ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and related notes thereto included in "Item 8. Financial Statements and Supplementary Data." This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those described in "Item 1A. Risk Factors" or set forth in other sections of this report.
We operate on a fiscal year that ends on the Saturday closest to December 31st each year. References to fiscal 2021, fiscal 2020, and fiscal 2019 refer to the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019, respectively. Our 2021 and 2019 fiscal years consisted of 52 weeks while our 2020 fiscal year consisted of 53 weeks.
OVERVIEW
We are a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold through a network of independently operated stores. Our flexible buying model allows us to offer quality, name-brand opportunistic products at prices generally 40% to 70% below those of conventional retailers. Entrepreneurial independent operators ("IOs") run our stores and create a neighborhood feel through personalized customer service and a localized product offering. As of January 1, 2022, we had 415 stores in California, Washington, Oregon, Pennsylvania, Idaho, Nevada and New Jersey.
COVID-19
On March 11, 2020, the World Health Organization declared the novel strain of coronavirus, COVID-19, a global pandemic and recommended containment and mitigation measures worldwide. As a result, many states, including states where we have significant operations, declared a state of emergency, closed non-essential businesses and enacted limitations on the size of gatherings. As we compare fiscal 2021 financial performance with the comparable period in fiscal 2020 that included significantly elevated COVID-related demand (only partially offset by periods of store closures) and financial outperformance relative to historical growth, we are reporting declines in year-over-year net sales and comparable store sales growth. In fiscal 2021, and ongoing to an extent, consumer behavior has been impacted by increased consumer mobility and travel, higher food-away-from-home spend, continued consolidation of grocery store visits, higher levels of government stimulus (the latter of which has led consumers to prioritize convenience over value) and elevated grocery e-commerce usage, all of which have negatively impacted our net sales. The combination of these factors, coupled with the evolving nature of the pandemic (especially with respect to the possibility of different variants in the future) and inflationary pressures, makes it difficult to predict near term consumer behavior and resulting sales trends for our business.
We and our IOs also had in fiscal 2021, and continue to have, staffing challenges and increased labor costs for a variety of reasons that are attributable to the COVID-19 pandemic and the related economic and regulatory environment. There was also a surge of positive COVID-19 cases related to the Delta variant around the country during the third quarter of fiscal 2021 and an additional surge of positive COVID-19 cases related to the Omicron variant in the fourth quarter of fiscal 2021, including states in which we operate, creating additional uncertainty and having a negative impact on staffing.
Since the start of the pandemic, certain inventory items have at times been, and may in the future again be, in short supply. COVID-19-related supply chain disruptions more recently have caused logistical challenges for us and many other retailers and manufacturers, causing delays in product delivery to our distribution centers, stores and customers. These logistical challenges also have caused increased delivery costs resulting from higher fuel costs, carrier rates and driver wages due to driver shortages, decreases in transportation capacity, and slowdowns. All of these factors could impact the ability of stores to operate normal hours of operation or have sufficient inventory at all times, which could result in our inability to satisfy customer demand and potential loss of market share. Further, we have experienced varying levels of inflation, resulting in part from supply disruptions, increased shipping and transportation costs, increased commodity costs, increased labor costs in the supply chain and other disruptions caused by the COVID-19 pandemic and the uncertain economic environment, which we have not been able to fully offset through price increases.
Planned construction and opening of new stores also have been, and may continue to be, negatively impacted due to increased lead times to acquire materials such as steel, obtain permits and licenses and set up utilities. Additionally, certain fixture upgrades and new refrigeration units now have longer lead times. Finally, we have incurred additional COVID-related expenses as a result of certain increased costs related to our IOs. For example, in fiscal 2021 we paid a portion of the costs of personal protective equipment and cleaning supplies for our IOs as well as reduced interest rates on outstanding IO notes.
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The trends leading consumers to prioritize convenience over value that we experienced in fiscal 2021 may continue into fiscal 2022, which could continue to negatively impact same store sales. The increased costs associated with staffing challenges and fuel, freight and distribution have negatively impacted our cost of sales and gross margin, and we expect this increased cost to continue into fiscal 2022. We also expect planned construction and opening of new stores to continue to experience delays, which has caused us to plan for lower new store growth in fiscal 2022 than our original goal of 10% and with more new stores weighted towards the second half of the year.
Our operating performance and financial results during fiscal years 2020 and 2021 and the volatility within those periods may not be meaningful indicators of future results. The impact of the COVID-19 pandemic and changing consumer behavior could continue to have a material adverse impact on our consolidated financial position, consolidated results of operations, and consolidated cash flows in fiscal 2022. In spite of these headwinds, we believe the flexibility of our unique buying model, our strong vendor relationships and our agile approach to inventory management have allowed us to maintain healthy inventory levels and an assortment of products for our customers.
Initial Public Offering and Secondary Public Offerings
In June 2019, we completed our initial public offering ("IPO") for net proceeds of $400.4 million, after deducting underwriting discounts and commissions and offering costs payable by us.
We used the net proceeds from our IPO, together with excess cash on hand, to prepay a portion of the term loan outstanding under our First Lien Credit Agreement and to repay in full our Second Lien Term Loan, allowing us to terminate such agreement. See "—Liquidity and Capital Resources" for additional information.
Between October 2019 and April 2020, certain of our selling stockholders completed secondary public offerings of shares of our common stock. We did not receive any proceeds from such offerings, but we incurred related offering costs of $3.2 million in the aggregate and received $6.2 million in cash (excluding withholding taxes) in connection with the exercise of options by certain participating stockholders.
In May 2020, the H&F Investor distributed the remainder of its holdings representing 9.6 million shares of our common stock to its equity holders. We did not receive any proceeds or incur any material costs related to this distribution.
Key Factors and Measures We Use to Evaluate Our Business
We consider a variety of financial and operating measures in assessing the performance of our business. The key generally accepted accounting principles ("GAAP") financial measures we use are net sales, gross profit and gross margin, selling, general and administrative expenses ("SG&A") and operating income. The key operational metrics and non-GAAP financial measures we use are number of new stores, comparable store sales, EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share.
Fiscal 2021 Overview
Key financial and operating performance results for our fiscal 2021 (52 weeks) compared to our fiscal 2020 (53 weeks) were as follows:
•Net sales decreased 1.8% to approximately $3.08 billion for fiscal 2021 from approximately $3.13 billion for fiscal 2020; on a 52-week basis, comparable store sales decreased by 6.0% in fiscal 2021 compared to a 12.7% increase in fiscal 2020. Fiscal 2020 contained one additional week ("53rd week") as compared to fiscal 2021. The 53rd week included $53.3 million in net sales.
•We opened 36 new stores and closed one, ending fiscal 2021 with 415 stores in seven states.
•Net income decreased 41.6% to $62.3 million, or $0.63 per diluted share for fiscal 2021, compared to net income of $106.7 million, or $1.08 per diluted share, for fiscal 2020.
•Adjusted EBITDA(1) decreased 11.0% to $198.5 million for fiscal 2021 compared to $222.9 million for fiscal 2020.
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•Adjusted net income(1) decreased 20.2% to $89.9 million, or $0.90 per adjusted diluted share(1), for fiscal 2021 compared to $112.7 million, or $1.14 per adjusted diluted share, for fiscal 2020.
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(1)Adjusted EBITDA, adjusted net income and adjusted diluted earnings per share are non-GAAP financial measures, which exclude the impact of certain special items. Please note that our non-GAAP financial measures should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. See the "Operating Metrics and Non-GAAP Financial Measures" section below for additional information about these items, including their definitions, how management utilizes such non-GAAP financial measures and reconciliations of the non-GAAP measures and the most directly comparable GAAP measures.
Key Components of Results of Operations
Net Sales
We recognize revenues from the sale of products at the point of sale, net of any taxes or deposits collected and remitted to governmental authorities. Discounts provided to customers by us are recognized at the time of sale as a reduction in sales as the products are sold. Discounts that are funded solely by IOs are not recognized as a reduction in sales as the IO bears the incidental costs arising from the discount. We do not accept manufacturer coupons. Sales consist of sales from comparable stores and non-comparable stores, described below under "Comparable Store Sales." Growth of our sales is generally driven by expansion of our store base in existing and new markets as well as comparable store sales growth. Sales are impacted by the spending habits of our customers, product mix and availability, as well as promotional and competitive activities. Our ever-changing selection of offerings across diverse product categories supports growth in sales by attracting new customers and encouraging repeat visits from our existing customers. The spending habits of our customers are affected by changes in macroeconomic conditions, such as those experienced due to the COVID-19 pandemic, and changes in discretionary income. Since the onset of the pandemic, consumer behavior has been impacted by consolidation of grocery store visits, elevated grocery e-commerce usage and higher levels of government stimulus, leading consumers to prioritize convenience over value and negatively impacting our sales. Our customers' discretionary income is primarily impacted by wages, fuel and other cost-of-living increases including food-at-home inflation, as well as consumer trends and preferences, which fluctuate depending on the environment. Because we offer a broad selection of merchandise at extreme values, historically our business has benefited from periods of economic uncertainty.
Cost of Sales, Gross Profit and Gross Margin
Cost of sales includes, among other things, merchandise costs, inventory markdowns, inventory losses and transportation, distribution and warehousing costs, including depreciation. Gross profit is equal to our sales less our cost of sales. Gross margin is gross profit as a percentage of our sales. Gross margin is a measure used by management to indicate whether we are selling merchandise at an appropriate gross profit. Gross margin is impacted by product mix and availability, as some products generally provide higher gross margins, and by our merchandise costs, which can vary. Gross margin is also impacted by the costs of distributing and transporting product to our stores, which can vary. Our gross profit is variable in nature and generally follows changes in sales. While our disciplined buying approach has produced consistent gross margins throughout economic cycles which we believe has helped to mitigate adverse impacts on gross profit and results of operations, changes in consumer demand like we experienced and continue to experience as a result of the COVID-19 pandemic, including inflationary cost increases for goods, labor and transportation, supply chain constraints and changes in discretionary income, have resulted and could continue to result in unexpected changes to our gross margins. The components of our cost of sales may not be comparable to the components of cost of sales or similar
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measures of our competitors and other retailers. As a result, our gross profit and gross margin may not be comparable to similar data made available by our competitors and other retailers.
