Grocery Outlet Holding Corp. - Quarter Report: 2023 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the quarterly period ended September 30, 2023
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the transition period from to
Commission File Number: 001-38950
Grocery Outlet Holding Corp.
(Exact name of registrant as specified in its charter)
| Delaware | 47-1874201 | |||||||||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||||||||
5650 Hollis Street, Emeryville, California | 94608 | |||||||||||||
| (Address of principal executive offices) | (Zip Code) | |||||||||||||
(510) 845-1999 | ||||||||||||||
| (Registrant's telephone number, including area code) | ||||||||||||||
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||||||||
| Common Stock, par value $0.001 per share | GO | Nasdaq Global Select Market | ||||||||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☒ | Accelerated filer | ☐ | ||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||
| Emerging growth company | ☐ | ||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of November 2, 2023, the registrant had 99,269,236 shares of common stock outstanding.
GROCERY OUTLET HOLDING CORP.
FORM 10-Q
TABLE OF CONTENTS
| Page | ||||||||
Item 2. | ||||||||
| Item 4. | ||||||||
1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10-Q ("Form 10-Q" or "report") constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this report other than statements of historical fact may constitute forward-looking statements, including statements regarding our future operating results and financial position, our business strategy and plans, business and market trends, our objectives for future operations, macroeconomic and geopolitical conditions, and the sufficiency of our cash balances, working capital and cash generated from operating, investing and financing activities for our future liquidity and capital resource needs. Words such as "anticipate," "believe," "estimate," "expect," "intend," "may," "outlook," "plan," "project," "seek," "will," and similar expressions, are intended to identify such forward-looking statements. These forward-looking statements are subject to a number of risks, uncertainties and assumptions that may cause actual results to differ materially from those expressed or implied by any forward-looking statements we make, including those described under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, and as described in other subsequent reports we file with the United States ("U.S.") Securities and Exchange Commission (the "SEC"), including this report. We encourage you to read this report and our other filings with the SEC carefully. Moreover, we operate in a very competitive and rapidly changing environment and new risks emerge from time to time.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, and our expectations based on third-party information and projections are from sources that management believes to be reputable, we cannot guarantee future results, levels of activities, performance or achievements. These forward-looking statements are made as of the date of this report or as of the date specified herein and we have based these forward-looking statements on our current expectations and projections about future events and trends. Except as required by law, we do not undertake any duty to update any of these forward-looking statements after the date of this report or to conform these statements to actual results or revised expectations.
As used in this report, references to "Grocery Outlet," "the Company," "registrant," "we," "us" and "our," refer to Grocery Outlet Holding Corp. and its consolidated subsidiary unless otherwise indicated or the context requires otherwise.
Website Disclosure
We use our website, https://investors.groceryoutlet.com, as a channel of distribution of Company information. Financial and other important information about us is routinely accessible through and posted on our website. Accordingly, investors should monitor our website, in addition to following our press releases, SEC filings and public conference calls and webcasts. The contents of our website and information accessible through our website is not, however, incorporated by reference or a part of this report. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and the proxy statements for our annual meetings of stockholders are available, free of charge, on our website as soon as practicable after we file the reports with the SEC.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GROCERY OUTLET HOLDING CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
| September 30, 2023 | December 31, 2022 | ||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 155,663 | $ | 102,728 | |||||||
Independent operator receivables and current portion of independent operator notes, net of allowance $5,024 and $2,238 | 9,269 | 10,805 | |||||||||
Other accounts receivable, net of allowance $77 and $7 | 13,876 | 4,368 | |||||||||
| Merchandise inventories | 308,605 | 334,319 | |||||||||
| Prepaid expenses and other current assets | 27,076 | 15,137 | |||||||||
| Total current assets | 514,489 | 467,357 | |||||||||
Independent operator notes and receivables, net of allowance $11,351 and $12,509 | 25,990 | 22,535 | |||||||||
| Property and equipment, net | 626,976 | 560,746 | |||||||||
| Operating lease right-of-use assets | 926,462 | 902,163 | |||||||||
| Intangible assets, net | 76,958 | 63,993 | |||||||||
| Goodwill | 747,943 | 747,943 | |||||||||
| Other assets | 10,641 | 7,667 | |||||||||
| Total assets | $ | 2,929,459 | $ | 2,772,404 | |||||||
| Liabilities and Stockholders' Equity | |||||||||||
| Current liabilities: | |||||||||||
| Trade accounts payable | $ | 183,982 | $ | 137,631 | |||||||
| Accrued and other current liabilities | 87,871 | 53,213 | |||||||||
| Accrued compensation | 28,252 | 27,194 | |||||||||
| Current portion of long-term debt | 5,625 | — | |||||||||
| Current lease liabilities | 63,333 | 54,586 | |||||||||
| Income and other taxes payable | 14,650 | 7,890 | |||||||||
| Total current liabilities | 383,713 | 280,514 | |||||||||
| Long-term debt, net | 288,884 | 379,650 | |||||||||
| Deferred income tax liabilities, net | 35,132 | 19,782 | |||||||||
| Long-term lease liabilities | 1,016,634 | 980,759 | |||||||||
| Other long-term liabilities | 2,005 | 1,485 | |||||||||
| Total liabilities | 1,726,368 | 1,662,190 | |||||||||
| Commitments and contingencies (Note 8) | |||||||||||
| Stockholders' equity: | |||||||||||
Common stock, par value $0.001 per share, 500,000,000 shares authorized; 99,338,790 and 97,674,356 shares issued and outstanding, respectively | 99 | 98 | |||||||||
Series A preferred stock, par value $0.001 per share, 50,000,000 shares authorized; no shares issued and outstanding | — | — | |||||||||
| Additional paid-in capital | 875,134 | 847,589 | |||||||||
| Retained earnings | 327,858 | 262,527 | |||||||||
| Total stockholders' equity | 1,203,091 | 1,110,214 | |||||||||
| Total liabilities and stockholders' equity | $ | 2,929,459 | $ | 2,772,404 | |||||||
See Notes to Condensed Consolidated Financial Statements
3
GROCERY OUTLET HOLDING CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Net sales | $ | 1,003,913 | $ | 918,185 | $ | 2,979,635 | $ | 2,647,271 | |||||||||||||||
| Cost of sales | 688,222 | 637,550 | 2,036,831 | 1,836,336 | |||||||||||||||||||
| Gross profit | 315,691 | 280,635 | 942,804 | 810,935 | |||||||||||||||||||
| Selling, general and administrative expenses | 278,134 | 255,948 | 835,948 | 739,909 | |||||||||||||||||||
| Operating income | 37,557 | 24,687 | 106,856 | 71,026 | |||||||||||||||||||
| Other expenses: | |||||||||||||||||||||||
| Interest expense, net | 4,226 | 4,798 | 14,911 | 12,355 | |||||||||||||||||||
| Loss on debt extinguishment and modification | — | — | 5,340 | 1,274 | |||||||||||||||||||
| Total other expenses | 4,226 | 4,798 | 20,251 | 13,629 | |||||||||||||||||||
| Income before income taxes | 33,331 | 19,889 | 86,605 | 57,397 | |||||||||||||||||||
| Income tax expense | 6,191 | 2,394 | 21,274 | 8,234 | |||||||||||||||||||
| Net income and comprehensive income | $ | 27,140 | $ | 17,495 | $ | 65,331 | $ | 49,163 | |||||||||||||||
| Basic earnings per share | $ | 0.27 | $ | 0.18 | $ | 0.66 | $ | 0.51 | |||||||||||||||
| Diluted earnings per share | $ | 0.27 | $ | 0.17 | $ | 0.65 | $ | 0.49 | |||||||||||||||
| Weighted average shares outstanding: | |||||||||||||||||||||||
| Basic | 99,108 | 97,057 | 98,514 | 96,587 | |||||||||||||||||||
| Diluted | 100,973 | 100,485 | 100,727 | 100,051 | |||||||||||||||||||
See Notes to Condensed Consolidated Financial Statements
4
GROCERY OUTLET HOLDING CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
(unaudited)
| Common Stock | Additional Paid-In Capital | Retained Earnings | Stockholders' Equity | ||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||
| Balance as of December 31, 2022 | 97,674,356 | $ | 98 | $ | 847,589 | $ | 262,527 | $ | 1,110,214 | ||||||||||||||||||||
| Exercise and vesting of share-based awards | 734,310 | — | 204 | — | 204 | ||||||||||||||||||||||||
| Share-based compensation expense | — | — | 6,676 | — | 6,676 | ||||||||||||||||||||||||
| Repurchase of common stock | (122,862) | — | (3,275) | — | (3,275) | ||||||||||||||||||||||||
| Net income and comprehensive income | — | — | — | 13,720 | 13,720 | ||||||||||||||||||||||||
| Balance as of April 1, 2023 | 98,285,804 | $ | 98 | $ | 851,194 | $ | 276,247 | $ | 1,127,539 | ||||||||||||||||||||
| Exercise and vesting of share-based awards, net of shares withheld for employee taxes | 487,445 | 1 | 1,507 | — | 1,508 | ||||||||||||||||||||||||
| Share-based compensation expense | — | — | 11,305 | — | 11,305 | ||||||||||||||||||||||||
| Dividends paid | — | — | (9) | — | (9) | ||||||||||||||||||||||||
| Net income and comprehensive income | — | — | — | 24,471 | 24,471 | ||||||||||||||||||||||||
| Balance as of July 1, 2023 | 98,773,249 | $ | 99 | $ | 863,997 | $ | 300,718 | $ | 1,164,814 | ||||||||||||||||||||
| Exercise and vesting of share-based awards, net of shares withheld for employee taxes | 565,541 | — | 3,602 | — | 3,602 | ||||||||||||||||||||||||
| Share-based compensation expense | — | — | 7,535 | — | 7,535 | ||||||||||||||||||||||||
| Net income and comprehensive income | — | — | — | 27,140 | 27,140 | ||||||||||||||||||||||||
| Balance as of September 30, 2023 | 99,338,790 | $ | 99 | $ | 875,134 | $ | 327,858 | $ | 1,203,091 | ||||||||||||||||||||
See Notes to Condensed Consolidated Financial Statements
5
GROCERY OUTLET HOLDING CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY, continued
(in thousands, except share amounts)
(unaudited)
| Common Stock | Additional Paid-In Capital | Retained Earnings | Stockholders' Equity | ||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||
| Balance as of January 1, 2022 | 96,144,433 | $ | 96 | $ | 811,701 | $ | 197,475 | $ | 1,009,272 | ||||||||||||||||||||
| Exercise and vesting of share-based awards | 276,473 | — | 887 | — | 887 | ||||||||||||||||||||||||
| Share-based compensation expense | — | — | 5,795 | — | 5,795 | ||||||||||||||||||||||||
| Repurchase of common stock | (139,718) | — | (3,451) | — | (3,451) | ||||||||||||||||||||||||
| Dividends paid | — | — | (7) | — | (7) | ||||||||||||||||||||||||
| Net income and comprehensive income | — | — | — | 11,574 | 11,574 | ||||||||||||||||||||||||
| Balance as of April 2, 2022 | 96,281,188 | $ | 96 | $ | 814,925 | $ | 209,049 | $ | 1,024,070 | ||||||||||||||||||||
| Exercise and vesting of share-based awards | 565,792 | 1 | 3,068 | — | 3,069 | ||||||||||||||||||||||||
| Share-based compensation expense | — | — | 9,484 | — | 9,484 | ||||||||||||||||||||||||
| Dividends paid | — | — | (26) | — | (26) | ||||||||||||||||||||||||
| Net income and comprehensive income | — | — | — | 20,094 | 20,094 | ||||||||||||||||||||||||
| Balance as of July 2, 2022 | 96,846,980 | $ | 97 | $ | 827,451 | $ | 229,143 | $ | 1,056,691 | ||||||||||||||||||||
| Exercise and vesting of share-based awards | 381,858 | — | 2,042 | — | 2,042 | ||||||||||||||||||||||||
