S-1/A
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As filed with the Securities and Exchange Commission on October 3, 2019.

Registration No. 333-234036

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 1

TO

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Grocery Outlet Holding Corp.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   5411   47-1874201

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

5650 Hollis Street

Emeryville, California 94608

(510) 845-1999

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Pamela B. Burke

Chief Administrative Officer, General Counsel and Secretary

Grocery Outlet Holding Corp.

5650 Hollis Street

Emeryville, California 94608

(510) 845-1999

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With copies to:

 

William B. Brentani

Simpson Thacher & Bartlett LLP

2475 Hanover Street

Palo Alto, California 94304

Tel: (650) 251-5000

Fax: (650) 251-5002

 

Bruce K. Dallas

Alan F. Denenberg

Emily Roberts

Davis Polk & Wardwell LLP

1600 El Camino Real

Menlo Park, California 94025

Tel: (650) 752-2000

Fax: (650) 752-3622

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

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 7(a)(2)(B) of the Securities Act.  ☐

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class

of Securities to be Registered

  Amount to be
Registered (1)
  Proposed Maximum
Offering Price Per
Share (2)
  Proposed Maximum
Aggregate Offering
Price (1)(2)
 

Amount of

Registration Fee (3)

Common stock, $0.001 par value per share

 

14,950,000

  $34.48   $515,476,000.00   $66,908.79

 

 

(1)

Includes 1,950,000 shares that the underwriters have the option to purchase. See “Underwriting.”

(2)

Estimated solely for the purpose of computing the amount of the registration fee. In accordance with Rule 457(c) under the Securities Act of 1933, as amended, the maximum price per share and maximum aggregate offering price are based on the average of the $34.99 (high) and $33.96 (low) sale price of the registrant’s common stock as reported on The Nasdaq Global Select Market on September 30, 2019, which date is within five business days prior to filing this Registration Statement.

(3)

Previously paid.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus dated October 3, 2019

PROSPECTUS

13,000,000 Shares

 

 

LOGO

Common Stock

 

 

This is a public offering of shares of common stock of Grocery Outlet Holding Corp.

The selling stockholders identified in this prospectus are offering 13,000,000 shares of our common stock. We are not selling any shares of common stock under this prospectus and will not receive any proceeds from the sale of the shares by the selling stockholders.

Our common stock is listed and traded on The Nasdaq Global Select Market (“Nasdaq”) under the symbol “GO.” On October 2, 2019, the last reported sale price of our common stock on Nasdaq was $33.01 per share.

Investing in the common stock involves risks that are described in the “Risk Factors ” section beginning on page 17 of this prospectus.

 

 

 

    

Per Share

    

    Total    

Public offering price

       $          $

Underwriting discount (1)

       $          $

Proceeds, before expenses, to selling stockholders

       $          $
  (1)

See “Underwriting” for a description of the compensation payable to the underwriters.

The selling stockholders have granted the underwriters an option exercisable for 30 days after the date of this prospectus, to purchase, from time to time, in whole or in part, up to an aggregate of 1,950,000 shares from the selling stockholder affiliated with Hellman & Friedman LLC at the public offering price less underwriting discounts and commissions.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The shares will be ready for delivery on or about                    , 2019.

 

 

 

BofA Merrill Lynch   Morgan Stanley   Deutsche Bank Securities   Jefferies

 

Barclays   Goldman Sachs & Co. LLC   Guggenheim Securities   UBS Investment Bank   Cowen

 

Telsey Advisory Group   Drexel Hamilton   Penserra Securities LLC

 

 

The date of this prospectus is                    , 2019.

 


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LOGO

 

With Grocery Outlet’s amazingly low prices on name-brand items, there’s no telling how good you’ll feel. We love brands. Like, really love them. That’s why we work hard every bring our customers the brands they love at prices that are nothing pure bliss. In fact, we’ve been helping customers save big since 1946.


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LOGO

15 CONSECUTIVE YEARS 10% OF COMPARABLE STORE SALES GROWTH STORE COUNT CAGR SINCE 2015 40-70% PRICES BELOW CONVENTIONAL RETAILERS *On name-brand, sourced products. opportunistically 4.2% AVERAGE COMPARABLE STORE SALES GROWTH SINCE 2015 $2.3B 2018 SALES 300 OVER STORES


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TABLE OF CONTENTS

 

    

Page

 

Prospectus Summary

     1  

Risk Factors

     17  

Special Note Regarding Forward-Looking Statements

     46  

Use of Proceeds

     49  

Dividend Policy

     50  

Capitalization

     51  

Selected Consolidated Financial Data

     52  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     57  

Business

     85  

Management

     100  

Executive Compensation

     106  

Certain Relationships and Related Party Transactions

     131  

Principal and Selling Stockholders

     133  

Description of Capital Stock

     136  

Shares Eligible for Future Sale

     145  

Certain United States Federal Income and Estate Tax Consequences to Non-U.S. Holders

     147  

Underwriting

     150  

Legal Matters

     158  

Experts

     158  

Where You Can Find Additional Information

     159  

Index to Consolidated Financial Statements

     F-1  

 

 

We, the selling stockholders and the underwriters have not authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses that we have prepared. We, the selling stockholders and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of the date on the front cover of this prospectus, regardless of the time of delivery of this prospectus or any sale of the shares. Our business, financial condition, results of operations and prospects may have changed since the date on the front cover of this prospectus.

For investors outside the United States: We, the selling stockholders and the underwriters have not done anything that would permit a public offering of the shares of our common stock or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside of the United States.

 

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PROSPECTUS SUMMARY

This summary highlights information contained in greater detail elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our common stock, you should carefully read this entire prospectus, including our financial statements and the related notes included elsewhere in this prospectus and the information set forth under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Unless otherwise indicated in this prospectus, references to the “Company,” “we,” “us” and “our” refer to Grocery Outlet Holding Corp. and its consolidated subsidiaries. References to “underwriters” refer to the firms listed on the cover page of this prospectus. References to the fiscal years 2015, 2016, 2017 and 2018 refer to the fiscal years ended January 2, 2016, December 31, 2016, December 30, 2017 and December 29, 2018, respectively. References to the first half 2018 and the first half 2019 refer to the 26 weeks ended June 30, 2018 and June 29, 2019, respectively.

Our Company

We are a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold through a network of independently operated stores. Each of our stores offers a fun, treasure hunt shopping experience in an easy-to-navigate, small-box format. An ever-changing assortment of “WOW!” deals, complemented by everyday staple products, generates customer excitement and encourages frequent visits from bargain-minded shoppers. 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. This differentiated approach has driven 15 consecutive years of positive comparable store sales growth.

Our founder, Jim Read, pioneered our opportunistic buying model in 1946 and subsequently developed the IO selling approach, which harnesses individual entrepreneurship and local decision-making to better serve our customers. Underlying this differentiated model was a mission that still guides us today: “Touching Lives for the Better.” Since 2006, the third generation of Read family leadership has advanced this mission and accelerated growth by strengthening our supplier relationships, introducing new product categories and expanding the store base from 128 to 330 stores across the West Coast and Pennsylvania. These efforts have more than tripled sales from approximately $640 million in 2006 to $2.3 billion in 2018, representing an 11% compound annual growth rate (“CAGR”). Our passionate, founding family-led management team remains a driving force behind our growth-oriented culture.

Our differentiated model for buying and selling delivers a “WOW!” shopping experience, which generates customer excitement, inspires loyalty and supports profitable sales growth:

 

   

How we buy: We source quality, name-brand consumables and fresh products opportunistically through a large, centralized purchasing team that leverages long-standing and actively managed supplier relationships to acquire merchandise at significant discounts. Our speed and efficiency in responding to supplier needs, combined with our specialized supply chain capabilities and flexible merchandising strategy, enhance our access to discounted products and allow us to turn inventory quickly and profitably. Our buyers proactively source on-trend products based on changing consumer preferences, including a wide selection of Natural, Organic, Specialty and Healthy (“NOSH”) products. We also source everyday staple products to complement our opportunistic offerings. We purchase over 85,000 stock keeping units (“SKUs”) from approximately 1,500 suppliers annually. Each store offers a curated and ever-changing assortment of approximately



 

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5,000 SKUs, creating a “buy now” sense of urgency that promotes return visits and fosters customer loyalty.

 

   

How we sell: Our stores are independently operated by entrepreneurial small business owners who have a relentless focus on selecting the best products for their communities, providing personalized customer service and driving improved store performance. Unlike a store manager of a traditional retailer, IOs are independent businesses and are responsible for store operations, including ordering, merchandising and managing inventory, marketing locally and directly hiring, training and employing their store workers. IOs initially contribute capital to establish their business and share store-level gross profits with us. These factors both align our interests and incentivize IOs to aggressively grow their business to realize substantial financial upside. This combination of local decision-making supported by our purchasing scale and corporate resources results in a “small business at scale” model that we believe is difficult for competitors to replicate.

Our value proposition has broad appeal with bargain-minded customers across all income levels, demographics and geographies. Customers visited our stores over 85 million times in 2018 with the average customer shopping twice per month and spending over $25 per transaction. We believe that our sustained focus on delivering ever-changing “WOW!” deals within a fun, treasure hunt shopping environment has generated strong customer loyalty and brand affinity. This customer enthusiasm is evidenced by our high scores on surveys designed to measure customer experience of our brand and 11 consecutive years of positive comparable store traffic growth. We believe that our broad customer appeal supports significant new store growth opportunities, and we plan to continue to expand our reach to additional customers and geographies across the United States.

Our stores have performed well across all economic cycles, as demonstrated by our 15 consecutive years of positive comparable store sales growth and consistent gross margins of between 30.1% and 30.8% since 2010.(1) In fact, our value proposition attracts even more customers in periods of economic uncertainty as evidenced by our average 13.5% comparable store sales growth during the recessionary economic conditions experienced in 2008 and 2009. Our model is also insulated from store labor-related variability because IOs directly employ their store workers. The result is lower corporate fixed costs, providing further protection in the event of an economic downturn.

15 Consecutive Years of Positive Comparable Store Sales Growth (2004 – 2018) (1)

 

LOGO

 

(1)

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business—Comparable Store Sales” and “—Gross Profit and Gross Margin.”



 

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Following the 2014 H&F Acquisition (as defined below), we made significant infrastructure investments and have continued to grow our business, as evidenced by the following achievements since 2015 through fiscal 2018:

 

   

Expanded our store count from 237 to 316 (as of December 29, 2018), a CAGR of 10.1%

 

   

Grown comparable store sales at an average annual rate of 4.2%

 

   

Increased sales from $1.6 billion to $2.3 billion, a CAGR of 12.0%

 

   

Maintained consistent gross margins of between 30.2% and 30.6% on an annual basis

 

   

Increased net income from $4.8 million to $15.9 million, a CAGR of 49.3%

 

   

Increased adjusted EBITDA from $108.2 million to $153.6 million, a CAGR of 12.4%

 

Store count   Sales ($MM) (1)   Net income ($MM) (2)   Adjusted EBITDA ($MM) (3)

 

LOGO

 

 

LOGO

 

 

LOGO

 

 

LOGO

 

(1)

For the 26 weeks ended June 29, 2019, our sales were $1.3 billion.

(2)

For the 26 weeks ended June 29, 2019, we recorded a net loss of $6.9 million.

(3)

For the 26 weeks ended June 29, 2019, our adjusted EBITDA was $84.1 million.

Our Competitive Strengths

We believe that the following competitive strengths are key drivers of our current success and position us for continued growth:

 

   

Powerful Customer Value Proposition Supported by a “WOW!” Experience. Delivering thrilling “WOW!” deals to our customers is a cornerstone of our business. We offer customers quality, name-brand consumables and fresh products at deep discounts in a fun, treasure hunt shopping environment. Our product offering is ever-changing with a constant rotation of opportunistic products, complemented by an assortment of competitively priced everyday staples across grocery, produce, refrigerated and frozen foods, beer and wine, fresh meat and seafood, general merchandise and health and beauty care. A typical Grocery Outlet basket is priced approximately 40% lower than conventional grocers and approximately 20% lower than the leading discounters. Our stores are convenient, easy to navigate and require neither membership fees nor bulk purchases for customers to save money. Upon entering a store, customers encounter a curated selection of fresh produce and perishables, complemented by a “Power Wall” showcasing many of our most exciting “WOW!” offerings. Our stores have wide aisles, clear signage and a high level of customer service. Upon checkout, a cashier “circles the savings” on each customer’s receipt, which reinforces the compelling value that we provide.

 

   

Flexible Sourcing and Distribution Model That Is Difficult to Replicate. Our flexible sourcing and distribution model differentiates us from traditional retailers and allows us to provide customers



 

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quality, name-brand products at exceptional values. As strong stewards of our suppliers’ brands, we are a preferred partner with a reputation for making rapid decisions, purchasing significant volumes and creatively solving suppliers’ inventory challenges to arrive at “win-win” outcomes. We take advantage of opportunities to acquire merchandise at substantial discounts that regularly arise from order cancellations, manufacturer overruns, packaging changes and approaching “sell-by” dates. We supplement our “WOW!” deals with everyday staples in order to provide a convenient shopping experience. Our buying strategy is deliberately flexible, which allows us to react to constantly changing opportunities. With over 60 people, our centralized sourcing team has deep experience and decades-long relationships with leading consumer packaged goods (“CPG”) companies. Our team is highly selective when evaluating the growing number of opportunities available to us and maintains a disciplined yet solutions-oriented approach. We buy from approximately 1,500 suppliers annually, with no supplier representing more than 5% of sales, and benefit from an average relationship of 30 years with our top 15 suppliers. Our specialized model is supported by a supply chain designed to quickly and efficiently deliver an ever-changing assortment of products to store shelves.

 

   

Independent Operators Who Are the Foundation of Our “Small Business at Scale” Model. Our stores are independent business entities operated by entrepreneurial small business owners who have a relentless focus on ordering and merchandising the best products for their communities, providing personalized customer service and driving improved store performance. We generally share 50% of store-level gross profits with IOs, thereby incentivizing them to aggressively grow their business and realize substantial financial upside. IOs leverage our national purchasing scale, sophisticated ordering and information systems and field support in order to operate more efficiently. This combination of local decision-making supported by our purchasing scale and corporate resources results in a “small business at scale” model that we believe is difficult for competitors to replicate. The vast majority of the IOs operate a single store, with most working as two-person teams, and, on average, have been operating their stores for more than five years. We encourage the IOs to establish local roots and actively participate in their communities to foster strong personal connections with customers. The IOs select approximately 75% of their merchandise based on local preferences, providing a unique assortment tailored to their community. Our collaborative relationship with the IOs creates a powerful selling model allowing us to deliver customers exceptional value with a local touch.

 

   

Proven and Consistent New Store Economics. Our new stores have generated robust store-level financial results, strong cash flow and attractive returns. Our highly flexible, small-box format of 15,000 to 20,000 total square feet has been successful across geographic regions, population densities and demographic groups, and has proved resilient to competitive entries from discounters and conventional retailers alike. On average, our stores achieve profitability during the first year of operations, reach maturity in four to five years and realize a payback on investment within four years. We have doubled our store count since 2011 and, on average, our stores opened during this time period with at least four years of operating history have produced year-four cash-on-cash returns of over 40%, outperforming our underwriting hurdles. We believe that our broad customer appeal, differentiated value proposition and the predictable financial performance of our stores across vintages provide a high degree of visibility into the embedded earnings growth from our recently opened stores.

 

   

Value-Oriented Brand Aligned with Favorable Consumer Trends. We believe that consumers’ search for value is the new normal in retail. The success of off-price retailers represents a secular consumer shift toward value as a leading factor in purchasing decisions. Moreover, as Millennials mature and Baby Boomers age, they are increasingly focused on value, driving shopper traffic



 

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towards the deep discount channel. According to published research, between 1988 and 2016, traditional grocery retailers ceded over 45 percentage points of market share to non-traditional grocery stores, including convenience stores, wholesale clubs, supercenters, dollar stores, drug stores and discounters. These trends have continued even after the completion of recessionary cycles, indicating that value remains a leading factor in consumers’ retail purchasing decisions despite the return of stronger economic conditions. According to the National Retail Federation, 89% of all shoppers across geographies, household incomes, genders and age demographics, shop at discount retailers, including off-price, dollar, outlet and discount grocery stores. We have spent decades building our IO and opportunistic purchasing models to offer deep discounts in a customer-friendly store environment, which enables us to take advantage of this ongoing preference for value.

 

   

Collaborative Company Culture Provides the Foundation for Continued Success. One of our key competitive advantages is our culture of family and community values, grounded in integrity, entrepreneurship, performance and collaboration. We have been dedicated to our mission of “Touching Lives for the Better” since our inception. Our passion and commitment are shared by team members throughout the entire organization, from the IOs and their employees to our distribution centers and corporate offices. We are a third-generation, family-run business led by CEO Eric Lindberg and Vice Chairman MacGregor Read. Both Messrs. Lindberg and Read have been with Grocery Outlet for over 20 years and have instilled a “servant leadership” mentality that empowers employees and IOs and forms the basis of our highly collaborative culture. These values are shared by a seasoned and cohesive management team with an average of 22 years of retail industry experience and a focus on consistent, long-term growth.

Our Growth Strategies

We plan to continue to drive sales growth and profitability by maintaining a relentless focus on our value proposition and executing on the following strategies:

 

   

Drive Comparable Sales Growth. We expect that our compelling value proposition will continue to attract new customers, drive repeat visits, increase basket sizes and, as a result, generate strong comparable store sales growth. We plan to:

 

   

Deliver More “WOW!” Deals and Expand Our Offerings. We intend to drive incremental traffic and increase our share of wallet by further leveraging our purchasing model. We continue to deepen existing and develop new supplier relationships to ensure that we are the preferred partner and the first call for opportunistic inventory. As a result, we believe there is a significant opportunity to source and offer more “WOW!” deals within existing and new product categories, thereby offering greater value and variety to customers. For example, in response to growing consumer preferences for fresh and healthy options, we have grown NOSH primarily through opportunistic purchasing to represent over 15% of our current product mix. More recently, we have expanded our offerings to include fresh seafood and grass-fed meat in order to increase sales to existing and new customers.

 

   

Support IOs in Enhancing the “WOW!” Customer Experience. We continue to implement operational initiatives to support IOs in enhancing the customer experience. We develop and improve tools that provide IOs with actionable insights on sales, margin and customer behavior, enabling them to further grow their business. Our recently enhanced inventory planning tools help IOs make better local assortment decisions while reducing out-of-stock items and losses related to product markdowns, throwaways and theft (“shrink”). We also regularly deploy updated fixtures, signage and enhanced in-store marketing to further improve the shopping experience, which we believe results in higher customer traffic and average basket sizes.



 

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Increase Customer Awareness and Engagement. Our marketing strategy is focused on growing awareness, encouraging new customers to visit our stores and increasing engagement with all bargain-minded consumers. Our recent emphasis on digital marketing is enabling us to deliver specific and real-time information to our customers about the most compelling “WOW!” deals at their local store. We have over one million email subscribers in our database, most of whom receive daily and weekly “WOW! Alerts.” Along with the IOs, we have begun to utilize social media to increase our brand affinity and interact with customers more directly on a daily basis. Looking forward, we see an opportunity to further personalize our digital communications to both increase engagement with our existing customers and introduce new customers to our stores. We will continue to supplement our digital marketing with traditional print and broadcast advertising including through our new marketing campaign, “Welcome to Bargain Bliss.”

 

   

Execute on Store Expansion Plans. We believe the success of our stores across a broad range of geographies, population densities and demographic groups creates a significant opportunity to profitably increase our store count. Our new stores typically require an average net cash investment of approximately $2.0 million and realize a payback on investment within four years. In 2018, we opened 26 new stores and expect to open 32 new stores in 2019. Based on our experience, in addition to research conducted by eSite Analytics, we believe there is an opportunity to establish over 400 additional locations in the states in which we currently operate and approximately 1,600 additional locations when neighboring states are included. Our goal is to expand our store base by approximately 10% annually by penetrating existing and contiguous regions. Over the long term, we believe the market potential exists to establish 4,800 locations nationally.

 

   

Implement Productivity Improvements to Reinvest in Our Value Proposition. Our seasoned management team has a proven track record of growing our business while maintaining a disciplined cost structure. Since the 2014 H&F Acquisition, we have made significant investments that have laid a solid foundation for future growth. For example, we recently implemented a new warehouse management system that has increased distribution labor productivity and improved store ordering capabilities to help reduce shrink. We have implemented and will continue to identify and implement productivity improvements through both operational initiatives and system enhancements, such as category assortment optimization, improved inventory management tools and greater purchasing specialization. We intend to reinforce our value proposition and drive further growth by reinvesting future productivity improvements into enhanced buying and selling capabilities.

Risks Related to Our Business

Investing in our common stock involves a high degree of risk. You should carefully consider these risks before investing in our common stock, including the risks related to our business and industry described under “Risk Factors” elsewhere in this prospectus. In particular, the following considerations, among others, may offset our competitive strengths or have a negative effect on our business strategy, which could cause a decline in the price of our common stock and result in a loss of all or a portion of your investment:

 

   

failure of suppliers to consistently supply us with opportunistic products at attractive pricing;

 

   

inability to successfully identify trends and maintain a consistent level of opportunistic products;

 

   

failure to maintain or increase comparable store sales;

 

   

failure to open, relocate or remodel stores on schedule;



 

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failure of the IOs to successfully manage their business;

 

   

inability to attract and retain qualified IOs;

 

   

the significant influence of the H&F Investor over us;

 

   

our ability to generate cash flow to service our substantial debt obligations; and

 

   

other factors set forth under “Risk Factors” in this prospectus.

Recent Developments

First Lien Credit Agreement Amendment

On July 23, 2019, we entered into an Incremental Agreement (as defined elsewhere in this prospectus) to amend our First Lien Credit Agreement (as defined elsewhere in this prospectus). The Incremental Agreement refinanced the term loan outstanding under the First Lien Credit Agreement with a replacement $475.2 million senior secured term loan credit facility with an applicable margin of 3.25% or 3.50% for Eurodollar loans and 2.25% or 2.50% for base rate loans, in each case depending on the public corporate family rating of GOBP Holdings, Inc. This new term loan matures on October 22, 2025, which is the same maturity date of the existing First Lien Credit Agreement.

California Enactment of AB-5

On September 18, 2019, the California state legislature enacted AB-5, a bill that amended the California Labor Code, California Unemployment Insurance Code and wage orders of the California Industrial Welfare Commission to provide that a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity can demonstrate that certain conditions are met. Those conditions include the fact that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, the person performs work that is outside the usual course of the hiring entity’s business, and the person is customarily engaged in an independently established trade, occupation, or business. Under our business model, the IOs are independent contractors and their employees are solely employed by them. The IOs are responsible for the payment of their employee’s wages and benefits in accordance with applicable local law. While this test is narrower than what was the traditional standard for employee/independent contractor classification in California, and while there has not been any guidance regarding its application due to AB-5’s recent adoption, we believe it is still appropriate to classify the California-based IOs as independent contractors. For a further discussion of related risks see “Risk Factors—Risks Related to Our Business—In the past, certain business models that use independent contractors to sell directly to customers have been subject to challenge under various laws, including laws relating to franchising, misclassification and joint employment. If our business model is determined to be a franchise, if IOs are found not to be independent contractors, but our employees, or if we are found to be a joint employer of an IO’s employees, our business and operations could be materially adversely affected.”

Preliminary Financial and Operational Information

The following information reflects our preliminary expectations of results for the thirteen weeks ended September 28, 2019, based on currently available information. We have provided ranges, rather than specific amounts, for the financial results below, primarily because our financial closing procedures for the thirteen weeks ended September 28, 2019 have just commenced and, as a result, we expect that our final results upon completion of our closing procedures may vary from the preliminary estimates included herein. For instance, we have not begun review of most account reconciliations or expense accruals, or prepared notes to our financial



 

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statements. These reconciliations and reviews include financial statement accounts such as cash, inventory, lease-related assets and liabilities and deferred income tax, as well as expense accruals including our cost of sales accruals, insurance claim reserves, stock-based compensation, public company costs and other operating expenses, which we are currently estimating. We anticipate that our consolidated financial statements for the thirteen weeks ended September 28, 2019 will not be available until after the date of this prospectus and will be included in our periodic report filed with the United States Securities and Exchange Commission (the “SEC”) following this offering.

Preliminary Financial Results

Although the financial results for the thirteen weeks ended September 28, 2019 are not yet finalized, we estimate that the financial results will fall within the following ranges, as compared to the thirteen weeks ended September 29, 2018:

 

     Thirteen Weeks Ended  
     September 29,
2018
    September 28,
2019
 
     Actual     Low     High  
     (in thousands)  

Net sales

   $ 576,843     $ 652,540     $ 652,540  

Income from operations

   $ 24,088     $ 20,400     $ 21,400  

Net income

   $ 7,669     $ 8,928     $ 9,648  

Adjusted EBITDA

   $ 39,026     $ 42,000     $ 43,000  

Comparable store sales growth (1)

     4.2     5.8     5.8

 

(1)

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business—Comparable Store Sales.”

We expect to report net sales for the thirteen weeks ended September 28, 2019 of $652.5 million compared to $576.8 million for the thirteen weeks ended September 29, 2018, an increase of $75.7 million or 13.1%. The increase in net sales for the thirteen weeks ended September 28, 2019 compared to the same period of 2018 is primarily due to non-comparable store sales growth attributable to the net 30 stores opened over the last 12 months as well as an increase in comparable store sales. We expect to report that comparable store sales increased 5.8% for the thirteen weeks ended September 28, 2019 compared to the same period of 2018 driven by increases in both the number of customer transactions and average transaction size. We expect to report income from operations for the thirteen weeks ended September 28, 2019 to be between $20.4 million and $21.4 million, compared to $24.1 million for the thirteen weeks ended September 29, 2018, a decrease of 13.2%, calculated using the midpoint of the range. Income from operations for the thirteen weeks ended September 28, 2019 reflects an estimated $3.0 million of compensation expense, which primarily consisted of non-cash stock compensation expense that is now recognized as a result of our initial public offering in June 2019, as well as approximately $2.0 million of additional costs to comply with public company requirements that were not incurred in the prior year including incremental insurance, accounting, and legal expense as well as costs required to comply with the Sarbanes-Oxley Act. We estimate that net income for the thirteen weeks ended September 28, 2019 will be between $8.9 million and $9.6 million, compared to $7.7 million for the thirteen weeks ended September 29, 2018, an increase of $1.6 million or 21.1%, calculated using the midpoint of the range. We estimate that adjusted EBITDA for the thirteen weeks ended September 28, 2019 will be between $42.0 million and $43.0 million compared to $39.0 million for the thirteen weeks ended September 29, 2018, an increase of $3.5 million or 8.9% calculated using the midpoint of the range. Our adjusted EBITDA estimate for the thirteen weeks ended September 28, 2019 includes approximately $2.0 million of additional costs to comply with public company requirements that were not incurred in the prior year including incremental insurance, accounting, and legal expense as well as costs required to comply with the Sarbanes-Oxley Act. We expect our gross margins for the thirteen weeks ended September 28, 2019 to be substantially consistent with our gross margins of 30.8% for the twenty six weeks ended June 29, 2019.



 

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Preliminary Operational Results

Although the operational results for the thirteen weeks ended September 28, 2019 are not yet finalized, we estimate that the operational results will be as follows, as compared to the thirteen weeks ended September 29, 2018:

 

     As of  
     September 29,
2018
     September 28,
2019
 

Number of new stores

     8        8  

Number of stores open at end of period

     307        337  

We opened eight new stores and closed one store during the thirteen weeks ended September 28, 2019, compared to eight new stores opened and one closure during the thirteen weeks ended September 29, 2018. As of September 28, 2019, we operated 337 stores, compared to 307 stores as of September 29, 2018.