Selling, General and Administrative Expenses
SG&A expenses are comprised of both store-related expenses and corporate expenses. Our IO store-related expenses include commissions paid to IOs, occupancy and our portion of maintenance costs and the cost of opening new IO stores. Company-operated store-related expenses include payroll, benefits, supplies and utilities. In addition, beginning in fiscal 2020, SG&A included incremental costs associated with COVID-19, such as cleaning and safety costs, costs for PPE and supplies. Corporate expenses include payroll and benefits for corporate and field support, marketing and advertising, insurance and professional services and operator recruiting and training costs. SG&A generally increases as we grow our store base and invest in our corporate infrastructure. SG&A expenses related to commissions paid to IOs are variable in nature and generally increase as gross profits rise and decrease as gross profits decline. The remainder of our expenses are primarily fixed in nature. We continue to closely manage our expenses and monitor SG&A as a percentage of sales. The components of our SG&A may not be comparable to the components of similar measures of our competitors and other retailers. We expect that our SG&A will continue to increase in future periods as we continue to grow our sales revenue and gross profits.
Operating Income
Operating income is gross profit less SG&A, depreciation and amortization and share-based compensation. Operating income excludes interest expense, net, gain on insurance recoveries, debt extinguishment and modification costs and income tax expense (benefit). We use operating income as an indicator of the productivity of our business and our ability to manage expenses.
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Results of Operations
The following tables summarize key components of our results of operations both in dollars and as a percentage of net sales (amounts in thousands, except for percentages):
Fiscal Year Ended
Operating expenses:
Other expenses (income):
Gain on insurance recoveries (3,970) — —
Debt extinguishment and modification costs — 198 5,634
Fiscal Year Ended
Percentage of net sales (1)
Operating expenses:
Selling, general and administrative 25.1 % 24.6 % 25.0 %
Depreciation and amortization 2.2 % 1.8 % 1.9 %
Share-based compensation 0.6 % 1.2 % 1.2 %
Income from operations 2.9 % 3.4 % 2.7 %
Other expense (income):
Interest expense, net 0.5 % 0.6 % 1.8 %
Gain on insurance recoveries (0.1) % — % — %
Debt extinguishment and modification costs — % — % 0.2 %
Total other expense (income) 0.4 % 0.6 % 2.0 %
Income before income taxes 2.5 % 2.8 % 0.7 %
Income tax expense (benefit) 0.5 % (0.6) % 0.1 %
Net income and comprehensive income 2.0 % 3.4 % 0.6 %
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(1)Components may not sum to totals due to rounding.
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Operating Metrics and Non-GAAP Financial Measures
Number of New Stores
The number of new stores reflects the number of stores opened during a particular reporting period. New stores require an initial capital investment in the store build-outs, fixtures and equipment which we amortize over time as well as cash required for inventory and pre-opening expenses.
We expect new store growth to be the primary driver of our sales growth over the long term. We lease substantially all of our store locations. Our initial lease terms on stores are typically ten years with options to renew for two or three successive five-year periods.
Comparable Store Sales
We use comparable store sales as an operating metric to measure performance of a store during the current reporting period against the performance of the same store in the corresponding period of the previous year. Comparable store sales are impacted by the same factors that impact net sales.
Comparable store sales consists of net sales from our stores beginning on the first day of the fourteenth full fiscal month following the store's opening, which is when we believe comparability is achieved. Included in our comparable store definition are those stores that have been remodeled, expanded, or relocated in their existing location or respective trade areas. Excluded from our comparable store definition are those stores that have been closed for an extended period as well as any planned store closures or dispositions. When applicable, as was the case with fiscal 2020, we exclude the net sales in the non-comparable week of a 53-week year from the same store sales calculation after comparing the current and prior year weekly periods that are most closely aligned.
Opening new stores is a primary component of our growth strategy and, as we continue to execute on our growth strategy, we expect a significant portion of our sales growth will be attributable to non-comparable store sales. Accordingly, comparable store sales is only one measure we use to assess the success of our growth strategy.
EBITDA, Adjusted EBITDA, Adjusted Net Income and Adjusted Earnings Per Share
EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share are supplemental key metrics used by management and our Board of Directors to assess our financial performance. EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share are also frequently used by analysts, investors and other interested parties to evaluate us and other companies in our industry. We use EBITDA, adjusted EBITDA, adjusted net income, and adjusted earnings per share to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions and to compare our performance against that of other peer companies using similar measures. In addition, we use adjusted EBITDA to supplement GAAP measures of performance to evaluate our performance in connection with compensation decisions. Management believes it is useful to investors and analysts to evaluate these non-GAAP measures on the same basis as management uses to evaluate our operating results. We believe that excluding items from operating income, net income and net income per diluted share that may not be indicative of, or are unrelated to, our core operating results, and that may vary in frequency or magnitude, enhances the comparability of our results and provides additional information for analyzing trends in our business.
We define EBITDA as net income before net interest expense, income taxes and depreciation and amortization expenses. Adjusted EBITDA represents EBITDA adjusted to exclude share-based compensation expense, non-cash rent, asset impairment and gain or loss on disposition, provision for (write-off of) accounts receivable reserves and certain other expenses that may not be indicative of, or are unrelated to, our core operating results, and that may vary in frequency or magnitude. Adjusted net income represents net income adjusted for the previously mentioned adjusted EBITDA adjustments, further adjusted for costs related to amortization of purchase accounting assets and deferred financing costs, tax adjustment to normalize the effective tax rate, and tax effect of total adjustments. Basic adjusted earnings per share is calculated using adjusted net income, as defined above, and basic weighted average shares outstanding. Diluted adjusted earnings per share is calculated using adjusted net income, as defined above, and diluted weighted average shares outstanding. EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share are non-GAAP measures and may not be comparable to similar measures reported by other companies. EBITDA, adjusted EBITDA, adjusted net income, and adjusted earnings per share have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. We address the limitations of the non-GAAP measures through the use of various GAAP measures. In the future we will incur expenses or charges such as those added back to calculate adjusted EBITDA or adjusted net income. Our presentation of EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share should not be construed as an inference that our future results will be unaffected by the adjustments we have used to derive our non-GAAP measures.
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The following table summarizes key operating metrics and non-GAAP financial measures for the periods presented (amounts in thousands, except for percentages and store counts):
Fiscal Year Ended
Other Financial and Operations Data
Number of stores open at end of period 415 380 347
Comparable store sales increase (decrease) (1) (6.0) % 12.7 % 5.2 %
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(1)Comparable store sales consist of net sales from our stores beginning on the first day of the fourteenth full fiscal month following the store's opening, which is when we believe comparability is achieved. For fiscal 2020, which is a 53-week year, we excluded the sales in the non-comparable week from the comparable store sales calculation after comparing the current and prior year weekly periods that are most closely aligned.
(2)See "—GAAP to Non-GAAP Reconciliations" section below for a reconciliation from our net income to EBITDA and adjusted EBITDA, net income to adjusted net income and GAAP earnings per share to adjusted earnings per share for the periods presented.
GAAP to Non-GAAP Reconciliations
The following tables provide a reconciliation from our GAAP net income to EBITDA and adjusted EBITDA, GAAP net income to adjusted net income, and our GAAP earnings per share to adjusted earnings per share for the periods presented (amounts in thousands, except per share data):
Fiscal Year Ended
Asset impairment and gain or loss on disposition (4) 1,241 1,727 1,957
Provision for (write-off of) accounts receivable reserves (5) 4,813 (456) 2,575
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Fiscal Year Ended
Asset impairment and gain or loss on disposition (4) 1,241 1,727 1,957
Provision for (write-off of) accounts receivable reserves (5) 4,813 (456) 2,575
Tax adjustment to normalize effective tax rate (8) (5,928) (44,089) (3,587)
GAAP earnings per share
Adjusted earnings per share
Weighted average shares outstanding
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(1)Includes depreciation related to our distribution centers which is included within the cost of sales line item in our consolidated statements of operations and comprehensive income. See NOTE 1—Organization and Summary of Significant Accounting Policies to our Consolidated Financial Statements for additional information about the components of cost of sales.
(2)Includes non-cash share-based compensation expense and $0.2 million, $0.4 million, and $3.6 million of cash dividends paid in fiscal 2021, 2020, and 2019 respectively, on vested share-based awards as a result of dividends declared in connection with recapitalizations that occurred in fiscal 2018 and 2016.
(3)Consists of the non-cash portion of rent expense, which represents the difference between our straight-line rent expense recognized under GAAP and cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant store growth in recent years.
(4)Represents impairment charges with respect to planned store closures and gains or losses on dispositions of assets in connection with store transitions to new IOs.
(5)Represents non-cash changes in reserves related to our IO notes and accounts receivable.
(6)Represents other non-recurring, non-cash or non-operational items, such as gain on insurance recoveries, technology upgrade implementation costs, personnel-related costs, costs related to employer payroll taxes associated with equity awards, legal settlements and other legal expenses, store closing costs, strategic project costs, secondary equity offering transaction costs, debt extinguishment and modification costs, and miscellaneous costs.
(7)Represents the amortization of debt issuance costs and incremental amortization of an asset step-up resulting from purchase price accounting related to our acquisition in 2014 by an investment fund affiliated with Hellman & Friedman LLC, which included trademarks, customer lists, and below-market leases.
(8)Represents adjustments to normalize the effective tax rate for the impact of unusual or infrequent tax items that we do not consider in our evaluation of ongoing performance, including excess tax benefits related to stock option exercises and vesting of RSUs that are recorded in earnings as discrete items in the reporting period in which they occur.
(9)Represents the tax effect of the total adjustments. We calculate the tax effect of the total adjustments on a discrete basis excluding any non-recurring and unusual tax items.
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Comparison of fiscal 2021 (52 weeks) to fiscal 2020 (53 weeks) (amounts in thousands, except percentages)
Net Sales
Fiscal Year Ended
The decrease in net sales for fiscal 2021 compared to fiscal 2020 was primarily attributable to a decrease in comparable stores sales as well as the impact of the 53rd week of fiscal 2020 which included $53.3 million of net sales, partially offset by non-comparable store sales growth attributable to the net 35 new stores opened during fiscal 2021.
Comparable store sales decreased 6.0% for fiscal 2021 compared to fiscal 2020 on a 52-week basis for both periods. The decrease was primarily attributable to a decrease in customer traffic, partially offset by an increase in average transaction size.