| Share-based compensation expense | — | — | 9,084 | — | 9,084 | ||||||||||||||||||||||||
| Net income and comprehensive income | — | — | — | 17,495 | 17,495 | ||||||||||||||||||||||||
| Balance as of October 1, 2022 | 97,228,838 | $ | 97 | $ | 838,577 | $ | 246,638 | $ | 1,085,312 | ||||||||||||||||||||
See Notes to Condensed Consolidated Financial Statements
6
GROCERY OUTLET HOLDING CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| 39 Weeks Ended | |||||||||||
| September 30, 2023 | October 1, 2022 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 65,331 | $ | 49,163 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation of property and equipment | 56,012 | 53,067 | |||||||||
| Amortization of intangible and other assets | 7,669 | 5,631 | |||||||||
| Amortization of debt issuance costs and debt discounts | 856 | 1,727 | |||||||||
| Non-cash rent | 4,144 | 5,360 | |||||||||
| Loss on debt extinguishment and modification | 5,340 | 1,274 | |||||||||
| Share-based compensation | 25,516 | 24,363 | |||||||||
| Provision for accounts receivable reserves | 2,777 | 2,773 | |||||||||
| Deferred income taxes | 15,350 | 7,633 | |||||||||
| Other | 477 | 890 | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Independent operator and other accounts receivable | (13,928) | (3,509) | |||||||||
| Merchandise inventories | 25,714 | (56,389) | |||||||||
| Prepaid expenses and other assets | (11,812) | (406) | |||||||||
| Income and other taxes payable | 6,760 | 1,729 | |||||||||
| Trade accounts payable, accrued compensation and other liabilities | 70,808 | 35,182 | |||||||||
| Operating lease liabilities | 15,204 | 11,372 | |||||||||
| Net cash provided by operating activities | 276,218 | 139,860 | |||||||||
| Cash flows from investing activities: | |||||||||||
| Advances to independent operators | (5,579) | (6,974) | |||||||||
| Repayments of advances from independent operators | 4,770 | 5,433 | |||||||||
| Purchases of property and equipment | (112,916) | (85,359) | |||||||||
| Proceeds from sales of assets | 24 | 34 | |||||||||
| Investments in intangible assets and licenses | (17,862) | (12,361) | |||||||||
| Proceeds from insurance recoveries - property and equipment | 533 | — | |||||||||
| Net cash used in investing activities | (131,030) | (99,227) | |||||||||
| Cash flows from financing activities: | |||||||||||
| Proceeds from exercise of stock options | 5,851 | 5,998 | |||||||||
| Tax withholding related to net settlement of employee share-based awards | (537) | — | |||||||||
| Proceeds from senior term loan due 2028 | 300,000 | — | |||||||||
| Proceeds from revolving credit facility | 25,000 | — | |||||||||
| Principal payments on revolving credit facility | (25,000) | — | |||||||||
| Principal payments on senior term loan due 2025 | (385,000) | (75,000) | |||||||||
| Principal payments on senior term loan due 2028 | (3,750) | — | |||||||||
| Principal payments on finance leases | (1,020) | (955) | |||||||||
| Repurchase of common stock | (3,275) | (3,451) | |||||||||
| Dividends paid | (9) | (33) | |||||||||
| Debt issuance costs paid | (4,513) | — | |||||||||
| Net cash used in financing activities | (92,253) | (73,441) | |||||||||
| Net increase (decrease) in cash and cash equivalents | 52,935 | (32,808) | |||||||||
| Cash and cash equivalents at beginning of period | 102,728 | 140,085 | |||||||||
| Cash and cash equivalents at end of period | $ | 155,663 | $ | 107,277 | |||||||
See Notes to Condensed Consolidated Financial Statements
7
GROCERY OUTLET HOLDING CORP.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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 subsidiary, "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. Effective July 12, 2023, subsidiaries Globe Intermediate Corp., GOBP Holdings, Inc. and GOBP Midco, Inc. were merged with and into Grocery Outlet Holding Corp. As of September 30, 2023, we had 455 stores throughout California, Washington, Oregon, Pennsylvania, Idaho, Nevada, Maryland and New Jersey.
Basis of Presentation — The accompanying unaudited condensed 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 United States ("U.S.") Securities and Exchange Commission (the "SEC") for interim reporting. Certain information and note disclosures included in our annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 (the "2022 Form 10-K"). The condensed consolidated balance sheet as of December 31, 2022 included herein has been derived from those audited consolidated financial statements.
Our unaudited condensed consolidated financial statements include the accounts of Grocery Outlet Holding Corp. and its wholly owned subsidiary. All intercompany balances and transactions were eliminated. In the opinion of management, these condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the periods presented. The interim results of operations and cash flows are not necessarily indicative of those results and cash flows expected for any future interim or annual period. Beginning with the first quarter of fiscal 2023, certain prior period amounts in the condensed consolidated statements of operations and comprehensive income have been reclassified to conform to the current period presentation. Specifically, in order to enhance the comparability of our results with our peers, depreciation and amortization expenses and share-based compensation expenses are now included in selling, general and administrative expenses. The reclassification of these items had no impact on net income, earnings per share, or retained earnings in the current or prior periods.
Use of Estimates — The preparation of condensed 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. We consider our accounting policy relating to long-lived asset impairment to be a significant accounting policy that involves management's estimate and judgment.
Segment Reporting — We manage our business as one operating segment. In addition, all of our sales were made to customers located in the U.S. and all property and equipment is located in the U.S.
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.
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 in our condensed consolidated balance sheets. Finance leases are included in other assets, current lease liabilities, and long-term lease liabilities in our condensed 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.
8
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.
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 or non-recurring basis as of September 30, 2023 or December 31, 2022. Generally, assets are recorded at fair value on a non-recurring basis as a result of impairment charges. There were no transfers of assets or liabilities between levels within the fair value hierarchy during the 39 weeks ended September 30, 2023.
Our financial assets and liabilities are carried at cost, which generally approximates their fair value, as described below:
Cash and cash equivalents, independent operator ("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, their variable interest rates or the effect of the related allowance for expected credit losses.
Independent operator 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 condensed consolidated balance sheets (amounts in thousands):
| September 30, 2023 | December 31, 2022 | ||||||||||||||||||||||
Carrying Amount (1) | Estimated Fair Value (2) | Carrying Amount (1) | Estimated Fair Value (3) | ||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||
| Senior term loans (Level 2) | $ | 294,509 | $ | 296,250 | $ | 379,650 | $ | 383,075 | |||||||||||||||
_______________________
(1)The carrying amounts of our senior term loans as of September 30, 2023 and December 31, 2022 were net of unamortized debt discounts of zero and $0.6 million, respectively, and debt issuance costs of $1.7 million and $4.7 million, respectively.
(2)The estimated fair value of our current senior term loan borrowings under our 2023 Credit Agreement, as defined in Note 3, was deemed to approximate the carrying value, excluding unamortized debt issuance costs, because the interest rate is variable with short reset periods and is reflective of the current market rate.
(3)The estimated fair value of our prior senior term loan, as defined in Note 3, was determined based on the average quoted bid-ask prices for the prior senior term loan in an over-the-counter market on the last trading day of the period presented.
9
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 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 net sales as the products are sold. Discounts provided by IOs are not recognized as a reduction in net 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 material performance obligations other than our gift card deferred revenue liability, or any material costs to obtain or fulfill a contract as of September 30, 2023 and December 31, 2022.
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 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 $2.8 million and $3.6 million as of September 30, 2023 and December 31, 2022, respectively. Breakage amounts were immaterial for the 13 and 39 weeks ended September 30, 2023 and October 1, 2022.
Disaggregated Revenues — The following table presents net sales revenue by type of product for the periods indicated (amounts in thousands):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
Perishable (1) | $ | 352,320 | $ | 324,652 | $ | 1,057,929 | $ | 951,034 | |||||||||||||||
Non-perishable (2) | 651,593 | 593,533 | 1,921,706 | 1,696,237 | |||||||||||||||||||
| Total net sales | $ | 1,003,913 | $ | 918,185 | $ | 2,979,635 | $ | 2,647,271 | |||||||||||||||
_______________________
(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.
Variable Interest Entities — In accordance with the variable interest entities sub-section of Accounting Standards Codification ("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 condensed 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 453, 438 and 427 stores operated by IOs as of September 30, 2023, December 31, 2022 and October 1, 2022, 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 selects 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. The IO is 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.
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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 $991.4 million and $903.1 million for the 13 weeks ended September 30, 2023 and October 1, 2022, respectively, and $2.94 billion and $2.60 billion for the 39 weeks ended September 30, 2023 and October 1, 2022, respectively. We, in turn, pay each IO 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 are expensed and included in SG&A. IO commissions were $161.7 million and $136.5 million for the 13 weeks ended September 30, 2023 and October 1, 2022, respectively, and $465.1 million and $395.7 million for the 39 weeks ended September 30, 2023 and October 1, 2022, respectively. IO commissions of $22.6 million and $6.2 million were included in accrued and other current liabilities as of September 30, 2023 and December 31, 2022, respectively.
An IO may fund its initial store investment from existing capital, a third-party loan or most commonly through a loan from us, as further discussed in Note 2. As collateral for IO obligations and performance, the Operator Agreement grants us the security interests in the assets owned by each IO 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, each IO is a VIE that we have a variable interest in. To determine if we are the primary beneficiary of a VIE, 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 the IO's 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 its 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 Agreement illustrate the lack of ultimate control over the IO. Therefore, we are not the primary beneficiary of these VIEs.
Our maximum exposure, in accordance with ASC Topic 810, to the IOs is generally limited to the IO notes and IO receivables due from these entities, which was $51.6 million and $48.1 million as of September 30, 2023 and December 31, 2022, respectively. See Note 2 for additional information.