Adjusted EBITDA Reconciliation

Adjusted EBITDA is a non-GAAP measure used by management to measure our operating performance. The following table provides a reconciliation from our preliminary estimates of net income to preliminary estimates of EBITDA and preliminary estimates of adjusted EBITDA for the thirteen weeks ended September 28, 2019 (at the low end and high end of the estimated ranges set forth above) and the thirteen weeks ended September 29, 2018. In addition, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business” for additional information as to how we define EBITDA and adjusted EBITDA, the reasons why we include these measures and certain limitations to their use.

 

     Thirteen Weeks Ended  
     September 29,
2018
     September 28,
2019
 
     Actual      Low      High  
     (in thousands)  

Net income

   $ 7,669      $ 8,928      $ 9,648  

Interest expense, net

     13,526        7,500        7,500  

Income tax expense

     2,892        3,472        3,752  

Depreciation and amortization expenses

     11,903        14,000        14,000  
  

 

 

    

 

 

    

 

 

 

EBITDA

     35,990        33,900        34,900  

Stock-based compensation expenses (a)

     121        3,000        3,000  

Debt extinguishment and modification costs (b)

     —          500        500  

Non-cash rent (c)

     2,201        1,800        1,800  

Asset impairment and gain or loss on disposition (d)

     51        400        400  

New store pre-opening expenses (e)

     337        400        400  

Provision for accounts receivable reserves (f)

     (106      500        500  

Other (g)

     432        1,500        1,500  
  

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

   $ 39,026      $ 42,000      $ 43,000  
  

 

 

    

 

 

    

 

 

 

 

(a)

Consists primarily of estimated non-cash stock compensation expense for the thirteen weeks ended September 28, 2019, with the remainder representing dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2016 Recapitalization (as defined elsewhere in this prospectus) and our 2018 Recapitalization (as defined elsewhere in this prospectus). We expect to pay an additional $4.2 million in the aggregate on options as they vest in respect of such dividends, of which $3.4 million is expected to be paid in the remainder of fiscal year 2019.



 

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(b)

Represents debt modification costs related to the write-off of debt issuance costs and non-capitalizable expenses related to the refinancing of our first lien credit facility.

(c)

Consists of the non-cash portion of rent expense, which reflects the extent to which our straight-line rent expense recognized under GAAP exceeds or is less than our cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant growth in recent years.

(d)

Represents impairment charges with respect to planned store closures and gains or losses on dispositions of assets in connection with store transitions to new IOs.

(e)

Includes marketing, occupancy and other expenses incurred in connection with store grand openings, including costs that will be the IO’s responsibility after store opening.

(f)

Represents non-cash changes in reserves related to our IO notes and accounts receivable.

(g)

Other non-recurring, non-cash or discrete items as determined by management, including offering and transaction-related costs, personnel-related costs, strategic project costs, legal expenses and miscellaneous costs.

Inclusion of Preliminary Financial and Operational Information

The preliminary financial and operational information included in this prospectus reflect management’s estimates based solely upon information available to us as of the date of this prospectus and are the responsibility of management. The preliminary consolidated financial results presented above are not a comprehensive statement of our financial results for the thirteen weeks ended September 28, 2019 and have not been audited, reviewed, or compiled by our independent registered public accounting firm, Deloitte & Touche LLP (“Deloitte”). Accordingly, Deloitte does not express an opinion and assumes no responsibility for and disclaims any association with such preliminary consolidated financial results. The preliminary consolidated financial results presented above are subject to the completion of our financial closing procedures, which have not yet been completed. Our actual results for the thirteen weeks ended September 28, 2019 will not be available until after this offering is completed and may vary from these estimates. Accordingly, you should not place undue reliance upon these preliminary financial results. For example, during the course of the preparation of the respective financial statements and related notes, additional items that would require adjustments to be made to the preliminary estimated consolidated financial results presented above may be identified. There can be no assurance that these estimates will be realized, and estimates are subject to risks and uncertainties, many of which are not within our control. See “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Our Sponsor

Hellman & Friedman LLC (“H&F”) is a leading private equity investment firm with offices in San Francisco, New York and London. Since its founding in 1984, H&F has raised over $50 billion of committed capital. The firm focuses on investing in outstanding businesses and serving as a value-added partner to management in select industries including retail & consumer, internet & media, software, financial services, business & information services, healthcare and industrials & energy. In 2014, an investment fund affiliated with H&F (the “H&F Investor”) acquired approximately 80% of our common stock from Berkshire Partners (the “2014 H&F Acquisition”). After the completion of this offering, the H&F Investor will own approximately 48.7% of our outstanding common stock, or approximately 46.5% if the underwriters exercise in full their option to purchase additional shares. For a discussion of certain risks, potential conflicts and other matters associated with the H&F Investor’s ownership of our common stock, see “Risk Factors—Risks Relating to this Offering and Ownership of Our Common Stock—The H&F Investor will continue to hold a significant percentage of our outstanding stock after this offering and its interests may be different than the interests of other holders of our securities” and “Description of Capital Stock.”



 

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Corporate Information

Grocery Outlet Holding Corp. was incorporated in Delaware on September 11, 2014. Our principal executive offices are located at 5650 Hollis Street, Emeryville, California 94608. Our telephone number is (510) 845-1999. Our website address is www.groceryoutlet.com. Information contained on, or that can be accessed through, our website does not constitute part of this prospectus, and inclusions of our website address in this prospectus are inactive textual references only.

Trademarks and Service Marks

We own or have rights to certain brand names, trademarks and services marks that we use in conjunction with the operation of our business. In addition, our name and logo are our trademarks or service marks. One of the more important trademarks that we use is Grocery Outlet Bargain MarketTM. This prospectus contains additional trademarks, trade names and service marks of other companies. We do not intend our use or display of other companies’ trademarks, trade names or service marks to imply relationships with, or endorsement or sponsorship of us by, these other companies.

Market, Industry and Other Data

This prospectus contains statistical data that we obtained from industry publications and reports. These publications generally indicate that they have obtained their information from sources believed to be reliable.



 

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The Offering

 

Common stock offered by the selling stockholders

13,000,000 shares.

 

Common stock to be outstanding immediately after this offering


88,763,234 shares, which assumes 451,470 shares issued in connection with the exercise of options by certain selling stockholders in connection with this offering. Except as provided in the immediately preceding sentence, the number of shares of common stock outstanding will not change as a result of this offering.

 

Option to purchase additional shares

The selling stockholders have granted the underwriters a 30-day option to purchase up to an additional 1,950,000 shares of common stock from the H&F Investor at the public offering price, less the underwriting discounts and commissions.

 

Use of proceeds

The selling stockholders will receive all of the net proceeds from the sale of shares of common stock in this offering. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders or if the underwriters exercise their option to purchase additional shares. See “Use of Proceeds.”

 

Risk factors

See “Risk Factors” and the other information included in this prospectus for a discussion of the factors you should consider carefully before deciding to invest in our common stock.

 

Dividend policy

We currently do not intend to declare any dividends on our common stock in the foreseeable future. Our ability to pay dividends on our common stock is limited by our First Lien Credit Agreement. See “Dividend Policy.”

 

Nasdaq symbol

“GO”

Except as otherwise indicated, all information in this prospectus regarding the number of shares of common stock that will be outstanding immediately after this offering is based on 88,311,764 shares of common stock outstanding as of June 29, 2019, and:

 

   

excludes 229,987 shares of common stock underlying 229,987 restricted stock units that were outstanding as of June 29, 2019;

 

   

excludes 6,653,092 shares of common stock issuable upon the exercise of time-based options to purchase shares of our common stock outstanding as of June 29, 2019 with a weighted average exercise price of $10.45 per share, which excludes those being exercised by certain selling stockholders in connection with this offering and 5,843,343 shares of common stock issuable upon the exercise of performance-based options to purchase shares of our common stock outstanding as of June 29, 2019 with a weighted average exercise price of $4.61 per share, which have not previously vested, will not vest upon the consummation of this offering and are eligible to vest only if and when the H&F Investor has achieved specified internal rates of return with respect to its investment in the Company; and

 

   

does not reflect 3,072,293 shares of common stock available for future issuance under our 2019 Incentive Plan (as defined elsewhere in this prospectus).



 

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Summary Consolidated Financial Data

The following table sets forth the summary consolidated financial data of the Company for the periods presented. The summary consolidated financial data for the fiscal years 2016, 2017 and 2018, all of which contained 52 weeks, are derived from our audited consolidated financial statements and the related notes appearing elsewhere in this prospectus. The summary consolidated financial data for the 26 weeks ended June 30, 2018 and June 29, 2019 and the summary balance sheet data as of June 29, 2019 are derived from our unaudited condensed consolidated financial statements and the related notes appearing elsewhere in this prospectus. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods and interim results are not necessarily indicative of results to be expected for the full year ended December 28, 2019.

The summary consolidated financial data set forth below should be read in conjunction with “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus. Some of the financial data contained in this prospectus reflects the effects of, and may not total due to, rounding.

 

     Fiscal Year Ended      26 Weeks Ended  
     December 31,
2016
     December 30,
2017
     December 29,
2018
     June 30,
2018
     June 29,
2019
 
     (in thousands, except per share data)  

Statement of Operations Data:

              

Net sales

   $ 1,831,531      $ 2,075,465      $ 2,287,660      $ 1,125,616      $ 1,251,560  

Cost of sales

     1,270,354        1,443,582        1,592,263        781,932        865,823  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     561,177        631,883        695,397        343,684        385,737  

Operating Expenses:

              

Selling, general and administrative expenses

     457,051        510,136        557,100        276,479        310,495  

Depreciation and amortization expenses

     37,152        43,152        45,421        22,413        24,890  

Stock-based compensation expenses

     2,905        1,659        10,409        263        22,961  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     497,108        554,947        612,930        299,155        358,346  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

     64,069        76,936        82,467        44,529        27,391  

Other Expense:

              

Interest expense, net

     47,147        49,698        55,362        26,886        31,890  

Debt extinguishment and modification costs

     —          1,466        5,253        —          5,162  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total other expense

     47,147        51,164        60,615        26,886        37,052  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     16,922        25,772        21,852        17,643        (9,661

Income tax expense (benefit)

     6,724        5,171        5,984        4,832        (2,803
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 10,198      $ 20,601      $ 15,868      $ 12,811      $ (6,858
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 


 

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     Fiscal Year Ended     26 Weeks Ended  
     December 31,
2016
    December 30,
2017
    December 29,
2018
    June 30,
2018
    June 29,
2019
 
     (in thousands, except per share data)  

Per Share Data:

          

Net income (loss) per share (basic and diluted)

          

Basic

   $ 0.15     $ 0.30     $ 0.24     $ 0.19     $ (0.10

Diluted

   $ 0.15     $ 0.30     $ 0.23     $ 0.19     $ (0.10

Weighted average shares outstanding (basic and diluted)

          

Basic

     68,260       68,232       68,473       68,471       69,494  

Diluted

     68,323       68,332       68,546       68,499       69,494  

Statement of Cash Flows Data:

          

Net cash provided by operating activities

   $ 70,875     $ 84,703     $ 105,811     $ 55,217     $ 39,718  

Net cash used in investing activities

     (65,416     (77,820     (73,550     (25,501     (44,523

Net cash provided by (used in) financing activities

     (4,328     (7,935     (16,999     (2,756     2,419  

 

     Fiscal Year Ended     26 Weeks Ended  
     December 31,
2016
    December 30,
2017
    December 29,
2018
    June 30,
2018
    June 29,
2019
 
     (dollars in thousands)  

Other Financial and Operations Data:

          

Number of new stores

     29       29       26       7       16  

Number of stores open at end of period

     265       293       316       300       330  

Comparable store sales growth (1)

     3.6     5.3     3.9     3.5     5.0

Gross margin

     30.6     30.4     30.4     30.5     30.8

Cash rent expense

   $ 62,805     $ 70,123     $ 78,058     $ 38,185     $ 42,680  

EBITDA (2)

   $ 101,221     $ 118,622     $ 124,271     $ 67,726     $ 48,234  

Adjusted EBITDA (2)

   $ 123,415     $ 136,319     $ 153,578     $ 75,234     $ 84,130  

Adjusted net income (2)

   $ 33,765     $ 48,655     $ 49,308     $ 24,448     $ 24,407  

 

     As of
June 29, 2019
 
     (in thousands

Balance Sheet Data:

  

Cash and cash equivalents

   $ 18,677  

Working capital (3)

     71,349  

Total assets

     2,081,598  

Total debt (4)

     462,386  

Total liabilities

     1,364,910  

Total stockholders’ equity

     716,688  

Total liabilities and stockholders’ equity

     2,081,598  

 

(1)

Comparable store sales consist of 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. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business—Comparable Store Sales”

(2)

Adjusted EBITDA is defined as net income (loss) before interest expense, taxes, depreciation and amortization (“EBITDA”) and other adjustments noted in the table below. Adjusted net income is defined as net income (loss) before the adjustments noted in the table below. We believe that the presentation of



 

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  EBITDA, adjusted EBITDA and adjusted net income are useful to investors because they are frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use EBITDA, adjusted EBITDA and adjusted net income to supplement United States Generally Accepted Accounting Principles (“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 EBITDA to supplement GAAP measures of performance to evaluate our performance in connection with compensation decisions. Management believes it is useful to investors and analysts to evaluate these non-GAAP measures on the same basis as management uses to evaluate our operating results.

EBITDA, adjusted EBITDA and adjusted net income are non-GAAP measures and may not be comparable to similar measures reported by other companies. EBITDA, adjusted EBITDA and adjusted net income 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 may incur expenses or charges such as those added back to calculate adjusted EBITDA or adjusted net income. Our presentation of adjusted EBITDA and adjusted net income should not be construed as an inference that our future results will be unaffected by these items. For further discussion of EBITDA, adjusted EBITDA and adjusted net income and for reconciliations of EBITDA, adjusted EBITDA and adjusted net income to net income, the most directly comparable GAAP measure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations.”

The following table provides a reconciliation from our net income to EBITDA and adjusted EBITDA and our net income to adjusted net income for the fiscal years 2016, 2017 and 2018 and the 26 weeks ended June 30, 2018 and June 29, 2019.

 

    Fiscal Year Ended     26 Weeks Ended  
    December 31,
2016
    December 30,
2017
    December 29,
2018
    June 30,
2018
    June 29,
2019
 
    (in thousands)  

Net income (loss)

  $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858

Interest expense, net

    47,147       49,698       55,362       26,886       31,890  

Income tax expense (benefit)

    6,724       5,171       5,984       4,832       (2,803

Depreciation and amortization expenses

    37,152       43,152       47,057       23,197       26,005  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

    101,221       118,622       124,271       67,726       48,234  

Stock-based compensation expenses (a)

    2,905       1,659       10,409       263       22,961  

Debt extinguishment and modification costs (b)

    —         1,466       5,253       —         5,162  

Non-cash rent (c)

    8,451       8,401       7,903       3,523       3,678  

Asset impairment and gain or loss on
disposition (d)

    519       549       1,306       (28     415  

New store pre-opening expenses (e)

    2,580       1,807       1,555       701       742  

Rent for acquired leases (f)

    2,388       72       —         —         —    

Provision for accounts receivable reserves (g)

    4,018       3,004       749       2,348       2,064  

Other (h)

    1,333       739       2,132       701       874  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 123,415     $ 136,319     $ 153,578     $ 75,234     $ 84,130  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 


 

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    Fiscal Year Ended     26 Weeks Ended  
    December 31,
2016
    December 30,
2017
    December 29,
2018
    June 30,
2018
    June 29,
2019
 
    (in thousands)  

Net income (loss)

  $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858

Stock-based compensation expenses (a)

    2,905       1,659       10,409       263       22,961  

Debt extinguishment and modification costs (b)

    —         1,466       5,253       —         5,162  

Non-cash rent (c)

    8,451       8,401       7,903       3,523       3,678  

Asset impairment and gain or loss on disposition (d)

    519       549       1,306       (28     415  

New store pre-opening expenses (e)

    2,580       1,807       1,555       701       742  

Rent for acquired leases (f)

    2,388       72       —         —         —    

Provision for accounts receivable reserves (g)

    4,018       3,004       749       2,348       2,064  

Other (h)

    1,333       739       2,132       701       874  

Amortization of purchase accounting assets and deferred financing costs (i)

    16,914       17,399       16,744       8,517       7,751  

Tax effect of total adjustments (j)

    (15,541     (7,042     (12,611     (4,388     (12,382
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

  $ 33,765     $ 48,655     $ 49,308     $ 24,448     $ 24,407  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a)

Represents non-cash stock compensation expense of $0.3 million in 2016, $0.4 million in each of 2017 and 2018, $0.2 million in the 26 weeks ended June 30, 2018 and $22.7 million in the 26 weeks ended June 29, 2019, with the remainder representing dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2016 Recapitalization (as defined elsewhere in this prospectus) and our 2018 Recapitalization (as defined elsewhere in this prospectus). We expect to pay an additional $4.2 million in the aggregate on options as they vest in respect of such dividends, of which $3.4 million is expected to be paid in the remainder of fiscal year 2019.

  (b)

Represents debt extinguishment and modification costs related to the write-off of debt issuance costs and non-capitalizable expenses related to the repricing of our first and second lien credit facilities in June 2017, the modification of our first and second lien credit facilities in connection with our 2018 Recapitalization and the extinguishment of our Second Lien Credit Agreement (as defined elsewhere in this prospectus) in June 2019.

  (c)

Consists of the non-cash portion of rent expense, which reflects the extent to which our straight-line rent expense recognized under GAAP exceeds or is less than our cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant growth in recent years.

  (d)

Represents impairment charges with respect to planned store closures and gains or losses on dispositions of assets in connection with store transitions to new IOs.

  (e)

Includes marketing, occupancy and other expenses incurred in connection with store grand openings, including costs that will be the IO’s responsibility after store opening.

  (f)

Represents cash occupancy expenses on leases acquired from Fresh & Easy Inc. in 2015 for the periods prior to opening new stores on such sites (commonly referred to as “dead rent”).

  (g)

Represents non-cash changes in reserves related to our IO notes and accounts receivable.

  (h)

Other non-recurring, non-cash or discrete items as determined by management, including personnel-related costs, strategic project costs, legal expenses, transaction-related costs, costs associated with closed stores and miscellaneous costs.

  (i)

Represents amortization of debt issuance costs and incremental amortization of an asset step-up resulting from purchase price accounting related to the 2014 H&F Acquisition which included trademarks, customer lists and below-market leases.

  (j)

Represents the tax effect of the total adjustments at our estimated effective tax rate.

 

(3)

Working capital is defined as current assets minus current liabilities.

(4)

Total debt consists of the current and long-term portions of our total debt outstanding, net of debt discount and debt issuance costs. Total gross debt outstanding was $475.5 million as of June 29, 2019.



 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors together with other information in this prospectus, including our consolidated financial statements and related notes included elsewhere in this prospectus, before deciding whether to invest in shares of our common stock. The occurrence of any of the events described below could harm our business, financial condition, results of operations and growth prospects. In such an event, the trading price of our common stock may decline and you may lose all or part of your investment.

Risks Related to Our Business

We depend on suppliers to consistently supply us with opportunistic products at attractive pricing, and any failure to procure such products could result in material adverse effects on our business, product inventories, sales and profit margins.

Our business is dependent on our ability to strategically source a sufficient volume and variety of opportunistic products at attractive pricing. While opportunistic buying, operating with appropriate inventory levels and frequent inventory turns are key elements of our business strategy, they subject us to risks related to the pricing, quantity, mix, quality and timing of inventory flowing to our stores. We do not have significant control over the supply, cost or availability of many of the products offered for sale in our stores. Shortages or disruptions in the availability of quality products that excite our customers could have a material adverse effect on our business, financial condition and results of operations.

All of our inventory is acquired through purchase orders and we generally do not have long-term contractual agreements with our suppliers that obligate them to provide us with products exclusively or at specified quantities or prices, or at all. As a result, any of our current suppliers may decide to sell products to our competitors and may not continue selling products to us. In order to retain our competitive advantage, we need to continue to develop and maintain relationships with qualified suppliers that can satisfy our standards for quality and our requirements for delivery of products in a timely and efficient manner at attractive prices. The need to develop new relationships will be particularly important as we seek to expand our operations and enhance our product offerings in the future.

While we have not experienced any difficulty in obtaining sufficient quantities of product to date, manufacturers and distributors of name-brand products have become increasingly consolidated. Further consolidation of manufacturers or distributors could reduce our supply options and detrimentally impact the terms under which we purchase products. If one or more of our existing significant suppliers were to be unable or unwilling to continue providing products to us on attractive terms, we may have difficulty obtaining alternative sources. We cannot assure you that we would be able to find replacement suppliers on commercially reasonable terms, which would have a material adverse effect on our financial condition, results of operations and cash flows. The loss of one or more of our existing significant suppliers or our inability to develop relationships with new suppliers could reduce our competitiveness, slow our plans for further expansion and cause our sales and operating results to be materially adversely affected.

Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints and general economic and political conditions that could limit their ability to provide us with quality products. These risks may delay or preclude delivery of product to us on a timely basis or at all.

We may not be able to successfully identify trends and maintain a consistent level of opportunistic products which could have a material adverse effect on our business, financial condition and results of operations.

Consumer preferences often change rapidly and without warning. We may not successfully address consumer trends or be able to acquire desirable products at discounts that excite our customers, which could add

 

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difficulty in attracting new customers and retaining existing customers and encouraging frequent visits. We generally make individual purchase decisions for products that become available, and these purchases may be for large quantities that we may not be able to sell on a timely or cost-effective basis. Some of our products are sourced from suppliers at significantly reduced prices for specific reasons, and we are not always able to purchase specific products on a recurring basis. To the extent that some of our suppliers are better able to manage their inventory levels and reduce the amount of their excess inventory, the amount of over-stock and short-dated products available to us could also be materially reduced, making it difficult to deliver products to our customers at attractive prices. Maintaining adequate inventory of quality, name-brand products requires significant attention and monitoring of market trends, local markets and developments with suppliers and our distribution network, and it is not certain that we or the IOs will be effective in inventory management.

We base our purchases of inventory, in part, on our sales forecasts. If our sales forecasts overestimate customer demand, we may experience higher inventory levels and need to take markdowns on excess or slow-moving inventory, leading to decreased profit margins. Conversely, if our sales forecasts underestimate customer demand, we may have insufficient inventory to meet demand, leading to lost sales, either of which could materially adversely affect our financial performance.

Our success depends on our ability and the ability of the IOs to maintain or increase comparable store sales, and if we are unable to achieve comparable store growth, our profitability and performance could be materially adversely impacted.

The IOs are responsible for store operations. Our success depends on increasing comparable store sales through our opportunistic purchasing strategy and the ability of the IOs to increase sales and profits. To increase sales and profits, and therefore comparable store sales growth, we and the IOs focus on delivering value and generating customer excitement by strengthening opportunistic purchasing, optimizing inventory management, maintaining strong store conditions and effectively marketing current products and new product offerings. We may not be able to maintain or improve the levels of comparable store sales that we have experienced in the past, and our comparable store sales growth is a significant driver of our profitability and overall business results. In addition, competition and pricing pressures from competitors may also materially adversely impact our operating margins. Our comparable store sales growth could be lower than our historical average or our future target for many reasons, including general economic conditions, operational performance, including by the IOs, price inflation or deflation, industry competition, new competitive entrants near our stores, price changes in response to competitive factors, the impact of new stores entering the comparable store base, cycling against any year or quarter of above-average sales results, possible supply shortages or other operational disruptions, the number and dollar amount of customer transactions in our stores, our ability to provide product or service offerings that generate new and repeat visits to our stores and the level of customer engagement that we and the IOs provide in our stores. In addition, we may not accurately model cannibalization for our new stores. Opening new stores in our established markets may result in inadvertent oversaturation, temporarily or permanently diverting customers and sales from our existing stores to new stores and reduce comparable store sales, thus adversely affecting our overall financial performance. These factors may cause our comparable store sales results to be materially lower than in recent periods, which could harm our profitability and business.

Because we compete to a substantial degree on price, changes affecting the market prices of the products we sell, including due to inflation or deflation or worsening economic conditions, could materially adversely affect our financial condition and operating results.

A critical differentiator of our business is our ability to offer value to our customers, including offering prices that are substantially below those offered by some of our competitors. We carefully monitor the market prices of our products in order to maintain our price advantage and reputation. If prices of goods increase and our suppliers seek price increases from us, we may not be able to mitigate such increases and would consider setting a higher price, which could deter customers. If our competitors substantially lower their prices, we may lose customers and mark down prices. Our profitability may be impacted by lower prices, which may impact gross

 

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margins. We may also experience reduced sales as a result of a decline in the number and average basket size of customer transactions.

In addition, the market price of the products we sell can be influenced by general economic conditions. For example, general deflation in the prices of the products we sell could cause us and the IOs to mark down prices and thereby reduce our gross profits and gross margins. Adverse general economic conditions could also increase costs to us, such as shipping rates, freight costs and store occupancy costs and further reduce our sales or increase our cost of goods sold or selling, general and administrative expenses. Our low-price model and competitive pressures may inhibit our ability to reflect these increased costs in the prices of our products, and therefore reduce our profitability and materially adversely affect our business, financial condition and results of operations.

If we cannot open, relocate or remodel stores on schedule, it could have a material adverse impact on our business, future growth and financial condition.

Our growth strategy largely depends on our ability to identify and open future store locations and relocate or remodel existing store locations in new and existing markets. We opened 29 and 26 new stores in 2017 and 2018, respectively. Our ability to open stores in a timely manner depends in part on the following factors: the ability to attract and develop potential IOs; the availability of attractive store locations and rent prices; the absence of entitlement processes or occupancy delays; the ability to negotiate acceptable lease and development terms; our relationships with current and prospective landlords; the ability to secure and manage the inventory necessary for the launch and operation of new stores; general economic conditions; and the availability of capital funding for expansion. Any or all of these factors and conditions could materially adversely affect our growth and profitability.

Based on our experience and research conducted for us by eSite Analytics, we believe there is an opportunity to establish over 400 additional locations in the states in which we currently operate and approximately 1,600 additional locations when neighboring states are included. Over the long term, we believe the market potential exists to establish 4,800 locations nationally. We have 32 store openings planned for 2019, and our goal is to expand our store base by approximately 10% annually over the next several years. However, we cannot assure you that we will achieve this level of new store growth. We may not have the level of cash flow or financing necessary to support our growth strategy. Additionally, our proposed expansion will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our existing business less efficiently, which in turn could cause deterioration in the financial performance of our existing stores. If we experience a decline in performance, we may slow or discontinue store openings, or we may decide to close stores that are unable to operate in a profitable manner. If we fail to successfully implement our growth strategy, including by opening new stores, our financial condition and operating results may be adversely affected.

Delays or failures in opening new stores or completing relocations or remodels could materially adversely affect our growth and/or profitability. Additionally, new stores might not always align with our expectations in terms of sales or capital expenditures and we may not achieve projected results.

Our newly opened stores may negatively impact our financial results in the short-term and may not achieve sales and operating levels consistent with our more mature stores on a timely basis or at all.

We have actively pursued new store growth, including in new markets, and plan to continue doing so in the future. Our new store openings may not be successful or reach the sales and profitability levels of our existing stores. Some new stores may be located in areas with different competitive and market conditions as well as different customer discretionary spending patterns than our existing markets. Some new stores and future new store opportunities may be located in new geographic areas where we have limited or no meaningful experience

 

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or brand recognition. We may experience a higher cost of entry in those markets as we build brand awareness and drive customers to incorporate us into their shopping habits. For example, in Southern California the IOs have experienced slower growth and profitability than our existing stores as they continue to build brand awareness in the market.