Cost of Sales
Fiscal Year Ended
The decrease in cost of sales for fiscal 2021 compared to fiscal 2020 was primarily the result of the comparable store sales decrease discussed above combined with cost of sales from the 53rd week of fiscal 2020, partially offset by new store growth and higher costs as a percentage of net sales.
Costs as a percentage of net sales increased for fiscal 2021 compared to fiscal 2020 due in large part to inflationary cost increases for goods, labor and transportation as well as supply chain constraints.
Gross Profit and Gross Margin
Fiscal Year Ended
The decrease in gross profit for fiscal 2021 compared to fiscal 2020 was primarily the result of a decrease in comparable stores sales and gross profit from the 53rd week of fiscal 2020, partially offset by new store growth. Our gross margin decreased modestly for fiscal 2021 compared to fiscal 2020 due to higher cost of sales as a percentage of net sales, as discussed previously.
Selling, General and Administrative Expenses
Fiscal Year Ended
The increase in SG&A for fiscal 2021 compared to fiscal 2020 was primarily driven by higher store occupancy and maintenance costs due to a higher store count and increased marketing expenses, partially offset by lower personnel costs as a result of decreased incentive compensation expenses and decreased commission payments to IOs.
As a percentage of net sales, SG&A increased slightly for fiscal 2021 compared to fiscal 2020 due to lower expense leverage as a result of reduced net sales.
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Depreciation and Amortization Expense
Fiscal Year End
% of net sales 2.2 % 1.8 %
The increase in depreciation and amortization expenses for fiscal 2021 compared to fiscal 2020 was primarily driven by new store growth and existing store investments.
Share-based Compensation Expense
Fiscal Year Ended
% of net sales 0.6 % 1.2 %
The decrease in share-based compensation expenses for fiscal 2021 compared to fiscal 2020 was primarily due to $26.1 million in share-based compensation expense we incurred in fiscal 2020 related to 5.8 million performance-based stock options that vested in connection with performance events achieved with the closing of our February and April 2020 secondary offerings. This decrease was partially offset by an increase in expense driven by RSUs and PSUs granted during fiscal 2021.
See NOTE 8—Share-based Awards to our Consolidated Financial Statements for additional information.
Interest Expense, net
Fiscal Year Ended
% of net sales 0.5 % 0.6 %
The decrease in interest expense, net for fiscal 2021 compared to fiscal 2020 was primarily driven by lower effective interest rates experienced under our First Lien Credit Agreement as a result of decreases in the London Inter-bank Offered Rate ("LIBOR"). Furthermore, fiscal 2020 included interest expense from the $90.0 million borrowed under the revolving credit facility of our First Lien Credit Agreement between March and May 2020, compared to no borrowings thereunder in fiscal 2021.
See NOTE 6—Long-term Debt to our Consolidated Financial Statements for additional information.
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Gain on Insurance Recoveries
Fiscal Year Ended
Gain on insurance recoveries $ (3,970) $ — $ (3,970) N/A
% of net sales (0.1) % — %
During fiscal 2021, we recorded a $4.0 million gain on insurance due to proceeds received related to the loss of our Paradise, California store due to a wildfire in 2018.
Debt Extinguishment and Modification Costs
Fiscal Year Ended
Debt extinguishment and modification costs $ — $ 198 $ (198) (100.0) %
% of net sales — % — %
During fiscal 2020, we wrote off $0.1 million of debt issuance costs and incurred $0.1 million of debt modification costs related to the repricing and amendment of our First Lien Credit Agreement. No such write-offs were made or debt modification costs incurred in fiscal 2021.
See NOTE 6—Long-term Debt to our Consolidated Financial Statements for additional information.
Income Tax Expense (Benefit)
Fiscal Year Ended
% of net sales 0.5 % (0.6) %
Effective tax rate 19.6 % (22.5) %
During fiscal 2021, we recorded a net income tax expense of $15.2 million compared to a net income tax benefit of $19.6 million for fiscal 2020. This change was primarily driven by a reduction in excess tax benefits related to the exercise of stock options and vesting of RSUs. Such excess tax benefits totaled $8.0 million for fiscal year 2021 compared to $44.1 million for fiscal year 2020.
See NOTE 10—Income Taxes to our Consolidated Financial Statements for additional information.
Net Income
Fiscal Year Ended
% of net sales 2.0 % 3.4 %
As a result of the foregoing factors, net income decreased in fiscal 2021 compared to fiscal 2020.
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Adjusted EBITDA
Fiscal Year Ended
The decrease in adjusted EBITDA for fiscal 2021 compared to fiscal 2020 was primarily due to a decrease in gross profit, which was primarily driven by a decrease in comparable store sales, on a 52-week basis, of 6.0% for fiscal 2021 compared to fiscal 2020, the impact of net sales from the 53rd week of fiscal 2020, and increases in cost of sales as a percentage of net sales primarily caused by inflationary pressures and supply chain constraints, partially offset by contribution from our non-comparable stores.
Adjusted Net Income
Fiscal Year Ended
The decrease in adjusted net income for fiscal 2021 compared to fiscal 2020 was primarily a result of the aforementioned drivers of the decrease in Adjusted EBITDA as well as increases in depreciation and amortization expenses caused by new store growth and other capital investments.
Comparison of fiscal 2020 (53 weeks) to fiscal 2019 (52 weeks)
For the comparison of fiscal 2020 to fiscal 2019, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021, as amended, under the subheading "Comparison of fiscal 2020 (53 weeks) to fiscal 2019 (52 weeks)."
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Liquidity and Capital Resources
Sources of Liquidity
Based on our current operations and new store growth plans, we expect to satisfy our short-term and long-term cash requirements through a combination of our existing cash and cash equivalents position, funds generated from operating activities, and the borrowing capacity available in the revolving credit facility under our first lien credit agreement (the "First Lien Credit Agreement"). If cash generated from our operations and borrowings under our revolving credit facility are not sufficient or available to meet our liquidity requirements, then we will be required to obtain additional equity or debt financing in the future. There can be no assurance equity or debt financing will be available to us when we need it or, if available, the terms will be satisfactory to us and not dilutive to our then-current stockholders. Additionally, we may seek to take advantage of market opportunities to refinance our existing debt instruments with new debt instruments at interest rates, maturities and terms we deem attractive. We may also, from time to time, in our sole discretion, purchase or retire all or a portion of our existing debt instruments through privately negotiated or open market transactions.
As of January 1, 2022, we had cash and cash equivalents of $140.1 million, which consisted primarily of cash held in checking and money market accounts with financial institutions. In addition, we have a revolving credit facility with $100.0 million in borrowing capacity under our First Lien Credit Agreement. We did not borrow under this revolving credit facility during fiscal 2021 and had no borrowings outstanding thereunder as of January 1, 2022. As of January 1, 2022, we had $3.5 million of outstanding standby letters of credit and $96.5 million of remaining borrowing capacity available under this revolving credit facility.
Material Cash Requirements
Leases
We have operating and finance lease arrangements for substantially all store locations, distribution centers, and certain office space and equipment. As of January 1, 2022, total lease assets and lease liabilities were $905.0 million and $1.0 billion, respectively, and we had executed leases for 25 store locations that we had not yet taken possession of with total undiscounted future lease payments of $141.9 million and lease terms through 2039. See NOTE 4—Leases to our Consolidated Financial Statements for further detail of our lease obligations and the timing of lease liability maturities.
Debt Obligations and Interest Payments
See NOTE 6—Long-term Debt to our Consolidated Financial Statements for further detail of our First Lien Credit Agreement, which consists of a $460.0 million senior term loan and a revolving credit facility for an amount up to $100.0 million, and the timing of principal maturities. As of January 1, 2022, based on the then current interest rate of 2.85%, expected future interest payments associated with our debt totaled $50.7 million, with $13.3 million payable during fiscal year 2022.
Capital Expenditures
Our capital expenditures are primarily related to new store openings, ongoing store maintenance and improvements, expenditures related to our distribution centers and infrastructure-related investments, including investments related to upgrading and maintaining our information technology systems and corporate offices. We expect to fund capital expenditures through cash generated from our operations. We expect capital expenditures of approximately $115.0 million, net of tenant improvement allowances, in fiscal year 2022, primarily related to new store openings and ongoing store maintenance and improvements.
Working Capital and Purchase Commitments
Our primary working capital requirements are for the purchase of inventory, payroll, rent, issuance of IO notes, other store facilities costs, distribution costs and general and administrative costs. Our working capital requirements fluctuate during the year, driven primarily by the timing of inventory fluctuations, new store openings and capital spending.
Our purchase commitments consist of non-cancelable obligations under service and supply contracts. As of January 1, 2022, we had total purchase obligations of $11.8 million, with $10.1 million payable during fiscal year 2022.
Share Repurchases and Dividends
We may repurchase our common stock pursuant to programs approved by our Board of Directors. As of January 1, 2022, we had $100.0 million of repurchase authority remaining under the current share repurchase program. See "Item 5. Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Issuer Purchases of Equity Securities" for discussion about our Board-authorized share repurchase program.
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As of January 1, 2022, we expect to pay an additional $0.2 million related to dividends declared in our recapitalization in 2018 for stock options that will vest during fiscal 2022 and beyond, of which $0.1 million is expected to be paid in fiscal 2022. Pursuant to The Globe Holding Corp. 2014 Plan, if we are unable to make those payments, we may instead elect to reduce the per share exercise price of each such option by an amount equal to the dividend amount in lieu of making the applicable dividend payment.
Debt Covenants
The First Lien Credit Agreement contains certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants. The First Lien Credit Agreement restricts us from entering into certain types of transactions and making certain types of payments including dividends and stock repurchases and other similar distributions, with certain exceptions. Additionally, borrowing availability under the revolving credit facility under our First Lien Credit Agreement is subject to a first lien secured leverage ratio of 7.00 to 1.00 (as defined in the First Lien Credit Agreement), tested quarterly if, and only if, the aggregate principal amount outstanding and/or issued, as applicable, from the revolving facility, letters of credit (to the extent not cash collateralized or backstopped or, in the aggregate, not in excess of the greater of $10.0 million and the stated face amount of letters of credit outstanding on the closing date) and swingline loans exceeds 35% of the total amount of the revolving credit facility commitments.
As of January 1, 2022, we were in compliance with all applicable financial covenant requirements for our First Lien Credit Agreement.