Recently Adopted Accounting Standards
Accounting Standards Update ("ASU") No. 2022-02 — In March 2022, the Financial Accounting Standards Board issued ASU No. 2022-02, Troubled Debt Restructurings and Vintage Disclosures ("ASU 2022-02"). ASU 2022-02 eliminates the accounting guidance on troubled debt restructurings for creditors in ASC Topic 310 and amends the guidance on "vintage disclosures" to require disclosure of current-period gross write-offs by year of origination. ASU 2022-02 also updates the requirements related to accounting for credit losses under ASC Topic 326 and adds enhanced disclosures for creditors with respect to loan refinancings and restructurings for borrowers experiencing financial difficulty. We adopted ASU 2022-02 beginning in the first quarter of fiscal 2023. The adoption of ASU 2022-02 had no material impact on our condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
No recently issued accounting pronouncements are expected to have a material effect in our condensed 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, which are payable on demand and have no maturity date, typically bear interest at rates between 5.50% 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 $1.4 million and $0.9 million as of September 30, 2023 and December 31, 2022, respectively. There were no IO notes that were past due or on a non-accrual status due to delinquency as of September 30, 2023 or
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December 31, 2022. Notes and receivables from our IOs 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 IO 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, and may or may not be participating in TCAP.
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 September 30, 2023 and December 31, 2022 consisted of the following (amounts in thousands):
| Allowance | Current Portion | Long-term Portion | |||||||||||||||||||||||||||||||||
| Gross | Current Portion | Long-term Portion | Net | ||||||||||||||||||||||||||||||||
| September 30, 2023 | |||||||||||||||||||||||||||||||||||
| Independent operator notes | $ | 38,799 | $ | (706) | $ | (10,600) | $ | 27,493 | $ | 1,503 | $ | 25,990 | |||||||||||||||||||||||
| Independent operator receivables | 12,835 | (4,318) | (751) | 7,766 | 7,766 | — | |||||||||||||||||||||||||||||
| Total | $ | 51,634 | $ | (5,024) | $ | (11,351) | $ | 35,259 | $ | 9,269 | $ | 25,990 | |||||||||||||||||||||||
| Allowance | Current Portion | Long-term Portion | |||||||||||||||||||||||||||||||||
| Gross | Current Portion | Long-term Portion | Net | ||||||||||||||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Independent operator notes | $ | 37,522 | $ | (700) | $ | (12,509) | $ | 24,313 | $ | 1,778 | $ | 22,535 | |||||||||||||||||||||||
| Independent operator receivables | 10,565 | (1,538) | — | 9,027 | 9,027 | — | |||||||||||||||||||||||||||||
| Total | $ | 48,087 | $ | (2,238) | $ | (12,509) | $ | 33,340 | $ | 10,805 | $ | 22,535 | |||||||||||||||||||||||
A summary of activity in the IO notes and IO receivables allowance was as follows (amounts in thousands):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Beginning balance | $ | 16,395 | $ | 13,097 | $ | 14,747 | $ | 11,912 | |||||||||||||||
| Provision for IO notes and IO receivables reserves | 598 | 712 | 2,708 | 2,727 | |||||||||||||||||||
| Write-off of provision for IO notes and IO receivables | (618) | (347) | (1,080) | (1,177) | |||||||||||||||||||
| Ending Balance | $ | 16,375 | $ | 13,462 | $ | 16,375 | $ | 13,462 | |||||||||||||||
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The following table presents the outstanding gross balance of IO notes by fiscal year of origination and credit quality indicator as of September 30, 2023 (amounts in thousands):
| Fiscal Year of Origination | |||||||||||||||||||||||||||||||||||||||||
| Credit Quality Indicator | 2023 (YTD) | 2022 | 2021 | 2020 | 2019 | Prior | Total | ||||||||||||||||||||||||||||||||||
| TCAP | $ | 1,980 | $ | 5,582 | $ | 4,549 | $ | 2,103 | $ | 402 | $ | 991 | $ | 15,607 | |||||||||||||||||||||||||||
| Non-TCAP | 2,512 | 3,851 | 3,656 | 2,525 | 1,430 | 1,653 | 15,627 | ||||||||||||||||||||||||||||||||||
| New store | 3,655 | 3,910 | — | — | — | — | 7,565 | ||||||||||||||||||||||||||||||||||
| Total | $ | 8,147 | $ | 13,343 | $ | 8,205 | $ | 4,628 | $ | 1,832 | $ | 2,644 | $ | 38,799 | |||||||||||||||||||||||||||
TCAP IO Notes
Notes of IOs participating in our TCAP represented 52.5% and 49.7% of total IO notes balances as of September 30, 2023 and December 31, 2022, respectively.
A total of $1.0 million of IO notes were added into our TCAP during the 13 weeks ended September 30, 2023. The weighted average contractual interest rate of such IO notes was reduced from 9.95% and, as of September 30, 2023, was 5.50%. In addition, $0.4 million of IO notes were transferred from TCAP to Non-TCAP during the 13 weeks ended September 30, 2023.
A total of $4.7 million of IO notes were added into our TCAP during the 39 weeks ended September 30, 2023. The weighted average contractual interest rate of such IO notes was reduced from 9.95% and, as of September 30, 2023, was 5.50%. In addition, $2.5 million of IO notes were transferred from TCAP to Non-TCAP during the 39 weeks ended September 30, 2023.
Note 3. Long-term Debt
Long-term debt consisted of the following (amounts in thousands):
| September 30, 2023 | December 31, 2022 | ||||||||||
| Senior term loan due 2025 | $ | — | $ | 385,000 | |||||||
| Senior term loan due 2028 | 296,250 | — | |||||||||
| Long-term debt, gross | 296,250 | 385,000 | |||||||||
Less: Unamortized debt issuance costs and debt discounts | (1,741) | (5,350) | |||||||||
| Long-term debt, less unamortized debt discounts and debt issuance costs | 294,509 | 379,650 | |||||||||
| Less: Current portion | (5,625) | — | |||||||||
| Long-term debt, net | $ | 288,884 | $ | 379,650 | |||||||
2023 Credit Agreement
On February 21, 2023, we entered into a credit agreement with Bank of America, N.A., as administrative agent and collateral agent, and the other parties party thereto (the "2023 Credit Agreement"). The 2023 Credit Agreement provides for senior secured credit facilities consisting of (i) a senior secured term loan facility (the "senior term loan") in an original aggregate principal amount of $300.0 million and (ii) a senior secured revolving credit facility (the "revolving credit facility" and, together with the senior term loan, the "new credit facilities") in an aggregate principal amount of $400.0 million. The revolving credit facility includes sub-commitments for $50.0 million letters of credit and $25.0 million of swingline loans. The senior term loan was borrowed in full at closing, and $25.0 million of the revolving credit facility was borrowed at closing.
Also on February 21, 2023, we repaid all of the outstanding indebtedness under our Prior First Lien Credit Agreement, defined below, as well as fees and expenses in connection therewith. All obligations of the Company’s subsidiaries under the Prior First Lien Credit Agreement were discharged as of such date. In connection with the closing of the 2023 Credit Agreement and repayment of the Prior First Lien Credit Agreement and in accordance with ASC Topic 470-50, Debt-Modifications and Extinguishments, we wrote off $5.1 million of previously unamortized debt issuance costs and debt discounts and incurred $0.2 million in debt modification costs, which were recorded within loss on debt extinguishment and modification for the 39 weeks ended September 30, 2023. Furthermore, a total of $4.6 million of creditor and third-party debt issuance costs were capitalized or carried over from the prior credit facilities, as defined below, and will be amortized over the term of the new credit facilities.
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Borrowings under the 2023 Credit Agreement bear interest at a rate equal to, at our option, either (a) the base rate, which is defined as a fluctuating rate per annum equal to the greatest of (i) the federal funds rate then in effect, plus 0.50%, (ii) the prime rate then in effect and (iii) a specified Term SOFR (as defined in the 2023 Credit Agreement) rate plus 1.00%, subject to the interest rate floors set forth therein, plus an applicable margin ranging from 0.75% to 1.75% based on our Total Net Leverage Ratio (as defined in the 2023 Credit Agreement); and (b) an adjusted Term SOFR rate determined on the basis of a one, three or six month interest period, plus 0.10%, subject to the interest rate floors set forth therein, plus an applicable margin ranging from 1.75% to 2.75% based on our Total Net Leverage Ratio. As of September 30, 2023, interest on borrowings under the new credit facilities was based on one-month Term SOFR with an applicable margin of 2.00%.
The new credit facilities of the 2023 Credit Agreement permit us to add incremental term loan facilities, increase any existing term loan facility, increase revolving commitments, and/or add incremental replacement revolving credit facility tranches. The aggregate principal amount of such incremental facilities are limited to (a) an amount not in excess of the sum of the greater of $200.0 million and 100% of Consolidated EBITDA (as defined in the 2023 Credit Agreement), subject to certain limitations, plus (b) voluntary prepayments of the term loan facility, voluntary permanent reductions of the commitments for the revolving credit facility and voluntary prepayments of indebtedness secured by liens on the collateral securing the new credit facilities, subject to certain exceptions, plus (c) an amount such that (assuming that the full amount of any such incremental revolving increase and/or incremental replacement revolving credit facility was drawn, and after giving effect to any appropriate pro forma adjustment events) we would be in compliance, on a pro forma basis (but excluding the cash proceeds of such incurrence), with a Total Net Leverage Ratio of 3.00 to 1.00.
Our obligations under the 2023 Credit Agreement are unconditionally guaranteed by the Company’s wholly owned restricted subsidiary, subject to certain exceptions. All obligations under the 2023 Credit Agreement, and the guarantees of such obligations, are secured, subject to permitted liens and other exceptions, by substantially all of the Company’s assets and those of the subsidiary guarantor.
The 2023 Credit Agreement requires us to make scheduled amortization payments of the senior term loan. We may voluntarily prepay the new credit facilities, in whole or in part, at any time without premium or penalty, subject to reimbursement of the lenders’ breakage and redeployment costs in applicable cases.
Senior Term Loan due 2028
Our senior term loan under our 2023 Credit Agreement matures on February 21, 2028 and had an interest rate of 7.42% as of September 30, 2023.
Revolving Credit Facility
As of September 30, 2023 we had $4.2 million of outstanding letters of credit and $395.8 million of remaining borrowing capacity available under the revolving credit facility, which matures on February 21, 2028. The interest rate on the revolving credit facility was 7.42% as of September 30, 2023. As discussed above, $25.0 million of the revolving credit facility was borrowed at closing. On April 21, 2023, we repaid the $25.0 million of principal on our revolving credit facility. No amounts were outstanding under the revolving credit facility as of September 30, 2023. Since the April 21, 2023 repayment, no amounts were borrowed under this revolving credit facility.
We are required to pay a quarterly commitment fee ranging from 0.15% to 0.30% on the daily unused amount of the commitment under the revolving credit facility based upon our Total Net Leverage Ratio. We are also required to pay fronting fees and other customary fees for letters of credit issued under the revolving credit facility.