New store openings may negatively impact our financial results in the short-term due to the effect of store opening costs and lower sales and contribution to overall profitability during the initial period following opening. New stores, particularly those in new markets, build their sales volume, brand recognition and customer base over time and, as a result, generally have lower margins and higher operating expenses as a percentage of sales than our more mature stores. New stores may not achieve sustained sales and operating levels consistent with our more mature store base on a timely basis or at all. This lack of performance may have a material adverse effect on our financial condition and operating results.

We may not anticipate all of the challenges imposed by the expansion of our operations into new geographic markets. We may not manage our expansion effectively, and our failure to achieve or properly execute our expansion plans could limit our growth or have a material adverse effect on our business, financial condition and results of operations. Further, we have experienced in the past, and expect to experience in the future, some sales cannibalization of our existing stores to our new stores. As some of our existing customers switch to new, closer locations within markets, our financial condition and operating results may be materially adversely affected.

Economic conditions and other economic factors may materially adversely affect our financial performance and other aspects of our business by negatively impacting our customers’ disposable income or discretionary spending, increasing our costs and expenses, affecting our ability to plan and execute our strategic initiatives, and materially adversely affecting our sales, results of operations and performance.

General conditions in the United States and global economy that are beyond our control may materially adversely affect our business and financial performance. While we have not previously been materially adversely affected by periods of decreased consumer spending, any factor that could materially adversely affect the disposable income of our customers could decrease our customers’ spending and number of trips to our stores, which could result in lower sales, increased markdowns on products, a reduction in profitability due to lower margins and may require increased selling and promotional expenses. These factors include but are not limited to unemployment, minimum wages, inflation and deflation, trade wars and interest and tax rates.

Many of the factors identified above also affect commodity rates, transportation costs, costs of labor, insurance and healthcare, the strength of the U.S. dollar, lease costs, measures that create barriers to or increase the costs associated with international trade, changes in laws, regulations and policies and other economic factors, all of which may impact our cost of goods sold and our selling, general and administrative expenses, which could materially adversely affect our business, financial condition and results of operations. These factors could also materially adversely affect our ability to plan and execute our strategic initiatives, invest in and open new stores, prevent current stores from closing, and may have other material adverse consequences which we are unable to fully anticipate or control, all of which may materially adversely affect our sales, cash flow, results of operations and performance. We have limited or no ability to control many of these factors.

Food retailers provide alternative options for consumers and compete aggressively to win those consumers; our failure to offer a compelling value proposition to consumers could limit our growth opportunities and materially adversely impact our financial performance.

The retail food industry includes mass and discount retailers, warehouse membership clubs, online retailers, conventional grocery stores and specialty stores. These businesses provide alternative options for the consumers whom we aim to serve. Our success relative to these retailers is driven by a combination of factors,

 

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primarily product selection and quality, price, location, customer engagement and store format. Our success depends on our ability to differentiate ourselves and provide value to our customers, and our failure to do so may negatively impact our sales. To the extent that other food retailers lower prices or run promotions, our ability to maintain profit margins and sales levels may be negatively impacted. We and the IOs may have to increase marketing expense to attract customers, and may have to mark down prices to be competitive and not lose market share. This limitation may materially adversely affect our margins and financial performance.

Competition for customers has intensified as other discount food retailers, such as WinCo and Aldi, have moved into, or increased their presence in, our geographic and product markets. We expect this competition to continue to increase. In addition, we experience high levels of competition when we enter new markets. Some of the other food retailers may have been in the region longer and may benefit from enhanced brand recognition in such regions. For example, we recently expanded in Southern California and, as of June 29, 2019, had 69 stores in that area. Our new stores in this market are competing against more established retailers. Some food retailers may have greater financial or marketing resources than the IOs do and may be able to devote greater resources to sourcing, promoting and selling their products than the IOs. As competition in certain regions intensifies, or we move into new regions or other food retailers open stores in close proximity to our stores, our results of operations and cash flows may be negatively impacted through a loss of sales, decrease in market share, reduction in margin from competitive price changes or greater operating costs.

We may not be able to retain the loyalty of our customers, the failure of which could have a material adverse effect on our business, financial condition and results of operations.

We depend on repeat visits by our customer base to drive our consistent sales and sales growth. Our average customer typically shops two times per month at our stores and spends over $25 per transaction. Competition for customers has also intensified from the use of mobile and web-based technology that facilitates online shopping and real-time product and price comparisons. We expect this competition to continue to increase. We do not maintain a loyalty program for customers, and our competitors may be able to offer their customers promotions or loyalty program incentives that could result in fewer shopping trips to or purchases from our stores. If we are unable to retain the loyalty of our customers, our sales could decrease and we may not be able to grow our store base as planned, which could have a material adverse effect on our business, financial condition and results of operations.

Our success depends upon our marketing, advertising and promotional efforts. If costs associated with these efforts increase, or if we are unable to implement them successfully, it could have a material adverse effect on our business, financial condition and results of operations.

We use marketing and promotional programs to attract customers into our stores and to encourage purchases. If we are unable to develop and implement effective marketing, advertising and promotional strategies, we may be unable to achieve and maintain brand awareness and repeat store visits. We may not be able to advertise cost effectively in new or smaller markets in which we have fewer stores, which could slow growth at such stores. Changes in the amount and degree of promotional intensity or merchandising strategies by our competitors could cause us to have difficulties in retaining existing customers and attracting new customers. If the efficacy of our marketing or promotional activities declines or if such activities of our competitors are more effective than ours, it could have a material adverse effect on our business, financial condition and results of operations.

If we fail to maintain our reputation and the value of our brand, including protection of our intellectual property, our sales and operating results may decline.

We believe our continued success depends on our ability to maintain and grow the value of our brand. Brand value is based in large part on perceptions of subjective qualities. Even isolated incidents involving our company, the IOs and their employees, suppliers, agents or third-party service providers, or the products we sell

 

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can erode trust and confidence. This is particularly the case if they result in adverse publicity, governmental investigations or litigation. The reputation of our company and our brand may be damaged in all, one or some of the markets in which we do business, by adverse events at the corporate level or by an IO acting outside of Grocery Outlet’s brand standards. Similarly, challenges or reactions to action (or inaction) or perceived action (or inaction), by us on issues like social policies, merchandising, compliance related to social, product, labor and environmental standards or other sensitive topics, and any perceived lack of transparency about such matters, could harm our reputation, particularly as expectations of companies and of companies’ corporate responsibility may continue to change. The increasing use of social media platforms and online forums may increase the chance that an adverse event could negatively affect the reputation of our brand. The online dissemination of negative information about our brand, including inaccurate information, could harm our reputation, business, competitive advantage and goodwill. Damage to our reputation could result in declines in customer loyalty and sales, affect our supplier relationships, business development opportunities and IO retention, divert attention and resources from management, including by requiring responses to inquiries or additional regulatory scrutiny, and otherwise materially adversely affect our results. Our brand could be materially adversely affected if our public image or reputation were to be tarnished by negative publicity.

We regard our intellectual property, including trademarks and service marks, as having significant value, and our brand is an important factor in the marketing of our stores. We monitor and protect against activities that might infringe, dilute or otherwise violate our trademarks and other intellectual property and rely on trademark and other laws of the United States, but we may not be able or willing to successfully enforce our trademarks or intellectual property rights against competitors or challenges by others. For example, we are aware of certain companies in jurisdictions where we do not currently operate using the term “GROCERY OUTLET.” Moreover, we have disclaimed the terms “GROCERY OUTLET” and “MARKET” with respect to our “GROCERY OUTLET BARGAIN MARKET” trademarks, among other disclaimed terms with respect to our registered trademarks and trademark applications. If a third party uses such disclaimed terms in its trademarks, we cannot object to such use. If we fail to protect our trademarks or other intellectual property rights, others may copy or use our trademarks or intellectual property without authorization, which may harm the value of our brand, reputation, competitive advantages and goodwill and adversely affect our financial condition, cash flows or results of operations. The value of our intellectual property could diminish if others assert rights in or ownership of our trademarks and other intellectual property rights, or trademarks that are similar to our trademarks. We may be unable to successfully resolve these types of conflicts to our satisfaction. Additionally, adequate remedies may not be available in the event of an unauthorized use or disclosure of our trade secrets or other intellectual property. We are susceptible to others infringing, misappropriating or otherwise violating our intellectual property rights. Actions we have taken to establish and protect our intellectual property rights may not be adequate to prevent copying of our intellectual property by others or to prevent others from seeking to invalidate our trademarks as a violation of the trademarks and intellectual property rights of others. In addition, unilateral actions in the U.S. or other countries, including changes to or the repeal of laws recognizing trademark or other intellectual property rights, could have an impact on our ability to enforce those rights.

There may in the future be opposition and cancellation proceedings from time to time with respect to some of our intellectual property rights. In some cases, litigation may be necessary to protect or enforce our trademarks and other intellectual property rights. Furthermore, third parties may assert intellectual property claims against us, and we may be subject to liability, required to enter into costly license agreements, if available at all, required to rebrand our products and/or prevented from selling some of our products if third parties successfully oppose or challenge our trademarks or successfully claim that we infringe, misappropriate or otherwise violate their trademarks, copyrights, patents or other intellectual property rights. Bringing or defending any such claim, regardless of merit, and whether successful or unsuccessful, could be expensive and time-consuming and have a negative effect on our business, reputation, results of operations and financial condition.

 

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Any significant disruption to our distribution network, the operations of our distributions centers and our timely receipt of inventory could materially adversely impact our operating performance.

We rely on our distribution and transportation network, including by means of truck, ocean and rail to provide goods to our distribution centers and stores in a timely and cost-effective manner. We use three primary leased distribution centers that we operate and five primary distribution centers operated by third-parties. Deliveries to our stores occur from our distribution centers or directly from our suppliers. Any disruption, unanticipated or unusual expense or operational failure related to this process could affect store operations negatively. For example, delivery delays or increases in transportation costs (including through increased fuel costs, increased carrier rates or driver wages as a result of driver shortages, a decrease in transportation capacity, or work stoppages or slowdowns) could significantly decrease our ability to generate sales and earn profits. In addition, events beyond our control, such as disruptions in operations due to fire or other catastrophic events or labor disagreements, may result in delays in the delivery of merchandise to our stores. While we maintain business interruption insurance, in the event our distribution centers are shut down for any reason, such insurance may not be sufficient, and any related insurance proceeds may not be timely paid to us. Furthermore, there can be no guarantee that we will be able to renew the leases or third-party distribution and transportation contracts, as applicable, on our distribution centers on attractive terms or at all, which may increase our expenses and cause temporary disruptions in our distribution network.

As we expand, effectively managing our distribution network and distribution centers becomes more complex. Our new store locations receiving shipments may be further away from our distribution centers, which may increase transportation costs and may create transportation scheduling strains, or may require us to add additional facilities to the network.

If consumer trends move toward private label and away from name-brand products, our competitive position in the market may weaken and our sales may be materially adversely affected.

Our business model has traditionally relied on the sale of name-brand products at meaningful discounts. Consumer acceptance of, and even preference for, private label products has been increasing, however, and a trend away from name-brand products could weaken our competitive position in the market. Private label products tend to be lower priced than name-brand products and, as a result, we may have more difficulty competing against private label products on the basis of price. While we may invest more in the future in developing our own private labels, there can be no assurance that the performance of any such private label products would be sufficient to offset the potential decreased sales of name-brand products. In addition, if we invest in expanding our private label products, we will need to make significant investments in developing effective quality control procedures. Any failure to appropriately address some or all of these risks could have a material adverse effect on our sales, business, results of operations and financial condition.

We will require significant capital to fund our expanding business. If we are unable to maintain sufficient levels of cash flow from our operations, we may not be able to execute or sustain our growth strategy or we may require additional financing, which may not be available to us on satisfactory terms or at all.

To support our expanding business and execute our growth strategy, we will need significant amounts of capital, including funds to pay our lease obligations, build out new stores and distribution centers, remodel our stores, purchase opportunistic inventory, pay employees and further invest in the business. Further, our plans to grow our store base may create cash flow pressure if new locations do not perform as projected.

We expect to primarily depend on cash flow from operations to fund our business and growth plans. We cannot assure you that cash generated by our operations will be sufficient to allow us to fund our growth plans. If we do not generate sufficient cash flow from operations, we may need to obtain additional funds through public or private financings, collaborative relationships or other arrangements. We cannot assure you that this additional funding, if needed, will be available on terms attractive to us, if at all. Any equity financing or debt financing that

 

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is convertible into equity that we may pursue could result in additional dilution to our existing stockholders. Tightening in the credit markets, low liquidity and volatility in the capital markets could result in diminished availability of credit, higher cost of borrowing and lack of confidence in the equity market, making it more difficult to obtain additional financing on terms that are favorable to us. Furthermore, any additional debt financing, if available, will increase our leverage and may involve restrictive covenants that could affect our ability to raise additional capital or operate our business. If such financing is not available to us, or is not available on satisfactory terms, our competitive position, business, financial condition and results of operations could be impeded and we may need to delay, limit or eliminate planned store openings or operations or other elements of our growth strategy. Such actions could harm our competitive position, business, financial condition and results of operations.

We are subject to risks associated with leasing substantial amounts of space, including future increases in occupancy costs.

We currently lease substantially all of our store locations, primary distribution centers and administrative offices (including our headquarters in Emeryville, California), and a number of these leases expire or are up for renewal each year. Our operating leases typically have initial lease terms of ten years with renewal options for two or three successive five-year periods at our discretion.

Typically, the largest portion of a store’s operating expense that we bear is the cost associated with leasing the location. Our rent expense for fiscal years 2017 and 2018 totaled $79.4 million and $86.0 million, respectively. We are also generally responsible for property taxes, insurance and common area maintenance for our leased properties. Our future minimum rental commitments for all operating leases in existence as of December 29, 2018 was $89.1 million for fiscal year 2019 and $1.2 billion in aggregate for fiscal years 2020 through 2038. We expect that many of the new stores we open will also be leased to us under operating leases, which will further increase our operating lease expenditures. If we are unable to make the required payments under our leases, the lenders or owners of the relevant stores, distribution centers or administrative offices may, among other things, repossess those assets, which could adversely affect our ability to conduct our operations. In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under our First Lien Credit Agreement (as defined elsewhere in this prospectus), which could cause the counterparties under those agreements to accelerate the obligations due thereunder.

The operating leases for our store locations, distribution centers and administrative offices expire at various dates through 2038. When the lease term for our stores expire, we may be unable to negotiate renewals, either on commercially reasonable terms or at all, which could cause us to close stores or to relocate stores within a market on less favorable terms. Any of these factors could cause us to close stores in desirable locations, which could have a material adverse impact on our results of operations.

Over time, current store locations may not continue to be desirable because of changes in demographics within the surrounding area or a decline in shopping traffic. While we have the right to terminate some of our leases under specified conditions, we may not be able to terminate a particular lease if or when we would like to do so. If we decide to close stores, we are generally required to continue to perform obligations under the applicable leases, which generally include paying rent and operating expenses for the balance of the lease term. When we assign leases or sublease space to third parties, we can remain liable on the lease obligations if the assignee or sublessee does not perform.

Any failure to maintain the security of information we hold relating to personal information or payment card data of our customers, employees and suppliers, whether as a result of cybersecurity attacks or otherwise, could subject us to litigation, government enforcement actions and costly response measures, and could materially disrupt our operations and harm our reputation and sales.

In the ordinary course of business, we and the IOs collect, store, process and transmit confidential business information and certain personal information relating to customers, employees and suppliers. However,

 

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all customer payment data is encrypted, and we do not store such data. We rely in part on commercially available systems, software, hardware, services, tools and monitoring to provide security for collection, storage, processing and transmission of personal and/or confidential information. It is possible that cyberattackers might compromise our security measures and obtain the personal and/or confidential information of the customers, employees and suppliers that we hold or our business information. Cyberattacks are rapidly evolving and those threats and the means for obtaining access to information in digital and other storage media are becoming increasingly sophisticated and may not immediately produce signs of intrusion.

Moreover, an employee, contractor or third party with whom we work or to whom we outsource business operations may fail to monitor their or our systems effectively, may fail to maintain appropriate safeguards, may misuse the personal and/or confidential information to which they have access, may attempt to circumvent our security measures, may purposefully or inadvertently allow unauthorized access to our systems or to personal and/or confidential information or may otherwise disrupt our business operations. We and our customers could suffer harm if valuable business data or employee, customer and other proprietary information were corrupted, lost or accessed or misappropriated by third parties due to a security failure in our systems or those of our suppliers or service providers. It could require significant expenditures to remediate any such failure or breach, severely damage our reputation and our relationships with customers, result in unwanted media attention and lost sales and expose us to risks of litigation and liability. In addition, as a result of recent security breaches at a number of prominent retailers, the media and public scrutiny of information security and privacy has become more intense and the regulatory environment has become increasingly uncertain, rigorous and complex. As a result, we may incur significant costs to comply with laws regarding the protection and unauthorized disclosure of personal information and we may not be able to comply with new regulations.

In addition, various federal, state and foreign legislative and regulatory bodies, or self-regulatory organizations, may expand current laws or regulations, enact new laws or regulations or issue revised rules or guidance regarding privacy, data protection, information security and consumer protection. For example, California recently enacted the California Consumer Privacy Act (“CCPA”), which will become effective on January 1, 2020 and will, among other things, require new disclosures to California consumers and afford such consumers new abilities to opt out of certain sales of personal information. It is likely that amendments will be proposed to this legislation in 2019, and it remains unclear what modifications, if any, will be made to the CCPA and how various provisions of the CCPA will be interpreted and enforced. The effects of the CCPA are potentially significant, and may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. Any failure to comply with the laws and regulations surrounding the protection of personal information, privacy and data security could subject us to legal and reputational risks, including significant fines for non-compliance, any of which could have a negative impact on revenues and profits.

Because we and the IOs accept payments using a variety of methods, including cash and checks, credit and debit cards, Electronic Benefit Transfer (“EBT”) cards and gift cards, we may be subject to additional rules, regulations, compliance requirements and higher fraud losses. For certain payment methods, we or the IOs pay interchange and other related card acceptance fees, along with additional transaction processing fees. We and the IOs rely on third parties to provide payment transaction processing services, including the processing of credit cards, debit cards, EBT cards and gift cards, and it could disrupt our business if these companies become unwilling or unable to provide these services to us, experience a data security incident or fail to comply with applicable rules and industry standards. We are also subject to payment card association operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change over time. For example, we and the IOs are subject to Payment Card Industry Data Security Standards, which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. In addition, if our internal systems are breached or compromised, we and the IOs may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our customers, and our business and operating results could be materially adversely affected.

 

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We do not currently compete in the growing online retail marketplace and any online retail services or e-commerce activities that we may launch in the future may require substantial investment and may not be successful.

We do not currently provide online services or e-commerce. To the extent that we implement e-commerce selling operations, we would incur substantial expenses related to such activities, be exposed to additional cybersecurity risks and potentially be subject to additional data privacy regulations. Further, any development of an online retail marketplace is a complex undertaking, and there is no guarantee that any resources we apply to this effort will result in increased sales or operating performance. Our failure to successfully respond to these risks and uncertainties might materially adversely affect sales in any e-commerce business that we establish in the future and could damage our reputation and brand. Additionally, certain of our competitors and a number of pure online retailers have established robust online operations. Increased competition from online grocery retailers and our lack of an online retail presence may reduce our customers’ desire to purchase products from us and could have a material adverse effect on our business, financial condition and results of operations.

Any material disruption to our information technology systems as a result of external factors or challenges or difficulties in maintaining or updating our existing technology or developing or implementing new technology could have a material adverse effect on our business or results of operations.

We rely on a variety of information technology systems for the efficient functioning of our business, including point of sale, inventory management, purchasing, financials, logistics, accounts payable and human resources information systems. We are dependent on the integrity, security and consistent operation of these systems and related back-up systems. Such systems are subject to damage or interruption from power outages, facility damage, computer and telecommunications failures, computer viruses, cybersecurity breaches, cyberattacks (including malicious codes, worms, phishing and denial of service attacks and ransomware), software upgrade failures or code defects, natural disasters and human error. Damage or interruption to, or defects of design related to, these systems or the integration of such systems may require a significant investment to fix or replace, and we may suffer interruptions or disruptions in our operations in the interim, may experience loss or corruption of critical data and may receive negative publicity, all of which could have a material adverse effect on our business or results of operations. Although we have taken steps designed to reduce the risk of these events occurring, there can be no guarantee that we or a third party on which we rely will not suffer one of these events.

We modify, update and replace our systems and infrastructure from time to time, including by adding new hardware, software and applications; maintaining, updating or replacing legacy programs; converting to global systems; integrating new service providers; and adding enhanced or new functionality, such as cloud computing technologies. In addition, we have a customized ERP system, components of which we are planning to replace in the next few years. There is a risk of business disruption, liability and reputational damage associated with these actions, including from not accurately capturing and maintaining data, efficiently testing and implementing changes, realizing the expected benefit of the change and managing the potential disruption of the actions and diversion of internal teams’ attention as the changes are implemented.

Further, potential issues associated with implementing technology initiatives and the time and resources required in seeking to optimize the benefits of new elements of our systems and its infrastructure could reduce the efficiency of our operations in the short term. The efficient operation and successful growth of our business depends upon our information systems, including our ability to operate, maintain and develop them effectively. A failure of those systems could disrupt our business, subject us to liability, damage our reputation, or otherwise impact our financial results.

 

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Real or perceived concerns that products we and the IOs sell could cause unexpected side effects, illness, injury or death could expose us to lawsuits and harm our reputation, which could result in unexpected costs.

If our products do not meet applicable safety standards or our customers’ expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. Any lost confidence on the part of our customers would be difficult and costly to reestablish. Issues regarding the quality or safety of any food items sold by us, regardless of the cause, could have a substantial and adverse effect on our sales and operating results.

There is increasing governmental scrutiny and regulation of and public awareness regarding food safety. Unexpected side effects, illness, injury or death caused by products we and the IOs sell or involving suppliers that supply us with products could result in the discontinuance of sales of these products or our relationship with such suppliers or prevent us from achieving market acceptance of the affected products. We cannot be sure that consumption or use of our products will not cause side effects, illness, injury or death in the future, as product deficiencies might not be identified before we sell such products to our customers.

We also may be subject to claims, lawsuits or government investigations relating to such matters resulting in costly product recalls and other liabilities that could materially adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could materially adversely affect our reputation with existing and potential customers and our corporate and brand image, and these effects could persist over the long term. Any claims brought against us may exceed our existing or future insurance policy coverage or limits. Any judgment against us that is in excess of our policy limits would have to be paid from our cash reserves, which would reduce our capital resources. Further, we may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets.

We are subject to laws and regulations generally applicable to retailers. Compliance with, failure to comply with, or changes to such laws and regulations could have a material adverse effect on our business and financial performance.

Our business is subject to numerous and frequently changing federal, state and local laws and regulations. We routinely incur significant costs in complying with these regulations. The complexity of the regulatory environment in which we and the IOs operate and the related cost of compliance are increasing due to additional legal and regulatory requirements, our expanding operation and increased enforcement efforts. Further, uncertainties exist regarding the future application of certain of these legal requirements to our business. New or existing laws, regulations and policies, liabilities arising thereunder and the related interpretations and enforcement practices, particularly those dealing with environmental protection and compliance, taxation, zoning and land use, workplace safety, public health, community right-to-know, product safety or labeling, food safety, alcohol and beverage sales, vitamin and supplements, information security and privacy and labor and employment, among others, or changes in existing laws, regulations, policies and the related interpretations and enforcement practices, particularly those governing the sale of products, may result in significant added expenses or may require extensive system and operating changes that may be difficult to implement and/or could materially increase our cost of doing business. For example, we or the IOs have had to comply with recent new laws in many of the states or counties in which we operate regarding recycling, waste, minimum wages, sick time, vacation, plastic bag and straw bans and sugar taxes. In addition, we and the IOs are subject to environmental laws pursuant to which we and the IOs could be strictly and jointly and severally liable for any contamination at our current or former locations, or at third-party waste disposal sites, regardless of our knowledge of or responsibility for such contamination.

Approximately 9% of sales are in the form of EBT payments and a substantial portion of these payments may be related to benefits associated with the Supplemental Nutritional Assistance Program (“SNAP”). Accordingly, changes in EBT regulations by the U.S. Department of Agriculture or in SNAP benefits by Congress could adversely affect our financial performance.

 

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We cannot assure you that we or the IOs will comply promptly and fully with all laws, regulations, policies and the related interpretations that apply to our stores. Untimely compliance or noncompliance with applicable regulations or untimely or incomplete execution of a required product recall, can result in the imposition of penalties (including loss of licenses, eligibility to accept certain government benefits such as SNAP or significant fines or monetary penalties), civil or criminal liability, damages, class action litigation or other litigation, in addition to reputational damage, which could have a material adverse effect on our business, financial condition and results of operations.

Legal proceedings from customers, suppliers, employees, governments or competitors could materially impact our business, reputation, financial condition, results of operations and cash flows.

From time to time, we are subject to allegations, and may be party to legal claims and regulatory proceedings, relating to our business operations. Such allegations, claims and proceedings may be brought by third parties, including our customers, suppliers, employees, governmental or regulatory bodies or competitors, and may include class actions. The outcome of litigation, particularly class action lawsuits, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. While the IOs and suppliers will typically indemnify us for certain adverse outcomes, we may still bear significant expenses related to such proceedings. While we maintain insurance, insurance coverage may not be adequate, and the cost to defend against future litigation may be significant.

From time to time, our employees may bring lawsuits against us regarding discrimination, creating a hostile workplace, sexual harassment and other employment issues. The IOs may also experience similar lawsuits from their own employees. In recent years, companies have experienced an increase in the number of discrimination and harassment and wage and hour claims generally. Coupled with the expansion of social media platforms that allow individuals with access to a broad audience, these claims have had a significant negative impact on some businesses. Some companies that have faced employment- or harassment-related lawsuits have had to terminate management or other key personnel, and have suffered reputational harm. If we were to face any employment-related or other claims, our reputation and business could be negatively affected. In addition, such lawsuits brought against the IOs, even if we are not named or are ultimately not found liable, could adversely impact our reputation and business.

Our current insurance program may expose us to unexpected costs and negatively affect our financial performance, particularly if we incur losses not covered by our insurance or if claims differ from our estimates.

Our insurance coverage reflects deductibles, self-insured retentions, limits of liability and similar provisions that we believe are reasonable based on our operations. However, there are types of losses we may incur but against which we cannot be insured or which we believe are not economically reasonable to insure, such as losses due to acts of war, employee and certain other crime, certain wage and hour and other employment-related claims, including class actions, actions based on certain consumer protection laws, and some natural and other disasters or similar events. If we incur these losses and they are material, our business could suffer. Certain material events, such as earthquakes or the recent California wildfires, may result in sizable losses for the insurance industry and adversely impact the availability of adequate insurance coverage or result in excessive premium increases. Our retail stores located in California, and the inventory in those stores, are not currently insured against losses due to earthquakes. We have experienced significant challenges in renewing the insurance policies for our stores as insurers have incurred substantial losses related to property claims from fires, floods and other catastrophic events and are significantly increasing policy premiums, increasing their requirements around building engineering standards or cutting back capacity for coverage offerings to layered/quota share. To offset negative insurance market trends, we may elect to increase our self-insurance coverage, accept higher deductibles or reduce the amount of coverage.