Cash Flows
The following table summarizes our cash flows for the periods presented (amounts in thousands):
Fiscal Year Ended
Net cash provided by (used in) financing activities 5,885 29,774 (17,778)
Cash Provided by Operating Activities
Net cash provided by operating activities was $165.6 million for fiscal 2021 compared to $181.2 million for fiscal 2020. The $15.7 million decrease was primarily due to lower net sales driven by a decrease in comparable store sales combined with fiscal 2020 including net sales from its 53rd week, partially offset by contribution from non-comparable stores. The decrease was additionally due to an increase of $4.6 million in cash used for merchandise inventory.
Net cash provided by operating activities was $181.2 million for fiscal 2020 compared to $132.8 million for fiscal 2019. The $48.4 million increase was primarily the result of increased net sales driven by new store growth and comparable store sales growth, partially offset by increased cost of sales and operating expenses, particularly commissions paid to IOs.
Cash Used in Investing Activities
Net cash used in investing activities for fiscal 2021, fiscal 2020, and fiscal 2019 was primarily for capital expenditures and loans to IOs.
Net cash used in investing activities was $136.7 million for fiscal 2021 compared to $133.8 million for fiscal 2020. The $2.9 million increase was primarily related to an increase of investments in computer software intangible assets in fiscal 2021 compared to fiscal 2020. Of the $136.7 million net cash used in investing activities during fiscal 2021, $123.4 million represented purchases of property and equipment prior to the application of tenant improvement allowances.
Net cash used in investing activities was $133.8 million for fiscal 2020 compared to $108.0 million for fiscal 2019. The $25.8 million increase was primarily related to an increase in the number of stores opened and under construction in fiscal 2020 compared to fiscal 2019. Of the $133.8 million net cash used in investing activities during fiscal 2020, $124.9 million represented purchases of property and equipment prior to the application of tenant improvement allowances.
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Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities was $5.9 million for fiscal 2021 compared to $29.8 million for fiscal 2020. The $23.9 million decrease was primarily due to a decrease in proceeds received from the exercise of stock options.
Net cash provided by financing activities was $29.8 million for fiscal 2020 compared to $17.8 million net cash used in financing activities for fiscal 2019. The net cash provided by financing activities of $29.8 million for fiscal 2020 was primarily due to proceeds received from the exercise of share-based awards slightly offset by principal payments on debt. The net cash used in financing activities of $17.8 million for fiscal 2019 was primarily due to $414.8 million of principal payments on debt and $7.2 million of offering cost payments related to our IPO, partially offset by proceeds of $407.7 million from the IPO, net of $27.1 million of underwriting discounts and commissions paid.
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Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with GAAP. A summary of our significant accounting policies can be found in NOTE 1—Organization and Summary of Significant Accounting Policies to our Consolidated Financial Statements. The preparation of our consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. These judgments and estimates are based on historical experience and other factors believed to be reasonable under the circumstances.
Management evaluated the development and selection of our critical accounting policies and estimates and believes that the following involves a higher degree of judgment or complexity and is most significant to reporting our results of operations and financial position, and is therefore discussed as critical. The following critical accounting policy reflects a significant estimate and judgment used in the preparation of our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected results can potentially have a materially favorable or unfavorable impact on subsequent results of operations.
Long-lived asset impairment
We evaluate long-lived assets, including property and equipment and lease right-of-use assets, for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. For purposes of this evaluation, long-lived assets are grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets. Our retail stores are evaluated for impairment at the store level. A long-lived asset or asset group may be impaired if its carrying value exceeds its estimated undiscounted future cash flows over its remaining useful life. The total amount of property and equipment, including store assets, and operating lease right-of-use assets as of January 1, 2022 were $499.4 million and $898.2 million, respectively.
Our impairment calculations contain uncertainties because they require us to make assumptions and to apply judgment to estimate future cash flows. Key assumptions used in estimating future cash flows include projected sales growth and operating expenses. Estimates of sales growth and operating expenses are based on internal projections and consider the store’s historical performance, length of time the store has been open, the local market economics and the business environment impacting the store’s performance. These estimates are subjective and our ability to realize future cash flows is affected by factors such as ongoing maintenance and improvement of the assets, changes in economic conditions and changes in operating performance. We have not made any material changes in the accounting methodology used to evaluate the impairment of long-lived assets during the last three fiscal years. We do not believe there is a reasonable likelihood there will be a material change in the estimates or assumptions used to calculate impairments of long-lived assets. However, if actual results are not consistent with our estimates and assumptions used to calculate estimated future cash flows, we may be exposed to impairment losses that could be material.
If a long-lived asset or asset group is determined to be impaired, we record an impairment loss for the amount by which the carrying value of the asset or asset group exceeds its fair value. The estimated fair value of the asset or asset group is based on the estimated discounted future cash flows of the asset or asset group using a discount rate commensurate with the related risk.
There were no adjustments to the carrying value of long-lived assets due to impairment charges during fiscal 2021 and 2020. We recorded impairment charges of $0.5 million during fiscal 2019.
Recent Accounting Pronouncements
Refer to NOTE 1—Organization and Summary of Significant Accounting Policies to our Consolidated Financial Statements.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our operating results are subject to market risk from interest rate fluctuations on our credit facilities, which bear variable interest rates. As of January 1, 2022, our outstanding credit facilities included a $460.0 million senior term loan under the First Lien Credit Agreement. As of January 1, 2022, the interest rate on the senior term loan was 2.85% (See NOTE 6—Long-term Debt to our Consolidated Financial Statements for additional information). Based on the outstanding balance and interest rate of our senior term loan as of January 1, 2022, a hypothetical 10% relative increase or decrease in the effective interest rate would cause an increase or decrease in interest expense of approximately $1.3 million over the next 12 months.
We do not use derivative financial instruments for speculative or trading purposes, but this does not preclude our adoption of specific hedging strategies in the future.
Impact of Inflation
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we have experienced varying levels of inflation, resulting in part from various supply disruptions, increased shipping and transportation costs, increased commodity costs, increased labor costs in the supply chain and other disruptions caused by the COVID‐19 pandemic and the uncertain economic environment. However, because of the flexibility of our unique buying model and our ability to price our products frequently, we were able to partially offset the impact of inflation on our business during fiscal 2021 through selective price increases. We cannot be assured that our results of operations and financial condition will not be materially impacted by inflation in the future.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
GROCERY OUTLET HOLDING CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34) 62
Consolidated Balance Sheets 64
Consolidated Statements of Operations and Comprehensive Income 65
Consolidated Statements of Stockholders' Equity 66
Consolidated Statements of Cash Flows 67
Notes to Consolidated Financial Statements 68
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of Grocery Outlet Holding Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Grocery Outlet Holding Corp. and subsidiaries (the "Company") as of January 1, 2022 and January 2, 2021, the related consolidated statements of operations and comprehensive income, stockholders' equity, and cash flows, for each of the fiscal years ended January 1, 2022, January 2, 2021 and December 28, 2019, and the related notes and Schedule I listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of January 1, 2022 and January 2, 2021, and the results of its operations and its cash flows for the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also 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 January 1, 2022, 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 March 2, 2022 expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (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 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 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 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 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 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 financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the 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.
Long-Lived Store Asset Impairment – Refer to Notes 1 and 3 to the financial statements
Critical Audit Matter Description
The Company performs an analysis of the carrying value of all long-lived store assets for impairment at an individual store level whenever events or changes in circumstances indicate that the carrying value of individual store assets may not be recoverable. The Company's impairment analysis determines whether projected undiscounted future cash flows from operations are sufficient to recover the carrying value of these store assets. Impairment may result when the carrying value of these store assets exceeds the estimated undiscounted future cash flows over the remaining useful life. The total amount of property and equipment, including store assets, and operating lease right-of-use assets as of January 1, 2022 are $499.4 million and $898.2 million, respectively. The Company's impairment analysis consists of (1) identifying stores with
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indicators of impairment, (2) testing the identified store assets for recoverability and (3) measuring the impairment loss, if any. During the year ended January 1, 2022, the Company recorded no impairment of long-lived assets.
The principal considerations for our determination that performing procedures relating to the impairment of store-level long-lived assets is a critical audit matter relates to the significant judgment by management in developing the estimated future discounted cash flows expected to be generated by the asset. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating the discounted cash flows, including the significant assumptions for sales growth rate and gross margin.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management's judgments regarding the forecasts of future cash flows included the following, among others:
•We tested the operating effectiveness of controls over management's long-lived store asset impairment evaluation, including those over future sales growth and gross margin projections
•We evaluated management's ability to accurately forecast future sales growth and gross margin by comparing actual results to management's historical forecasts
•We evaluated the reasonableness of management's sales growth and gross margin forecasts by comparing the forecasts to:
◦Current and past sales and gross margins of the overall Company and individual store level asset groups
◦Consistency with external market and industry data
◦Internal communications to management and the Board of Directors
•We tested the completeness, accuracy, and relevance of underlying data used in the valuations
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
March 2, 2022
We have served as the Company's auditor since 2007.
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GROCERY OUTLET HOLDING CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
Assets
Current assets:
Other accounts receivable, net of allowance $57 and $39 3,159 5,950
Prepaid expenses and other current assets 16,780 20,081
Deferred income tax assets, net — 3,529
Liabilities and Stockholders' Equity
Current liabilities:
Income and other taxes payable 7,185 7,547
Deferred income tax liabilities, net 9,416 —
Commitments and contingencies (NOTE 12)
Stockholders' equity:
See Notes to Consolidated Financial Statements
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GROCERY OUTLET HOLDING CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
Fiscal Year Ended
Operating expenses:
Other expenses (income):
Gain on insurance recoveries (3,970) — —
Debt extinguishment and modification costs — 198 5,634
Diluted earnings per share $ 0.63 $ 1.08 $ 0.19
Weighted average shares outstanding:
See Notes to Consolidated Financial Statements
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GROCERY OUTLET HOLDING CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
Shares Amount Shares Amount Shares Amount
Cumulative effect of accounting change 168 168
Other direct initial public offering costs (7,245) (7,245)
Redemption of preferred shares (1) — —
Cumulative effect of accounting change 439 439
See Notes to Consolidated Financial Statements
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GROCERY OUTLET HOLDING CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Fiscal Year Ended
Cash flows from operating activities:
Amortization of intangible and other assets 7,682 7,302 7,237
Amortization of debt issuance costs and debt discounts 2,511 2,452 2,542
Gain on insurance recoveries (3,970) — —
Debt extinguishment and modification costs — 198 5,634
Changes in operating assets and liabilities:
Independent operator and other accounts receivable (21) (4,943) (3,649)
Prepaid expenses and other current assets 3,301 (6,628) 498
Cash flows from investing activities:
Repayments of advances from independent operators 4,563 6,793 4,473
Investments in intangible assets and licenses (9,772) (5,861) (3,073)
Proceeds from insurance recoveries - property and equipment 1,867 305 —
Cash flows from financing activities:
Proceeds from revolving credit facility loan — 90,000 —
Principal payments on revolving credit facility loan — (90,000) —
Other direct costs paid related to the initial public offering — — (7,062)
Principal payments on term loans — (188) (414,813)
Principal payments on other borrowings (1,155) (1,024) (865)
Debt issuance costs paid — (701) (690)
Net cash provided by (used in) financing activities 5,885 29,774 (17,778)
Supplemental disclosure of cash flow information:
Income taxes paid (refunded) in cash $ 477 $ 5,186 $ (65)
Intangible assets accrued at end of period $ 1,613 $ 1,050 $ —
See Notes to Consolidated Financial Statements
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GROCERY OUTLET HOLDING CORP.