Prior First Lien Credit Agreement
One of our former wholly owned subsidiaries, which has since been merged with and into Grocery Outlet Holding Corp., was the borrower under a first lien credit agreement (the "Prior First Lien Credit Agreement") with a syndicate of lenders that consisted of a $385.0 million senior term loan (the "prior senior term loan") and a revolving credit facility (the "prior revolving credit facility" and, together with the prior senior term loan, the "prior credit facilities") for an amount up to $100.0 million.
Prior Senior Term Loan due 2025
Our prior senior term loan under our Prior First Lien Credit Agreement had a maturity of October 22, 2025 and had an applicable margin of 2.75% for Eurodollar loans and 1.75% for base rate loans.
On April 29, 2022, we prepaid $75.0 million of principal on the prior senior term loan outstanding under our Prior First Lien Credit Agreement. In connection with the payment, we wrote off $1.3 million of previously unamortized debt issuance costs and debt discounts.
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As discussed above, on February 21, 2023, in connection with the closing of the 2023 Credit Agreement, we repaid the remaining $385.0 million of principal on the prior senior term loan outstanding under our Prior First Lien Credit Agreement.
Prior Revolving Credit Facility
Our prior revolving credit facility under our Prior First Lien Credit Agreement had a maturity of October 23, 2023. No amounts were outstanding under the prior revolving credit facility as of December 31, 2022 and no amounts were outstanding as of final repayment of the Prior First Lien Credit Agreement.
We were required to pay a quarterly commitment fee ranging from 0.25% to 0.50% on the daily unused amount of the commitment under the prior revolving credit facility based upon the leverage ratio defined in the agreement and certain criteria specified in the agreement. We were also required to pay fronting fees and other customary fees for letters of credit issued under the prior revolving credit facility.
Debt Covenants
The 2023 Credit Agreement contains certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants. The 2023 Credit Agreement contains certain covenants that, among other things, limit our ability and the ability of our restricted subsidiary to: pay dividends or distributions, repurchase equity, prepay junior debt and make certain investments; incur additional debt or issue certain disqualified stock and preferred stock; incur liens on assets; merge or consolidate with another company or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets; enter into transactions with affiliates; and allow to exist certain restrictions on the ability of our subsidiary to pay dividends or make other payments to the borrower. The 2023 Credit Agreement also contains financial performance covenants requiring us to satisfy a maximum total net leverage ratio test and a minimum interest coverage ratio test as of the last day of each fiscal quarter. The maximum total net leverage ratio test requires us to be in compliance with a Total Net Leverage Ratio no greater than 3.50 to 1.00 as of the last day of each test period ending prior to the test period ending on or about December 31, 2025, and no greater than 3.25 to 1.00 as of the last day of each test period ending thereafter, subject to certain adjustments set forth in the 2023 Credit Agreement. The minimum interest coverage ratio test requires us to be in compliance with a Consolidated Interest Coverage Ratio (as defined in the 2023 Credit Agreement) no less than 1.75 to 1.00 as of the last day of each test period.
As of September 30, 2023, we were in compliance with all applicable financial covenant requirements for our 2023 Credit Agreement.
Schedule of Principal Maturities
Principal maturities of debt as of September 30, 2023 are as follows (amounts in thousands):
| Remainder of fiscal 2023 | $ | — | |||
| Fiscal 2024 | 7,500 | ||||
| Fiscal 2025 | 15,000 | ||||
| Fiscal 2026 | 15,000 | ||||
| Fiscal 2027 | 15,000 | ||||
| Thereafter | 243,750 | ||||
| Total | $ | 296,250 | |||
Interest Expense, Net
Interest expense, net, consisted of the following (amounts in thousands):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Interest on loans | $ | 5,853 | $ | 5,015 | $ | 18,827 | $ | 12,335 | |||||||||||||||
| Amortization of debt issuance costs and debt discounts | 228 | 537 | 856 | 1,727 | |||||||||||||||||||
| Interest on finance leases | 97 | 81 | 247 | 265 | |||||||||||||||||||
| Other | 13 | 5 | 13 | 5 | |||||||||||||||||||
| Interest income | (1,965) | (840) | (5,032) | (1,977) | |||||||||||||||||||
| Interest expense, net | $ | 4,226 | $ | 4,798 | $ | 14,911 | $ | 12,355 | |||||||||||||||
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Loss on Debt Extinguishment and Modification
Loss on debt extinguishment and modification consisted of the following (amounts in thousands):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Write off of debt issuance costs | $ | — | $ | — | $ | 4,518 | $ | 1,127 | |||||||||||||||
| Write off of debt discounts | — | — | 578 | 147 | |||||||||||||||||||
| Debt modification costs | — | — | 244 | — | |||||||||||||||||||
| Loss on debt extinguishment and modification | $ | — | $ | — | $ | 5,340 | $ | 1,274 | |||||||||||||||
Note 4. Stockholders' Equity
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 repurchases under a Rule 10b5-1 plan (which would permit shares to be repurchased when we might otherwise be precluded from doing so under securities laws). Any repurchased shares are constructively retired and returned to an unissued status.
During the 13 weeks ended September 30, 2023, we did not repurchase any shares of common stock under the share repurchase program. During the 39 weeks ended September 30, 2023, we repurchased 122,862 shares of common stock under the share repurchase program totaling $3.3 million at an average price of $26.66 per share in open-market transactions pursuant to a Rule 10b5-1 plan.
During the 13 weeks ended October 1, 2022, we did not repurchase any shares of common stock under the share repurchase program. During the 39 weeks ended October 1, 2022, we repurchased 139,718 shares of common stock under the share repurchase program totaling $3.5 million at an average price of $24.70 per share in open-market transactions pursuant to a Rule 10b5-1 plan.
As of September 30, 2023, we had $93.3 million of repurchase authority remaining under the share repurchase program.
Note 5. Share-based Awards
For a discussion of our share-based incentive plans, refer to Note 8 of our 2022 Form 10-K.
Share-based Award Activity
The following table summarizes stock option activity under all equity incentive plans during the 39 weeks ended September 30, 2023:
| Time-Based Stock Options | Performance-Based Stock Options | ||||||||||||||||||||||
| Number of Options | Weighted-Average Exercise Price | Number of Options | Weighted-Average Exercise Price | ||||||||||||||||||||
Options outstanding as of December 31, 2022 | 2,562,774 | $ | 12.13 | 801,635 | $ | 4.68 | |||||||||||||||||
| Exercised | (459,466) | 8.06 | (565,947) | 3.91 | |||||||||||||||||||
| Forfeitures | (8,279) | 21.93 | — | — | |||||||||||||||||||
Options outstanding as of September 30, 2023 | 2,095,029 | $ | 12.99 | 235,688 | $ | 6.53 | |||||||||||||||||
Options vested and exercisable as of September 30, 2023 | 2,061,230 | $ | 13.00 | 235,688 | $ | 6.53 | |||||||||||||||||
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The following table summarizes restricted stock unit ("RSU") activity under all equity incentive plans during the 39 weeks ended September 30, 2023:
| Number of Shares | Weighted-Average Grant Date Fair Value | ||||||||||
Unvested balance as of December 31, 2022 | 690,354 | $ | 31.79 | ||||||||
| Granted | 525,467 | 27.51 | |||||||||
| Vested | (345,573) | 32.51 | |||||||||
| Forfeitures | (33,019) | 30.06 | |||||||||
Unvested balance as of September 30, 2023 | 837,229 | $ | 28.87 | ||||||||
The following table summarizes performance-based restricted stock unit ("PSU") activity under the Grocery Outlet Holding Corp. 2019 Incentive Plan during the 39 weeks ended September 30, 2023:
| Number of Shares | Weighted-Average Grant Date Fair Value | ||||||||||
Unvested balance as of December 31, 2022 | 1,331,803 | $ | 32.89 | ||||||||
Granted (1) | 445,809 | 27.34 | |||||||||
Adjustment for expected performance achievement (2) | 383,279 | 30.80 | |||||||||
| Vested | (436,522) | 36.90 | |||||||||
| Forfeitures | (13,930) | 30.60 | |||||||||
Unvested balance as of September 30, 2023 (3) | 1,710,439 | $ | 29.97 | ||||||||
_______________________
(1)Represents initial grant of PSUs based on performance target level achievement of 100%.
(2)Represents the year-to-date adjustment to previously granted PSUs based on performance expectations as of September 30, 2023.
(3)An additional 475,869 PSUs could potentially be included if the maximum performance level of 200% is reached for all PSUs outstanding as of September 30, 2023.
Share-based Compensation Expense
We recognize compensation expense for stock options, RSUs and PSUs by amortizing the grant date fair value on a straight-line basis over the expected vesting period to the extent we determine the vesting of the grant is probable. We recognize share-based award forfeitures in the period such forfeitures occur.
Share-based compensation expense consisted of the following (amounts in thousands):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Time-based stock options | $ | 25 | $ | (696) | $ | 747 | $ | 321 | |||||||||||||||
| RSUs | 3,074 | 4,225 | 8,264 | 11,747 | |||||||||||||||||||
| PSUs | 4,436 | 5,555 | 16,496 | 12,262 | |||||||||||||||||||
Dividends (1) | — | — | 9 | 33 | |||||||||||||||||||
| Share-based compensation expense | $ | 7,535 | $ | 9,084 | $ | 25,516 | $ | 24,363 | |||||||||||||||
_______________________
(1)Represents cash dividends paid upon vesting of share-based awards as a result of dividends declared in connection with a recapitalization that occurred in fiscal 2018.
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Note 6. Income Taxes
Our income tax expense and effective income tax rate were as follows (amounts in thousands, except percentages):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Income tax expense | $ | 6,191 | $ | 2,394 | $ | 21,274 | $ | 8,234 | |||||||||||||||
| Effective income tax rate | 18.6 | % | 12.0 | % | 24.6 | % | 14.3 | % | |||||||||||||||
Our tax provision for interim periods is determined using an estimated annual effective tax rate, adjusted for discrete events arising in each respective quarter. During each interim period, we update the estimated annual effective tax rate. Our effective income tax rate for the 13 and 39 weeks ended September 30, 2023 was lower than the combined U.S. federal and state statutory income tax rate primarily due to excess tax benefits related to the exercise of stock options, partially offset by non-deductible executive compensation under Internal Revenue Code Section 162(m). The increase in our effective income tax rate for the 13 weeks ended September 30, 2023 compared to the 13 weeks ended October 1, 2022 was primarily driven by increased pretax income without a proportional increase in tax benefits related to the exercise of stock options as well as non-deductible executive compensation under Internal Revenue Code Section 162(m) during the 13 weeks ended September 30, 2023, which was not applicable during the 13 weeks ended October 1, 2022. The increase in our effective income tax rate for the 39 weeks ended September 30, 2023 compared to the 39 weeks ended October 1, 2022 was primarily driven by lower excess tax benefits related to the exercise of stock options as well as non-deductible executive compensation under Internal Revenue Code Section 162(m) during the 39 weeks ended September 30, 2023, which was not applicable during the 39 weeks ended October 1, 2022.