 

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In addition, we self-insure, or insure through captive insurance companies, a significant portion of expected losses under our workers’ compensation, automobile liability and general liability insurance programs. Unanticipated changes in any applicable actuarial assumptions and management estimates underlying our recorded liabilities for these losses, including expected increases in medical and indemnity costs, could result in materially different expenses than expected under these programs, which could have a material adverse effect on our results of operations and financial condition. If we experience a greater number of these losses than we anticipate, it could have a material adverse effect on our business, financial condition and results of operations. IOs are required to maintain certain types and amounts of insurance coverage. If they fail to secure adequate insurance, injured parties may bring actions against us.

If we or the IOs are unable to attract, train and retain highly qualified employees, our financial performance may be negatively affected.

Our future growth, performance and positive customer experience depends on our and the IOs’ ability to attract, train, retain and motivate qualified employees who understand and appreciate our culture and are able to represent our brand effectively and establish credibility with our business partners and customers. We and the IOs face intense competition for employees. If we and the IOs are unable to attract and retain adequate numbers of qualified employees, our operations, customer service levels and support functions could suffer. There is no assurance that we and the IOs will be able to attract or retain highly qualified employees to operate our business.

Labor relation difficulties could materially adversely affect our business.

Employees at two Company-operated stores are represented by the United Food and Commercial Workers Union. Our employees and those of the IOs have the right at any time to form or affiliate with a union. As we continue to grow, enter different regions and operate distribution centers, unions may attempt to organize the employees of our different IOs or our distribution centers within certain regions. We cannot predict the adverse effects that any future organizational activities will have on our business, financial condition and operating results. If we or the IOs were to become subject to work stoppages, we could experience disruption in our operations and increases in our labor costs, either of which could materially adversely affect our business, financial condition and operating results.

Our success depends in part on our executive officers and other key personnel. If we lose key personnel or are unable to hire additional qualified personnel, it could have a material adverse effect on our business, financial condition and results of operations.

We believe that our success depends to a significant extent on the skills, experience and efforts of our executive officers and other key personnel. The unexpected loss of services of any of our executive officers or other key personnel could have a material adverse effect on our business and operations. In addition, any such departure could be viewed in a negative light by investors and analysts, which may cause our stock price to decline. We do not maintain key person insurance on any of our key personnel. There can be no assurance that our executive succession planning, retention or hiring efforts will be successful. Competition for skilled and experienced management in our industry is intense, and we may not be successful in attracting and retaining qualified personnel. Failure to attract and retain qualified personnel could have a material adverse effect on our business, financial condition and results of operations.

Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters may materially impact reporting of our financial condition and results of operations.

Accounting principles generally accepted in the United States and related accounting pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, such as accounting for long-lived asset impairment, goodwill, variable interest entities and stock-based

 

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compensation, are complex and involve subjective assumptions, estimates and judgments by our management. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgements by our management could significantly change or add significant volatility to our reported or expected financial performance. For example, our adoption of Accounting Standards Codification Topic 842, Leases had a material impact on our financial statements. For more information see “Recently Issued Accounting Standards” in Note 1 to our audited consolidated financial statements included elsewhere in this prospectus.

Goodwill, other intangible assets and long-lived assets represent a significant portion of our total assets, and any impairment of these assets could materially adversely affect our financial condition and results of operations.

We monitor the recoverability of our long-lived assets, such as our store investments, and evaluate them annually to determine if impairment has occurred. Accounting rules require us to review the carrying value of our goodwill and other intangible assets for impairment annually or whenever events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. Such indicators are based on market conditions and the operational performance of our business. If the testing performed indicates that impairment has occurred, we are required to record a non-cash impairment charge for the difference between the carrying value of the intangible assets or goodwill and the fair value of the intangible assets and the implied fair value of the goodwill, respectively, in the period the determination is made. The testing of long-lived assets, intangible assets and goodwill for impairment requires us to make estimates that are subject to significant assumptions about our future sales, profitability, cash flow, fair value of assets and liabilities, weighted average cost of capital, as well as other assumptions. Changes in these estimates, or changes in actual performance compared with these estimates, may affect the fair value of intangible assets or goodwill, which may result in an impairment charge.

We may take impairment charges in the future based on such assumptions. We cannot accurately predict the amount or timing of any impairment of assets. If a significant amount of our goodwill and other intangible assets were deemed to be impaired, our financial condition and results of operations could be materially adversely affected.

A significant decline in our operating profit and taxable income may impair our ability to realize the value of our deferred tax assets.

We are required by accounting rules to periodically assess our deferred tax assets for a valuation allowance, if necessary. In performing these assessments, we use our historical financial performance to determine whether we have potential valuation allowance concerns and as evidence to support our assumptions about future financial performance. A significant decline in our financial performance could negatively affect the results of our assessments of the recoverability of our deferred tax assets. A valuation allowance against our deferred tax assets could be material and could have a material adverse impact on our financial condition and results of operations.

Tax matters could materially adversely affect our results of operations and financial condition.

We are subject to federal and state income and other taxes in the United States. We compute our income tax provision based on enacted federal and state tax rates. Additionally, changes in the enacted tax rates, adverse outcomes in tax audits, or any change in the pronouncements relating to accounting for income taxes could have a material adverse effect on our financial condition and results of operations.

In December 2017, the U.S. Tax Cut and Jobs Act of 2017 (the “2017 Tax Act”) significantly revised the current federal income tax code with significant changes to corporate taxation, including reducing the corporate tax rate, limiting certain tax deductions and modifying or repealing many business deductions and credits. While the 2017 Tax Act reduced the federal income tax rate for corporations, it created certain limits and

 

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potentially changes the timing of certain deductions which could reduce our cash flow in certain periods. Many aspects of the new law are uncertain and are subject to further guidance from U.S. regulators and significant judgements will need to be made in the interpretation of various provisions. In addition, it is uncertain if and to what extent various states will conform to the newly enacted federal tax law, which could also impact our tax obligations.

As of December 29, 2018, we had a tax-effected deferred tax asset of $55.1 million. Our ability to use our deferred tax asset is dependent on our ability to generate future earnings within the operating loss carry-forward periods, which are generally 20 years. Some or all of our deferred tax asset could expire unused if we are unable to generate taxable income in the future sufficient to utilize the deferred tax asset, or we enter into transactions that limit our right to use it. If a material portion of our deferred tax asset expires unused, it could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock. Our ability to realize the deferred tax asset is periodically reviewed and any necessary valuation allowance is recorded or adjusted accordingly.

In addition, certain states and local jurisdictions have recently approved or proposed gross receipt tax measures. For example, in November 2018, San Francisco voters approved a corporate tax measure, which establishes a new 0.5% gross receipts tax. Should these gross receipt tax measures succeed in other jurisdictions in which we operate, we anticipate an increase in our operating expenses.

Natural disasters and unusual weather conditions (whether or not caused by climate change), pandemic outbreaks, terrorist acts, global political events and other serious catastrophic events could disrupt business and result in lower sales and otherwise materially adversely affect our financial performance.

Natural disasters, such as fires, earthquakes, hurricanes, floods, tornadoes, unusual weather conditions, pandemic outbreaks, terrorist acts or disruptive global political events, or similar disruptions could materially adversely affect our business and financial performance. For example, our store in Paradise, California was lost due to the fires in that area in November 2018. Uncharacteristic or significant weather conditions can affect consumer shopping patterns, which could lead to lost sales or greater than expected markdowns and materially adversely affect our short-term results of operations. To the extent these events result in the closure of one or more of our distribution centers, a significant number of stores, or our administrative offices or impact one or more of our key suppliers, our operations and financial performance could be materially adversely affected through an inability to make deliveries or provide other support functions to our stores and through lost sales. In addition, these events could result in increases in fuel (or other energy) prices or a fuel shortage, delays in opening new stores, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some domestic and overseas suppliers, the temporary disruption in the transport of goods from overseas, delay or increased transportation costs in the delivery of goods to our distribution centers or stores, the inability of customers to reach or have transportation to our stores directly affected by such events, the temporary reduction in the availability of products in our stores and disruption of our utility services or to our information systems. These events also can have indirect consequences such as increases in the costs of insurance if they result in significant loss of property or other insurable damage.

The current geographic concentration of our stores creates an exposure to local or regional downturns, natural or man-made disasters or other catastrophic occurrences.

As of June 29, 2019, we operated 186 stores and distributed product from three distribution centers in California, making California our largest market, representing 56% of our total stores. As a result, our business is currently more susceptible to regional conditions than the operations of more geographically diversified competitors, and we are vulnerable to economic downturns in those regions. Any unforeseen events or circumstances that negatively affect these areas could materially adversely affect our sales and profitability. These factors include, among other things, changes in demographics, population and employee bases, wage increases, changes in economic conditions, severe weather conditions and climate change, property tax increases

 

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and other catastrophic occurrences, such as wildfires and flooding. Such conditions may result in reduced customer traffic and spending in our stores, physical damage to our stores, loss of inventory, closure of one or more of our stores, inadequate workforce in our markets, temporary disruption in the supply of products, delays in the delivery of goods to our stores, increased expenses and a reduction in the availability of products in our stores. Any of these factors may disrupt our business and materially adversely affect our financial condition and results of operations.

We may be required to devote substantial time to complying with public company regulations, which could negatively impact our financial performance and cause our results of operations or financial condition to suffer.

As a newly public company, we have incurred and will incur additional legal, accounting, insurance, investor relations and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We have incurred and will incur costs associated with the rules of Nasdaq, the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the Dodd-Frank Wall Street Reform and Consumer Protection Act and related rules implemented by the SEC. The expenses incurred by public companies generally for director and officer liability insurance and reporting and corporate governance purposes have been increasing and may continue to increase. The Exchange Act requires us to file annual, quarterly and current reports with respect to our business and financial condition within specified time periods and to prepare a proxy statement with respect to our annual meeting of stockholders. Our management and other personnel will need to devote substantial amounts of time to ensure that we comply with all of the reporting requirements, limiting time spent focused on revenue-producing activities. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and internal controls over financial reporting. Nasdaq requires that we comply with various corporate governance requirements. These rules and regulations, and applicable case law, may increase our legal and financial compliance costs and make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations can also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. For example, the cost of director and officer liability insurance for California-based companies has recently increased significantly. These laws and regulations can also make it more difficult for us to attract and retain qualified persons to serve on our board, our board committees or as our executive officers. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory actions and potentially civil litigation.

Our management has limited experience managing a public company, and our current resources may not be sufficient to fulfill our public company obligations.

Following the completion of our initial public offering on June 24, 2019, we became subject to various regulatory requirements, including those of the SEC and Nasdaq. These requirements include record keeping, financial reporting and corporate governance rules and regulations. Our management team has limited experience in managing a public company. Our internal infrastructure may not be adequate to support our increased reporting obligations, and we may be unable to hire, train or retain necessary staff and may initially be reliant on engaging outside consultants or professionals to overcome our lack of experience. Our business could be adversely affected if our internal infrastructure is inadequate, we are unable to engage outside consultants, or are otherwise unable to fulfill our public company obligations.

Changes in accounting rules or interpretations thereof, changes to underlying legal agreements as well as other factors applicable to our analysis of the IO entities as variable interest entities could significantly impact our ability to issue our financial statements on a timely basis.

In accordance with the variable interest entities sub-section of Accounting Standards Codification Topic 810, Consolidation, we assess during each of our reporting periods whether we are considered the primary

 

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beneficiary of a variable interest entity (“VIE”) and therefore are required to consolidate the VIE in our financial statements. We have concluded that the IO entities represent VIEs. However, we have concluded we are not such VIE’s primary beneficiary and, accordingly, we do not consolidate the IO entities’ financial information. Changes in accounting rules or interpretations thereof, changes to the underlying Operator Agreements (as defined elsewhere in this prospectus) as well as other factors that may impact the economic performance of the IO entities which may be relevant to our analysis of whether to consolidate the IO entities as VIEs could significantly impact our ability to issue our financial statements on a timely basis if, as a result, we are determined to be the primary beneficiary of the IO entities and should consolidate such entities. For example, collecting the requisite accounting data from certain of our IO entities in order to consolidate their financial information would involve substantial time, effort and cost. For more information see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates.”

Risks Related to Our IO Model

If the IOs are not successful in managing their business, our financial results and brand image could be negatively affected.

The financial health of the IOs is critical to their and our success. The IOs are business entities owned by entrepreneurs who generally live in the same community as the store that they operate as our independent contractor. IOs are responsible for operating their store consistent with our brand standards, hiring and supervising store-level employees, merchandising and selling products and managing and paying the expenses associated with their business. Although we select IOs through a rigorous vetting and training process, and continue to help IOs develop their business skills after they enter into an Operator Agreement with us, it is difficult to predict in advance whether a particular IO will be successful. If an IO is unable to successfully establish, manage and operate the store, their store’s performance and quality of service could be materially adversely affected. In addition, any poor performance could negatively affect our financial results and our brand reputation.

Failure of the IOs to repay notes outstanding to us may materially adversely affect our financial performance.

We extend financing to IOs for their initial startup costs in the form of notes payable to us that bear interest at a rate of 9.95%. We lower the interest rate and delay repayment obligations on the notes outstanding for certain of the IOs participating in our Temporary Commission Adjustment Program (“TCAP”). The TCAP allows us to provide a greater commission to participating IOs who are struggling to meet their working capital needs for various reasons, such as entry into a new market or new competition. There can be no assurance that any IO, particularly those participating in TCAP, will achieve long-term store volumes or profitability that will allow them to repay any amounts due nor is there any assurance that any IO will be able to repay amounts due through other means.

The outstanding aggregate balance of notes receivable from IOs has increased over time as we have accelerated new store growth and initial IO capital and working capital requirements have increased. This balance may continue to increase as we open new stores. There were $16.5 million and $23.5 million of notes to IOs outstanding as of December 30, 2017 and December 29, 2018, respectively, and $9.0 million and $9.1 million reserved as of December 30, 2017 and December 29, 2018, respectively.

If we are unable to attract and retain qualified IOs, our financial performance may be negatively affected.

Our future growth and performance depend on our ability to attract, develop and retain qualified IOs who understand and appreciate our culture and are able to represent our brand effectively. A material decrease in profitability of the IOs may make it more difficult for us to attract and retain qualified IOs. While we use a

 

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variety of methods to attract and develop the IOs, including through our Aspiring Operators in Training (“AOT”) program, there can be no assurance that we will continue to be able to recruit and retain a sufficient number of qualified AOTs and other candidates to open successful new locations in order to meet our growth targets. Our ability to maintain our current performance and achieve future growth additionally depends on the IOs’ ability to meet their labor needs while controlling wage and labor-related costs.

If the IOs are unable to avoid excess inventory shrink, our business and results of operations may be adversely affected.

The IOs order merchandise solely from us, which we, in turn, deliver to IOs on a consignment basis. As a result, we retain ownership of all merchandise until the point in time that merchandise is sold to a customer. The IOs, however, are responsible for inventory management at their stores. Any spoiled, damaged or stolen merchandise, markdowns or price changes impact gross margin and, therefore, IO commission. We generally split these losses equally with IOs, however, excessive levels of shrink are deducted from commissions paid to IOs. Excessive shrink generally indicates poor inventory management and the IO’s failure to use due care to secure their store against theft. If IOs were to not effectively control or manage inventory in their stores, they could experience higher rates of inventory shrink which could have a material adverse effect on their financial health, which in turn, may materially and adversely affect our business and results of operations.

Our Operator Agreements may be terminated, and any loss or changeover of an IO may cause material business disruptions.

Each Operator Agreement is subject to termination by either party without cause upon 75 days’ notice. We may also terminate immediately “for cause.” The “for cause” termination triggers include, among other things, a failure to meet our brand standards, misuse of our trademarks and actions that in our reasonable business judgment threaten to harm our business reputation.

As of June 29, 2019, 324 of our 330 stores were operated by IOs, while the remaining 6 stores were operated by us. If we or an IO terminates the Operator Agreement then we must approve a new IO for that store. Any IO changeover consumes substantial time and resources. Often, a changeover will involve more than one transition, as an IO may move from an existing store, thereby creating an opening at the IO’s previous store. A failure to transition a store successfully to another IO can negatively impact the customer experience or compromise our brand standards. Termination of an Operator Agreement could therefore result in the reduction of our sales and operating cash flow, and may materially adversely affect our business, financial condition and results of operations.

Legal proceedings initiated against the IOs could materially impact our business, reputation, financial condition, results of operations and cash flows.

We and the IOs are subject to a variety of litigation risks, including, but not limited to, individual personal injury, product liability, intellectual property, employment-related actions, litigation with or involving our relationship with IOs and property disputes and other legal actions in the ordinary course of our respective businesses. If the IOs are unable to provide an adequate remedy in a legal action, the plaintiffs may attempt to hold us liable. We maintain that under current applicable laws and regulations we are not joint employers with the IOs, and should not be held liable for their actions. However, these types of claims may increase costs and affect the scope and terms of insurance or indemnifications we and the IOs may have.

Our Operator Agreements require each IO to maintain certain insurance types and levels. Losses arising from certain extraordinary hazards, employment matters or other matters, however, may not be covered, and insurance may not be available (or may be available only at prohibitively expensive rates) with respect to many other risks, or IOs may fail to procure the required insurance. Moreover, any loss incurred could exceed policy limits and policy payments made to IOs may not be made on a timely basis.

 

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Any legal actions against the IOs may negatively affect the reputation of our brand, which could result in a reduction of our sales and operating cash flow, which could be material and which could adversely affect our business, financial condition and results of operations.

In the past, certain business models that use independent contractors to sell directly to customers have been subject to challenge under various laws, including laws relating to franchising, misclassification and joint employment. If our business model is determined to be a franchise, if IOs are found not to be independent contractors, but our employees, or if we are found to be a joint employer of an IO’s employees, our business and operations could be materially adversely affected.

The IOs are independent contractors. Independent contractors and the companies that engage their services have come under increased legal and regulatory scrutiny in recent years as courts have adopted new standards for these classifications and federal legislators continue to introduce legislation concerning the classification of independent contractors as employees, including legislation that proposes to increase the tax and labor penalties against employers who intentionally or unintentionally misclassify employees as independent contractors and are found to have violated employees’ overtime or wage requirements. Federal and state tax and other regulatory authorities and courts apply a variety of standards in their determination of independent contractor status. There is a risk that a governmental agency or court could disagree with our assessment that IOs are independent contractors or that these laws and regulations could change. If any IOs were determined to be our employees, we would incur additional exposure under federal and state tax, workers’ compensation, unemployment benefits, labor, employment, environmental and tort laws, which could potentially include prior periods, as well as potential liability for employee benefits and tax withholdings.

Even if IOs are properly classified as independent contractors, there is a risk that a governmental agency or court might disagree with our assessment that each IO is the sole employer of its workers and seek to hold us jointly and separately responsible as a co-employer of an IO’s workers. In this case, we would incur additional exposure under federal and state tax, workers’ compensation, unemployment benefits, labor, employment and tort laws, which could potentially include prior periods, as well as potential liability for employee benefits and tax withholdings since joint employers are each separately responsible for their co-employees’ benefits. A misclassification ruling would mean that both IOs and IOs’ employees are our employees, it would also mean that an IOs’ employees are also our employees.

We continue to observe and monitor our compliance with current applicable laws and regulations, but we cannot predict whether laws and regulations adopted in the future, or standards adopted by the courts, regarding the classification of independent contractors will materially adversely affect our business or operations. Further, if we were to become subject to franchise laws or regulations, it would require us to provide additional disclosures, register with state franchise agencies, impact our ability to terminate our Operator Agreements and may increase the expense of, or adversely impact our recruitment of new IOs.

Our success depends on our ability to maintain positive relationships with the IOs and any failure to maintain our relationships on positive terms could materially adversely affect our business, reputation, financial condition and results of operations.

The IOs develop and operate their stores under terms set forth in our Operator Agreements. These agreements give rise to relationships that involve a complex set of mutual obligations and depends on mutual cooperation and trust. We have a standard Operator Agreement that we use with the IOs, which contributes to uniformity of brand standards. We generally have positive relationships with the IOs, based in part on our common understanding of our mutual rights and obligations under the Operator Agreement. However, we and the IOs may not always maintain a positive relationship or always interpret the Operator Agreement in the same way. Our failure to maintain positive relationships with the IOs could individually or in the aggregate cause us to change or limit our business practices, which may make our business model less attractive to the IOs or stockholders or more costly to operate. Active and/or potential disputes with IOs could damage our brand image and reputation.

 

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The success of our business depends in large part on our ability to maintain IOs in profitable stores. If we fail to maintain our IO relationships on acceptable terms, or if one or more of the more profitable IOs were to terminate their Operator Agreements, become insolvent or otherwise fail to comply with brand standards, our business, reputation, financial condition and results of operations could be materially and adversely affected.

The IOs could take actions that could harm our business.

The IOs are contractually obligated to operate their stores in accordance with the brand standards set forth in the Operator Agreements. However, IOs are independent contractors whom we do not control. The IOs operate and oversee the daily operations of their stores and have sole control over all of their employees and other workforce decisions. As a result, IOs make decisions independent of us that bear directly on the ultimate success and performance of their store. Nevertheless, the nature of the brand license creates a symbiotic relationship between our outcome and each IO. Indeed, because we and each of the IOs associate our separate businesses with the Grocery Outlet name and brand reputation, the failure of any IO to comply with our brand standards could potentially have repercussions that extend beyond that IO’s own market area and materially adversely affect not only our business, but the business of other IOs and the general brand image and reputation of the Grocery Outlet name. This, in turn, could materially and adversely affect our business and operating results. If any particular IO operates a store in a manner inconsistent with our brand standards, we cannot assure you that we will be able to terminate the Operator Agreement of that IO without disruptions to the operations and sales of that IO’s store or other stores.

Risks Associated with Our Indebtedness

Our substantial indebtedness could materially adversely affect our financial condition and our ability to operate our business, react to changes in the economy or industry or pay our debts and meet our obligations under our debt and could divert our cash flow from operations for debt payments.

We have a significant amount of indebtedness. As of June 29, 2019, our total borrowings under our First Lien Credit Agreement was $475.2 million. Although we used substantially all of the proceeds from our initial public offering to repay indebtedness, we continue to have a significant amount of indebtedness. In addition, as of June 29, 2019, we had a $100.0 million revolving credit facility under our First Lien Credit Agreement under which we had $96.4 million of availability after giving effect to outstanding letters of credit. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities.” In addition, subject to restrictions in our First Lien Credit Agreement, we may incur additional debt.

Our substantial debt could have important consequences to you, including the following:

 

   

it may be difficult for us to satisfy our obligations, including debt service requirements under our outstanding debt, resulting in possible defaults on and acceleration of such indebtedness;

 

   

our ability to obtain additional financing for working capital, capital expenditures, debt service requirements or other general corporate purposes may be impaired;

 

   

a substantial portion of cash flow from operations may be dedicated to the payment of principal and interest on our debt, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures, future business opportunities, acquisitions and other purposes;

 

   

we are more vulnerable to economic downturns and adverse industry conditions and our flexibility to plan for, or react to, changes in our business or industry is more limited;

 

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our ability to capitalize on business opportunities and to react to competitive pressures, as compared to our competitors, may be compromised due to our high level of debt; and

 

   

our ability to borrow additional funds or to refinance debt may be limited.

Furthermore, all of our debt under our First Lien Credit Agreement bears interest at variable rates. If these rates were to increase significantly, whether because of an increase in market interest rates or a decrease in our creditworthiness, our ability to borrow additional funds may be reduced and the risks related to our substantial debt would intensify.

Servicing our debt requires a significant amount of cash. Our ability to generate sufficient cash depends on numerous factors beyond our control, and we may be unable to generate sufficient cash flow to service our debt obligations.

Our business may not generate sufficient cash flow from operating activities to service our debt obligations. Our ability to make payments on and to refinance our debt and to fund planned capital expenditures depends on our ability to generate cash in the future. To some extent, this is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

If we are unable to generate sufficient cash flow from operations to service our debt and meet our other commitments, we may need to refinance all or a portion of our debt, sell material assets or operations, delay capital expenditures or raise additional debt or equity capital. We may not be able to effect any of these actions on a timely basis, on commercially reasonable terms or at all, and these actions may not be sufficient to meet our capital requirements. In addition, the terms of our existing or future debt agreements may restrict us from pursuing any of these alternatives.

Restrictive covenants in our First Lien Credit Agreement may restrict our ability to pursue our business strategies, and failure to comply with any of these restrictions could result in acceleration of our debt.

The operating and financial restrictions and covenants in our First Lien Credit Agreement may materially adversely affect our ability to finance future operations or capital needs or to engage in other business activities. Such restrictions and covenants limit our ability, among other things, to:

 

   

incur additional debt or issue certain preferred shares;

 

   

pay dividends on or make distributions in respect of our common stock or make other restricted payments;

 

   

make certain investments;

 

   

sell certain assets;

 

   

create liens on certain assets to secure debt;

 

   

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;

 

   

make certain payments in respect of certain junior debt obligations;

 

   

enter into certain transactions with our affiliates; and

 

   

designate our subsidiaries as unrestricted subsidiaries.

 

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A breach of any of these covenants could result in a default under our First Lien Credit Agreement. Upon the occurrence of an event of default under our First Lien Credit Agreement, the lenders could elect to declare all amounts outstanding under our First Lien Credit Agreement to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under our First Lien Credit Agreement could proceed against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of our assets as collateral to secure our First Lien Credit Agreement. Our future operating results may not be sufficient to enable compliance with the financial maintenance covenant in our First Lien Credit Agreement, or any other indebtedness and we may not have sufficient assets to repay amounts outstanding under our First Lien Credit Agreement. In addition, in the event of an acceleration of our debt upon a default, we may not have or be able to obtain sufficient funds to make any accelerated payments.

Furthermore, the terms of any future indebtedness we may incur could have further additional restrictive covenants. We may not be able to maintain compliance with these covenants in the future, and in the event that we are not able to maintain compliance, we cannot assure you that we will be able to obtain waivers from the lenders or amend the covenants.

Despite current debt levels, we and our subsidiaries may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage.

We and our subsidiaries may be able to incur substantial additional debt in the future. Although our First Lien Credit Agreement contains restrictions on the incurrence of additional debt, these restrictions are subject to a number of qualifications and exceptions, and the debt incurred in compliance with these restrictions could be substantial. Additionally, we may successfully obtain waivers of these restrictions. If we incur additional debt above the levels currently in effect, the risks associated with our leverage, including those described above, would increase. Our First Lien Credit Agreement includes a $100.0 million revolving credit facility under which we had $96.4 million of availability as of June 29, 2019 after giving effect to outstanding letters of credit.

Risks Related to this Offering and Ownership of Our Common Stock

The market price of our common stock has been volatile and may continue to fluctuate substantially, which could result in substantial losses for purchasers of our common stock.

The trading price of our common stock has been and is likely to continue to be volatile. The stock market has experienced extreme volatility. This volatility often has been unrelated or disproportionate to the operating performance of particular companies. Since shares of our common stock were sold in our initial public offering in June 2019 at a price of $22.00 per share, our stock price has ranged from $27.75 to $47.57 through September 30, 2019. The market price of our common stock has been highly volatile and may continue to fluctuate substantially due to a number of factors such as those listed in “—Risks Related to Our Business” and the following:

 

   

results of operations that vary from the expectations of securities analysts and investors;

 

   

results of operations that vary from those of our competitors;

 

   

changes in expectations as to our future financial performance, including financial estimates and investment recommendations by securities analysts and investors;

 

   

declines in the market prices of stocks generally;

 

   

strategic actions by us or our competitors;

 

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announcements by us or our competitors of significant contracts, new products, acquisitions, joint marketing relationships, joint ventures, other strategic relationships or capital commitments;

 

   

changes in general economic or market conditions or trends in our industry or markets;

 

   

changes in business or regulatory conditions;

 

   

additions or departures of key management personnel;

 

   

future sales of our common stock or other securities by us or our existing stockholders, or the perception of such future sales;

 

   

investor perceptions of the investment opportunity associated with our common stock relative to other investment alternatives;

 

   

the public’s response to press releases or other public announcements by us or third parties, including our filings with the SEC;

 

   

announcements relating to litigation;

 

   

guidance, if any, that we provide to the public, any changes in this guidance or our failure to meet this guidance;

 

   

the development and sustainability of an active trading market for our stock;

 

   

changes in accounting principles; and

 

   

other events or factors, including those resulting from natural disasters, war, acts of terrorism or responses to these events.