Notes to Consolidated Financial Statements
NOTE 1—Organization and Summary of Significant Accounting Policies
Description of Business — Based in Emeryville, California, and incorporated in Delaware in 2014, Grocery Outlet Holding Corp. (together with its wholly owned subsidiaries, collectively, "Grocery Outlet," "we," or the "Company") is a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold through a network of independently operated stores. As of January 1, 2022, we had 415 stores throughout California, Washington, Oregon, Pennsylvania, Idaho, Nevada and New Jersey.
Grocery Outlet Holding Corp. (the "Parent Company") owns 100% of Globe Intermediate Corp. ("Intermediate"), which owns 100% of GOBP Holdings, Inc. ("GOBP Holdings"), which owns 100% of GOBP Midco, Inc. ("Midco"), which owns 100% of Grocery Outlet Inc. ("GOI").
Fiscal Year — We operate on a fiscal year that ends on the Saturday closest to December 31st each year. The fiscal years ended January 1, 2022 ("fiscal 2021") and December 28, 2019 ("fiscal 2019") consisted of 52 weeks while the fiscal year ended January 2, 2021 ("fiscal 2020") consisted of 53 weeks.
Basis of Presentation — The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the applicable rules and regulations of the U.S. Securities and Exchange Commission (the "SEC"). Our consolidated financial statements include the accounts of Grocery Outlet Holding Corp. and its wholly owned subsidiaries. All intercompany balances and transactions were eliminated. In the opinion of management, these consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the periods presented. Certain prior period amounts in the notes to the consolidated financial statements have been reclassified to conform to the current period presentation. The reclassification of these items had no impact on net income, earnings per share, or retained earnings in the current or prior period.
Use of Estimates — The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results can differ from these estimates depending upon certain risks and uncertainties. Changes in these estimates are recorded when known.
Segment Reporting — We manage our business as one operating segment. All of our sales were made to customers located in the United States and all property and equipment is located in the United States.
Cash and Cash Equivalents — We consider all highly liquid investments, purchased with original maturities of three months or less, to be cash equivalents. All cash equivalents are unrestricted and available for immediate use.
Allowance for Independent Operator ("IO") Receivables and IO Notes and Other Accounts Receivable — We maintain allowances and accruals for estimated losses of amounts advanced to IOs and other third parties determined to be uncollectible. See NOTE 2—Independent Operator Notes and Independent Operator Receivables, for additional information.
Concentrations of Credit Risk — Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents and accounts and notes receivable. Although we deposit our cash with creditworthy financial institutions, our deposits typically exceed federally insured limits. To date, we have not experienced any losses on our cash deposits. No single customer or store represented more than 10% of net sales for the fiscal years ended January 1, 2022, January 2, 2021 and December 28, 2019. No single customer or IO represented more than 10% of accounts receivable or notes receivable as of January 1, 2022 and January 2, 2021.
Merchandise Inventories — Merchandise inventories are valued at the lower of cost or net realizable value. Cost is determined by the weighted-average cost method for warehouse inventories and the retail inventory method for store inventories. We provide for estimated inventory losses between physical inventory counts based on historical averages. This provision is adjusted periodically to reflect the actual shrink results of the physical inventory counts.
Property and Equipment — Property and equipment is stated at cost less accumulated depreciation and includes expenditures for significant improvements to leased premises. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets, generally ranging from three to 15 years. Amortization of leasehold improvements is calculated based on the shorter of their estimated useful life or the remaining terms of the lease. Remaining lease terms currently range from one to 17 years.
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We evaluate events and changes in circumstances that could indicate carrying amounts of long-lived assets, including property and equipment, may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether or not the carrying value of such assets will be recovered through undiscounted future cash flows derived from their use and eventual disposition. For purposes of this assessment, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities, primarily at an individual store level. If the sum of the undiscounted future cash flows is less than the carrying amount of an asset, we record an impairment loss for the amount by which the carrying amount of the asset exceeds its fair value. The total amount of property and equipment, including store assets, and operating lease right-of-use assets as of January 1, 2022 were $499.4 million and $898.2 million, respectively. The estimated fair value of the asset or asset group is based on the estimated discounted future cash flows of the asset or asset group using a discount rate commensurate with the related risk. There were no adjustments to the carrying value of long-lived assets due to impairment charges during fiscal 2021 and 2020. We recorded impairment charges of $0.5 million during fiscal 2019. See NOTE 3—Property and Equipment, for additional information.
Leases — We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use assets, current lease liabilities, and long-term lease liabilities on our consolidated balance sheets. Finance leases are included in other assets, current lease liabilities, and long-term lease liabilities on our consolidated balance sheets. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease over the same term. Right-of-use assets and liabilities are recognized at commencement date based on the present value of the lease payments over the lease term, reduced by landlord incentives. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate, which is estimated to approximate the interest rate on a collateralized basis with similar terms and payments based on the information available at the commencement date to determine the present value of our lease payments. Lease term is defined as the non-cancelable period of the lease plus any options to extend or terminate the lease when it is reasonably certain that we will exercise the option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term while finance lease payments are charged to interest expense and depreciation and amortization expense over the lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet; lease expense for these short-term leases is recognized on a straight-line basis over the lease term.
We generally lease retail facilities for store locations, distribution centers, office space and equipment and account for these leases as operating leases. We account for one retail store lease and certain equipment leases as finance leases. Lease and non-lease components are accounted for separately. We sublease certain real estate to unrelated third parties under non-cancelable leases and the sublease portfolio consists of operating leases for retail stores.
Goodwill and Other Intangible Assets — We have both goodwill and intangible assets recorded on our consolidated balance sheets.
Goodwill represents the difference between the purchase price and the fair value of assets and liabilities acquired in a business combination. Goodwill is not amortized, but rather is subject to an annual impairment evaluation which is performed during our fourth quarter or when events or changes in circumstances indicate that the value of goodwill may be impaired. Our impairment evaluation of goodwill consists of an initial qualitative assessment of our reporting unit to determine whether it is more-likely-than-not that the fair value of the reporting unit is less than its carrying value. If it is concluded that this is the case, a quantitative evaluation, based on discounted cash flows, is performed which requires us to estimate future cash flows, growth rates and economic and market conditions. If the quantitative evaluation indicates that goodwill is not recoverable, an impairment loss is calculated and recognized during that period. Measurement of such an impairment loss would be based on the excess of the carrying amount over fair value. There were no goodwill impairment charges recorded during the fiscal years ended January 1, 2022, January 2, 2021 and December 28, 2019. There were no changes in the carrying amount of goodwill for the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019.
Intangible assets include trademarks, computer software, and liquor licenses. Trademarks represent the value of all our trademarks and trade names in the marketplace. We are amortizing the value assigned to the trade names on a straight-line basis over 15 years. Computer software includes both acquired software and eligible costs to develop internal-use software that are incurred during the application development stage. These assets are amortized over their estimated useful lives of three to 10 years. Liquor license assets have been classified as indefinite-lived intangible assets and accordingly, are not subject to amortization. We review our intangible assets for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. If the carrying amount of the intangible assets are not recoverable, the impairment is measured as the amount by which the carrying value of the intangible asset exceeds its fair value. There were no impairments of intangible assets recognized during the fiscal years ended January 1, 2022, January 2, 2021 and December 28, 2019.
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Fair Value Measurements — Fair value is defined as the exchange price, or exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The fair value of financial instruments is categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is measured using inputs from the three levels of the fair value hierarchy, which are described as follows:
Level 1 — Quoted prices in active markets for identical assets or liabilities
Level 2 — Quoted prices for similar assets and liabilities in active markets or inputs that are observable
Level 3 — Unobservable inputs in which there is little or no market data, which requires us to develop our own assumptions when pricing the financial instruments, such as cash flow modeling assumptions.
The assets' or liabilities' fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The fair value framework requires that we maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
There were no assets or liabilities measured at fair value on a recurring basis as of January 1, 2022 or January 2, 2021. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. See NOTE 3—Property and Equipment and NOTE 5—Goodwill and Intangible Assets, for additional information. There were no transfers of assets or liabilities between levels within the fair value hierarchy during the fiscal years ended January 1, 2022 or January 2, 2021.
Our financial assets and liabilities are carried at cost, which generally approximates their fair value, as described below:
Cash and cash equivalents, IO receivables, other accounts receivable and accounts payable — The carrying value of such financial instruments approximates their fair value due to factors such as their short-term nature or their variable interest rates.
IO notes receivable (net) — The carrying value of such financial instruments approximates their fair value due to the effect of the related allowance for expected credit losses.
The following table sets forth by level within the fair value hierarchy the carrying amounts and estimated fair values of our significant financial liabilities that are not recorded at fair value on the consolidated balance sheets (amounts in thousands):
Financial Liabilities:
_______________________
(1)The carrying amounts as of January 1, 2022 and January 2, 2021 are net of unamortized debt discounts of $1.0 million and $1.2 million, respectively, and debt issuance costs of $7.5 million and $9.5 million, respectively.
(2)The estimated fair value of our term loan was determined based on the average quoted bid-ask prices for the term loan in an over-the-counter market on the last trading day of fiscal 2021 and 2020.