Our policy is to recognize interest and penalties associated with uncertain tax positions as part of the income tax provision in our condensed consolidated statements of operations and comprehensive income and include accrued interest and penalties with the related income tax liability on our condensed consolidated balance sheets. To date, we have not recognized any interest and penalties, nor have we accrued for or made payments for interest and penalties. We had no uncertain tax positions as of September 30, 2023 and December 31, 2022, respectively, and do not anticipate having any material uncertain tax positions within the next 12 months.
Note 7. Related Party Transactions
Related Party Leases
As of September 30, 2023 and October 1, 2022, we leased 14 and 15 store locations, respectively, and one warehouse location from entities in which Eric Lindberg, Jr., Chairman of our Board of Directors (and formerly our Chief Executive Officer until December 31, 2022), and MacGregor Read, Jr., who served as Vice Chairman of our Board of Directors until September 1, 2022, or their respective families, had a direct or indirect financial interest. As of September 30, 2023, the right-of-use assets and lease liabilities related to these properties was $35.5 million and $40.4 million, respectively. As of December 31, 2022, the right-of-use assets and lease liabilities related to these properties was $40.5 million and $45.5 million, respectively. These related parties received aggregate lease payments from us of $1.7 million for each of the 13 weeks ended September 30, 2023 and October 1, 2022, respectively, and $5.1 million for each of the 39 weeks ended September 30, 2023 and October 1, 2022.
Independent Operator Notes and Independent Operator Receivables
We offer interest-bearing notes to IOs and the gross amount of IO operating notes and IO receivables due was $51.6 million and $48.1 million as of September 30, 2023 and December 31, 2022, respectively. See Note 2 for additional information.
Note 8. Commitments and Contingencies
We are involved from time to time in claims, proceedings and litigation arising in the normal course of business. We establish an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. In such cases, there may be a possible exposure to loss in excess of any amounts accrued. We monitor those matters for developments that would affect the likelihood of a loss and the accrued amount, if any, thereof, and adjust the amount as appropriate. If the loss contingency at issue is not both probable and reasonably estimable, we do not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. If it is at least a reasonable possibility that a material loss will occur, we will provide disclosure regarding the contingency. Management believes that we do not have any pending litigation that, separately or in the aggregate, would have a material adverse effect on our results of operations, financial condition or cash flows.
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Note 9. Earnings Per Share
The following table sets forth the calculation of basic and diluted earnings per share (amounts in thousands, except per share data):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Numerator | |||||||||||||||||||||||
| Net income and comprehensive income | $ | 27,140 | $ | 17,495 | $ | 65,331 | $ | 49,163 | |||||||||||||||
| Denominator | |||||||||||||||||||||||
Weighted-average shares outstanding – basic | 99,108 | 97,057 | 98,514 | 96,587 | |||||||||||||||||||
| Effect of dilutive options | 1,624 | 2,847 | 1,913 | 3,031 | |||||||||||||||||||
Effect of dilutive RSUs and PSUs (1) | 241 | 581 | 300 | 433 | |||||||||||||||||||
Weighted-average shares outstanding – diluted | 100,973 | 100,485 | 100,727 | 100,051 | |||||||||||||||||||
| Earnings per share: | |||||||||||||||||||||||
| Basic | $ | 0.27 | $ | 0.18 | $ | 0.66 | $ | 0.51 | |||||||||||||||
| Diluted | $ | 0.27 | $ | 0.17 | $ | 0.65 | $ | 0.49 | |||||||||||||||
_______________________
(1)We are required to include in diluted weighted-average shares outstanding contingently issuable shares that would be issued assuming the end of our reporting period was the end of the relevant PSU award contingency period.
The following weighted-average common share equivalents were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive (amounts in thousands):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| RSUs | 10 | 10 | 42 | 7 | |||||||||||||||||||
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Item 2. 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 unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this report, and the audited consolidated financial statements and related notes thereto and management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 ("2022 Form 10-K"). 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 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 the third quarter of fiscal 2023 and the third quarter of fiscal 2022 refer to the 13 weeks ended September 30, 2023 and October 1, 2022, respectively.
As used in this report, references to "Grocery Outlet," "the Company," "the registrant," "we," "us" and "our," refer to Grocery Outlet Holding Corp. and its consolidated subsidiary unless otherwise indicated or the context requires otherwise.
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 September 30, 2023, we had 455 stores in California, Washington, Oregon, Pennsylvania, Idaho, Nevada, Maryland and New Jersey.
Over the past several years, and to a lesser extent recently, our business has been and continues to be impacted by macroeconomic conditions including supply chain and labor challenges, inflation, and changes in consumer behavior, and our IOs have been impacted by staffing challenges and increased labor costs and utility costs within their businesses. The extent of the continuing impact of these factors on our operational and financial performance will depend on many factors, including certain factors outside of our control.
We continue to utilize our unique buying model, our strong vendor relationships and our agile approach to inventory management to offer customers a compelling assortment at a deep value. While product costs have largely stabilized for us during the recent fiscal quarters, we continue to incur greater selling, general and administrative expenses ("SG&A") related to personnel, travel, and other third party and operational costs due to the aforementioned factors. Further, planned construction and opening of new stores has been, and may continue to be, negatively impacted due to both increased lead times to acquire materials, obtain permits and licenses as well as higher construction and development related costs.
Our new store growth efforts for fiscal 2024 and beyond are focused on organic growth together with new real estate opportunities that align with our long-term geographic expansion and store growth strategies. Complementary growth opportunities may include expanding strategic relationships with large property owners, evaluating acquisitions of opportunistic real estate that become available through consolidation in the retail sector, and exploring strategic regional acquisitions of operating businesses.
During the third quarter of fiscal 2023, we replaced components of our enterprise resource planning system, including our financial ledger, inventory management platform and product data warehouse system. The implementation of these system upgrades has resulted in disruption to our business operations, which impacted our results of operations during the period, as more fully described below in “Comparison of the 13 and 39 weeks ended September 30, 2023 and October 1, 2022." For the fourth quarter of fiscal 2023, we expect the system implementation disruptions to continue to impact sales and gross margin as well as SG&A related to the incremental commission support that we are electing to provide to our operators.
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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, 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.
Third Quarter of Fiscal 2023 Overview
Key financial and operating performance results for the third quarter of fiscal 2023 compared to the third quarter of fiscal 2022 were as follows:
•Net sales increased 9.3% to $1.00 billion from $918.2 million in the third quarter of fiscal 2022
•Comparable store sales increased by 6.4%, driven by a 8.6% increase in the number of transactions partially offset by a 1.9% decrease in average transaction size.
•Gross margin increased by 80 basis points to 31.4%, compared to gross margin of 30.6% in the third quarter of fiscal 2022.
•In late August, we implemented new technology platforms and, as a result, experienced disruptions which are estimated to have negatively impacted comparable store sales by approximately 150 basis points and gross margin by 50 basis points in the third quarter.
•We opened eight new stores, ending the third quarter of fiscal 2023 with 455 stores in eight states.
•Net income increased 55.1% to $27.1 million, or $0.27 per diluted share, compared to net income of $17.5 million, or $0.17 per diluted share, in the third quarter of fiscal 2022.
•Adjusted EBITDA(1) increased 20.0% to $68.1 million compared to $56.8 million in the third quarter of fiscal 2022.
•Adjusted net income(1) increased 23.4% to $31.0 million, or $0.31 per adjusted diluted share(1), compared to $25.1 million, or $0.25 per adjusted diluted share, in the third quarter of fiscal 2022.
_______________________
(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. Beginning with the fourth quarter of fiscal 2022, we updated our definitions of adjusted EBITDA, adjusted net income and adjusted earnings per share to no longer exclude the impact of non-cash rent expense and the provision for accounts receivable reserves. The presentation for adjusted EBITDA, adjusted net income and adjusted earnings per share for the 13 and 39 weeks ended October 1, 2022 have been recast to reflect these changes. See the "Operating Metrics and Non-GAAP Financial Measures" section of our 2022 Form 10-K, for additional information. Furthermore, see the "Operating Metrics and Non-GAAP Financial Measures" section below for additional information about these items, including their definitions, how the non-GAAP measures provide useful information to investors and how management utilizes them, 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 net sales as the products are sold. Discounts that are funded solely by IOs are not recognized as a reduction in net sales as the IO bears the incidental costs arising from the discount. We do not accept manufacturer coupons. Net sales consist of net sales from comparable stores, described below under "Comparable Store Sales," and non-comparable stores. Growth of our net sales is generally driven by expansion of our store base in existing and new markets as well as comparable store sales growth. Net sales are impacted by the spending habits of our customers, product mix and supply, as well as promotional and competitive activities. Our ever-changing selection of offerings across diverse product categories supports growth in net 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, governmental benefit programs such as the Supplemental Nutrition Assistance Program and discretionary income. Our customers' discretionary income is 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.
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Cost of Sales, Gross Profit and Gross Margin
Cost of sales includes, among other things, merchandise costs, inventory markdowns, inventory losses, transportation costs and distribution and warehousing costs, including depreciation. Gross profit is equal to our net sales less our cost of sales. Gross margin is gross profit as a percentage of our net 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 net 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 current macroeconomic conditions, 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 higher variability to our gross margins. The components of our cost of sales, as well as our gross profit and gross margin, may not be comparable to the same or similar measures of our competitors and other retailers.
Selling, General and Administrative Expenses
SG&A are comprised of both store-related expenses and corporate expenses. Our store-related expenses include commissions paid to IOs, occupancy and our portion of maintenance costs, depreciation and amortization of store-related assets and the cost of opening new IO stores. Company-operated store-related expenses also include payroll, benefits, supplies and utilities. Corporate expenses include payroll and benefits for corporate and field support, share-based compensation, marketing and advertising, insurance and professional services, depreciation and amortization of corporate assets and operator recruiting and training costs. We continue to closely manage our expenses and monitor SG&A as a percentage of net sales. SG&A generally increases as we grow our store base and invest in our corporate infrastructure. SG&A related to commissions paid to IOs are variable in nature and generally increase as gross profits rise and decrease as gross profits decline. We expect that our SG&A will continue to increase in future periods as we continue to grow our net sales and gross profits. The components of our SG&A may not be comparable to the components of similar measures of our competitors and other retailers.
In the first quarter of fiscal 2023, in order to enhance the comparability of our results with our peers, we updated our presentation of the condensed consolidated statements of operations and comprehensive income to include depreciation and amortization expenses and share-based compensation expenses within selling, general and administrative expenses. Prior period amounts have been reclassified to conform to 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 periods.
Operating Income
Operating income is gross profit less SG&A. Operating income excludes interest expense, net, loss on debt extinguishment and modification and income tax expense. We use operating income as an indicator of the productivity of our business and our ability to manage expenses.
