expense 3.6 4.0 3.7

Enhanced food deduction (0.5 ) (0.6 ) (1.3 )

Deferred tax liability adjustment 0.8 (0.3 ) (0.5 )

Other, net (3.9 ) (2.0 ) (2.6 )

The Company’s effective tax rate was 21.0% in the year ended September 30, 2021 compared to 22.1% in the year ended September 30, 2020. The Company’s effective tax rate increased from 20.3% in the year ended September 30, 2019 to 22.1% in the year ended September 30, 2020 primarily due to a cost segregation study performed resulting in a tax benefit of approximately $0.5 million for the year ended September 30, 2019. The Company had a similar tax benefit as a result of the accelerated depreciation allowed under the CARES Act related to Qualified Improvement Property for the year ended September 30, 2020. However, due to higher pre-tax income in the year ended September 30, 2020, this resulted in a lower impact on the effective rate.

Deferred taxes have been classified on the consolidated balance sheets as follows, dollars in thousands:

As of September 30,

Long-term assets $ — —

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The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities are as follows, dollars in thousands:

As of September 30,

Deferred tax assets

Deferred tax liabilities

Subleases — (99 )

The Company believes that it is more likely than not that it will fully realize all deferred tax assets in the form of future deductions based on the nature of the deductible temporary differences and expected future taxable income.

The Company did not utilize federal income tax carryforwards or federal tax credit carryforwards in the year ended September 30, 2021. The Company utilized approximately $0.2 million in tax effected federal income tax carryforwards and approximately $0.4 million in federal tax credit carryforwards in the year ended September 30, 2020. The Company utilized less than $0.1 million in tax effected state income tax carryforwards in the years ended September 30, 2021 and 2020.

The Company did not have any uncertain tax positions as of September 30, 2021 and 2020.

The Company files income tax returns with federal, state and local tax authorities. With limited exceptions, the Company is no longer subject to federal income tax examinations for fiscal years 2017 and prior and is no longer subject to state and local income tax examinations for fiscal years 2016 and prior.

16. Defined Contribution Plan

The Company has a defined contribution retirement plan (the Retirement Plan) covering substantially all employees who meet certain eligibility requirements as to age and length of service. The Retirement Plan incorporates the salary deferral provisions of Section 401(k) of the Internal Revenue Code of 1986, as amended (the Code). Employees may defer up to the annual maximum limit prescribed by the Code. The Company, on a discretionary basis, may match up to 25% of participant contributions up to a maximum annual employer match of $2,500. During the year ended September 30, 2021, the Company accrued $0.9 million for matching contributions to be paid out after the plan year ending December 31, 2021. In January 2021, the Company funded matching contributions of $1.2 million to participants’ accounts for the plan year ended December 31, 2020.

17. Segment Reporting

The Company has one reporting segment, natural and organic retail stores. The Company’s revenue is derived from the sale of natural and organic products at its stores. All existing operations are domestic.

18. Commitments and Contingencies

Self-Insurance

The Company is self-insured for certain losses relating to employee medical and dental benefits and workers compensation, subject to a stop loss policy. The self-insurance liability related to claims under the Company’s health benefit plans is determined based on analysis of actual claims. The amounts related to these claims are included as a component of payroll and employee-related expenses in accrued expenses. Liabilities associated with the risks that are retained by the Company are estimated, in part, by considering historical claims experience, demographic factors and other actuarial assumptions. While the Company believes that its assumptions are appropriate, the estimated accrual for these liabilities could be significantly affected if future occurrences and claims materially differ from these assumptions and historical trends.

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Legal

In January 2020, a former assistant store manager filed a purported class action lawsuit in the United States District Court for the District of Colorado on behalf of current and former assistant store managers alleging that the Company violated the Fair Labor Standards Act (“FLSA”) and Colorado labor laws by misclassifying the assistant store managers as exempt. The alleged violations relate to failure to pay for overtime work. In November 2020, the court granted plaintiffs’ motion for conditional certification with regard to the FLSA claim. In September 2021, the court ordered 56 opt-in plaintiffs to individual arbitration, leaving 101 FLSA plaintiffs in the FLSA collective action. The litigation is currently in the discovery stage. The plaintiffs did not quantify any alleged damages. The Company believes these claims are without merit and intends to defend the matter vigorously. Given the preliminary stage of the case and the legal standards that must be met for, among other things, class certification, the Company is unable to reasonably estimate at this time the possible range of loss, if any, that may result from this action.

The Company is otherwise periodically involved in various legal proceedings that are incidental to the conduct of its business, including but not limited to employment discrimination claims, customer injury claims and investigations. When the potential liability from a matter can be estimated and the loss is considered probable, the Company records the estimated loss. Due to uncertainties related to the resolution of lawsuits, investigations and claims, the ultimate outcome may differ from the estimates. Although the Company cannot predict with certainty the ultimate resolution of any lawsuits, investigations and claims asserted against it, management does not believe any currently pending legal proceeding to which the Company is a party will have a material adverse effect on its financial statements.

19. Selected Quarterly Financial Data (Unaudited)

The summarized unaudited quarterly financial data presented below reflect all adjustments, which in the opinion of management are of a normal and recurring nature, necessary to present fairly the results of operations for the periods presented.

Summarized unaudited quarterly financial data for each fiscal year is as follows, dollars in thousands, except per share data:

Fiscal Year Ended September 30, 2021 Three months ended

Fiscal Year Ended September 30, 2020 Three months ended

20. Subsequent Events

On November 18, 2021, the Board approved a quarterly cash dividend of $0.10 per share, which will be paid on December 15, 2021to stockholders of record as of the close of business on November 29, 2021.

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Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of consolidated financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that:

We have assessed the effectiveness of our internal control over financial reporting as of September 30, 2021 using the criteria described in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment of the design and related testing of the internal control over financial reporting, management concluded that, as of September 30, 2021, we maintained effective internal control over financial reporting.

Our independent registered public accounting firm, KPMG LLP, audited the effectiveness of our internal control over financial reporting. KPMG LLP’s attestation report is included in “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.

Natural Grocers by Vitamin Cottage, Inc. NGVC US Equity

NGVC · 10-K · period ended 2021-09-30

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

Item 8. Financial Statements and Supplementary Data.

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Item 9A. Controls and Procedures.

Natural Grocers by Vitamin Cottage, Inc. NGVC US Equity☆

NGVC · 10-K · period ended 2021-09-30

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

Item 8. Financial Statements and Supplementary Data.

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Item 9A. Controls and Procedures.

Natural Grocers by Vitamin Cottage, Inc. NGVC US Equity