Revenue Recognition
Net Sales — We recognize revenue from the sale of products at the point of sale, net of any taxes or deposits collected and remitted to governmental authorities. For e-commerce related sales in which a third-party company provides home delivery service, revenue is recognized upon delivery to the customer. Our performance obligations are satisfied upon the transfer of goods to the customer, at the point of sale, and payment from customers is also due at the time of sale. Discounts provided to customers by us are recognized at the time of sale as a reduction in sales as the products are sold. Discounts provided by IOs are not recognized as a reduction in sales as these are provided solely by the IO who bears the incremental costs arising from the discount. We do not accept manufacturer coupons.
We do not have any material contract assets or receivables from contracts with customers, any revenue recognized in the current year from performance obligations satisfied in previous periods, any performance obligations, or any material costs to obtain or fulfill a contract as of January 1, 2022 and January 2, 2021.
Gift Cards — We record a deferred revenue liability when a Grocery Outlet gift card is sold. Revenue related to gift cards is recognized as the gift cards are redeemed, which is when we have satisfied our performance obligation. While gift cards are generally redeemed within 12 months, some are never fully redeemed. We reduce the liability and recognize
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revenue for the unused portion of the gift cards ("breakage") under the proportional method, where recognition of breakage income is based upon the historical run-off rate of unredeemed gift cards. Our gift card deferred revenue liability was $3.6 million as of January 1, 2022 and $3.2 million as of January 2, 2021. Breakage amounts were $0.3 million and $0.2 million for the fiscal years ended January 1, 2022 and January 2, 2021, respectively, and less than $0.1 million for the fiscal year ended December 28, 2019.
Disaggregated Revenues —The following table presents net sales revenue by type of product for the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019 (amounts in thousands); e-commerce sales have been allocated to their respective product type:
_______________________
(1)Perishable departments include dairy and deli; produce and floral; and fresh meat and seafood.
(2)Non-perishable departments include non-perishable grocery; general merchandise; health and beauty care; frozen foods; and beer and wine.
(3)The fiscal years ended January 1, 2022 and December 28, 2019 consisted of 52 weeks while the fiscal year ended January 2, 2021 consisted of 53 weeks.
Cost of Sales — Cost of sales includes, among other things, merchandise costs, inventory markdowns, shrink and transportation, third-party delivery fees and distribution and warehousing costs, including depreciation.
Marketing and Advertising Expenses — Costs for store promotions, newspaper, television, radio and other media advertising are expensed at the time the promotion or advertising takes place. Advertising costs are included in SG&A in the accompanying consolidated statements of operations and comprehensive income and amounted to approximately $32.6 million, $25.9 million and $26.2 million, respectively, in the fiscal years ended January 1, 2022, January 2, 2021 and December 28, 2019.
Share-based Awards — We estimate the fair value of time-based stock option awards subject to only a service condition on the date of grant using the Black-Scholes valuation model. The Black-Scholes model requires the use of certain input assumptions. Because we completed our IPO during fiscal 2019, for awards granted in fiscal 2019 we had limited historical exercise data from which to derive such input assumptions, including an option's expected term and the price volatility of the underlying stock. Consequently, we determined the expected term using an accepted, simplified formula which derives an expected term by taking the sum of the contractual term and adding the length of the vesting period and dividing by two. We estimated stock price volatility for our common stock by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option grants. Industry peers consist of several public companies in our industry which are of similar size, complexity and stage of development. The risk-free interest rate for the expected term of the option was based on the U.S. Treasury implied yield at the date of grant. We did not award any time-based or performance-based stock options during fiscal 2021 and 2020.
We estimate the fair value of performance-based stock option awards subject to both a market condition and a performance condition on the date of grant using a Monte Carlo simulation approach implemented in a risk-neutral framework.
We estimate the fair value of restricted stock units ("RSUs") and performance-based restricted stock units ("PSUs") based upon the closing price of our common stock as reported on the Nasdaq Global Select Market on the date of grant. The PSUs vest in one installment after a three year performance period based on the achievement of cumulative operating goals.
We recognize compensation expense for share-based payment awards with only a service condition on a straight-line basis over the requisite service period, which is generally the award's vesting period. Vesting of these awards would be accelerated for certain employees in the event of a change in control as well as certain termination events. Compensation expense for share-based payment awards subject to vesting based upon the achievement of a performance condition is recognized on a graded-vesting basis at the time the achievement of the performance condition becomes probable.
We recognize share-based award forfeitures as they occur rather than estimating by applying a forfeiture rate.
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While we recognize share-based compensation expense over the performance period and/or requisite service period based on the fair market value of the award as of the grant date, we will not know the actual amount of tax benefit an award will generate until such award is exercised (or vested for RSUs or PSUs)). Until such award is exercised (or vested for RSUs or PSUs) we assume that the amount ultimately recognized for tax purposes is the same amount we are currently recognizing in our operating results, that is for "book" purposes. Consequently, our deferred tax asset related to share-based compensation expense, which totaled $10.9 million as of January 1, 2022, is based on each qualifying award's grant date fair value rather than the award's to-be-determined exercise date intrinsic value (or vesting date fair value). For awards exercised (or vested for RSUs) during our fiscal year ended January 1, 2022, the difference between the grant date fair value and the exercise or vest date intrinsic value totaled $30.3 million. If the share price for our common stock were to depreciate for a sustained period of time, we could be required to recognize a tax shortfall. Such shortfalls could have a material effect on our cash flows and financial results. See NOTE 8—Share-based Awards and NOTE 10—Income Taxes, for additional information.
Income Taxes — Income taxes are accounted for using an asset and liability approach that requires recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. In estimating future tax consequences, all expected future events are considered, other than changes in the tax law. A valuation allowance is established, when necessary, to reduce net deferred income tax assets to the amount expected to be realized. We have not recorded any valuation allowances against our deferred income tax balances for the fiscal years ended January 1, 2022 and January 2, 2021. Significant items comprising our future tax benefits and liabilities (deferred tax assets and liabilities) include net operating losses, depreciation and amortization, goodwill, intangible assets, lease liability obligations and right-of-use assets.
We recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. We record uncertain tax positions in accordance with ASC Topic 740, Income Taxes, on the basis of a two-step process in which (i) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (ii) for those tax positions that meet the more likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
Variable Interest Entities — In accordance with the variable interest entities sub-section of ASC Topic 810, Consolidation, we assess at each reporting period whether we, or any consolidated entity, are considered the primary beneficiary of a variable interest entity ("VIE") and therefore required to consolidate the financial results of the VIE in our consolidated financial statements. Determining whether to consolidate a VIE may require judgment in assessing (i) whether an entity is a VIE, and (ii) if a reporting entity is a VIE's primary beneficiary. A reporting entity is determined to be a VIE's primary beneficiary if it has the power to direct the activities that most significantly impact a VIE's economic performance and the obligation to absorb losses or rights to receive benefits that could potentially be significant to a VIE.
We had 411, 375 and 342 stores operated by IOs as of January 1, 2022, January 2, 2021 and December 28, 2019, respectively. We have agreements in place with each IO. The IO orders merchandise exclusively from us which is provided to the IO on consignment. Under the Independent Operator Agreement (the "Operator Agreement"), the IO may select a majority of merchandise that we consign to the IO, which the IO chooses from our merchandise order guide according to the IO's knowledge and experience with local customer purchasing trends, preferences, historical sales and similar factors. The Operator Agreement gives the IO discretion to adjust our initial prices if the overall effect of all price changes at any time comports with the reputation of our Grocery Outlet retail stores for selling quality, name-brand consumables and fresh products and other merchandise at extreme discounts. IOs are required to furnish initial working capital and to acquire certain store and safety assets. The IO is also required to hire, train and employ a properly trained workforce sufficient in number to enable the IO to fulfill its obligations under the Operator Agreement. Additionally, the IO is responsible for expenses required for business operations, including all labor costs, utilities, credit card processing fees, supplies, taxes, fines, levies and other expenses. Either party may terminate the Operator Agreement without cause upon 75 days' notice.
As consignor of all merchandise to each IO, the aggregate net sales proceeds from merchandise sales belongs to us. Net sales related to IO stores were $3.0 billion, $3.1 billion, and $2.5 billion for the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019, respectively. We, in turn, pay IOs a commission based on a share of the gross profit of the store. Inventories and related net sales proceeds are our property, and we are responsible for store rent and related occupancy costs. IO commissions were expensed and included in SG&A. IO commissions were $463.8 million, $469.3 million, and $382.8 million for the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019, respectively. IO commissions of $9.1 million and $6.0 million were included in accrued expenses as of January 1, 2022 and January 2, 2021, respectively.
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IOs may fund their initial store investment from existing capital, a third-party loan or most commonly through a loan from us, as further discussed in NOTE 2—Independent Operator Notes and Independent Operator Receivables. As collateral for IO obligations and performance, the Operator Agreements grant us the security interests in the assets owned by the IOs related to the respective store. Since the total investment at risk associated with each IO is not sufficient to permit each IO to finance its activities without additional subordinated financial support, the IOs are VIEs which we have variable interests in. To determine if we are the primary beneficiary of these VIEs, we evaluate whether we have (i) the power to direct the activities that most significantly impact the IO's economic performance and (ii) the obligation to absorb losses or the right to receive benefits of the IO that could potentially be significant to the IO. Our evaluation includes identification of significant activities and an assessment of its ability to direct those activities.
Activities that most significantly impact the IO's economic performance relate to sales and labor. Sales activities that significantly impact the IO's economic performance include determining what merchandise the IO will order and sell and the price of such merchandise, both of which the IO controls. The IO is also responsible for all of their own labor. Labor activities that significantly impact the IO's economic performance include hiring, training, supervising, directing, compensating (including wages, salaries and employee benefits) and terminating all of the employees of the IO, activities which the IO controls. Accordingly, the IO has the power to direct the activities that most significantly impact the IO's economic performance. Furthermore, the mutual termination rights associated with the Operator Agreements illustrate the lack of ultimate control over the IO. Therefore, the Company is not the primary beneficiary of these VIEs.
Our maximum exposure to the IOs is generally limited to the IO notes and IO receivables due from these entities, which was $40.6 million and $41.0 million as of January 1, 2022 and January 2, 2021, respectively. See NOTE 2—Independent Operator Notes and Independent Operator Receivables, for additional information.