22
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):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Net sales | $ | 1,003,913 | $ | 918,185 | $ | 2,979,635 | $ | 2,647,271 | |||||||||||||||
| Cost of sales | 688,222 | 637,550 | 2,036,831 | 1,836,336 | |||||||||||||||||||
| Gross profit | 315,691 | 280,635 | 942,804 | 810,935 | |||||||||||||||||||
| Selling, general and administrative expenses | 278,134 | 255,948 | 835,948 | 739,909 | |||||||||||||||||||
| Operating income | 37,557 | 24,687 | 106,856 | 71,026 | |||||||||||||||||||
| Other expenses: | |||||||||||||||||||||||
| Interest expense, net | 4,226 | 4,798 | 14,911 | 12,355 | |||||||||||||||||||
| Loss on debt extinguishment and modification | — | — | 5,340 | 1,274 | |||||||||||||||||||
| Total other expenses | 4,226 | 4,798 | 20,251 | 13,629 | |||||||||||||||||||
| Income before income taxes | 33,331 | 19,889 | 86,605 | 57,397 | |||||||||||||||||||
| Income tax expense | 6,191 | 2,394 | 21,274 | 8,234 | |||||||||||||||||||
| Net income and comprehensive income | $ | 27,140 | $ | 17,495 | $ | 65,331 | $ | 49,163 | |||||||||||||||
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
Percentage of net sales (1) | |||||||||||||||||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||||||||
| Cost of sales | 68.6 | % | 69.4 | % | 68.4 | % | 69.4 | % | |||||||||||||||
| Gross profit | 31.4 | % | 30.6 | % | 31.6 | % | 30.6 | % | |||||||||||||||
| Selling, general and administrative expenses | 27.7 | % | 27.9 | % | 28.1 | % | 27.9 | % | |||||||||||||||
| Operating income | 3.7 | % | 2.7 | % | 3.6 | % | 2.7 | % | |||||||||||||||
| Other expenses: | |||||||||||||||||||||||
| Interest expense, net | 0.4 | % | 0.5 | % | 0.5 | % | 0.5 | % | |||||||||||||||
| Loss on debt extinguishment and modification | — | % | — | % | 0.2 | % | — | % | |||||||||||||||
| Total other expenses | 0.4 | % | 0.5 | % | 0.7 | % | 0.5 | % | |||||||||||||||
| Income before income taxes | 3.3 | % | 2.2 | % | 2.9 | % | 2.2 | % | |||||||||||||||
| Income tax expense | 0.6 | % | 0.3 | % | 0.7 | % | 0.3 | % | |||||||||||||||
| Net income and comprehensive income | 2.7 | % | 1.9 | % | 2.2 | % | 1.9 | % | |||||||||||||||
_______________________
(1)Components may not sum to totals due to rounding.
23
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 from us for store build-outs, fixtures and equipment that 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 net 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 temporarily closed for an extended period, those that have had their business materially disrupted for both planned projects as well as due to unforeseen circumstances, permanent store closures and dispositions. When applicable, as was the case with fiscal 2020 and will be the case with fiscal 2025, 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 that a significant portion of our net sales growth will be attributable to non-comparable store net sales. Accordingly, comparable store sales is only one of many measures 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. 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 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. 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, loss on debt extinguishment and modification, asset impairment and gain or loss on disposition 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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Beginning with the fourth quarter of fiscal 2022, we updated our definitions of adjusted EBITDA, adjusted net income and adjusted earnings per share to no longer exclude the impact of non-cash rent expense and the provision for accounts receivable reserves. The presentation for adjusted EBITDA, adjusted net income and adjusted earnings per share for the 13 and 39 weeks ended October 1, 2022 has been recast to reflect these changes.
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):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
Other Financial and Operations Data | |||||||||||||||||||||||
| Number of new stores | 8 | 6 | 15 | 17 | |||||||||||||||||||
| Number of stores open at end of period | 455 | 431 | 455 | 431 | |||||||||||||||||||
Comparable store sales increase (1) | 6.4 | % | 15.4 | % | 9.2 | % | 10.6 | % | |||||||||||||||
EBITDA (2) | $ | 59,443 | $ | 44,841 | $ | 165,197 | $ | 128,450 | |||||||||||||||
Adjusted EBITDA (2) | $ | 68,143 | $ | 56,789 | $ | 201,740 | $ | 160,353 | |||||||||||||||
Adjusted net income (2) | $ | 30,989 | $ | 25,104 | $ | 89,932 | $ | 71,243 | |||||||||||||||
_______________________
(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.
(2)See "GAAP to Non-GAAP Reconciliations" section below for the applicable reconciliations.
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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):
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Net income | $ | 27,140 | $ | 17,495 | $ | 65,331 | $ | 49,163 | |||||||||||||||
| Interest expense, net | 4,226 | 4,798 | 14,911 | 12,355 | |||||||||||||||||||
| Income tax expense | 6,191 | 2,394 | 21,274 | 8,234 | |||||||||||||||||||
| Depreciation and amortization expenses | 21,886 | 20,154 | 63,681 | 58,698 | |||||||||||||||||||
| EBITDA | 59,443 | 44,841 | 165,197 | 128,450 | |||||||||||||||||||
Share-based compensation expenses (1) | 7,535 | 9,084 | 25,516 | 24,363 | |||||||||||||||||||
Loss on debt extinguishment and modification (2) | — | — | 5,340 | 1,274 | |||||||||||||||||||
Asset impairment and gain or loss on disposition (3) | 117 | 343 | 460 | 888 | |||||||||||||||||||
Other (4) | 1,048 | 2,521 | 5,227 | 5,378 | |||||||||||||||||||
| Adjusted EBITDA | $ | 68,143 | $ | 56,789 | $ | 201,740 | $ | 160,353 | |||||||||||||||
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | September 30, 2023 | October 1, 2022 | ||||||||||||||||||||
| Net income | $ | 27,140 | $ | 17,495 | $ | 65,331 | $ | 49,163 | |||||||||||||||
Share-based compensation expenses (1) | 7,535 | 9,084 | 25,516 | 24,363 | |||||||||||||||||||
Loss on debt extinguishment and modification (2) | — | — | 5,340 | 1,274 | |||||||||||||||||||
Asset impairment and gain or loss on disposition (3) | 117 | 343 | 460 | 888 | |||||||||||||||||||
Other (4) | 1,048 | 2,521 | 5,227 | 5,378 | |||||||||||||||||||
Amortization of purchase accounting assets and deferred financing costs (5) | 1,424 | 3,031 | 4,415 | 9,198 | |||||||||||||||||||
Tax adjustment to normalize effective tax rate (6) | (3,418) | (3,178) | (4,274) | (7,649) | |||||||||||||||||||
Tax effect of total adjustments (7) | (2,857) | (4,192) | (12,083) | (11,372) | |||||||||||||||||||
| Adjusted net income | $ | 30,989 | $ | 25,104 | $ | 89,932 | $ | 71,243 | |||||||||||||||
| GAAP earnings per share | |||||||||||||||||||||||
| Basic | $ | 0.27 | $ | 0.18 | $ | 0.66 | $ | 0.51 | |||||||||||||||
| Diluted | $ | 0.27 | $ | 0.17 | $ | 0.65 | $ | 0.49 | |||||||||||||||
| Adjusted earnings per share | |||||||||||||||||||||||
| Basic | $ | 0.31 | $ | 0.26 | $ | 0.91 | $ | 0.74 | |||||||||||||||
| Diluted | $ | 0.31 | $ | 0.25 | $ | 0.89 | $ | 0.71 | |||||||||||||||
| Weighted average shares outstanding | |||||||||||||||||||||||
| Basic | 99,108 | 97,057 | 98,514 | 96,587 | |||||||||||||||||||
| Diluted | 100,973 | 100,485 | 100,727 | 100,051 | |||||||||||||||||||
___________________________
(1)Includes non-cash share-based compensation expense and cash dividends paid on vested share-based awards as a result of dividends declared in connection with a recapitalization that occurred in fiscal 2018. See "Share-based Compensation Expense" in the "Comparison of the 13 and 39 weeks ended September 30, 2023 and October 1, 2022" section below for additional information.
(2)Represents the write-off of debt issuance costs and debt discounts as well as debt modification costs related to refinancing and/or repayment of our credit facilities. See Note 3 to the condensed consolidated financial statements for additional information.
(3)Represents asset impairment charges and gains or losses on dispositions of assets.
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(4)Represents other non-recurring, non-cash or non-operational items, such as technology upgrade implementation costs, costs related to employer payroll taxes associated with equity awards, legal settlements and other legal expenses, store closing costs, certain personnel-related costs and miscellaneous costs.
(5)Represents the amortization of debt issuance costs as well as the 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.
(6)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 expenses or benefits related to stock option exercises and vesting of restricted stock units ("RSUs") that are recorded in earnings as discrete items in the reporting period in which they occur.
(7)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.
Comparison of the 13 and 39 weeks ended September 30, 2023 and October 1, 2022 (amounts in thousands, except percentages)
Net Sales
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Net sales | $ | 1,003,913 | $ | 918,185 | $ | 85,728 | 9.3 | % | $ | 2,979,635 | $ | 2,647,271 | $ | 332,364 | 12.6 | % | |||||||||||||||||||||||||||||||
The increase in net sales for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 was primarily attributable to an increase in comparable store sales as well as non-comparable store net sales growth primarily from the 24 net new stores opened over the last 12 months, partially offset by disruptions related to our aforementioned system upgrades.
Comparable store sales increased 6.4% for the 13 weeks ended September 30, 2023 and 9.2% for the 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022. The increase in comparable store sales for the 13 weeks ended September 30, 2023 was driven by a 8.6% increase in the number of transactions, partially offset by a 1.9% decrease in average transaction size. The increase in comparable store sales for the 39 weeks ended September 30, 2023 was driven by an 8.6% increase in the number of transactions and a 0.5% increase in average transaction size. Our comparable store sales increases for these periods reflects the impact of disruptions related to our system upgrades.
Cost of Sales
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Cost of sales | $ | 688,222 | $ | 637,550 | $ | 50,672 | 7.9 | % | $ | 2,036,831 | $ | 1,836,336 | $ | 200,495 | 10.9 | % | |||||||||||||||||||||||||||||||
| % of net sales | 68.6 | % | 69.4 | % | 68.4 | % | 69.4 | % | |||||||||||||||||||||||||||||||||||||||
The increase in cost of sales for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 was primarily the result of an increase in comparable store sales combined with non-comparable net sales from 24 net new stores opened over the last 12 months as well as by impacts related to our system upgrades.
Cost as a percentage of net sales decreased for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 primarily due to our changing assortment along with strong purchasing and inventory management, partially offset by impacts related to our system upgrades.