These broad market and industry fluctuations may materially adversely affect the market price of our common stock, regardless of our actual operating performance. In addition, price volatility may be greater if the public float and trading volume of our common stock are low.

In the past, following periods of market volatility, stockholders have instituted securities class action litigation. If we were involved in securities litigation, it could have a substantial cost and divert resources and the attention of executive management from our business regardless of the outcome of such litigation.

Our quarterly operating results fluctuate and may fall short of prior periods, our projections or the expectations of securities analysts or investors, which could materially adversely affect our stock price.

Our operating results have fluctuated from quarter to quarter at points in the past, and they may do so in the future. Therefore, results of any one fiscal quarter are not a reliable indication of results to be expected for any other fiscal quarter or for any year. If we fail to increase our results over prior periods, to achieve our projected results or to meet the expectations of securities analysts or investors, our stock price may decline, and the decrease in the stock price may be disproportionate to the shortfall in our financial performance. Results may be affected by various factors, including those described in these risk factors. We maintain a forecasting process that seeks to plan sales and align expenses. If we do not control costs or appropriately adjust costs to actual results, or if actual results differ significantly from our forecast, our financial performance could be materially adversely affected.

 

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We are a holding company with no operations and rely on our operating subsidiaries to provide us with funds necessary to meet our financial obligations.

We are a holding company with no material direct operations. Our principal assets are the shares of common stock of Globe Intermediate Corp. that we hold. Globe Intermediate Corp. is the indirect parent of Grocery Outlet Inc. which, together with its subsidiaries, owns substantially all of our operating assets. As a result, we are dependent on loans, dividends and other payments from our subsidiaries to generate the funds necessary to meet our financial obligations. Our subsidiaries are legally distinct from us and may be prohibited or restricted from paying dividends or otherwise making funds available to us under certain conditions. If we are unable to obtain funds from our subsidiaries, we may be unable to meet our financial obligations.

We currently do not intend to declare dividends on our common stock in the foreseeable future and, as a result, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

We currently do not expect to declare any dividends on our common stock in the foreseeable future. Instead, we anticipate that all of our earnings in the foreseeable future will be used to provide working capital, to support our operations and to finance the growth and development of our business. Any determination to declare or pay dividends in the future will be at the discretion of our board of directors, subject to applicable laws and dependent upon a number of factors, including our earnings, capital requirements and overall financial conditions. In addition, our ability to pay dividends on our common stock is currently limited by the covenants of our First Lien Credit Agreement and may be further restricted by the terms of any future debt or preferred securities. Accordingly, your only opportunity to achieve a return on your investment in our company may be if the market price of our common stock appreciates and you sell your shares at a profit. The market price for our common stock may never exceed, and may fall below, the price that you pay for such common stock.

If securities analysts do not publish research or reports about our business or if they downgrade our stock or our sector, our stock price and trading volume could decline.

The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about us or our business or industry. We do not control these analysts. Furthermore, if one or more of the analysts who do cover us downgrade our stock or our industry, or the stock of any of our competitors, or publish inaccurate or unfavorable research about our business or industry, the price of our stock could decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline.

Future sales, or the perception of future sales, by us or our existing stockholders in the public market following this offering could cause the market price for our common stock to decline.

After this offering, the sale of shares of our common stock in the public market, or the perception that such sales could occur, could harm the prevailing market price of shares of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

In connection with this offering, BofA Securities, Inc. and Morgan Stanley & Co. LLC, as representatives of the several underwriters of our initial public offering, have agreed to release the restrictions under the lock-up agreements that were executed in connection with our initial public offering with respect to 13,000,000 shares (up to 14,950,000 shares including the underwriters’ option to purchase additional shares) of our common stock in this offering that are held by the selling stockholders, which includes 721,443 shares owned by certain of our directors and/or executive officers and their affiliated entities and 11,398,299 shares owned by the H&F Investor (up to 12,281,299 shares including the underwriters’ option to purchase additional shares); provided, however, that the release of shares of our common stock held by the selling stockholders is

 

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limited to the shares actually sold in this offering. BofA Securities, Inc. and Morgan Stanley & Co. LLC, as representatives of the several underwriters of our initial public offering, may, in their sole discretion, from time to time permit our stockholders to sell additional shares and waive the contractual lock-up prior to the expiration of the lock-up agreements, as they have done with respect to the shares being released in connection with this offering.

In addition, in connection with this offering, BofA Securities, Inc. and Morgan Stanley & Co. LLC, as representatives of the several underwriters of our initial public offering, have agreed to release the restrictions under the lock-up agreements that were executed in connection with our initial public offering with respect to 883,000 shares of our common stock that are held by the H&F Investor and 50,000 shares of our common stock that are held by an entity affiliated with our CEO, Eric Lindberg. The H&F Investor will distribute its shares to its direct and indirect partners for the sole purpose of charitable giving. Mr. Lindberg’s affiliate will also donate its shares to a charity.

In connection with this offering, our board of directors has agreed to release the restriction under the amended and restated stockholders agreement which prohibits certain transfers of shares of our common stock held by certain stockholders (other than the H&F Investor) prior to the expiration of the period specified in the lock-up agreements that were executed in connection with our initial public offering with respect to 1,888,469 shares of our common stock, which includes the 771,443 shares owned by certain of our directors and/or executive officers and their affiliated entities included in the release by BofA Securities, Inc. and Morgan Stanley & Co. LLC described above.

In addition to the existing lock-up agreements that were executed in connection with our initial public offering, the selling stockholders and each of our directors and executive officers have entered into lock-up agreements in connection with this offering, on substantially similar terms, which expire 90 days from the date of this prospectus. Upon completion of this offering, based on the number of shares outstanding on June 29, 2019, 53,990,613 shares of our common stock will be restricted from sale as a result of lock-up agreements with the underwriters through the date that is 90 days from the date of this prospectus.

After this offering, the holders of an aggregate of 54,827,691 shares of our outstanding common stock immediately following this offering (assuming no exercise of the underwriters’ option to purchase additional shares and without giving effect to the expected charitable donations discussed above), will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares held by our affiliates as defined in Rule 144 under the Securities Act. See “Shares Eligible for Future Sale.”

As restrictions on resale end or if these stockholders exercise their registration rights, the market price of our shares of common stock could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them. These factors could also make it more difficult for us to raise additional funds through future offerings of our shares of common stock or other securities.

In addition, the shares of our common stock reserved for future issuance under our 2014 Stock Plan (as defined elsewhere in this prospectus) and our 2019 Incentive Plan (as defined elsewhere in this prospectus) will become eligible for sale in the public market once those shares are issued, subject to provisions relating to various vesting agreements, lock-up agreements and Rule 144 under the Securities Act, as applicable. A total of 16,284,163 shares of common stock have been reserved for future issuance under our 2014 Stock Plan and our 2019 Incentive Plan.

In the future, we may also issue our securities in connection with investments or acquisitions. The amount of shares of our common stock issued in connection with an investment or acquisition could constitute a

 

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material portion of our then-outstanding shares of our common stock. Any issuance of additional securities in connection with investments or acquisitions may result in additional dilution to you.

Provisions in our organizational documents could delay or prevent a change of control.

Certain provisions of our amended and restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a merger, acquisition, tender offer, takeover attempt or other change of control transaction that a stockholder might consider to be in its best interest, including attempts that might result in a premium over the market price of our common stock.

These provisions provide for, among other things:

 

   

the division of our board of directors into three classes, as nearly equal in size as possible, which directors in each class serving three-year terms and with terms of the directors of only one class expiring in any given year;

 

   

that at any time when the H&F Investor and certain of its affiliates beneficially own, in the aggregate, less than 40% in voting power of the stock of our company entitled to vote generally in the election of directors, directors may only be removed for cause, and only by the affirmative vote of the holders of at least two-thirds in voting power of all the then-outstanding shares of stock entitled to vote thereon, voting together as a single class;

 

   

the ability of our board of directors to issue one or more series of preferred stock with voting or other rights or preferences that could have the effect of impeding the success of an attempt to acquire us or otherwise effect a change of control;

 

 

   

advance notice for nominations of directors by stockholders and for stockholders to include matters to be considered at stockholder meetings;

 

   

the right of the H&F Investor and certain of its affiliates to nominate a number of members of our board of directors proportionate to their collective ownership of our common stock and the obligation of certain of our other pre-initial public offering stockholders to support such nominees;

 

   

the right of certain other pre-initial public offering investors to nominate one member of our board of directors and the obligation of the H&F Investor and certain of our other pre-initial public offering stockholders to support such nominee;

 

   

certain limitations on convening special stockholder meetings; and

 

   

that certain provisions of our amended and restated certificate of incorporation and amended and restated bylaws may be amended only by the affirmative vote of the holders of at least two-thirds in voting power of all the then-outstanding shares of our stock entitled to vote thereon, voting together as a single class, if the H&F Investor and certain of its affiliates beneficially own, in the aggregate, less than 40% in voting power of our stock entitled to vote generally in the election of directors.

These provisions could make it more difficult for a third party to acquire us, even if the third-party’s offer may be considered beneficial by many of our stockholders. As a result, our stockholders may be limited in their ability to obtain a premium for their shares. See “Description of Capital Stock.”

 

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The H&F Investor will continue to hold a significant percentage of our outstanding stock after this offering and its interests may be different than the interests of other holders of our securities.

Upon the completion of this offering, the H&F Investor will own approximately 48.7% of our outstanding common stock, or approximately 46.5% if the underwriters exercise in full their option to purchase additional shares. As a result, the H&F Investor is able to control or influence actions to be taken by us, including future issuances of our common stock or other securities, the payment of dividends, if any, on our common stock, amendments to our organizational documents and the approval of significant corporate transactions, including mergers, sales of substantially all of our assets, distributions of our assets, the incurrence of indebtedness and any incurrence of liens on our assets.

The interests of the H&F Investor may be materially different than the interests of our other stakeholders. In addition, the H&F Investor may have an interest in pursuing acquisitions, divestitures and other transactions that, in their judgment, could enhance its investment, even though such transactions might involve risks to you. For example, the H&F Investor may cause us to take actions or pursue strategies that could impact our ability to make payments under our First Lien Credit Agreement or that cause a change of control. In addition, to the extent permitted by our First Lien Credit Agreement, the H&F Investor may cause us to pay dividends rather than make capital expenditures or repay debt. The H&F Investor is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Our amended and restated certificate of incorporation provides that none of the H&F Investor, any of its affiliates or any director who is not employed by us (including any non-employee director who serves as one of our officers in both his director and officer capacities) or his or her affiliates will have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we operate. The H&F Investor also may pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us.

So long as the H&F Investor continues to own a significant amount of our outstanding common stock, even if such amount is less than 50%, it will continue to be able to strongly influence or effectively control our decisions and, so long as the H&F Investor continues to own shares of our outstanding common stock, nominate individuals to our board of directors pursuant to the stockholders agreement we are parties to. See “Certain Relationships and Related Party Transactions—Stockholders Agreement.” In addition, the H&F Investor will be able to determine the outcome of all matters requiring stockholder approval and will be able to cause or prevent a change of control of our company or a change in the composition of our board of directors and could preclude any unsolicited acquisition of our company. The concentration of ownership could deprive you of an opportunity to receive a premium for your shares of common stock as part of a sale of our company and ultimately might affect the market price of our common stock.

Failure to comply with requirements to design, implement and maintain effective internal controls could have a material adverse effect on our business and stock price.

As a privately-held company, we were not required to evaluate our internal control over financial reporting in a manner that meets the standards of publicly traded companies required by Section 404(a) of the Sarbanes-Oxley Act (“Section 404”). As a public company, we have significant requirements for enhanced financial reporting and internal controls. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. If we are unable to establish or maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations on a timely basis, result in material misstatements in our consolidated financial statements and harm our results of operations. In addition, we are required, pursuant to Section 404, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting in our

 

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annual report for the year ended January 2, 2021. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. Testing and maintaining internal controls may divert our management’s attention from other matters that are important to our business. Our independent registered public accounting firm will be required to issue an attestation report on effectiveness of our internal controls in our annual report for the year ended January 2, 2021.

In connection with the implementation of the necessary procedures and practices related to internal control over financial reporting, we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. In addition, we may encounter problems or delays in completing the remediation of any deficiencies identified by our independent registered public accounting firm in connection with the issuance of their attestation report.

Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. A material weaknesses in internal control could result in our failure to detect a material misstatement of our annual or quarterly consolidated financial statements or disclosures. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If we are unable to conclude that we have effective internal control over financial reporting, investors could lose confidence in our reported financial information, which could have a material adverse effect on the trading price of our common stock.

Our amended and restated bylaws provide, subject to limited exceptions, that the Court of Chancery of the State of Delaware and, to the extent enforceable, the federal district courts of the United States of America will be the sole and exclusive forums for certain stockholder litigation matters, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated bylaws provide, subject to limited exceptions, that unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall, to the fullest extent permitted by law, be the sole and exclusive forum for any (i) derivative action or proceeding brought on behalf of our company, (ii) action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of our company to the Company or our stockholders, (iii) action asserting a claim against the Company or any director, officer or other employee of the Company arising pursuant to any provision of the Delaware General Corporation Law, or the DGCL, or our amended and restated certificate of incorporation or our amended and restated bylaws or as to which the DGCL confers jurisdiction on the Court of Chancery of the State of Delaware or (iv) action asserting a claim against the Company or any director, officer or other employee of the Company governed by the internal affairs doctrine. These provisions shall not apply to suits brought to enforce a duty or liability created by the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. Unless we consent in writing to the selections of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act, subject to and contingent upon a final adjudication in the State of Delaware of the enforceability of such exclusive forum provision. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and consented to the forum provisions in our amended and restated bylaws.

These choice of forum provisions may limit a stockholder’s ability to bring a claim in a different judicial forum, including one that it may find favorable or convenient for disputes with us or any of our directors, officers or other employees which may discourage lawsuits with respect to such claims. Alternatively, if a court were to find the choice of forum provisions that will be contained in our amended and restated bylaws to be inapplicable or unenforceable with respect to one or more of the specified types of actions or proceedings, we

 

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may incur additional costs associated with resolving such action in other jurisdictions, which could harm our business, operating results and financial condition. For example, the Court of Chancery of the State of Delaware recently determined that a provision stating that U.S. federal district courts are the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act is not enforceable. However, this decision may be reviewed and ultimately overturned by the Delaware Supreme Court.

Our board of directors is authorized to issue and designate shares of our preferred stock in additional series without stockholder approval.

Our amended and restated certificate of incorporation authorizes our board of directors, without the approval of our stockholders, to issue 50,000,000 shares of our preferred stock, subject to limitations prescribed by applicable law, rules and regulations and the provisions of our amended and restated certificate of incorporation, as shares of preferred stock in series, to establish from time to time the number of shares to be included in each such series and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. The powers, preferences and rights of these additional series of preferred stock may be senior to or on parity with our common stock, which may reduce its value.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

All statements (other than statements of historical facts) in this prospectus regarding the prospects of the industry and our prospects, plans, financial position and business strategy may constitute forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “should,” “expect,” “intend,” “will,” “estimate,” “anticipate,” “believe,” “predict,” “potential” or “continue” or the negatives of these terms or variations of them or similar terminology. Forward-looking statements include our expectations regarding our financial and operational information as of and for the thirteen weeks ended September 28, 2019 after the completion of our closing procedures. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot provide any assurance that these expectations will prove to be correct. Such statements reflect the current views of our management with respect to our business, results of operations and future financial performance. The following factors are among those that may cause actual results to differ materially from the forward-looking statements:

 

   

failure of suppliers to consistently supply us with opportunistic products at attractive pricing;

 

   

inability to successfully identify trends and maintain a consistent level of opportunistic products;

 

   

failure to maintain or increase comparable store sales;

 

   

changes affecting the market prices of the products we sell;

 

   

failure to open, relocate or remodel stores on schedule;

 

   

risks associated with newly opened stores;

 

   

risks associated with economic conditions;

 

   

competition in the retail food industry;

 

   

inability to retain the loyalty of our customers;

 

   

costs and implementation difficulties associated with marketing, advertising and promotions;

 

   

failure to maintain our reputation and the value of our brand, including protecting our intellectual property;

 

   

any significant disruption to our distribution network, the operations of our distributions centers and our timely receipt of inventory;

 

   

movement of consumer trends toward private labels and away from name-brand products;

 

   

inability to maintain sufficient levels of cash flow from our operations;

 

   

risks associated with leasing substantial amounts of space;

 

   

failure to maintain the security of information we hold relating to personal information or payment card data of our customers, employees and suppliers;

 

   

failure to participate effectively or at all in the growing online retail marketplace;

 

   

material disruption to our information technology systems;

 

   

risks associated with products we and the IOs sell;

 

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risks associated with laws and regulations generally applicable to retailers;

 

   

legal proceedings from customers, suppliers, employees, governments or competitors;

 

   

unexpected costs and negative effects associated with our insurance program;

 

   

inability to attract, train and retain highly qualified employees;

 

   

difficulties associated with labor relations;

 

   

loss of our key personnel or inability to hire additional qualified personnel;

 

   

changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters;

 

   

impairment of goodwill and other intangible assets;

 

   

any significant decline in our operating profit and taxable income;

 

   

risks associated with tax matters;

 

   

natural disasters and unusual weather conditions (whether or not caused by climate change), pandemic outbreaks, terrorist acts, global political events and other serious catastrophic events;

 

   

economic downturns or natural or man-made disasters in geographies where our stores are located;

 

   

management’s limited experience managing a public company;

 

   

risks associated with IOs being consolidated into our financial statements;

 

   

failure of the IOs to successfully manage their business;

 

   

failure of the IOs to repay notes outstanding to us;

 

   

inability to attract and retain qualified IOs;

 

   

inability of the IOs to avoid excess inventory shrink;

 

   

any loss or changeover of an IO;

 

   

legal proceedings initiated against the IOs;

 

   

legal challenges to the independent contractor business model;

 

   

failure to maintain positive relationships with the IOs;

 

   

risks associated with actions the IOs could take that could harm our business;

 

   

the significant influence of the H&F Investor over us;

 

   

our ability to generate cash flow to service our substantial debt obligations; and

 

   

the other factors discussed under “Risk Factors.”

 

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The preceding list is not intended to be an exhaustive list of all of our forward-looking statements. The forward-looking statements are based on our beliefs, assumptions and expectations of future performance, taking into account the information currently available to us. These statements are only predictions based upon our current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements. Other sections of this prospectus may include additional factors that could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Before investing in our common stock, investors should be aware that the occurrence of the events described under the caption “Risk Factors” and elsewhere in this prospectus could have a material adverse effect on our business, results of operations and future financial performance.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance and events and circumstances reflected in the forward-looking statements will be achieved or occur. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this prospectus to conform these statements to actual results or to changes in our expectations.

 

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USE OF PROCEEDS

We are filing the registration statement of which this prospectus is a part to permit holders of the shares of our common stock included in the section entitled “Principal and Selling Stockholders” to resell such shares. The selling stockholders will receive all of the net proceeds from the sale of shares of common stock in this offering. We are not selling any shares of common stock under this prospectus and will not receive any proceeds from the sale of shares by the selling stockholders or if the underwriters exercise their option to purchase additional shares.

 

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DIVIDEND POLICY

We currently do not expect to declare any dividends on our common stock in the foreseeable future. Instead, we anticipate that all of our earnings in the foreseeable future will be used to provide working capital, to support our operations, to finance the growth and development of our business and to reduce our net debt. Any determination to declare dividends in the future will be at the discretion of our board of directors, subject to applicable laws, and will be dependent on a number of factors, including our earnings, capital requirements and overall financial condition. In addition, because we are a holding company, our ability to pay dividends on our common stock may be limited by restrictions on our ability to obtain sufficient funds through dividends from subsidiaries, including restrictions under our First Lien Credit Agreement, and may be further restricted by the terms of any future debt or preferred securities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities” for more information about our First Lien Credit Agreement.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of June 29, 2019.

You should read this table together with “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

     As of
June 29, 2019
 
     (in thousands)  

Cash and cash equivalents

   $ 18,677  
  

 

 

 

Long-term debt, including current portion of long-term debt:

  

First Lien Credit Agreement (1)

   $ 475,188  

Other long-term debt

     357  

Combined aggregate unamortized debt discount and debt issuance costs

     (13,159
  

 

 

 

Total debt

     462,386  
  

 

 

 

Stockholders’ equity:

  

Common stock, $0.001 par value; 500,000,000 shares authorized, 88,311,764 shares issued and outstanding

     88  

Preferred stock, $0.001 par value; 50,000,000 shares authorized, no shares issued and outstanding

     —    

Additional paid-in capital

     711,200  

Retained earnings

     5,400  
  

 

 

 

Total stockholders’ equity

     716,688  
  

 

 

 

Total capitalization

   $ 1,179,074  
  

 

 

 

 

(1)

As of June 29, 2019, we had a $100.0 million revolving credit facility under our First Lien Credit Agreement under which we had $96.4 million of availability thereunder after giving effect to outstanding letters of credit as of such date.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth the selected consolidated financial data of the Company for the periods presented. The selected consolidated financial data for the fiscal years 2016, 2017 and 2018 and the summary balance sheet data as of December 30, 2017 and December 29, 2018 are derived from our audited consolidated financial statements and the related notes appearing elsewhere in this prospectus. The selected consolidated financial data for the period from December 29, 2013 through October 7, 2014, for the period from October 8, 2014 through January 3, 2015 and for fiscal year 2015 and the summary balance sheet data as of January 3, 2015 and January 2, 2016 presented below were derived from unaudited consolidated financial statements which are not included in this prospectus. The selected consolidated financial data for the 26 weeks ended June 30, 2018 and June 29, 2019 and the summary balance sheet data as of June 29, 2019 are derived from our unaudited condensed consolidated financial statements and the related notes appearing elsewhere in this prospectus. All unaudited consolidated financial statements referenced herein were prepared on a basis consistent with the audited consolidated financial statements and in the opinion of management reflect all adjustments necessary for a fair statement of the financial information. The summary balance sheet data as of December 31, 2016 presented below was derived from audited consolidated financial statements which are not included in this prospectus. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods and interim results are not necessarily indicative of results to be expected for the full year ended December 28, 2019. We operate on a fiscal year that ends on the Saturday closest to December 31st each year. Fiscal years 2015 through 2018 all contained 52 weeks and the fiscal year ended January 3, 2015 contained 53 weeks.

 

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The selected consolidated financial data set forth below should be read in conjunction with “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

   

Predecessor

         

Successor

 
   

Period from
December 29,
2013 through
October  7,
2014

         

Period from
October 8,
2014
through
January  3,
2015

   

Fiscal Year Ended

   

26 Weeks Ended

 
   

January 2,
2016

   

December 31,
2016

   

December 30,
2017

   

December 29,
2018

   

June 30,
2018

   

June 29,
2019

 
                (in thousands, except per share data)  

Statement of Operations Data:

                   

Net sales

  $ 1,139,429         $ 371,015     $ 1,627,306     $ 1,831,531     $ 2,075,465     $ 2,287,660     $ 1,125,616     $ 1,251,560  

Cost of sales

    793,227           266,929       1,135,090       1,270,354       1,443,582       1,592,263       781,932       865,823  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    346,202           104,086       492,216       561,177       631,883       695,397       343,684       385,737  

Operating expenses:

                   

Selling, general and administrative expenses

    292,628           91,867       401,204       457,051       510,136       557,100       276,479       310,495  

Depreciation and amortization expenses

    28,829           7,384       31,243       37,152       43,152       45,421       22,413       24,890  

Stock-based compensation expenses

    68,502           —         172       2,905       1,659       10,409       263       22,961  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    389,959           99,251       432,619       497,108       554,947       612,930       299,155       358,346  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (43,757         4,835       59,597       64,069       76,936       82,467       44,529       27,391  

Other expense:

                   

Interest expense, net

    24,348           11,573       45,900       47,147       49,698       55,362       26,886       31,890  

Debt extinguishment and modification costs

    —             12,695       5,473       —         1,466       5,253       —         5,162  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

    24,348           24,268       51,373       47,147       51,164       60,615       26,886       37,052  

Income (loss) before income taxes

    (68,105         (19,433     8,224       16,922       25,772       21,852       17,643       (9,661

Income tax expense (benefit)

    (24,753         (7,644     3,459       6,724       5,171       5,984       4,832       (2,803
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (43,352       $ (11,789   $ 4,765     $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share Data (1):

                   

Net income (loss) per share (basic and diluted)

                   

Basic

        $ (0.17   $ 0.07     $ 0.15     $ 0.30     $ 0.24     $ 0.19     $ (0.10

Diluted

        $ (0.17   $ 0.07     $ 0.15     $ 0.30     $ 0.23     $ 0.19     $ (0.10

Weighted average shares outstanding (basic and diluted)

                   

Basic

          68,384       68,219       68,260       68,232       68,473       68,471       69,494  

Diluted

          68,452       68,266       68,323       68,332       68,546       68,499       69,494  

Statement of Cash Flows Data:

                   

Net cash provided by (used in) operating activities

  $ 46,136         $ (80,770   $ 43,176     $ 70,875     $ 84,703     $ 105,811     $ 55,217     $ 39,718  

Net cash used in investing activities

    (35,104         (1,027,156     (50,624     (65,416     (77,820     (73,550     (25,501     (44,523

Net cash provided by (used in) financing activities

    (3,067         1,106,426       (7,773     (4,328     (7,935     (16,999     (2,756     2,419  

 

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Predecessor

         

Successor

 
   

Period from
December 29,
2013 through
October  7,
2014

         

Period from
October 8,
2014
through
January  3,
2015

   

Fiscal Year Ended

   

26 Weeks Ended

 
   

January 2,
2016

   

December 31,
2016

   

December 30,
2017

   

December 29,
2018

   

June 30,
2018

   

June 29,
2019

 
                (dollars in thousands)  

Other Financial and Operations Data:

                   

Number of new stores

    14           3       20       29       29       26       7       16  

Number of stores open at end of period

    216           218       237       265       293       316       300       330  

Comparable store sales growth (2)

    5.3         5.0     4.2     3.6     5.3     3.9     3.5     5.0

Gross margin

    30.4         28.1     30.2     30.6     30.4     30.4     30.5     30.8

EBITDA (3)

  $ (14,928       $ (476   $ 85,367     $ 101,221     $ 118,622     $ 124,271     $ 67,726     $ 48,234  

Adjusted EBITDA (3)

  $ 58,326         $ 43,047     $ 108,236     $ 123,415     $ 136,319     $ 153,578     $ 75,234     $ 84,130  

Adjusted net income (3)

  $ 5,506         $ 17,932     $ 27,642     $ 33,765     $ 48,655     $ 49,308     $ 24,448     $ 24,407  

 

    

Successor

 
    

As of

 
    

January 3,

2015

    

January 2,
2016

    

December 31,
2016

    

December 30,
2017

    

December 29,
2018

    

June 29,
2019

 
     (in thousands)  

Balance Sheet Data:

                 

Cash and cash equivalents

   $ 20,943      $ 5,722      $ 6,853      $ 5,801      $ 21,063      $ 18,677  

Working capital (4)

     59,345        62,746        68,186        76,224        89,448        71,349  

Total assets (5)

     1,201,628        1,220,853        1,268,470        1,317,871        1,376,862        2,081,598  

Total debt (6)

     624,455        625,782        711,866        710,886        857,368        462,386  

Total liabilities (5)

     726,782        741,070        862,118        890,738        1,076,911        1,364,910  

Total stockholders’ equity

     474,846        479,783        406,352        427,133        299,951        716,688  

Total liabilities and stockholders’ equity (5)

     1,201,628        1,220,853        1,268,470        1,317,871        1,376,862        2,081,598  

 

(1)

We have not presented per share data for the 2014 predecessor period as we believe the information will not be meaningful to investors due to the differences in the legal entity structure and capitalization.