Net Income Per Share — Basic net income per share is calculated using net income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted net income per share reflects the dilutive effects of stock options and RSUs outstanding during the period, to the extent such securities would not be anti-dilutive, and is determined using the treasury stock method.
Recently Adopted Accounting Standards
ASU No. 2019-12 —In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 simplifies accounting guidance for certain tax matters including franchise taxes, certain transactions that result in a step-up in tax basis of goodwill, and enacted changes in tax laws in interim periods. In addition, it eliminates a company's need to evaluate certain exceptions relating to the incremental approach for intra-period tax allocation, accounting for basis differences when there are ownership changes in foreign investments, and interim period income tax accounting for year-to-date losses that exceed anticipated losses. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. We adopted ASU 2019-12 beginning in the first quarter of fiscal 2021. The adoption of ASU 2019-12 did not have a material impact on our consolidated financial statements.
Recently Issued Accounting Pronouncements
No recently issued accounting pronouncements are expected to have a material effect on our consolidated financial statements.
NOTE 2—Independent Operator Notes and Independent Operator Receivables
The amounts included in IO notes and IO receivables consist primarily of funds we loaned to IOs, net of estimated uncollectible amounts. IO notes are payable on demand and typically bear interest at rates between 3.00% and 9.95%. Accrued interest receivable on IO notes is included within the "independent operator receivables and current portion of independent operator notes, net of allowance" line item on the condensed consolidated balance sheets and was $0.5 million and $0.4 million as of January 1, 2022 and January 2, 2021, respectively. There were no IO notes that were past due or on a non-accrual status due to delinquency as of January 1, 2022 or January 2, 2021. Notes and receivables from our IOs
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participating in our TCAP, as defined below, are not considered to be past due or on a non-accrual status due to delinquency and are excluded from such measures.
IO notes and receivables are financial assets which are measured and carried at amortized cost. An allowance for expected credit losses is deducted from (for expected losses) or added to (for expected recoveries) the amortized cost basis of these assets to arrive at the net carrying amount expected to be collected for such assets.
The allowance is estimated using an expected loss framework, which includes information about past events, current conditions, and reasonable and supportable forecasts that impact the collectibility of the reported amounts of the assets over their lifetime. The allowance is evaluated on a collective basis for assets with shared risk characteristics and credit quality indicators. The primary shared risk characteristic and credit quality indicator pools that we use as a basis for collective evaluation include:
•TCAP — Includes the notes and receivables from IOs with stores that have been open for more than 18 months that are participating in our Temporary Commission Adjustment Program ("TCAP") as of the end of each reporting period. TCAP allows us to provide a greater commission to participating IOs who require assistance in meeting their working capital needs for various reasons, such as new or increased competition or differences in IO skills and experience.
•Non-TCAP — Includes the notes and receivables from IOs with stores that have been open for more than 18 months that are not participating in TCAP as of the end of each reporting period.
•New store — Includes the notes and receivables from IOs with stores that have been open for less than 18 months as of the end of each reporting period.
Assets without such shared risk characteristics or credit quality indicators, such as assets with unique circumstances or with delinquencies and historical losses in excess of their TCAP, non-TCAP or new store peers are evaluated on an individual basis.
Amounts due from IOs and the related allowances as of January 1, 2022 and January 2, 2021 consisted of the following (amounts in thousands):
Allowance Current Portion Long-term Portion
Gross Current Portion Long-term Portion Net
Allowance Current Portion Long-term Portion
Gross Current Portion Long-term Portion Net
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A summary of activity in the IO notes and IO receivables allowance was as follows (amounts in thousands):
Fiscal Year Ended
Provision for IO notes and IO receivables 4,790 (473) 2,741
Cumulative effect of accounting change — (439) —
Write-off of provision for IO notes and IO receivables (987) (1,350) (1,437)
The following table presents the amortized cost basis of IO notes by year of origination and credit quality indicator as of January 1, 2022 (amounts in thousands):
NOTE 3—Property and Equipment
Property and equipment as of January 1, 2022 and January 2, 2021 consisted of the following (amounts in thousands):
Construction in progress is primarily composed of leasehold improvements and fixtures and equipment related to new or remodeled stores where construction had not been completed at year-end.
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Depreciation expense on property and equipment for fiscal 2021, 2020 and 2019 was as follows (amounts in thousands):
Fiscal Year Ended
Total depreciation expense on property and equipment $ 63,442 $ 50,749 $ 42,906
NOTE 4—Leases
Leases for 15 of our store locations and one warehouse location are controlled by related parties as of January 1, 2022 and January 2, 2021. See NOTE 11—Related Party Transactions, for additional information.
As of January 1, 2022, we had executed leases for 25 store locations that we had not yet taken possession of with total undiscounted future lease payments of $141.9 million and lease terms through 2039.
Based upon our initial investment in store leasehold improvements, we utilize an initial, reasonably-certain lease life of 15 years. Most leases include one or more options to renew, with renewal terms that can extend the lease term from five to 15 years or more. Our leases do not include any material residual value guarantees or material restrictive covenants. We also have non-cancelable subleases with unrelated third parties with future minimum rental receipts as of January 1, 2022 totaling $5.3 million ending in various years through 2036, which have not been deducted from the future minimum lease payments.
The balance sheet classification of our right-of-use lease assets and lease liabilities was as follows (amounts in thousands):
Leases Classification January 1,2022 January 2,2021
Assets:
Operating lease assets Operating right-of-use assets $ 898,152 $ 835,397
Finance lease assets Other assets 6,896 5,973
Liabilities:
Current
Operating Current lease liabilities $ 49,861 $ 47,730
Finance Current lease liabilities 1,275 945
Noncurrent
Finance Long-term lease liabilities 5,642 5,109
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The components of lease expense were as follows (amounts in thousands):
Fiscal Year Ended
Finance lease cost:
Amortization of right-of-use assets Depreciation and amortization 1,249 964 817
Interest on leased liabilities Interest expense, net 378 376 263
Variable lease cost Selling, general and administrative expenses 547 700 668
_______________________
(1)Certain supply chain related lease costs herein are included in cost of sales.
Maturities of lease liabilities as of January 1, 2022 were as follows (amounts in thousands):
Operating Leases Finance Leases Total
The weighted-average lease terms and discount rates of operating and finance leases were as follows:
Weighted-average remaining lease term:
Operating leases 11.6 years 12.0 years
Finance leases 5.8 years 6.7 years
Weighted-average discount rate:
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Supplemental cash flow information related to leases was as follows (amounts in thousands):
Fiscal Year Ended
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from finance leases $ 378 $ 378 $ 337
Finance cash flows from finance leases $ 1,155 $ 821 $ 675
NOTE 5—Goodwill and Intangible Assets
Information regarding our goodwill and intangible assets as of January 1, 2022 was as follows (amounts in thousands):
Gross Carrying Amount Accumulated Amortization Net Carrying Amount
Information regarding our goodwill and intangible assets as of January 2, 2021 was as follows (amounts in thousands):
Gross Carrying Amount Accumulated Amortization Net Carrying Amount
Amortization expense for finite-lived intangible assets was $6.6 million, $6.5 million, and $6.7 million for the fiscal years ended January 1, 2022, January 2, 2021, and December 28, 2019, respectively.
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The estimated future amortization expense related to finite-lived intangible assets as of January 1, 2022 is as follows (amounts in thousands):
NOTE 6—Long-term Debt
Long-term debt consisted of the following (amounts in thousands):
First Lien Credit Agreement:
Less: Unamortized debt discounts and debt issuance costs (8,532) (10,767)
First Lien Credit Agreement
GOBP Holdings, our wholly owned subsidiary, together with another of our wholly owned subsidiaries, has a first lien credit agreement (the "First Lien Credit Agreement") with a syndicate of lenders that consists of a $460.0 million senior term loan and a revolving credit facility for an amount up to $100.0 million, with sub-commitments for a $35.0 million letter of credit and $20.0 million of swingline loans as of January 1, 2022. The First Lien Credit Agreement permits voluntary prepayment on borrowings without premium or penalty. Borrowings under the First Lien Credit Agreement are secured by substantially all the assets of the borrower subsidiary and its guarantors.
Term Loan
Our $460.0 million senior term loan matures on October 22, 2025 and had an interest rate of 2.85% as of January 1, 2022. Due to previous prepayments on the term loan, no further principal payment on the term loan will be due until the maturity date. The terms of the First Lien Credit Agreement include mandatory prepayment requirements on the term loan if certain conditions are met (as described in the First Lien Credit Agreement).
On January 24, 2020, GOBP Holdings together with another of our wholly owned subsidiaries, entered into a second incremental agreement (the "Second Incremental Agreement") which amended a previous incremental agreement (the "First Incremental Agreement"). The Second Incremental Agreement refinanced a previous replacement term loan under the First Incremental Agreement with a replacement $460.0 million senior secured term loan (the "Second Replacement Term Loan") with an applicable margin of 2.75% for Eurodollar loans and 1.75% for base rate loans, in each case depending on the public corporate family rating of GOBP Holdings, and made certain other corresponding technical changes and updates to the First Incremental Agreement. We wrote off debt issuance costs of $0.1 million and incurred debt modification costs of $0.1 million during the first quarter of fiscal 2020 in connection with this refinance.
Other than as described above, the Second Replacement Term Loan has the same terms as provided under the original First Lien Credit Agreement and the First Incremental Agreement. Additionally, the parties to the Second Incremental Agreement continue to have the same obligations set forth in the original First Lien Credit Agreement and the First Incremental Agreement.
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Revolving Credit Facility
As of January 1, 2022, we had $3.5 million of outstanding standby letters of credit and $96.5 million of remaining borrowing capacity available under the revolving credit facility. No amounts were outstanding under the revolving credit facility as of January 1, 2022 and January 2, 2021.
We are required to pay a quarterly commitment fee ranging from 0.25% to 0.50% on the daily unused amount of the commitment under the revolving credit facility based upon the leverage ratio defined in the agreement and certain criteria specified in the agreement. We are also required to pay fronting fees and other customary fees for letters of credit issued under the revolving credit facility. The interest rate for the revolving credit facility is determined based on a formula using certain market rates.
On March 19, 2020, we borrowed $90.0 million under the revolving credit facility of our First Lien Credit Agreement (the "Revolving Credit Facility Loan"), the proceeds of which were to be used as reserve funding for working capital needs as a precautionary measure in light of the economic uncertainty surrounding the COVID-19 pandemic. On May 26, 2020, we repaid the Revolving Credit Facility Loan in full. No amounts were borrowed under the Revolving Credit Facility Loan during the fiscal year ended January 1, 2022.