Gross Profit and Gross Margin
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Gross profit | $ | 315,691 | $ | 280,635 | $ | 35,056 | 12.5 | % | $ | 942,804 | $ | 810,935 | $ | 131,869 | 16.3 | % | |||||||||||||||||||||||||||||||
| Gross margin | 31.4 | % | 30.6 | % | 31.6 | % | 30.6 | % | |||||||||||||||||||||||||||||||||||||||
The increase in gross profit for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 was primarily the result of an increase in comparable store sales combined with non-comparable sales from 24 net new stores opened over the last 12 months, partially offset by impacts related to our system upgrades.
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Gross margin increased for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 primarily due to our changing assortment along with strong purchasing and inventory management, partially offset by impacts related to our system upgrades.
Selling, General and Administrative Expenses
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| SG&A | $ | 278,134 | $ | 255,948 | $ | 22,186 | 8.7 | % | $ | 835,948 | $ | 739,909 | $ | 96,039 | 13.0 | % | |||||||||||||||||||||||||||||||
| % of net sales | 27.7 | % | 27.9 | % | 28.1 | % | 27.9 | % | |||||||||||||||||||||||||||||||||||||||
The increase in SG&A for the 13 weeks ended September 30, 2023 compared to the same period in fiscal 2022 was driven by $19.1 million in higher store-related expenses and $3.0 million in higher corporate-related expenses. Store-related expenses primarily increased as a result of higher commission payments to IOs, reflecting gross profit growth together with incremental support we elected to provide to our IOs in connection with our system upgrades, as well as higher store occupancy costs due to 24 net new stores opened over the last 12 months, partially offset by the recognition of an e-commerce vendor obligation. Corporate-related expenses increased largely due to increased personnel costs primarily related to higher incentive compensation expense, reflecting strong performance trends relative to target for the 13 weeks ended September 30, 2023.
The increase in SG&A for the 39 weeks ended September 30, 2023 compared to the same period in fiscal 2022 was driven by $72.9 million in higher store-related expenses and $23.2 million in higher corporate-related expenses. Store-related expenses primarily increased as a result of higher commission payments to IOs, reflecting gross profit growth together with incremental support we elected to provide to our IOs in connection with our system upgrades, as well as higher store occupancy costs due to 24 net new stores opened over the last 12 months, partially offset by the recognition of an e-commerce vendor obligation. Corporate-related expenses increased largely due to increased personnel costs primarily related to higher incentive compensation expense, reflecting strong performance trends relative to target for the 39 weeks ended September 30, 2023.
As a percentage of net sales, SG&A decreased for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 primarily due to the aforementioned factors.
Interest Expense, Net
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Interest expense, net | $ | 4,226 | $ | 4,798 | $ | (572) | (11.9) | % | $ | 14,911 | $ | 12,355 | $ | 2,556 | 20.7 | % | |||||||||||||||||||||||||||||||
| % of net sales | 0.4 | % | 0.5 | % | 0.5 | % | 0.5 | % | |||||||||||||||||||||||||||||||||||||||
The decrease in net interest expense for the 13 weeks ended September 30, 2023 compared to the same period in fiscal 2022 was primarily driven by a decrease in principal debt outstanding over the last 12 months combined with increased interest income from IO notes and cash and cash equivalents, partially offset by increases in the effective borrowing rate. See Note 3 to the condensed consolidated financial statements for additional information.
The increase in net interest expense for the 39 weeks ended September 30, 2023 compared to the same period in fiscal 2022 was primarily driven by increases in the effective borrowing rate, partially offset by a decrease in principal debt outstanding over the last 12 months combined with increased interest income from IO notes and cash and cash equivalents. See Note 3 to the condensed consolidated financial statements for additional information.
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Loss on Debt Extinguishment and Modification
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Loss on debt extinguishment and modification | $ | — | $ | — | $ | — | — | % | $ | 5,340 | $ | 1,274 | $ | 4,066 | 319.2 | % | |||||||||||||||||||||||||||||||
| % of net sales | — | % | — | % | 0.2 | % | — | % | |||||||||||||||||||||||||||||||||||||||
During the 39 weeks ended September 30, 2023, we recorded a $5.3 million loss on debt extinguishment related to the payoff of $385.0 million of principal on the senior term loan outstanding under our prior credit facilities. During the 39 weeks ended October 1, 2022, we recorded a $1.3 million loss on debt extinguishment related to the prepayment of $75.0 million of principal on the senior term loan outstanding under our prior credit facilities. See Note 3 to the condensed consolidated financial statements for additional information.
Income Tax Expense
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Income tax expense | $ | 6,191 | $ | 2,394 | $ | 3,797 | 158.6 | % | $ | 21,274 | $ | 8,234 | $ | 13,040 | 158.4 | % | |||||||||||||||||||||||||||||||
| % of net sales | 0.6 | % | 0.3 | % | 0.7 | % | 0.3 | % | |||||||||||||||||||||||||||||||||||||||
| Effective tax rate | 18.6 | % | 12.0 | % | 24.6 | % | 14.3 | % | |||||||||||||||||||||||||||||||||||||||
The increase in income tax expense for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 was primarily due to higher pretax income.
The increase in our effective income tax rate for the 13 weeks ended September 30, 2023 compared to the 13 weeks ended October 1, 2022 was primarily driven by increased pretax income without a proportional increase in tax benefits related to the exercise of stock options as well as non-deductible executive compensation under Internal Revenue Code Section 162(m) during the 13 weeks ended September 30, 2023, which was not applicable during the 13 weeks ended October 1, 2022. The increase in our effective income tax rate for the 39 weeks ended September 30, 2023 compared to the 39 weeks ended October 1, 2022 was primarily driven by lower excess tax benefits related to the exercise of stock options as well as non-deductible executive compensation under Internal Revenue Code Section 162(m) during the 39 weeks ended September 30, 2023, which was not applicable during the 39 weeks ended October 1, 2022.
Net Income
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Net income | $ | 27,140 | $ | 17,495 | $ | 9,645 | 55.1 | % | $ | 65,331 | $ | 49,163 | $ | 16,168 | 32.9 | % | |||||||||||||||||||||||||||||||
| % of net sales | 2.7 | % | 1.9 | % | 2.2 | % | 1.9 | % | |||||||||||||||||||||||||||||||||||||||
As a result of the foregoing factors, net income increased for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022.
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Adjusted EBITDA
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 68,143 | $ | 56,789 | $ | 11,354 | 20.0 | % | $ | 201,740 | $ | 160,353 | $ | 41,387 | 25.8 | % | |||||||||||||||||||||||||||||||
The increase in adjusted EBITDA for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 was primarily due to an increase in comparable store sales of 6.4% for the 13 weeks ended September 30, 2023 and 9.2% for the 39 weeks ended September 30, 2023, as well as higher net sales resulting from new store growth, combined with increased gross margin.
Adjusted Net Income
| 13 Weeks Ended | 39 Weeks Ended | ||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||
| Adjusted net income | $ | 30,989 | $ | 25,104 | $ | 5,885 | 23.4 | % | $ | 89,932 | $ | 71,243 | $ | 18,689 | 26.2 | % | |||||||||||||||||||||||||||||||
The increase in adjusted net income for the 13 and 39 weeks ended September 30, 2023 compared to the same periods in fiscal 2022 was primarily due to an increase in comparable store sales of 6.4% for the 13 weeks ended September 30, 2023 and 9.2% for the 39 weeks ended September 30, 2023, as well as higher net sales resulting from new store growth, combined with increased gross margin.
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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 credit agreement, dated as of February 21, 2023 (the "2023 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.
As of September 30, 2023, we had cash and cash equivalents of $155.7 million, which consisted primarily of cash held in checking and money market accounts with financial institutions. These balances were slightly above normalized levels as we experienced longer payable processing times as a result of our system implementation. In addition, we have a revolving credit facility with $400.0 million in borrowing capacity under our 2023 Credit Agreement. As of September 30, 2023, we had no borrowings outstanding under the revolving credit facility and $4.2 million of outstanding standby letters of credit, resulting in $395.8 million of remaining borrowing capacity available under this revolving credit facility.
On February 21, 2023, we entered into the 2023 Credit Agreement, which provides for senior secured credit facilities consisting of (i) a senior secured term loan facility (the "senior term loan") in an original aggregate principal amount of $300.0 million and (ii) a senior secured revolving credit facility (the "revolving credit facility" and, together with the senior term loan, the "new credit facilities") in an aggregate principal amount of $400.0 million. The senior term loan was borrowed in full on such date, and $25.0 million of the revolving credit facility was borrowed on such date. See Note 3 to our condensed consolidated financial statements for additional information.
We may also, from time to time, at our sole discretion, prepay or retire all or a portion of our outstanding debt. On April 21, 2023, we repaid the $25.0 million of principal on our revolving credit facility. Since the April 21, 2023 repayment, no amounts were borrowed under this revolving credit facility.
The senior secured credit facilities of the 2023 Credit Agreement permit us to add incremental term loan facilities, increase any existing term loan facility, increase revolving commitments, and/or add incremental replacement revolving credit facility tranches. The aggregate principal amount of such incremental facilities are limited to (a) an amount not in excess of the sum of the greater of $200.0 million and 100% of Consolidated EBITDA (as defined in the 2023 Credit Agreement), subject to certain limitations, plus (b) voluntary prepayments of the term loan facility, voluntary permanent reductions of the commitments for the revolving credit facility and voluntary prepayments of indebtedness secured by liens on the collateral securing the credit facilities, subject to certain exceptions, plus (c) an amount such that (assuming that the full amount of any such incremental revolving increase and/or incremental replacement revolving credit facility was drawn, and after giving effect to any appropriate pro forma adjustment events) we would be in compliance, on a pro forma basis (but excluding the cash proceeds of such incurrence), with a Total Net Leverage Ratio (as defined in the 2023 Credit Agreement) of 3.00 to 1.00.
Material Cash Requirements
Other than the information noted below and the refinancing of our credit facilities in February 2023 (See Note 3 to the condensed consolidated financial statements for additional information), there has been no material change in our material cash requirements since the end of fiscal 2022. See our 2022 Form 10-K for additional information.
Capital Expenditures
Capital expenditures include purchases of capital assets such as property and equipment as well as intangible assets and licenses. Capital expenditures for the 39 weeks ended September 30, 2023, before the impact of tenant improvement allowances, were $130.8 million, and, net of tenant improvement allowances, were $116.6 million. We continue to expect total capital expenditures, net of tenant improvement allowances, to be approximately $155.0 million for fiscal 2023.
Debt Obligations
The 2023 Credit Agreement requires us to make scheduled quarterly amortization payments of the senior term loan. Such payments total $52.5 million over the remaining term of the senior term loan, with none payable over the remainder of fiscal 2023. The remaining senior term loan principal balance will become due in February 2028 at maturity. See Note 3 to our condensed consolidated financial statements for additional information.