(2)

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business—Comparable Store Sales.”

 

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(3)

For more information on our use of EBITDA, adjusted EBITDA and adjusted net income see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business—EBITDA, Adjusted EBITDA and Adjusted Net Income.” The following table provides a reconciliation from our net income to EBITDA and adjusted EBITDA and our net income to adjusted net income for the period from December 29, 2013 through October 7, 2014 and the period from October 8, 2014 through January 3, 2015, the fiscal years 2015, 2016, 2017 and 2018 and the 26 weeks ended June 30, 2018 and June 29, 2019.

 

   

Predecessor

         

Successor

 
   

Period from
December 29,
2013 through
October  7,
2014

         

Period from
October 8,
2014 through
January  3,
2015

   

Fiscal Year Ended

   

26 Weeks Ended

 
   

January 2,
2016

   

December 31,
2016

   

December 30,
2017

   

December 29,
2018

   

June 30,
2018

   

June 29,
2019

 
                (in thousands)  

Net income (loss)

  $ (43,352       $ (11,789   $ 4,765     $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858

Interest expense, net

    24,348           11,573       45,900       47,147       49,698       55,362       26,886       31,890  

Income tax (benefit) expense

    (24,753         (7,644     3,459       6,724       5,171       5,984       4,832       (2,803

Depreciation and amortization expenses

    28,829           7,384       31,243       37,152       43,152       47,057       23,197       26,005  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

    (14,928         (476     85,367       101,221       118,622       124,271       67,726       48,234  

Stock-based compensation expenses (a)

    68,502           —         172       2,905       1,659       10,409       263       22,961  

Purchase accounting inventory adjustments (b)

    —             7,100       —         —         —         —         —         —    

Debt extinguishment and modification costs (c)

    —             12,695       5,473       —         1,466       5,253       —         5,162  

Non-cash rent (d)

    1,422           2,356       9,937       8,451       8,401       7,903       3,523       3,678  

Asset impairment and gain or loss on disposition (e)

    (49         48       889       519       549       1,306       (28     415  

New store pre-opening expenses (f)

    745           205       1,693       2,580       1,807       1,555       701       742  

Rent for acquired leases (g)

    —             —         2,385       2,388       72       —         —         —    

Provision for accounts receivable
reserves (h)

    700           1,100       1,225       4,018       3,004       749       2,348       2,064  

Other (i)

    1,934           20,019       1,095       1,333       739       2,132       701       874  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 58,326         $ 43,047     $ 108,236     $ 123,415     $ 136,319     $ 153,578     $ 75,234     $ 84,130  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Predecessor

         

Successor

 
   

Period from
December 29,
2013 through
October 7,

2014

         

Period from
October 8,
2014 through
January 3,

2015

   

Fiscal Year Ended

   

26 Weeks Ended

 
   

January 2,
2016

   

December 31,
2016

   

December 30,
2017

   

December 29,
2018

   

June 30,
2018

   

June 29,
2019

 
                (in thousands)                                      

Net income (loss)

  $ (43,352       $ (11,789   $ 4,765     $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858

Stock-based compensation expenses (a)

    68,502           —         172       2,905       1,659       10,409       263       22,961  

Purchase accounting inventory adjustment (b)

    —             7,100       —         —         —         —         —         —    

Debt extinguishment and modification costs (c)

    —             12,695       5,473       —         1,466       5,253       —         5,162  

Non-cash rent (d)

    1,422           2,356       9,937       8,451       8,401       7,903       3,523       3,678  

Asset impairment and gain or loss on disposition (e)

    (49         48       889       519       549       1,306       (28     415  

New store pre-opening expenses (f)

    745           205       1,693       2,580       1,807       1,555       701       742  

Rent for acquired leases (g)

    —             —         2,385       2,388       72       —         —         —    

Provision for accounts receivable reserves (h)

    700           1,100       1,225       4,018       3,004       749       2,348       2,064  

Other (i)

    1,934           20,019       1,095       1,333       739       2,132       701       874  

Amortization of purchase accounting assets and deferred financing costs (j)

    4,310           3,659       16,618       16,914       17,399       16,744       8,517       7,751  

Tax effect of total adjustments (k)

    (28,706         (17,461     (16,610     (15,541     (7,042     (12,611     (4,388     (12,382
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

  $ 5,506         $ 17,932     $ 27,642     $ 33,765     $ 48,655     $ 49,308     $ 24,448     $ 24,407  
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a)

Represents non-cash stock compensation expense of $68.5 million in 2014 related to the 2014 H&F Acquisition, $0.2 million in 2015, $0.3 million in 2016, $0.4 million in each of 2017 and 2018, $0.2 million in the 26 weeks ended June 30, 2018 and $22.7 million in the 26 weeks ended June 29, 2019, with the remainder representing dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2016 Recapitalization and our 2018 Recapitalization. We expect to pay an additional $4.2 million in the aggregate on options as they vest in respect of such dividends, of which $3.4 million is expected to be paid in the remainder of fiscal 2019.

  (b)

Reflects an inventory step-up resulting from the application of purchase accounting relating to the 2014 H&F Acquisition.

  (c)

Represents debt extinguishment and modification costs related to the write-off of debt issuance costs and non-capitalizable expenses related to the 2014 H&F Acquisition, June 2017 repricing of our first and second lien credit facilities, the modification of our first and second lien credit facilities in connection with our 2018 Recapitalization and the extinguishment of our Second Lien Credit Agreement in June 2019.

  (d)

Consists of the non-cash portion of rent expense, which reflects the extent to which our straight-line rent expense recognized under GAAP exceeds or is less than our cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant growth in recent years.

  (e)

Represents impairment charges with respect to planned store closures and gains or losses on dispositions of assets in connection with store transitions to new IOs.

  (f)

Includes marketing, occupancy and other expenses incurred in connection with store grand openings, including costs that will be the IO’s responsibility after store opening.

  (g)

Represents cash occupancy expenses on leases acquired from Fresh & Easy Inc. in 2015 for the periods prior to opening new stores on such sites (commonly referred to as “dead rent”).

  (h)

Represents non-cash changes in reserves related to our IO notes and accounts receivable.

  (i)

Transaction expenses relating to the 2014 H&F Acquisition and other non-recurring, non-cash or discrete items as determined by management, including personnel-related costs, strategic project costs, legal expenses, costs associated with closed stores and miscellaneous costs.

  (j)

Represents amortization of debt issuance costs and incremental amortization of an asset step-up resulting from purchase price accounting related to the 2014 H&F Acquisition which included trademarks, customer lists and below-market leases.

  (k)

Represents the tax effect of the total adjustments at our estimated effective tax rate.

(4)

Working capital is defined as current assets minus current liabilities.

(5)

In connection with the adoption of Accounting Standards Codification Topic 842, we have recognized an operating right-of-use asset of $676.2 million and a lease liability of $753.3 million as of June 29, 2019.

(6)

Total debt consists of the current and long-term portions of our total debt outstanding, net of debt discount and debt issuance costs. Total gross debt outstanding was $650.0 million, $645.5 million, $730.3 million, $725.0 million, $875.0 million and $475.5 million as of January 3, 2015, January 2, 2016, December 31, 2016, December 30, 2017, December 29, 2018 and June 29, 2019, respectively.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with the section titled “Selected Consolidated Financial Data” and our consolidated financial statements and related notes which are included elsewhere in this prospectus. 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 under “Risk Factors” or in other sections of this prospectus.

We operate on a fiscal year that ends on the Saturday closest to December 31st each year. References to the years 2016, 2017 and 2018 refer to the fiscal years ended December 31, 2016, December 30, 2017 and December 29, 2018, each of which contained 52 weeks. References to the first half 2019 and first half 2018 refer to the 26 weeks ended June 29, 2019 and June 30, 2018, respectively.

Our Company

We are a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold through a network of independently operated stores. Each of our stores offers a fun, treasure hunt shopping experience in an easy-to-navigate, small-box format. An ever-changing assortment of “WOW!” deals, complemented by everyday staple products, generates customer excitement and encourages frequent visits from bargain-minded shoppers. 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. This differentiated approach has driven 15 consecutive years of positive comparable store sales growth.

Our differentiated model for buying and selling delivers a “WOW!” shopping experience, which generates customer excitement, inspires loyalty and supports profitable sales growth:

 

   

How we buy: We source quality, name-brand consumables and fresh products opportunistically through a large, centralized purchasing team that leverages long-standing and actively managed supplier relationships to acquire merchandise at significant discounts. Our speed and efficiency in responding to supplier needs combined with our specialized supply chain capabilities and flexible merchandising strategy enhance our access to discounted products and allow us to turn inventory quickly and profitably. Our buyers proactively source on-trend products based on changing consumer preferences, including a wide selection of Natural, Organic, Specialty and Healthy (“NOSH”) products. We also source everyday staple products to complement our opportunistic offerings. We purchase over 85,000 stock keeping units (“SKUs”) from approximately 1,500 suppliers annually. Each store offers a curated and ever-changing assortment of approximately 5,000 SKUs, creating a “buy now” sense of urgency that promotes return visits and fosters customer loyalty.

 

   

How we sell: Our stores are independently operated by entrepreneurial small business owners that have a relentless focus on selecting the best products for their communities, providing personalized customer service and driving improved store performance. Unlike a store manager of a traditional retailer, IOs are independent businesses and are responsible for store operations, including ordering, merchandising and managing inventory, marketing locally and directly hiring, training and employing their store workers. IOs also initially contribute capital to establish their business and share store-level gross profits with us. This both aligns our interests and incentivizes IOs to aggressively grow their business to realize substantial financial upside. This combination of local decision-making supported by our purchasing scale and corporate resources results in a “small business at scale” model that we believe is difficult for competitors to replicate.

 

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Our Growth Strategies

We plan to continue to drive sales growth and profitability by maintaining a relentless focus on our value proposition and executing on the following strategies:

 

   

Drive Comparable Sales Growth. We expect that our compelling value proposition will continue to attract new customers, drive repeat visits, increase basket sizes and, as a result, generate strong comparable store sales growth. We plan to:

 

   

Deliver More “WOW!” Deals and Expand Our Offerings. We intend to drive incremental traffic and increase our share of wallet by further leveraging our purchasing model. We continue to deepen existing and develop new supplier relationships to ensure that we are the preferred partner and the first call for opportunistic inventory. As a result, we believe there is a significant opportunity to source and offer more “WOW!” deals within existing and new product categories, thereby offering greater value and variety to customers. For example, in response to growing consumer preferences for fresh and healthy options, we have grown NOSH primarily through opportunistic purchasing to represent over 15% of our current product mix. More recently, we have expanded our offerings to include fresh seafood and grass-fed meat in order to increase sales to existing and new customers.

 

   

Support IOs in Enhancing the “WOW!” Customer Experience. We continue to implement operational initiatives to support IOs in enhancing the customer experience. We develop and improve tools that provide IOs with actionable insights on sales, margin and customer behavior, enabling them to further grow their business. Our recently enhanced inventory planning tools help IOs make better local assortment decisions while reducing out-of-stock items and losses related to product markdowns, throwaways and theft (“shrink”). We also regularly deploy updated fixtures, signage and enhanced in-store marketing to further improve the shopping experience, which we believe results in higher customer traffic and average basket sizes.

 

   

Increase Customer Awareness and Engagement. Our marketing strategy is focused on growing awareness, encourage new customers to visit our stores and increasing engagement with all bargain-minded consumers. Our recent emphasis on digital marketing is enabling us to deliver specific and real-time information to our customers about the most compelling “WOW!” deals at their local store. We have over one million email subscribers in our database, most of whom receive daily and weekly “WOW! Alerts.” Along with the IOs, we have begun to utilize social media to increase our brand affinity and interact with customers more directly on a daily basis. Looking forward, we see an opportunity to further personalize our digital communications to both increase engagement with our existing customers and introduce new customers to our stores. We will continue to supplement our digital marketing with traditional print and broadcast advertising including through our new marketing campaign, “Welcome to Bargain Bliss.”

 

   

Execute on Store Expansion Plans. We believe the success of our stores across a broad range of geographies, population densities and demographic groups creates a significant opportunity to profitably increase our store count. Our new stores typically require an average net cash investment of approximately $2.0 million and realize a payback on investment within four years. In 2018, we opened 26 new stores and expect to open 32 new stores in 2019. Based on our experience, in addition to research conducted by eSite Analytics, we believe there is an opportunity to establish over 400 additional locations in the states in which we currently operate and approximately 1,600 additional locations when neighboring states are included. Our goal is to expand our store base by approximately 10% annually by penetrating existing and contiguous regions. Over the long term, we believe the market potential exists to establish 4,800 locations nationally.

 

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Implement Productivity Improvements to Reinvest in Our Value Proposition. Our seasoned management team has a proven track record of growing our business while maintaining a disciplined cost structure. Since the 2014 H&F Acquisition, we have made significant investments that have laid a solid foundation for future growth. For example, we recently implemented a new warehouse management system that has yielded increased distribution labor productivity and improved store ordering capabilities to help reduce shrink. We have implemented and will continue to identify and implement productivity improvements through both operational initiatives and system enhancements, such as category assortment optimization, improved inventory management tools and greater purchasing specialization. We intend to reinforce our value proposition and drive further growth by reinvesting future productivity improvements into enhanced buying and selling capabilities.

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 GAAP measures we use are sales, gross profit and gross margin, selling, general and administrative expenses (“SG&A”) and operating income. The key non-GAAP measures we use are number of new stores, comparable store sales, EBITDA, adjusted EBITDA and adjusted net income.

Number of New Stores

The number of new stores reflects the number of stores opened during a particular reporting period. New stores require an initial capital investment in the store build-outs, fixtures and equipment which we amortize over time as well as cash required for inventory and pre-opening expenses.

We opened 29 new stores in each of fiscal years 2016 and 2017, opened 26 new stores in fiscal year 2018, seven new stores in the first half 2018 and 16 new stores in the first half 2019, all of which are operated by IOs. We closed one store in each of fiscal years 2016 and 2017 and closed three stores in fiscal year 2018. Those store closures included two Company-operated stores closed at the end of their lease terms, one Company-operated store closed due to landlord site redevelopment, one IO store destroyed by wildfire and one IO store closed at the end of its lease term. We closed no stores in the first half 2018 and two stores in the first half 2019 both of which were at the end of their respective lease terms. We expect new store growth of IO stores to be the primary driver of our sales growth. 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.

Sales

We recognize revenues from the sale of products at the point of sale, net of any taxes or deposits collected and remitted to governmental authorities. Discounts provided to customers by us are recognized at the time of sale as a reduction in sales as the products are sold. Discounts that are funded solely by IOs are not recognized as a reduction in sales as the IO bears the incidental costs arising from the discount. We do not accept manufacturer coupons. Sales consist of sales from comparable stores and non-comparable stores, described below under “Comparable Store Sales.” Growth of our sales is primarily driven by expansion of our store base in existing and new markets as well as comparable store sales growth. Sales are impacted by product mix and availability, as well as promotional and competitive activities and the spending habits of our customers. Our ever-changing selection of offerings across diverse product categories supports growth in sales by attracting new customers and encouraging repeat visits from our existing customers.

The spending habits of our customers are subject to macroeconomic conditions and changes in discretionary income. Our customers’ discretionary income is primarily impacted by wages, fuel and other cost-of-living increases including food-at-home inflation, as well as consumer trends and preferences, which

 

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fluctuate depending on the environment. Because we offer a broad selection of merchandise at extreme values, in the past we have benefited from periods of economic uncertainty.

Comparable Store Sales

Comparable store sales 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 sales.

Comparable store sales consist of sales from our stores beginning on the first day of the fourteenth full fiscal month following the store’s opening, which is when we believe comparability is achieved. Included in our comparable store definition are those stores that have been remodeled, expanded, or relocated in their existing location or respective trade areas. Excluded from our comparable store definition are those stores that have been closed for an extended period as well as any planned store closures or dispositions. When applicable, we exclude the sales in the non-comparable week of a 53-week year from the same store sales calculation.

Opening new stores is a primary component of our growth strategy and, as we continue to execute on our growth strategy, we expect a significant portion of our sales growth will be attributable to non-comparable store sales. Accordingly, comparable store sales are only one measure we use to assess the success of our growth strategy.

Prior to 2014, we calculated comparable store sales growth based on gross sales for stores beginning on the 366th day after opening. While we believe results under this prior method do not materially differ from results under our current method, we believe that our current methodology more appropriately adjusts for higher sales volumes that typically occur in conjunction with a store’s grand opening events.

Gross Profit and Gross Margin

Gross profit is equal to our sales less our cost of sales. Cost of sales includes, among other things, merchandise costs, inventory markdowns, shrink and transportation, distribution and warehousing costs, including depreciation. Gross margin is gross profit as a percentage of our sales. Gross margin is a measure used by management to indicate whether we are selling merchandise at an appropriate gross profit.

Gross margin is impacted by product mix and availability, as some products generally provide higher gross margins, and by our merchandise costs, which can vary. Gross margin is also impacted by the costs of distributing and transporting product to our stores, which can vary.

Our gross profit is variable in nature and generally follows changes in sales. 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.

The components of our cost of sales may not be comparable to the components of cost of sales or similar measures of our competitors and other retailers. As a result, our gross profit and gross margin may not be comparable to similar data made available by our competitors and other retailers.

Prior to 2014, we calculated gross margin based on gross sales, not deducting for deposits collected or discounts provided, and excluding warehouse depreciation.

Selling, General and Administrative Expenses

SG&A expenses are comprised of both store-related expenses and corporate expenses. Store-related expenses include commissions paid to IOs, occupancy and shared maintenance costs, Company-operated store

 

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expenses, including payroll, benefits, supplies and utilities and the cost of opening new IO stores. Corporate expenses include payroll and benefits for corporate and field support, marketing and advertising, insurance and professional services and AOT recruiting and training costs. SG&A generally increases as we grow our store base and invest in corporate infrastructure. SG&A expenses related to commissions paid to IOs are variable in nature and generally increase as gross profits rise. The remainder of our expenses are primarily fixed in nature. We continue to closely manage our expenses and monitor SG&A as a percentage of sales.

The components of our SG&A may not be comparable to the components of similar measures of other retailers. We expect that our SG&A will continue to increase in future periods as we grow.

Operating Income

Operating income is gross profit less SG&A, depreciation and amortization and stock-based compensation. Operating income excludes interest expense, net, debt extinguishment and modification costs and income tax expense. We use operating income as an indicator of the productivity of our business and our ability to manage expenses.

EBITDA, Adjusted EBITDA and Adjusted Net Income

EBITDA, adjusted EBITDA and adjusted net income are key metrics used by management and our board of directors to assess our financial performance. EBITDA, adjusted EBITDA and adjusted net income are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use EBITDA, adjusted EBITDA and adjusted net income 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 EBITDA to supplement GAAP measures of performance to evaluate our performance in connection with compensation decisions. Management believes it is useful to investors and analysts to evaluate these non-GAAP measures on the same basis as management uses to evaluate our operating results. We believe that excluding items from operating income, net income and net income per diluted share that may not be indicative of, or are unrelated to, our core operating results, and that may vary in frequency or magnitude, enhances the comparability of our results and provides a better baseline 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 stock-based compensation expense, purchase accounting inventory adjustments, debt extinguishment and modification costs, non-cash rent, asset impairment and gain or loss on disposition, new store pre-opening expenses, dead rent for acquired leases, provision for accounts receivable reserves and other expenses. Adjusted net income represents net income adjusted for the previously mentioned EBITDA adjustments, further adjusted for costs related to amortization of purchase accounting assets and deferred financing costs and tax effect of total adjustments. EBITDA, adjusted EBITDA and adjusted net income are non-GAAP measures and may not be comparable to similar measures reported by other companies. EBITDA, adjusted EBITDA and adjusted net income 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 may incur expenses or charges such as those added back to calculate adjusted EBITDA or adjusted net income. Our presentation of adjusted EBITDA and adjusted net income should not be construed as an inference that our future results will be unaffected by these items. For further discussion of EBITDA, adjusted EBITDA and adjusted net income and for reconciliations of EBITDA, adjusted EBITDA and adjusted net income to net income, the most directly comparable GAAP measure, see “—Results of Operations.”

Other Return Metrics

Cash-on-cash return is a supplemental measure of operating performance that is neither required by nor presented in accordance with GAAP and our calculations thereof may not be comparable to those presented by

 

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other companies. We present this measure as we believe it is frequently used by securities analysts, investors and other interested parties to evaluate companies in our industry and we use it internally as a benchmark to compare our performance to that of our competitors. We define cash-on-cash returns for a given store for a given period as the EBITDA generated solely by such store for that period divided by the total initial net cash investment for that store.

Factors Affecting the Comparability of our Results of Operations

Our results over the past three years have been affected by the following events, which must be understood in order to assess the comparability of our period-to-period financial performance and condition.

Store Openings and Closings

In the first half 2018, we opened seven stores and in the first half 2019 we opened 16 stores. We opened 29 new stores in each of fiscal years 2016 and 2017 and opened 26 new stores in fiscal year 2018. All of the stores we opened in the first half of 2018 and 2019 and in the fiscal years 2016, 2017 and 2018 are operated by IOs. In the first half 2018, we closed no stores and in the first half 2019 we closed two stores both of which were at the end of their respective lease terms. We closed one store in each of fiscal years 2016 and 2017 and closed three stores in fiscal year 2018. Those store closures included two Company-operated stores closed at the end of their lease terms, one Company-operated store closed due to landlord site redevelopment, one IO store destroyed by wildfire and one IO store closed at the end of its lease term. In fiscal 2019, we expect to open 32 new stores and close three stores.

Financing Transactions and Payments to Stockholders

On October 22, 2018, we entered into our first lien credit agreement (the “First Lien Credit Agreement”), which included a term loan facility in an amount equal to $725.0 million and a revolving credit facility in an amount equal to $100.0 million and our second lien credit agreement (our “Second Lien Credit Agreement”) in an amount equal to $150.0 million, refinancing the existing first lien credit facility and the existing second lien credit facility (together the “Existing Credit Facilities”). The proceeds from the First Lien Credit Agreement and Second Lien Credit Agreement were used to repay the amounts outstanding under the Existing Credit Facilities in an aggregate amount of $724.5 million, pay an aggregate cash dividend of $152.2 million to holders of our common stock, and pay bank fees and related transaction expenses of $10.0 million (the “2018 Recapitalization”).

On June 23, 2016, we increased the aggregate principal of our first lien credit agreement by $90.0 million. This increase was used to pay an aggregate cash dividend of $86.5 million to holders of our common stock (the “2016 Recapitalization”).

On June 24, 2019, we completed our initial public offering in which we sold 19,765,625 shares of our common stock, including 2,578,125 shares from the full exercise of the underwriters’ option to purchase additional shares, at a public offering price of $22.0 per share. We received net proceeds of $407.7 million after deducting underwriting discounts and commissions of $27.1 million.

The terms of our First Lien Credit Agreement and Second Lien Credit Agreement permit voluntarily prepayment without premium or penalty subject to certain conditions. In connection with the closing of our initial public offering on June 24, 2019, using the net proceeds from the offering together with our excess cash on hand, we repaid in full the $150.0 million outstanding principal amount under the Second Lien Credit Agreement plus $3.6 million accrued and unpaid interest and terminated the Second Lien Credit Agreement. In addition, we prepaid a portion of the amounts outstanding under the First Lien Credit Agreement totaling $248.0 million principal amount plus interest of $3.8 million. We elected to apply the prepayment against the remaining principal installments in the direct order of maturity. No further principal payment on this term loan will be due until its maturity in October 2025.

On July 23, 2019, we entered into an incremental agreement (the “Incremental Agreement”) to amend the First Lien Credit Agreement. The Incremental Agreement refinanced the term loan outstanding under the

 

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First Lien Credit Agreement with a replacement $475.2 million senior secured term loan credit facility with an applicable margin of 3.25% or 3.50% for Eurodollar loans and 2.25% or 2.50% for base rate loans, in each case depending on the public corporate family rating of GOBP Holdings, Inc. This new term loan matures on October 22, 2025, which is the same maturity date of the existing First Lien Credit Agreement.

The 2014 H&F Acquisition

As a result of the 2014 H&F Acquisition, we recorded certain fair value adjustments related to acquired assets and liabilities in accordance with Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. These fair value adjustments included an increase in the carrying value of inventory, an increase in the depreciable carrying values of property and equipment, an increase in the carrying values of amortizing intangible assets, including trademarks, customer lists and below market leases, and goodwill. These fair value adjustments, except for goodwill, are amortized and expensed in our consolidated statements of operations based on the estimated useful lives of the related assets.

Depreciation and Amortization Expenses

Depreciation and amortization (exclusive of depreciation included in cost of sales) primarily consists of depreciation and amortization for buildings, store leasehold improvements and equipment. Property and equipment are stated at original cost less accumulated depreciation and amortization. Depreciation and amortization are calculated over the estimated useful lives of the related assets, or in the case of leasehold improvements, the lesser of the useful lives or the remaining term of the lease. Expenditures for additions, renewals and betterments are capitalized; expenditures for maintenance and repairs are expensed as incurred. Depreciation is computed on the straight-line method for financial reporting purposes.

In addition to depreciation and amortization incurred in the normal course of business, we also expense depreciation and amortization resulting from the various purchase accounting adjustments described above in “—The 2014 H&F Acquisition” as well as our subsequent financing transactions which totaled $7.8 million in the first half of 2019 and $8.5 million in the first half of 2018. For the first half 2019, this amount included approximately $2.8 million of fixed asset depreciation related to the fair market value of assets, $1.3 million of amortization of debt issuance costs, $2.0 million of amortization of trademarks and $1.7 million of amortization of below market leases. For the first half 2018, this amount included approximately $2.8 million of fixed asset depreciation related to the fair market value of assets, $2.2 million of amortization of debt issuance costs, $2.0 million of amortization of trademarks and $1.5 million of amortization of below market leases.

Stock-based Compensation Expenses

We recognize stock-based compensation expense related to restricted stock units (“RSUs”) held by directors. Prior to our initial public offering, we had not recognized stock-based compensation expense related to time-based or performance-based options as a change in control event or initial public offering is not deemed probable until such event occurs, and, until such an event occurs our time-based and performance-based options are subject to a post-termination repurchase right by us, and as a result, other than in limited circumstances, stock issued upon the exercise of the option could be repurchased at our discretion. This repurchase feature resulted in no compensation expense being recognized in connection with options granted by us until such time as the exercise of the options could occur without our repurchase of the shares (that is, on or after a liquidity event, such as a change in control or an initial public offering of shares of our common stock). Upon the consummation of our initial public offering in June 2019, the repurchase feature lapsed, and we accordingly began to recognize compensation expense with respect to outstanding option awards. We also recognize stock-based compensation expense for compensatory payments related to vested options such as the dividend payments related to the 2016 Recapitalization and 2018 Recapitalization.

 

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Results of Operations

The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of our sales.

We derived the consolidated statements of income for the fiscal years 2016, 2017 and 2018 and the 26 weeks ended June 30, 2018 and June 29, 2019 from our consolidated financial statements and related notes. Our historical results are not necessarily indicative of the results that may be expected in the future.