Debt Covenants
The First Lien Credit Agreement contains certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants. The First Lien Credit Agreement restricts us from entering into certain types of transactions and making certain types of payments including dividends and stock repurchase and other similar distributions, with certain exceptions. Additionally, borrowing availability under the revolving credit facility under our First Lien Credit Agreement is subject to a first lien secured leverage ratio (as defined in the First Lien Credit Agreement) of 7.00 to 1.00, tested quarterly if, and only if, the aggregate principal amount outstanding and/or issued, as applicable, from the revolving facility, letters of credit (to the extent not cash collateralized or backstopped or, in the aggregate, not in excess of the greater of $10.0 million and the stated face amount of letters of credit outstanding on the closing date) and swingline loans exceeds 35% of the total amount of the revolving credit facility commitments (as defined in the First Lien Credit Agreement).
As of January 1, 2022, we were in compliance with all applicable financial covenant requirements for our First Lien Credit Agreement.
Schedule of Principal Maturities
Principal maturities of debt as of January 1, 2022 are as follows (amounts in thousands):
Thereafter —
Interest Expense, Net
Interest expense, net, consisted of the following (amounts in thousands):
Fiscal Year Ended
Amortization of debt issuance costs and debt discounts 2,511 2,452 2,542
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Debt Extinguishment and Modification Costs
Debt extinguishment and modification costs consisted of the following (amounts in thousands):
Fiscal Year Ended
Write-off of debt issuance costs $ — $ 74 $ 4,110
Debt modification costs — 124 150
Write off of debt discounts — — 1,374
Debt extinguishment and modification costs $ — $ 198 $ 5,634
NOTE 7—Stockholders' Equity
As of January 1, 2022, the total amount of the Company’s authorized capital stock consisted of 500,000,000 shares of common stock, par value $0.001 per share, and 50,000,000 shares of undesignated preferred stock, par value of $0.001 per share.
Common Stock
Holders of our common stock are entitled to one vote for each share held of record on all matters on which stockholders are entitled to vote generally, including the election or removal of directors. The holders of our common stock do not have cumulative voting rights in the election of directors.
Preferred Stock
We did not have any shares of preferred stock issued or outstanding as of January 1, 2022. Our Board of Directors has the authority to issue shares of preferred stock from time to time on terms it may determine, with respect to any series of preferred stock, the powers (including voting powers), preferences and relative, participating, optional and other special rights, and the qualifications, limitations or restrictions thereof as the board of directors may from time to time determine, which could affect the relative voting power or other rights of the holders of our common stock. The issuance of preferred stock could have the effect of decreasing the trading price of our common stock, restricting dividends on the common stock, diluting the voting power of our common stock, or subordinating the liquidation rights of the common stock.
Dividend Rights
Holders of our common stock are entitled to receive dividends when, as and if declared by our board of directors out of funds legally available therefor, subject to any statutory or contractual restrictions on the payment of dividends and to the rights of the holders or one or more outstanding series of our preferred stock.
Initial Public Offering
In June 2019, we completed an initial public offering ("IPO") of 19,765,625 shares of our common stock at a public offering price of $22.00 per share for net proceeds of $407.7 million, after deducting underwriting discounts and commissions of $27.1 million. We also incurred offering costs payable by us of $7.2 million. The shares of common stock sold in the IPO and the net proceeds from the IPO included the full exercise of the underwriters' option to purchase additional shares.
Our Amended and Restated Certificate of Incorporation (the "Charter") became effective in connection with the completion of the IPO on June 24, 2019. The Charter, among other things, provided that all of our outstanding shares of nonvoting common stock were automatically converted into shares of voting common stock on a one-for-one basis and that our authorized capital stock consisted of 500,000,000 shares of common stock, and 50,000,000 shares of preferred stock, par value $0.001 per share. Our bylaws were also amended and restated as of June 24, 2019. Additionally, upon the closing of the IPO, we redeemed all of our outstanding preferred stock for an aggregate of $1.00.
On June 24, 2019, we used the net proceeds from the IPO to repay $150.0 million in principal on the outstanding term loan under our second lien credit agreement, dated as of October 22, 2018 (as amended, the "Second Lien Credit Agreement"), as well as accrued and unpaid interest as of that date of $3.6 million, and terminated the Second Lien Credit Agreement. In addition, using the remainder of net proceeds, together with excess cash on hand, we prepaid a portion of our outstanding senior secured term loan under our First Lien Credit Agreement (as defined below) totaling $248.0 million
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plus accrued interest of $3.8 million. On October 23, 2019, we prepaid an additional $15.0 million of principal on the senior secured term loan under the First Lien Credit Agreement.
Secondary Public Offerings
On October 8, 2019, certain of our selling stockholders completed a secondary public offering of shares of our common stock. We did not receive any of the proceeds from the sale of these shares by the selling stockholders. We incurred related offering costs of $1.1 million, which we recognized in selling, general and administrative expenses ("SG&A") for fiscal 2019, and received $3.2 million in cash (excluding withholding taxes) in connection with the exercise of 451,470 options by certain stockholders participating in this secondary public offering.
On February 3, 2020, certain selling stockholders completed an additional secondary public offering of shares of our common stock. We did not receive any of the proceeds from the sale of these shares by the selling stockholders. We incurred offering costs of $1.1 million, which we recognized in SG&A during fiscal 2020. We received $1.4 million in cash (excluding withholding taxes) in connection with the exercise of 191,470 options by certain stockholders participating in this secondary public offering.
On April 27, 2020, certain of our selling stockholders completed another secondary public offering of shares of our common stock. We did not receive any of the proceeds from the sale of these shares by the selling stockholders. We incurred related offering costs of $1.0 million which we recognized in SG&A during fiscal 2020. We received $1.6 million in cash (excluding withholding taxes) in connection with the exercise of 269,000 options by certain stockholders participating in this secondary public offering.
On May 28, 2020, the stockholder affiliated with our former private equity sponsor, Hellman and Friedman LLC (the "H&F Investor"), distributed the remainder of its holdings representing 9.6 million shares of our common stock to its equity holders. We did not receive any proceeds or incur any material costs related to this distribution.
Share Repurchase Program
In November 2021, our Board of Directors approved a share repurchase program. This program, effective November 5, 2021 and without an expiration date, authorized us to repurchase up to $100.0 million of our outstanding common stock utilizing a variety of methods including open market purchases, accelerated share repurchase programs, privately negotiated transactions, structured repurchase transactions and under a Rule 10b5-1 plan (which would permit shares to be repurchased when the Company might otherwise be precluded from doing so under securities laws). During the fiscal year ended January 1, 2022, we did not purchase any of our equity securities. As of January 1, 2022, we had $100.0 million of repurchase authority remaining under the share repurchase program.
NOTE 8—Share-based Awards
Share-based Incentive Plans
The Globe Holding Corp. 2014 Stock Incentive Plan (the "2014 Plan") became effective on October 21, 2014. Under the 2014 Plan, we granted stock options and RSUs to purchase shares of our common stock. Effective as of June 19, 2019, we terminated the 2014 Plan and as a result no further equity awards may be issued under the 2014 Plan. Any outstanding awards granted under the 2014 Plan will remain subject to the terms of the 2014 Plan and the applicable equity award agreements.
On June 4, 2019, our Board of Directors and stockholders approved the Grocery Outlet Holding Corp. 2019 Incentive Plan (the "2019 Plan"). A total of 4,597,862 shares of common stock were reserved for issuance under the 2019 Plan at that time. In addition, on the first day of each fiscal year beginning in fiscal 2020 and ending in fiscal 2029, the 2019 Plan provides for an annual automatic increase of the shares reserved for issuance in an amount equal to the positive difference between (i) 4% of the "outstanding common stock" (as defined in the 2019 Plan) on the last day of the immediately preceding fiscal year and (ii) the plan share reserve on the last day of the immediately preceding fiscal year, or a lesser number as determined by our Board of Directors. As of January 1, 2022, there were a total of 6,048,252 shares of common stock reserved for issuance under the 2019 Plan, which includes 501,845 shares added effective January 3, 2021 per the above noted annual automatic increase. As of January 1, 2022, there were 3,330,247 remaining shares available for issuance of new equity awards under the 2019 Plan.
Long-term incentive programs ("LTIPs") under the 2019 Plan consist of time-based RSUs and PSUs. RSUs granted under the LTIPs generally vest over one to three years. Half of the total PSUs granted under the LTIPs will vest upon the achievement of certain revenue-based performance targets ("Tranche I PSUs") and half will vest upon the achievement of certain adjusted EBITDA-based performance targets ("Tranche II PSUs") as determined by the Compensation Committee following the last day of a three-year performance period. The number of PSUs ultimately earned will equal the number of
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Tranche I and Tranche II PSUs granted multiplied by the applicable percentage of actual revenue and adjusted-EBITDA performance target levels achieved, and can range from 0% to 200% of the number of PSUs granted.
Fair Value Determination
The fair value of stock option, RSU and PSU awards is determined as of the grant date. For time-based stock options, a Black-Scholes valuation model is utilized to estimate the fair value of the awards. For performance-based stock options, a Monte Carlo simulation approach implemented in a risk-neutral framework is utilized to estimate the fair value of the awards. For RSUs and PSUs, the closing price of our common stock as reported on the grant date is utilized to estimate the fair value of the awards.
The respective valuation methods resulted in weighted-average grant date fair values for time-based stock options, performance-based stock options, RSUs, and PSUs granted during fiscal 2021, 2020 and 2019 as follows:
Fiscal Year Ended
Time-based stock options N/A N/A $ 7.61
Performance-based stock options N/A N/A $ 5.78
We did not award any time-based or performance-based stock options during fiscal 2021 and 2020. The grant date fair value of time-based stock options awarded during fiscal 2019 was estimated using the Black-Scholes valuation model with the following weighted-average assumptions:
Exercise price $ 21.66
Volatility 30.2 %
Risk-free interest rate 1.9 %
Dividend yield — %
Expected term (in years) 6.8
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Grant Activity
The following table summarizes stock option activity under all equity incentive plans during fiscal 2021, 2020 and 2019:
Time-Based Stock Options Performance-Based Stock Options
Granted — — — —
Granted — — — —