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Debt Covenants
The 2023 Credit Agreement contains certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants. The 2023 Credit Agreement contains certain covenants that, among other things, limit the our ability and the ability of our restricted subsidiary to: pay dividends or distributions, repurchase equity, prepay junior debt and make certain investments; incur additional debt or issue certain disqualified stock and preferred stock; incur liens on assets; merge or consolidate with another company or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets; enter into transactions with affiliates; and allow to exist certain restrictions on the ability of our subsidiary to pay dividends or make other payments to the borrower. The 2023 Credit Agreement also contains financial performance covenants requiring us to satisfy a maximum total net leverage ratio test and a minimum interest coverage ratio test as of the last day of each fiscal quarter. The maximum total net leverage ratio test requires us to be in compliance with a Total Net Leverage Ratio no greater than 3.50 to 1.00 as of the last day of each test period ending prior to the test period ending on or about December 31, 2025, and no greater than 3.25 to 1.00 as of the last day of each test period ending thereafter, subject to certain adjustments set forth in the 2023 Credit Agreement. The minimum interest coverage ratio test requires us to be in compliance with a Consolidated Interest Coverage Ratio (as defined in the 2023 Credit Agreement) no less than 1.75 to 1.00 as of the last day of each test period.
As of September 30, 2023, we were in compliance with all applicable financial covenant requirements for our 2023 Credit Agreement.
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Cash Flows
The following table summarizes our cash flows for the periods presented (amounts in thousands, except percentages):
| 39 Weeks Ended | |||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | $ Change | % Change | ||||||||||||||||||||
| Net cash provided by operating activities | $ | 276,218 | $ | 139,860 | $ | 136,358 | 97.5 | % | |||||||||||||||
| Net cash used in investing activities | (131,030) | (99,227) | (31,803) | 32.1 | % | ||||||||||||||||||
| Net cash used in financing activities | (92,253) | (73,441) | (18,812) | 25.6 | % | ||||||||||||||||||
| Net increase (decrease) in cash and cash equivalents | $ | 52,935 | $ | (32,808) | $ | 85,743 | 261.3 | % | |||||||||||||||
Cash Provided by Operating Activities
Net cash provided by operating activities was $276.2 million for the 39 weeks ended September 30, 2023 compared to $139.9 million for the same period in fiscal 2022. The increase in net cash provided by operating activities of $136.4 million for the 39 weeks ended September 30, 2023 compared to the same period in fiscal 2022 was primarily driven by changes in merchandise inventory levels, higher trade accounts payable, and higher accrued expenses combined with increased net sales driven by comparable stores sales and new store growth. The increases in trade accounts payable and accrued expenses were partially attributable to disruptions related to our aforementioned system upgrades.
Cash Used in Investing Activities
Net cash used in investing activities was $131.0 million for the 39 weeks ended September 30, 2023 compared to $99.2 million for the same period in fiscal 2022. The increase in net cash used in investing activities of $31.8 million for the 39 weeks ended September 30, 2023 compared to the same period in fiscal 2022 was primarily due to increased spending on property and equipment due to higher store count as well as increased investments in computer software intangible assets related to upgrading our financial ledger, inventory management platform and product data warehouse system.
Cash Used in Financing Activities
Net cash used in financing activities of $92.3 million for the 39 weeks ended September 30, 2023 was primarily due to the payoff of $385.0 million of principal on the prior senior term loan outstanding under our prior credit facilities, repayment of the $25.0 million of principal on our revolving credit facility, $4.5 million in debt issuance costs paid, $3.8 million in scheduled principal payments on the senior term loan under our new current credit facilities and the repurchase of $3.3 million worth of common stock, partially offset by $325.0 million in proceeds from the new credit facilities. Net cash used in financing activities of $73.4 million for the 39 weeks ended October 1, 2022 was primarily due to the prepayment of $75.0 million of principal on the senior term loan outstanding under our prior credit facilities as well as the repurchase of $3.5 million worth of common stock, partially offset by $6.0 million in proceeds from the exercise of stock options.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP and the applicable rules and regulations of the SEC for interim reporting. The preparation of our condensed consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our judgments and estimates are based on historical experience and other factors believed to be reasonable under the circumstances. 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.
There have been no material changes to our critical accounting policies and estimates during the 39 weeks ended September 30, 2023 from those disclosed in our 2022 Form 10-K.
Recent Accounting Pronouncements
Refer to Note 1 to the condensed consolidated financial statements included elsewhere in this report.
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Item 3. 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 September 30, 2023, our outstanding borrowings included $296.3 million from our senior term loan under the 2023 Credit Agreement. As of September 30, 2023, the interest rate on the senior term loan was 7.42% (See Note 3 to our condensed consolidated financial statements for additional information). Based on the outstanding balance and interest rate of our senior term loan as of September 30, 2023, a hypothetical 10% relative increase or decrease in the interest rate would cause an increase or decrease in interest expense of approximately $2.2 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 over the last several years 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, increased SG&A related to personnel, travel, and other operational costs and other disruptions caused by the current macroeconomic environment. Similarly, our IOs have been impacted by staffing challenges and increased labor costs and utility costs within their businesses. Furthermore, our results of operations and financial condition may be materially impacted by inflation in the future.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. Our disclosure controls are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2023.
Changes in Internal Control over Financial Reporting
During the quarter ended September 30, 2023, we replaced components of our enterprise resource planning system, including our financial ledger, inventory management platform and product data warehouse system. These new systems are intended to provide us with enhanced transactional processing, security and management tools, and are an important element of our system of disclosure controls and procedures. We modified certain existing internal controls, as well as implemented new controls and procedures impacted by the implementation of these new systems. We will continue to monitor and evaluate the operating effectiveness of the related controls during subsequent periods. Except for the implementation of these new systems, there was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Controls
In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be party to litigation that arises in the ordinary course of our business. Management believes that we do not have any pending litigation that, separately or in the aggregate, would have a material adverse effect on our results of operations, financial condition or cash flows, and no material legal proceedings were terminated, settled or otherwise resolved during the 13 weeks ended September 30, 2023.
SEC regulations require us to disclose information about certain environmental proceedings if we reasonably believe that such proceedings may result in monetary sanctions above a stated threshold. Pursuant to SEC regulations, we use a threshold of $1.0 million for purposes of determining whether disclosure of any such proceedings is required.
Item 1A. Risk Factors
In addition to the other information set forth in this Quarterly Report on Form 10-Q, our business, financial condition and operating results can be affected by a number of factors, whether currently known or unknown, including but not limited to those described in Part I, Item 1A of our 2022 Form 10-K under the heading "Risk Factors," any one or more of which could, directly or indirectly, cause our actual financial condition and operating results to vary materially from past, or from anticipated future, financial condition and operating results. Any of these factors, in whole or in part, could materially and adversely affect our business, financial condition, operating results and stock price. There have been no material changes to our risk factors since the 2022 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the 13 weeks ended September 30, 2023, we did not repurchase any shares of our common stock.
Item 3. Default Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosure
Not applicable.
Item 5. Other Information
Rule 10b5-1 Trading Plans - Directors and Section 16 Officers
The following table describes contracts, instructions or written plans for the sale or purchase of our securities adopted by our directors and Officers (as such term is defined under Section 16 of the Exchange Act) during the 13 weeks ended September 30, 2023, each of which is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) of the Exchange Act, each referred to as Rule 10b5-1 trading plan.
| Name and Position | Date of Adoption of Rule 10b5-1 Trading Plan | Scheduled Expiration of Rule 10b5-1 Trading Plan (1) | Aggregate Number of Securities to be Purchased or Sold | |||||||||||||||||
Eric J. Lindberg, Jr. Chairman of the Board of Directors | 8/15/2023 | 8/23/2024 | Up to 680,000 shares of our common stock upon the exercise of stock options (2) | |||||||||||||||||
Steven K. Wilson EVP, Chief Purchasing Officer | 8/28/2023 | 8/16/2024 | Up to 144,666 shares of our common stock (which includes 32,017 shares upon the exercise of stock options) (2) | |||||||||||||||||
Thomas F. Herman Separate Property Trust (3) | 8/30/2023 | 12/31/2024 | Up to 17,000 shares of our common stock | |||||||||||||||||
_______________________
(1)A trading plan may also expire on such earlier date as all transactions under the trading plan are completed.
(2)The stock options included in Messrs. Lindberg and Wilson's 10b5-1 plans have expiration dates of October 21, 2024 and November 25, 2024, respectively.
(3)Thomas F. Herman, a member of our Board of Directors, is a trustee of the Thomas F. Herman Separate Property Trust.
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During the 13 weeks ended September 30, 2023, none of our directors and Officers (i) adopted a contract, instruction or written plan for the purchase or sale of our securities in any "non-Rule 10b5-1 trading arrangement" or (ii) terminated a contract, instruction or written plan for the purchase or sale of our securities that was a Rule 10b5-1 trading plan or any "non-Rule 10b5-1 trading arrangement."
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Item 6. Exhibits
| Incorporated by Reference | ||||||||||||||||||||||||||||||||
| Exhibit No. | Exhibit | Form | File No. | Filing Date | Exhibit No. | |||||||||||||||||||||||||||
| 3.1 | 8-K | 001-38950 | 6/10/2022 | 3.1 | ||||||||||||||||||||||||||||
| 3.2 | 8-K | 001-38950 | 4/8/2022 | 3.1 | ||||||||||||||||||||||||||||
| 10.1†* | ||||||||||||||||||||||||||||||||
| 31.1* | ||||||||||||||||||||||||||||||||
| 31.2* | ||||||||||||||||||||||||||||||||
| 32.1** | ||||||||||||||||||||||||||||||||
| 32.2** | ||||||||||||||||||||||||||||||||
| 101.INS | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |||||||||||||||||||||||||||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document | |||||||||||||||||||||||||||||||
| 101.CAL | Inline XBRL Extension Calculation Linkbase Document | |||||||||||||||||||||||||||||||
| 101.DEF | Inline XBRL Extension Definition Linkbase Document | |||||||||||||||||||||||||||||||
| 101.LAB | Inline XBRL Extension Label Linkbase Document | |||||||||||||||||||||||||||||||
| 101.PRE | Inline XBRL Extension Presentation Linkbase Document | |||||||||||||||||||||||||||||||
| 104 | Cover Page Interactive Data File - the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document and included as Exhibit 101. | |||||||||||||||||||||||||||||||
____________________________________
| † | Management contract or compensatory plan or arrangement. | |||||||
| * | Filed herewith. | |||||||
** | Furnished herewith. The certifications attached as Exhibit 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q are deemed furnished and not filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Grocery Outlet Holding Corp. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing. | |||||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Grocery Outlet Holding Corp. | ||||||||||||||
| Date: | November 8, 2023 | By: | /s/ Charles C. Bracher | |||||||||||
| Charles C. Bracher Chief Financial Officer (Principal Financial Officer) | ||||||||||||||
| Date: | November 8, 2023 | By: | /s/ Lindsay E. Gray | |||||||||||
| Lindsay E. Gray Senior Vice President, Accounting (Principal Accounting Officer) | ||||||||||||||
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