 

    

Fiscal
Year 2016

   

Fiscal
Year 2017

   

Fiscal
Year 2018

   

26 Weeks

Ended
June 30, 2018

   

26 Weeks

Ended
June 29, 2019

 
     (dollars in thousands)  

Net sales

   $ 1,831,531     $ 2,075,465     $ 2,287,660     $ 1,125,616     $ 1,251,560  

Cost of sales

     1,270,354       1,443,582       1,592,263       781,932       865,823  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     561,177       631,883       695,397       343,684       385,737  

Operating expenses:

          

Selling, general and administrative expenses

     457,051       510,136       557,100       276,479       310,495  

Depreciation and amortization expenses

     37,152       43,152       45,421       22,413       24,890  

Stock-based compensation

     2,905       1,659       10,409       263       22,961  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     497,108       554,947       612,930       299,155       358,346  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     64,069       76,936       82,467       44,529       27,391  

Other expense:

          

Interest expense, net

     47,147       49,698       55,362       26,886       31,890  

Debt extinguishment and modification costs

     —         1,466       5,253       —         5,162  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     47,147       51,164       60,615       26,886       37,052  

Income (loss) before income taxes

     16,922       25,772       21,852       17,643       (9,661

Income tax expense (benefit)

     6,724       5,171       5,984       4,832       (2,803
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of sales (1):

          

Net sales

     100.0     100.0     100.0     100.0     100.0

Cost of sales

     69.4     69.6     69.6     69.5     69.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

     30.6     30.4     30.4     30.5     30.8

Selling, general and administrative expenses

     25.0     24.6     24.4     24.6     24.8

Depreciation and amortization expenses

     2.0     2.1     2.0     2.0     2.0

Stock-based compensation

     0.2     0.1     0.5     0.0     1.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     27.1     26.7     26.8     26.6     28.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     3.5     3.7     3.6     4.0     2.2

Interest expense, net

     2.6     2.4     2.4     2.4     2.5

Debt extinguishment and modification costs

     0.0     0.1     0.2     0.0     0.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     2.6     2.5     2.6     2.4     3.0

Income (loss) before income taxes

     0.9     1.2     1.0     1.6     (0.8 )% 

Income tax expense (benefit)

     0.4     0.2     0.3     0.4     (0.2 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     0.6     1.0     0.7     1.1     (0.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Fiscal
Year 2016

   

Fiscal
Year 2017

   

Fiscal
Year 2018

   

26 Weeks

Ended
June 30, 2018

   

26 Weeks

Ended
June 29, 2019

 
     (dollars in thousands)  

Other Financial and Operations Data:

          

Number of new stores

     29       29       26       7       16  

Number of stores open at end of period

     265       293       316       300       330  

Comparable store sales growth (2)

     3.6     5.3     3.9     3.5     5.0

EBITDA (3)

   $ 101,221     $ 118,622     $ 124,271     $ 67,726     $ 48,234  

Adjusted EBITDA (3)

   $ 123,415     $ 136,319     $ 153,578     $ 75,234     $ 84,130  

Adjusted net income (3)

   $ 33,765     $ 48,655     $ 49,308     $ 24,448     $ 24,407  

 

(1)

Components may not add to totals due to rounding.

(2)

Comparable store sales consist of 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. See “—Comparable Store Sales.”

(3)

The following table provides a reconciliation from our net income to EBITDA and adjusted EBITDA and our net income to adjusted net income for the fiscal years 2016, 2017 and 2018 and the 26 weeks ended June 30, 2018 and June 29, 2019.

 

    

Fiscal
Year 2016

    

Fiscal
Year 2017

    

Fiscal
Year 2018

    

26 Weeks
Ended
June 30, 2018

   

26 Weeks
Ended
June 29, 2019

 
     (in thousands)  

Net income (loss)

   $ 10,198      $ 20,601      $ 15,868      $ 12,811     $ (6,858

Interest expense, net

     47,147        49,698        55,362        26,886       31,890  

Income tax expense (benefit)

     6,724        5,171        5,984        4,832       (2,803

Depreciation and amortization expenses

     37,152        43,152        47,057        23,197       26,005  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

EBITDA

     101,221        118,622        124,271        67,726       48,234  

Stock-based compensation expenses (a)

     2,905        1,659        10,409        263       22,961  

Debt extinguishment and modification costs (b)

     —          1,466        5,253        —         5,162  

Non-cash rent (c)

     8,451        8,401        7,903        3,523       3,678  

Asset impairment and gain or loss on disposition (d)

     519        549        1,306        (28     415  

New store pre-opening expenses (e)

     2,580        1,807        1,555        701       742  

Rent for acquired leases (f)

     2,388        72        —          —         —    

Provision for accounts receivable reserves (g)

     4,018        3,004        749        2,348       2,064  

Other (h)

     1,333        739        2,132        701       874  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted EBITDA

   $ 123,415      $ 136,319      $ 153,578      $ 75,234     $ 84,130  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Fiscal
Year 2016

   

Fiscal
Year 2017

   

Fiscal
Year 2018

   

26 Weeks
Ended
June 30, 2018

   

26 Weeks
Ended
June 29, 2019

 
     (in thousands)  

Net income (loss)

   $ 10,198     $ 20,601     $ 15,868     $ 12,811     $ (6,858

Stock-based compensation expenses (a)

     2,905       1,659       10,409       263       22,961  

Debt extinguishment and modification
costs (b)

     —         1,466       5,253       —         5,162  

Non-cash rent (c)

     8,451       8,401       7,903       3,523       3,678  

Asset impairment and gain or loss on disposition (d)

     519       549       1,306       (28     415  

New store pre-opening expenses (e)

     2,580       1,807       1,555       701       742  

Rent for acquired leases (f)

     2,388       72       —         —         —    

Provision for accounts receivable reserve (g)

     4,018       3,004       749       2,348       2,064  

Other (h)

     1,333       739       2,132       701       874  

Amortization of purchase accounting assets and deferred financing costs (i)

     16,914       17,399       16,744       8,517       7,751  

Tax effect of total adjustments (j)

     (15,541     (7,042     (12,611     (4,388     (12,382
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

   $ 33,765     $ 48,655     $ 49,308     $ 24,448     $ 24,407  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a)

Represents non-cash stock compensation expense of $0.3 million in 2016, $0.4 million in each of 2017 and 2018, $0.2 million in the 26 weeks ended June 30, 2018 and $22.7 million in the 26 weeks ended June 29, 2019, with the remainder representing dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2016 Recapitalization and our 2018 Recapitalization. We expect to pay an additional $4.2 million in the aggregate on options as they vest in respect of such dividends, of which $3.4 million is expected to be paid in the remainder of fiscal year 2019.

  (b)

Represents debt extinguishment and modification costs related to the write-off of debt issuance costs and non-capitalizable expenses related to the repricing of our first and second lien credit facilities in June 2017, the modification of our first and second lien credit facilities in connection with our 2018 Recapitalization and the extinguishment of our Second Lien Credit Agreement in June 2019.

  (c)

Consists of the non-cash portion of rent expense, which reflects the extent to which our straight-line rent expense recognized under GAAP exceeds or is less than our cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant growth in recent years.

  (d)

Represents impairment charges with respect to planned store closures and gains or losses on dispositions of assets in connection with store transitions to new IOs.

  (e)

Includes marketing, occupancy and other expenses incurred in connection with store grand openings, including costs that will be the IO’s responsibility after store opening.

  (f)

Represents cash occupancy expenses on leases acquired from Fresh & Easy Inc. in 2015 for the periods prior to opening new stores on such sites (commonly referred to as “dead rent”).

  (g)

Represents non-cash changes in reserves related to our IO notes and accounts receivable.

  (h)

Other non-recurring, non-cash or discrete items as determined by management, including personnel-related costs, strategic project costs, legal expenses, transaction related costs, costs associated with closed stores and miscellaneous costs.

  (i)

Represents amortization of debt issuance costs and incremental amortization of an asset step-up resulting from purchase price accounting related to the 2014 H&F Acquisition which included trademarks, customer lists and below-market leases.

  (j)

Represents the tax effect of the total adjustments at our estimated effective tax rate.

 

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The 26 Weeks Ended June 29, 2019 Compared to the 26 Weeks Ended June 30, 2018

Sales

Sales increased to $1.3 billion for the 26 weeks ended June 29, 2019 from $1.1 billion for the 26 weeks ended June 30, 2018, an increase of $125.9 million or 11.2%. The increase was the result of non-comparable store sales growth attributable to the net 30 stores opened over the last 12 months as well as an increase in comparable store sales.

Comparable store sales growth increased to 5.0% for the first half 2019 from 3.5% for the first half 2018. Comparable store sales in the first half 2019 were driven by a strong product offering, the expansion of our digital marketing initiatives and continued growth of our NOSH business. Additionally, we benefited modestly from the later Easter in 2019 compared to 2018.

Cost of Sales

Cost of sales increased $83.9 million for the 26 weeks ended June 29, 2019 to $865.8 million, or 69.2% of sales, from $781.9 million, or 69.5% of sales, for the 26 weeks ended June 30, 2018. The increase in cost of sales was primarily the result of new store growth and an increase in comparable store sales. Costs as a percentage of sales decreased slightly due to strong purchasing and inventory management.

Gross Profit and Gross Margin

Gross profit increased to $385.7 million for the 26 weeks ended June 29, 2019 from $343.7 million for the 26 weeks ended June 30, 2018, an increase of $42.1 million, or 12.2%. The increase in gross profit was primarily the result of new store growth and an increase in comparable store sales. Our gross margin increased modestly to 30.8% for the 26 weeks ended June 29, 2019 from 30.5% for the 26 weeks ended June 30, 2018.

Selling, General and Administrative Expenses

SG&A increased to $310.5 million for the 26 weeks ended June 29, 2019 from $276.5 million for the 26 weeks ended June 30, 2018, an increase of $34.0 million, or 12.3%. The increase in SG&A was primarily driven by increased selling expenses related to new store growth and higher sales volume. These increased expenses consisted primarily of commissions, store occupancy and shared maintenance costs, as well as investments in general and administrative infrastructure to support continued growth in the business. As a percentage of sales, SG&A increased modestly to 24.8% for the 26 weeks ended June 29, 2019 compared to 24.6% for the 26 weeks ended June 30, 2018.

Depreciation and Amortization Expense

Depreciation and amortization expenses (exclusive of depreciation included in cost of sales) increased to $24.9 million for the 26 weeks ended June 29, 2019 from $22.4 million for the 26 weeks ended June 30, 2018, an increase of $2.5 million, or 11.1%. The increase is primarily driven by new store growth and other capital investments.

Stock-based Compensation

Stock-based compensation increased to $23.0 million for the 26 weeks ended June 29, 2019 from $0.3 million for the 26 weeks ended June 30, 2018, an increase of $22.7 million. The increase was primarily driven by the $22.4 million stock-based compensation expense related to time-based options granted prior to our initial public offering. For more information see Note 6 to our audited consolidated financial statements included elsewhere in this prospectus.

 

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Interest Expense, net

Interest expense, net, increased to $31.9 million for the 26 weeks ended June 29, 2019 from $26.9 million for the 26 weeks ended June 30, 2018, an increase of $5.0 million or 18.6%. The increase in the 26 weeks ended June 29, 2019 was primarily driven by higher total borrowings under our First Lien Credit Agreement.

In connection with the closing of our initial public offering on June 24, 2019, we repaid in full the $150.0 million outstanding principal amount on our Second Lien Credit Agreement and terminated the Second Lien Credit Agreement. Additionally, we prepaid a portion of our term loan outstanding under the First Lien Credit Agreement totaling $248.0 million principal amount. In July 2019, we repriced and amended our existing First Lien Credit Agreement by replacing the existing term loan with a new $475.2 million senior secured term loan credit facility. As part of this repricing transaction, we reduced the applicable margin rates on the new term loan. See Note 5 to the unaudited condensed consolidated financial statements for additional information. Accordingly, we expect our interest expense to decrease in the remainder of fiscal 2019 compared to fiscal 2018.

Debt Extinguishment and Modification Costs

We repaid in full the $150.0 million outstanding principal amount on our Second Lien Credit Agreement and terminated the Second Lien Credit Agreement in the second quarter 2019 as described above. Accordingly, we recorded debt extinguishment costs in the first half of 2019 to reflect the write off of our debt issuance costs of $3.8 million and loan discounts of $1.4 million. See Note 5 to the unaudited condensed consolidated financial statements for more information.

Income Tax Expense

Income tax benefit increased to $2.8 million for the 26 weeks ended June 29, 2019 from an income tax expense of $4.8 million for the 26 weeks ended June 30, 2018, an increase of $7.6 million, or 158.5%. This increase in income tax benefit was primarily the result of the net loss before taxes, which was mainly due to the stock-based compensation expense of $22.8 million we recognized in the second quarter 2019 in connection with our initial public offering as discussed above.

Net Income (Loss)

As a result of the foregoing, we recorded a net loss of $6.9 million for the 26 weeks ended June 29, 2019, compared to net income of $12.8 million for the 26 weeks ended June 30, 2018, a decrease of $19.7 million, or 153.5%.

Adjusted EBITDA

Adjusted EBITDA increased to $84.1 million for the 26 weeks ended June 29, 2019 from $75.2 million for the 26 weeks ended June 30, 2018, an increase of $8.9 million, or 11.8%. The increase in adjusted EBITDA for the 26 weeks ended June 29, 2019 is primarily due to our increase in sales, which was primarily driven by the increase in quarter-end store count compared to the 26 weeks ended June 30, 2018 and the increase in comparable sales to 5.0%. Additionally, our gross margin increased modestly for the 26 weeks ended June 29, 2019 compared to the 26 weeks ended June 30, 2018 as discussed above.

Adjusted Net Income

Adjusted net income remained relatively flat at $24.4 million for the 26 weeks ended June 29, 2019 and the 26 weeks ended June 30, 2018.

 

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Fiscal Year 2018 Compared to Fiscal Year 2017

Sales

Sales increased to $2.3 billion for 2018 from $2.1 billion for 2017, an increase of $212.2 million or 10.2%. The increase was the result of comparable store sales increase of 3.9% and non-comparable store sales at stores that have not been open for a full 13 fiscal months.

Comparable store sales increased 3.9% for 2018. Comparable store sales in 2018 were driven by increases in both the average transaction size and number of customer transactions. Comparable store sales growth was driven by strong opportunistic purchasing, the expansion of our digital marketing initiatives and the continued growth of our NOSH business.

Cost of Sales

Cost of sales increased $148.7 million in 2018 to $1.6 billion, or 69.6% of sales, from $1.4 billion, or 69.6% of sales, for 2017. The increase in cost of sales was primarily the result of new store growth and an increase in comparable store sales. Costs as a percentage of sales remained flat.

Gross Profit and Gross Margin

Gross profit increased to $695.4 million for 2018 from $631.9 million for 2017, an increase of $63.5 million, or 10.0%. The increase in gross profit was primarily the result of new store growth and an increase in comparable store sales. Our gross margin remained flat at 30.4% for 2018 and 2017, respectively.

Selling, General and Administrative Expenses

SG&A increased to $557.1 million for 2018 from $510.1 million for 2017, an increase of $47.0 million, or 9.2%. The increase in SG&A was primarily driven by increased selling expenses related to new store growth and higher sales volume. These increased expenses consisted primarily of commissions, store occupancy and shared maintenance costs, as well as investments in general and administration infrastructure to support continued growth in the business. As a percentage of sales, SG&A improved to 24.4% for 2018 compared to 24.6% for 2017. This improvement was driven partially by a decrease in the provision for IO notes and receivables. The provision decreased in 2018 compared to 2017 due to a combination of improved store performance and operational efficiencies which have helped mitigate rising costs for IOs, improving the collectability of IO notes and receivables. As a percentage of total IO notes and receivables, our 2018 reserve was 32.7%. However, IOs manage their own finances and their financial acumen and expense management practices vary significantly. As we do not control the management decisions in the stores, and as IOs implement a variety of practices with variability in their individual and collective outcomes, we experience variability in the provision and allowance over time as we assess the ability of each IO to repay the notes.

Depreciation and Amortization Expense

Depreciation and amortization expenses (exclusive of depreciation included in cost of sales) increased to $45.4 million for 2018 from $43.2 million for 2017, an increase of $2.3 million, or 5.3%. The increase is primarily a result of new store growth and other capital investments.

Stock-based Compensation

Stock-based compensation increased to $10.4 million for 2018 from $1.7 million for 2017, an increase of $8.7 million. The increase is a result of dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2018 Recapitalization and 2016 Recapitalization.

 

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Interest Expense, net

Interest expense, net, increased to $55.4 million for 2018 from $49.7 million for 2017, an increase of $5.7 million or 11.4%. The increase in 2018 was driven by rising interest rates and an increase of $150.0 million in our total debt related to the 2018 Recapitalization.

Debt Extinguishment and Modification Costs

Debt extinguishment and modification costs increased to $5.3 million for 2018 from $1.5 million for 2017, an increase of $3.8 million or 258.3%. The increase in 2018 was driven by the write-off of debt issuance costs and non-capitalizable modification costs related to the 2018 Recapitalization.

Income Tax Expense

Income tax expense increased to $6.0 million for 2018 from $5.2 million for 2017, an increase of $0.8 million, or 15.7%. This increase in income tax expense was the result of an increase in our effective tax rate, which was due to a $5.4 million provisional tax benefit recorded in the 2017 fiscal year pursuant to the provisions of the 2017 Tax Act. As a result, our effective tax rate increased to 27.4% for 2018 from 20.1% for 2017. The effective tax rate increase was partially offset by a $3.9 million decrease in income before taxes. The 2017 Tax Act was enacted on December 22, 2017 and among other things, decreased the existing maximum federal corporate income tax rate from 35% to 21%. The provisional tax benefit of $5.4 million recorded in the previous fiscal year was primarily due to the net impact of the revaluation of net deferred tax liability balances at fiscal year-end.

Net Income

As a result of the foregoing, net income decreased to $15.9 million for 2018 from $20.6 million for 2017, a decrease of $4.7 million, or 23.0%.

Adjusted EBITDA

Adjusted EBITDA increased to $153.6 million for 2018 from $136.3 million for 2017, an increase of $17.3 million, or 12.7%. The increase in adjusted EBITDA for 2018 is due primarily to our increase in sales, which was driven by a 3.9% increase in comparable store sales and an increase in year-end store count compared to 2017 of 23 stores.

Adjusted Net Income

Adjusted net income increased to $49.3 million for 2018 from $48.7 million for 2017, an increase of $0.6 million, or 1.3%. The increase in adjusted net income for 2018 is due primarily to our increase in sales, which was driven by a 3.9% increase in comparable store sales and an increase in year-end store count compared to 2017 of 23 stores.

Fiscal Year 2017 Compared to Fiscal Year 2016

Sales

Sales increased to $2.1 billion for 2017 from $1.8 billion for 2016, an increase of $243.9 million, or 13.3%. The increase was the result of comparable store sales increase of 5.3% and non-comparable store sales at stores that have not been open for a full 13 fiscal months.

 

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Comparable store sales increased 5.3% for 2017. Comparable store sales in 2017 were driven by increases in both the average transaction size, in part due to food-at-home inflation, as well as the number of customer transactions. Comparable store sales growth was driven by continued customer excitement in response to our “WOW!” deals and the ongoing growth of fresh and healthy products.

Cost of Sales

Cost of sales increased $173.2 million in 2017 to $1.4 billion, or 69.6% of sales, from $1.3 billion, or 69.4% of sales, for 2016. The increase as a percentage of sales of 0.2% was primarily attributable to higher product costs which included the impact of inflation.

Gross Profit and Gross Margin

Gross profit increased to $631.9 million for 2017 from $561.2 million for 2016, an increase of $70.7 million, or 12.6%. The increase in gross profit was primarily the result of new store growth and increases in comparable store sales. Our gross margin decreased to 30.4% from 30.6% for 2017 and 2016, respectively. The modest gross margin decline in 2017 is due to slightly decreasing merchandise margins which were impacted by inflation.

Selling, General and Administrative Expenses

SG&A increased to $510.1 million for 2017 from $457.1 million for 2016, an increase of $53.1 million, or 11.6%. As a percentage of sales, SG&A improved to 24.6% for 2017 compared to 25.0% for 2016. These increased expenses consisted primarily of commissions, store occupancy and shared maintenance costs, as well as investments in general and administration infrastructure to support continued growth in the business.

Depreciation and Amortization Expense

Depreciation and amortization expenses increased to $43.2 million for 2017 from $37.2 million for 2016, an increase of $6.0 million, or 16.1%. The increase is primarily a result of new store growth.

Stock-based Compensation

Stock-based compensation decreased to $1.7 million for 2017 from $2.9 million for 2016, a decrease of $1.2 million. The decrease is a result of dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2016 Recapitalization.

Interest Expense, net

Interest expense, net, increased to $49.7 million for 2017 from $47.1 million for 2016, an increase of $2.6 million or 5.4%. The increase is primarily the result of rising interest rates and the full year impact of the $90.0 million increase to our first lien credit facility related to our 2016 Recapitalization.

Debt Extinguishment and Modification Costs

Loss on extinguishment of debt increased to $1.5 million for 2017 from zero for 2016. The 2017 expenses were a write-off of debt issuance costs related to the repricing of our first and second lien credit facilities in June 2017.

Income Tax Expense

Income tax expense decreased to $5.2 million for 2017 from $6.7 million for 2016, a decrease of $1.6 million, or 23.1%. The decrease in income tax expense was primarily the result of the 2017 Tax Act,

 

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partially offset by the $8.9 million increase in pre-tax net income. Pursuant to the provisions of the 2017 Tax Act, we recorded a provisional tax benefit of $5.4 million primarily due to the net impact of the revaluation of net deferred tax liability balances at fiscal year-end. As a result, our effective tax rate decreased to 20.1% for 2017 from 39.7% for 2016.

Net Income

As a result of the foregoing, net income increased to $20.6 million for 2017 from $10.2 million for 2016, an increase of $10.4 million, or 102.0%.

Adjusted EBITDA

Adjusted EBITDA increased to $136.3 million for 2017 from $123.4 million for 2016, an increase of $12.9 million, or 10.5%. The increase in adjusted EBITDA for 2017 is due primarily to our increase in sales, which was driven by a 5.3% increase in comparable store sales and an increase in store count over 2016 of 28 stores.

Adjusted Net Income

Adjusted net income increased to $48.7 million for 2017 from $33.8 million for 2016, an increase of $14.9 million, or 44.1%. The increase in adjusted net income for 2017 is due to our increase in sales, which was driven by a 5.3% increase in comparable store sales and an increase in store count over 2016 of 28 stores, as well as a reduction in our effective tax rate.

Quarterly Results of Operations

The following table sets forth certain financial and operating information for each of our last eight fiscal quarters. The quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the information presented. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this prospectus. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year.

 

    

Third
Quarter
2017

   

Fourth
Quarter
2017

   

First
Quarter
2018

   

Second
Quarter
2018

   

Third
Quarter
2018

   

Fourth
Quarter
2018

   

First
Quarter
2019

   

Second
Quarter
2019

 
     (unaudited)
(dollars in thousands)
 

Selected Statements of Operations Data:

                

Net sales

   $ 525,406     $ 533,987     $ 550,558     $ 575,058     $ 576,843     $ 585,201     $ 606,271     $ 645,289  

Gross profit

     158,905       160,514       168,569       175,115       175,548       176,165       187,017       198,720  

Income from operations

     20,531       16,811       20,521       24,007       24,088       13,851       21,656       5,735  

Net income (loss) (1)

     4,842       7,999       5,525       7,286       7,669       (4,612     3,774       (10,632

Selected Other Financial and Operations Data:

                

Number of new stores

     3       11       3       4       8       11       8       8  

Number of stores open at end of period

     282       293       296       300       307       316       323       330  

Comparable store sales growth

     5.3     5.1     4.5     2.7     4.2     4.1     4.2     5.8

Gross margin

     30.2     30.1     30.6     30.5     30.4     30.1     30.8     30.8

EBITDA (2)

   $ 31,758     $ 27,692     $ 32,056     $ 35,670     $ 35,990     $ 20,555     $ 34,505     $ 13,729  

Adjusted EBITDA (2)

   $ 34,600     $ 33,842     $ 36,112     $ 39,122     $ 39,026     $ 39,318     $ 39,123     $ 45,007  

 

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(1)

The increase to net income in fourth quarter 2017 is primarily the result of the 2017 Tax Act. The reduction in income from operations in fourth quarter 2018 is primarily related to stock-based compensation associated with the 2018 Recapitalization. The reduction in net income in fourth quarter 2018 is primarily related to stock-based compensation and debt extinguishment and modification costs associated with the 2018 Recapitalization. The reduction in income from operations and net income in second quarter 2019 is primarily related to stock-based compensation associated with the initial public offering and debt extinguishment and modification costs associated with the extinguishment of the Second Lien Credit Agreement.

(2)

The following table provides a reconciliation from our net income to EBITDA and adjusted EBITDA for each of our last nine fiscal quarters.

 

    

Third
Quarter
2017

   

Fourth
Quarter
2017

   

First
Quarter
2018

   

Second
Quarter
2018

    

Third
Quarter
2018

   

Fourth
Quarter
2018

   

First
Quarter
2019

    

Second
Quarter
2019

 
    

(unaudited)

(in thousands)

 

Net income (loss) (1)

   $ 4,842     $ 7,999     $ 5,525     $ 7,286      $ 7,669     $ (4,612   $ 3,774        (10,632

Interest expense, net

     12,261       12,469       12,912       13,974        13,526       14,950       16,438        15,452  

Income tax expense (benefit) (1)

     3,391       (3,656     2,084       2,748        2,892       (1,739     1,444        (4,247

Depreciation and amortization

     11,264       10,880       11,535       11,662        11,903       11,956       12,849        13,156  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

EBITDA

     31,758       27,692       32,056       35,670        35,990       20,555       34,505        13,729  

Stock-based compensation expenses (a)

     127       1,308       134       129        121       10,025       211        22,750  

Debt extinguishment and modification cost (b)

     37       —         —         —          —         5,253       —          5,162  

Non-cash rent (c)

     2,008       1,958       1,840       1,683        2,201       2,179       1,862        1,816  

Asset impairment and gain or loss on disposition (d)

     (177     661       (52     24        51       1,282       182        233  

New store pre-opening expenses (e)

     348       572       270       431        337       517       421        321  

Rent for acquired leases (f)

     —         —         —         —          —         —         —          —    

Provision for accounts receivable reserves (g)

     348       1,215       1,538       810        (106     (1,493     1,483        581  

Other (h)

     151       436       326       375        432       1,000       459        415  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Adjusted EBITDA

   $ 34,600     $ 33,842     $ 36,112     $ 39,122      $ 39,026     $ 39,318     $ 39,123      $ 45,007  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

 

  (1)

The increase to net income and the tax benefit recognized in fourth quarter 2017 is primarily the result of the 2017 Tax Act. The net loss recognized in fourth quarter 2018 and resulting tax benefit is related to stock-based compensation and debt extinguishment and modification costs associated with the 2018 Recapitalization. The net loss recognized in second quarter 2019 and resulting tax benefit is primarily related to stock-based compensation associated with the initial public offering and debt extinguishment and modification costs associated with the extinguishment of the Second Lien Credit Agreement.

  (a)

Represents non-cash stock compensation expense of approximately $0.1 million per quarter, except for second quarter 2019 in which we recognized $22.6 million of non-cash stock compensation expense primarily associated with the initial public offering. The remainder represents dividend cash payments made in respect of vested options as a result of dividends declared in connection with our 2016 Recapitalization and our 2018 Recapitalization. We expect to pay an additional $4.2 million in the aggregate on options as they vest in respect of such dividends, of which $3.4 million is expected to be paid in the remainder of fiscal year 2019.

  (b)

Represents debt extinguishment and modification costs related to the write-off of debt issuance costs and non-capitalizable expenses related to the repricing of first and second lien credit facilities in June 2017, the modification of our first and second lien credit facilities in connection with our 2018 Recapitalization and the extinguishment of our Second Lien Credit Agreement in second quarter 2019.

  (c)

Consists of the non-cash portion of rent expense, which reflects the extent to which our straight-line rent expense recognized under GAAP exceeds or is less than our cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant growth in recent years.

  (d)

Represents impairment charges with respect to planned store closures and gains or losses on dispositions of assets in connection with store transitions to new IOs.

  (e)

Includes marketing, occupancy and other expenses incurred in connection with store grand openings, including costs that will be the IO’s responsibility after store opening.

 

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  (f)

Represents cash occupancy expenses on leases acquired from Fresh & Easy Inc. in 2015 for the periods prior to opening new stores on such sites (commonly referred to as “dead rent”).

  (g)

Represents non-cash changes in reserves related to our IO notes and accounts receivable.

  (h)

Other non-recurring, non-cash or discrete items as determined by management, including personnel related costs, strategic project costs, legal expenses, transaction related costs, costs associated with closed stores and miscellaneous costs.

Liquidity and Capital Resources

Overview

Our primary sources of liquidity are net cash provided by operating activities and borrowings and availability under our First Lien Credit Agreement. Historically, we have funded our capital expenditures and working capital requirements with internally generated cash on hand and most recently through our initial public offering of our common stock in June 2019. We also have a $100.0 million revolving credit facility available under our First Lien Credit Agreement described below. Our primary cash needs are for capital expenditures, working capital and to meet debt service requirements. As of June 29, 2019, we did not have any outstanding borrowings under the revolving credit facility available under our First Lien Credit Agreement. As of such date we had outstanding letters of credit of $3.6 million under that revolving credit facility with $96.4 million available to be borrowed thereunder, and $18.7 million of cash and cash equivalents on hand.

On June 24, 2019, we completed our initial public offering in which we sold 19,765,625 shares of our common stock, including 2,578,125 shares from the full exercise of the underwriters’ option to purchase additional shares, at a public offering price of $22.0 per share. We received net proceeds of $407.7 million after deducting underwriting discounts and commissions of $27.1 million. We also incurred estimated offering costs payable by us of $7.2 million of which we had paid out a total of $5.1 million as of June 29, 2019. We expect to pay out the remainder of these estimated offering costs in the third fiscal quarter of 2019.

The terms of our First Lien Credit Agreement and Second Lien Credit Agreement permit voluntarily prepayment without premium or penalty subject to certain conditions. In connection with the closing of our initial public offering on June 24, 2019, using the net proceeds from the offering together with our excess cash on hand, we repaid in full the $150.0 million principal amount outstanding under the Second Lien Credit Agreement plus $3.6 million accrued and unpaid interest and terminated the Second Lien Credit Agreement. In addition, we prepaid a portion of the amounts outstanding under the First Lien Credit Agreement totaling $248.0 million principal amount plus interest of $3.8 million. We elected to apply the prepayment against the remaining principal installments in the direct order of maturity. No further principal payment on this term loan will be due until its maturity in October 2025.

On July 23, 2019, we entered into the Incremental Agreement to amend the First Lien Credit Agreement. The Incremental Agreement refinanced the term loan outstanding under the First Lien Credit Agreement with a replacement $475.2 million senior secured term loan credit facility with an applicable margin of 3.25% or 3.50% for Eurodollar loans and 2.25% or 2.50% for base rate loans, in each case depending on the public corporate family rating of GOBP Holdings, Inc. This new term loan matures on October 22, 2025, which is the same maturity date of the existing First Lien Credit Agreement.

On October 22, 2018, we used proceeds from the term loan under our First Lien Credit Agreement to pay an aggregate cash dividend of $152.2 million to holders of our common stock in connection with the 2018 Recapitalization. On June 23, 2016 we used proceeds from the existing first lien credit agreement to pay an aggregate cash dividend of $86.5 million to holders of our common stock in connection with the 2016 Recapitalization.

As of June 29, 2019, in connection with the 2018 Recapitalization and the 2016 Recapitalization, we expect to pay an additional $4.2 million in aggregate on options as they vest in respect of such dividends, of which $3.4 million is expected to be paid in the remainder of fiscal year 2019.

 

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Our capital expenditures are primarily related to new store openings, ongoing store maintenance and improvements, expenditures related to our distribution centers and infrastructure-related investments, including investments related to upgrading and maintaining our information technology systems and corporate offices. We spent $41.5 million in the first half of 2019 and $62.9 million, $74.1 million and $67.9 million for capital expenditures in 2016, 2017 and 2018, respectively. We expect to fund capital expenditures from net cash provided by operating activities.

Our primary working capital requirements are for the purchase of inventory, payroll, rent, issuance of IO notes, other store facilities costs, distribution costs and general and administrative costs. Our working capital requirements fluctuate during the year, driven primarily by the timing of opportunistic inventory purchases and new store openings.

The percentage of allowance on independent operator receivables and notes on the current and long-term portions are 16% and 37%, respectively. The current portion of IO notes and receivables is reserved for at a lower rate as the current portion is primarily comprised of operational payables which IOs typically prioritize over making loan payments based upon historical experience. The allowance is also based on an evaluation of overall credit quality, the estimated value of the underlying collateral and historical collections experience of stores with similar economic performance.

Based on our new store growth plans, we believe our cash and cash equivalents position, net cash provided by operating activities and availability under our First Lien Credit Agreement will be adequate to finance our planned capital expenditures, working capital requirements and debt service over the next 12 months. If cash provided by operating activities and borrowings under our First Lien Credit Agreement are not sufficient or available to meet our capital 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.

Summary of Cash Flows

A summary of our cash flows from operating, investing and financing activities is presented in the following table:

 

    

Fiscal
Year 2016

   

Fiscal
Year 2017

   

Fiscal
Year 2018

   

First
Half 2018

   

First
Half 2019

 
     (in thousands)  

Net cash provided by operating activities

   $ 70,875     $ 84,703     $ 105,811     $ 55,217     $ 39,718  

Net cash used in investing activities

     (65,416     (77,820     (73,550     (25,501     (44,523

Net cash provided by (used in) financing activities

     (4,328     (7,935     (16,999     (2,756     2,419  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ 1,131     $ (1,052   $ 15,262     $ 26,960     $ (2,386
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash Provided by Operating Activities

Net cash provided by operating activities for the first half of 2019 was $39.7 million, a decrease from $55.0 million for the same period of 2018. The decrease in net cash provided by operating activities was primarily driven by changes to working capital related to new store growth, partially offset by the increase in non-cash stock-based compensation and non-cash debt extinguishment costs. Upon the completion of our initial public offering, we incurred stock-based compensation expense of $22.4 million related to time-based options granted prior to our initial public offering. For more information see Note 6 to our audited consolidated financial statements included elsewhere in this prospectus. Additionally, we wrote off our debt issuance costs of $3.8 million and loan discounts of $1.4 million related to our repayment of our Second Lien Credit Agreement and the termination of the Second Lien Credit Agreement as described above.

 

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Net cash provided by operating activities for 2018 was $105.8 million, an increase from $84.7 million for 2017. The increase in net cash provided by operating activities was primarily the result of increased operating income, as adjusted for the impact of stock-based compensation related to the 2018 Recapitalization.

Net cash provided by operating activities for 2017 was $84.7 million, an increase from $70.9 million for 2016. The increase in net cash provided by operating activities was primarily the result of increased operating income.

Cash Used in Investing Activities

Net cash used in investing activities for the 26 weeks ended June 29, 2019 and for the same period of 2018 was primarily for capital expenditures and cash advanced to IOs. The increase in net cash used in investing activities of $19.0 million was primarily related to capital expenditures for 16 new store openings and one relocation in the first half of 2019 compared to seven new store openings in same period of 2018.

We plan to invest capital expenditures between $85.0 million and $90.0 million, net of tenant improvement allowances, in fiscal year 2019. We expect approximately 65% of our 2019 capital investment will be directed towards the opening of 32 new stores in the aggregate and one store relocation.

Net cash used in investing activities decreased for 2018 to $73.6 million from $77.8 million for 2017. The decrease in net cash used in investing activities relates to capital expenditures for 26 new store openings in 2018 compared to 29 new store openings in 2017, partially offset by a net increase in cash advances to IOs.

Net cash used in investing activities increased for 2017 to $77.8 million from $65.4 million for 2016, primarily relating to capital expenditures for new stores and a net increase in advances to IOs. We opened 29 stores in both years. Additional 2017 capital expenditures included investments in additional corporate office space, a new warehouse management system and upgraded point of sale technology.

Cash Used in Financing Activities

Net cash provided by financing activities was $2.4 million for the 26 weeks ended June 29, 2019 compared to net cash used in financing activities of $2.8 million for the same period of 2018. The increase was primarily driven by our debt repayments and offering cost payments, offset in part by the proceeds from our initial public offering, net of underwriting discounts and commissions paid. As described above, in June 2019, using the net proceeds from our initial public offering and excess cash on hand, we repaid in full the $150.0 million principal amount outstanding under the Second Lien Credit Agreement and prepaid a portion of the amount outstanding under our First Lien Credit Agreement totaling $248.0 million principal amount.

Net cash used in financing activities increased for 2018 to $17.0 million from $7.9 million for 2017. The increase in net cash used in 2018 is primarily the result of the net cash used to pay bank fees and transaction expenses related to the refinancing of our Existing Credit Facilities in connection with the 2018 Recapitalization.

Net cash used in financing activities increased for 2017 to $7.9 million from $4.3 million for 2016. The increase in net cash used in 2017 is primarily the result of cash provided in connection with the 2016 Recapitalization in order to fund future cash payments to be made in respect of options as they vest as a result of dividends declared in connection with our 2016 Recapitalization and our 2018 Recapitalization.

Credit Facilities

First Lien Credit Agreement

One of our subsidiaries, GOBP Holdings, Inc. (the “Borrower”), is party to the First Lien Credit Agreement which provided for a $725.0 million senior term loan and provides for commitments under a

 

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revolving credit facility in an aggregate principal amount of $100.0 million, with a sub-commitment for issuance of letters of credit of $35.0 million and a sub-commitment for $20.0 million of swingline loans. The First Lien Credit Agreement matures on October 22, 2025, with respect to the term loan thereunder, and October 23, 2023, with respect to the revolving credit facility thereunder.

The First Lien Credit Agreement permits voluntarily prepayment on borrowings without premium or penalty. In connection with the closing of our initial public offering on June 24, 2019, we prepaid $248.0 million of principal and $3.8 million of interest on June 24, 2019 and elected to apply the prepayment against the remaining principal installments in the direct order of maturity. No further principal payment on the term loan will be due until the maturity date of this term loan. The terms of the First Lien Credit Agreement include mandatory prepayment requirements on the term loan if certain conditions are met (as described further below and in the First Lien Credit Agreement).

On July 23, 2019, the Borrower together with another of our wholly-owned subsidiaries entered into the Incremental Agreement to amend the First Lien Credit Agreement. The Incremental Agreement refinanced the term loan outstanding under the First Lien Credit Agreement with a replacement $475.2 million senior secured term loan credit facility. This new term loan matures on October 22, 2025, which is the same maturity date as provided under our First Lien Credit Agreement.

Borrowings under the First Lien Credit Agreement, after giving effect to the Incremental Agreement, bear interest at a rate per annum equal to either (a) the Eurodollar rate, with a floor of 0.00%, as adjusted for the reserve percentage required under regulations issued by the Federal Reserve Board for determining maximum reserve requirements with respect to Eurocurrency funding, plus an applicable margin rate of between 3.25% and 3.50% for the term loan, depending on the public corporate family rating of the Borrower and between 3.25% and 3.75% for revolving credit loans, depending on the applicable first lien secured leverage ratio or (b) an ABR rate, with a floor of 0.00%, plus an applicable margin rate of between 2.25% and 2.50% for the term loan, depending on the public corporate family rating of the Borrower or between 2.25% and 2.75% for revolving credit loans, depending on the applicable first lien secured leverage ratio. The ABR rate is determined as the greater of (a) the prime rate, (b) the federal funds effective rate, plus 0.50% or (c) the Eurodollar rate plus 1.00%.

The First Lien Credit Agreement provides that the Borrower may request increased commitments and additional term loans or additional term or revolving facilities under the First Lien Credit Agreement, in each case, subject to certain conditions and in an aggregate principal amount not to exceed the sum of (a) the greater of (i) $160.0 million and (ii) 100% of Consolidated EBITDA (as defined in the First Lien Credit Agreement) for the most recently completed four fiscal quarter period for which internal financial statements are available and ended on or prior to the date of any such incurrence, plus (b) an additional amount, subject to compliance on a pro forma basis with (i) a consolidated first lien debt to Consolidated EBITDA ratio of no greater than 4.50 to 1.00 for incremental first lien debt or (ii) if incurred in connection with a permitted acquisition or other investment, the applicable ratio immediately prior to such acquisition or other investment plus certain other amounts as specified in the First Lien Credit Agreement. The First Lien Credit Agreement also provides for the incurrence of junior secured and unsecured debt, subject to certain conditions specified in the First Lien Credit Agreement.

The First Lien Credit Agreement requires the Borrower to prepay, subject to certain exceptions, outstanding term loan thereunder with:

 

   

50% (which percentage will be reduced to 25% and 0% based upon the achievement and maintenance of first lien secured leverage ratios equal to or less than 4.00 to 1.00 and 3.75 to 1.00, respectively) of our annual excess cash flow;

 

   

100% (which percentage will be reduced to 50% and 0% based upon the achievement and maintenance of first lien secured leverage ratios equal to or less than 4.00 to 1.00 and 3.75 to 1.00,

 

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respectively) of net cash proceeds of non-ordinary course asset sales or other dispositions of property, in excess of the amount permitted under the First Lien Credit Agreement; and

 

   

100% of net cash proceeds of certain issuances of debt obligations of the Borrower and its restricted subsidiaries after the closing date, except as permitted under the First Lien Credit Agreement.

There is no scheduled amortization under the revolving credit facility. The Borrower may voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans under the First Lien Credit Agreement at any time without premium or penalty. In the event of a repricing transaction closing prior to the six-month anniversary of the closing date, the Borrower shall pay a fee in an amount equal to 1.0% of either (x) the aggregate principal amount of the initial term loan prepaid in connection with a repricing transaction that includes the incurrence of any term loan or (y) the aggregate principal amount of all initial term loans outstanding on such date that are subject to an effective pricing reduction pursuant to a repricing transaction that effectively reduces the effective yield for the initial term loan (except for a reduction in connection with an initial public offering, change of control or other material permitted acquisition).

All obligations under the First Lien Credit Agreement and Second Lien Credit Agreement are unconditionally guaranteed by Globe Intermediate Corp. (“Holdings”), the Borrower and certain of the Borrower’s existing and future direct and indirect wholly-owned domestic subsidiaries, subject to certain exceptions. All obligations under the First Lien Credit Agreement, and the guarantees of those obligations, are secured on a first lien basis, subject to certain exceptions, by substantially all of Holdings’ and the Borrower’s assets and the assets of the other guarantors.

The First Lien Credit Agreement contains covenants that, among other things, limit our ability to incur additional debt; create liens against our assets; make acquisitions; pay dividends on our capital stock or redeem, repurchase or retire our capital stock; make investments, acquisitions, loans and advances; create negative pledges; and merge or consolidate with another entity and transfer or sell assets.

In addition, the revolving credit facility is subject to a first lien secured leverage ratio test of 7.00 to 1.00, tested quarterly if, and only if, on the last day of any fiscal quarter, the revolving facility, letters of credit (to the extent not cash collateralized or backstopped or, in the aggregate, not in excess of the greater of (x) $10.0 million and (y) the stated face amount of letters of credit of the Borrower and its subsidiaries outstanding on the closing date) and swingline loans are outstanding and/or issued, as applicable, in an aggregate principal amount exceed 35% of the total amount of the revolving credit facility commitments thereunder.

The First Lien Credit Agreement also contains certain customary representations and warranties, affirmative covenants and reporting obligations. In addition, the lenders under the First Lien Credit Agreement will be permitted to accelerate the loans and terminate commitments thereunder or exercise other specified remedies available to secured creditors upon the occurrence of certain events of default, subject to certain grace periods and exceptions, which include, among others, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain material indebtedness, certain events of bankruptcy and insolvency, certain pension plan related events, material judgments and any change of control.

As of June 29, 2019, we had $475.2 million of outstanding borrowing on the First Lien Credit Agreement, and no outstanding borrowings under the revolving credit facility, with $96.4 million of borrowing availability and outstanding letters of credit of $3.6 million under the First Lien Credit Agreement.

Second Lien Credit Agreement

The Borrower was party to a Second Lien Credit Agreement providing for a $150.0 million senior term loan. The term loan under the Second Lien Credit Agreement would have matured on October 22, 2026.

 

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The term loan under the Second Lien Credit Agreement did not require minimum quarterly principal payment. The Second Lien Credit Agreement did require mandatory prepayment if certain conditions were met and permitted voluntarily prepayment on borrowings without premium or penalty, subject to certain conditions.

On June 24, 2019, we terminated the Second Lien Credit Agreement and repaid in full the outstanding principal balance of $150.0 million and accrued interest of $3.6 million. Accordingly, we wrote off the remaining debt issuance costs of $3.8 million and loan discounts of $1.4 million on June 24, 2019.

Debt Covenant

The First Lien Credit Agreement and Second Lien Credit Agreement contain certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants. The First Lien Credit Agreement has the ability to restrict us from entering into certain types of transactions and making certain types of payments including dividends and stock repurchase and other similar distributions, with certain exceptions. Additionally, the revolving credit facility under our First Lien Credit Agreement is subject to a first lien secured leverage ratio of 7.00 to 1:00, tested quarterly if, and only if, the aggregate principal amount from the revolving facility, letters of credit (to the extent not cash collateralized or backstopped or, in the aggregate, not in excess of the greater of $10.0 million and the stated face amount of letters of credit outstanding on the closing date) and swingline loans outstanding and/or issued, as applicable, 35% of the total amount of the revolving credit facility commitments.

As of June 29, 2019, we were not subject to the first lien secured leverage ratio testing requirement. Additionally, we were in compliance with all applicable covenant requirements as of June 29, 2019 for our First Lien Credit Agreement and as of June 24, 2019, the agreement termination date, for our Second Lien Credit Agreement.

Contractual Obligations

We enter into long-term contractual obligations and commitments in the normal course of business, primarily operating leases. The contractual commitment amounts in the table below are associated with agreements that are enforceable and legally binding. Obligations under contracts that we can cancel without a significant penalty are not included in the below table.

As of December 29, 2018, our contractual obligations and other commitments were:

 

    

Less than
1 year

    

2-3 Years

    

4-5 Years

    

Thereafter

    

Total

 
     (in thousands)  

Lease obligations (1)

   $ 89,123      $ 197,126      $ 197,256      $ 850,746      $ 1,334,251  

Principal payments of long-term debt (2)

     7,349        16,556        14,789        835,096        873,790  

Interest on long-term debt (3)

     49,463        131,710        115,169        117,430        413,772  

Purchase commitments (4)

     10,000        20,000        8,206        —          38,206  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 155,935      $ 365,392      $ 335,420      $ 1,803,272      $ 2,660,019  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Includes the initial lease term and optional renewal terms that are included in the lease term of our headquarters, store and distribution center leases.

(2)

Not reflected in this table is the repayment of an aggregate of $150.0 million in principal amount of term loans under our Second Lien Credit Agreement, which was repaid on June 24, 2019 in connection with our initial public offering.

(3)

Represents the expected cash payments for interest on our long-term debt based on the amounts outstanding as of the end of each period and the interest rates applicable on such debt as of December 29, 2018.

(4)

Represents a purchase commitment for fresh meat with our primary fresh meat vendor.

 

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As of June 29, 2019, our contractual obligations and other commitments were:

 

    

Less than
1 year

    

2-3 Years

    

4-5 Years

    

Thereafter

    

Total

 
     (in thousands)  

Lease obligations (1)

   $ 46,102      $ 186,537      $ 185,411      $ 772,580      $ 1,190,630  

Principal payments of long-term debt

     90        267        —          475,188        475,545  

Interest on long-term debt (2)

     13,878        56,047        55,513        50,405        175,843  

Purchase commitments (3)

     5,000        20,000        8,206        —          33,206  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 65,070      $ 262,851      $ 249,130      $ 1,298,173      $ 1,875,224  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Includes the initial lease term and optional renewal terms that are included in the lease term of our headquarters, store and distribution center leases.

(2)

Represents the expected cash payments for interest on our long-term debt based on the amounts outstanding as of the end of each period and the interest rates applicable on such debt as of December 29, 2018.

(3)

Represents a purchase commitment for fresh meat with our primary fresh meat vendor.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of June 29, 2019.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with GAAP. A summary of our significant accounting policies can be found in Note 1 to our audited consolidated financial statements included elsewhere in this prospectus. The preparation of these consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. These judgements and estimates are based on historical and other factors believed to be reasonable under the circumstances.

Management evaluated the development and selection of our critical accounting policies and estimates and believes that the following involve a higher degree of judgment or complexity and are most significant to reporting our results of operations and financial position, and are therefore discussed as critical. The following critical accounting policies reflect the significant estimates and judgments used in the preparation of our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected results can potentially have a materially favorable or unfavorable impact on sequent results of operations. More information on all of our significant accounting policies can be found in Note 1 to our audited consolidated financial statements included elsewhere in this prospectus.

Long-Lived Asset Impairment—We evaluate events and changes in circumstances that could indicate carrying amounts of long-lived assets, including property and equipment, may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether or not the carrying value of such assets will be recovered through undiscounted future cash flows derived from their use and eventual disposition. For purposes of this assessment, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If the sum of the undiscounted future cash flows is less than the carrying amount of an asset, we record an impairment loss for the amount by which the carrying amount of the assets exceeds its fair value.

Goodwill—We have goodwill recorded on our consolidated balance sheet. Goodwill is not amortized, but rather is subject to an annual impairment test. The annual impairment testing date is the first day of the fourth quarter. Should certain events or indicators of impairment occur between annual impairment tests, we would

 

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perform an impairment test of goodwill at that date. In this analysis, our assets and liabilities, including goodwill and other intangible assets, are assigned to the respective reporting unit. Measurement of an impairment loss would be based on the excess of the carrying amount of the reporting unit over its fair value.

The fair value of the reporting unit is determined using a combination of the income approach, which estimates the fair value of the reporting unit based on its discounted future cash flows, and two market approach methodologies, which estimate the fair value of the reporting unit based on market prices for publicly traded comparable companies as well as revenue and earnings multiples for merged and acquired companies in a similar industry.

Stock-based Compensation—Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized on a straight-line method over the requisite service period for awards expected to vest. We estimate the fair value of employee stock-based payment awards subject to only a service condition on the date of grant using the Black-Scholes valuation model. The Black-Scholes model requires the use of highly subjective and complex assumptions, including the option’s expected term and the price volatility of the underlying stock. We estimate the fair value of employee stock-based payment awards subject to both a market condition and the occurrence of a performance condition on the date of grant using a Monte Carlo simulation model that assumes the performance criteria will be met and the target payout levels will be achieved. We will continue to use the Black-Scholes and Monte Carlo models for option pricing following the consummation of this offering.

Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We recognize compensation expense for awards expected to vest with only a service condition on a straight-line basis over the requisite service period, which is generally the award’s vesting period. Vesting of these awards is accelerated for certain employees in the event of a change in control. Compensation expense for employee stock-based awards whose vesting is subject to the fulfillment of both a market condition and the occurrence of a performance condition is recognized on a graded-vesting basis at the time the achievement of the performance condition becomes probable.

Prior to our initial public offering in June 2019, as our common stock has never been publicly traded, the expected stock price volatility for the common stock was estimated by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option grants. Industry peers consist of several public companies in our industry which are of similar size, complexity and stage of development. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury implied yield at the date of grant. The weighted-average expected term is determined with reference to historical exercise and post-vesting cancellation experience and the vesting period and contractual term of the awards. The forfeitures rate is estimated based on historical experience and expected future activity.

Prior to our initial public offering in June 2019, as our common stock had never been previously publicly traded, the fair value of shares of common stock underlying the stock options has historically been the determined by our board of directors, with input from management. Because prior to our initial public offering in June 2019 there was no public market for our common stock, the board of directors determined the fair value of common stock at the time of grant by considering a number of objective and subjective factors including quarterly independent third-party valuations of our common stock, operating and financial performance, the lack of liquidity of our capital stock and general and industry specific economic outlook, among other factors. The third-party valuation of our common stock used a combination of the discounted cash flow method under the income approach, the guideline public company method under the market approach and the guideline merged and acquired method under the market approach. The material assumptions used in the income approach method is the estimated future cash flows and the associated discount rate used to discount such cash flows. The material assumptions used in the market approach methods are estimated future revenue and EBITDA. While these material assumptions are subjective in nature, we have not deemed them complex. Following the consummation of this offering, the fair value of our common stock will continue to be the closing price of our common stock as reported on the date of grant.

 

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Variable Interest Entities—In accordance with the variable interest entities sub-section of ASC Topic 810, Consolidation, we assess at each reporting period whether we, or any consolidated entity, are considered the primary beneficiary of a variable interest entity (“VIE”) and therefore required to consolidate it. 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 290, 308 and 324 stores operated by independent operators as of June 30, 2018, December 29, 2018 and June 29, 2019, respectively. We have Operator Agreements in place with each IO. The IO orders its merchandise exclusively from us which is provided to the independent operator on consignment. Under the Operator Agreement, the IO may select a majority of merchandise that we consign to the IO, which the IO chooses from our merchandise order guide according to IO’s knowledge and experience with local customer purchasing trends, preferences, historical sales and similar factors. The Operator Agreement gives the IO discretion to adjust our initial prices if the overall effect of all price changes at any time comports with the reputation of our Grocery Outlet retail stores for selling quality, name-brand consumables and fresh products and other merchandise at extreme discounts. IOs are required to furnish initial working capital and to acquire certain store and safety assets. The IO is 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. The IO is responsible for expenses required for business operations, including all labor costs, utilities, credit card processing fees, supplies, taxes, fines, levies, and other expenses. Either party may terminate the Operator Agreement without cause upon 75 days’ notice.

As consignor of all merchandise to each IO, the aggregate sales proceeds from merchandise sales belongs to us. Sales related to independent operator stores were $557.1 million and $629.7 million for the 13 weeks ended June 30, 2018 and June 29, 2019, respectively, and $1,089.8 million and $1,219.0 million for the 26 weeks ended June 30, 2018 and June 29, 2019, respectively. We, in turn, pay IOs a commission based on a share of the gross profit of the store. Inventories and related sales proceeds are our property, and we are responsible for store rent and related occupancy costs. Independent operator commissions are expensed and included in selling, general and administrative expenses. Independent operator commissions were $85.4 million and $95.8 million for the 13 weeks ended June 30, 2018 and June 29, 2019, respectively, and $168.1 million and $187.0 million for the 26 weeks ended June 30, 2018 and June 29, 2019, respectively. Independent operator commissions of $3.9 million and $1.8 million were included in accrued expenses as of December 29, 2018 and June 29, 2019, respectively.

IOs may fund their initial store investment from existing capital, a third-party loan or most commonly through a loan from us (Note 2). To ensure IO performance, the Operator Agreements grant us the security interests in the assets owned by the IO. 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 and, as a result, the IO are VIEs which we have variable interests in. To determine if we are the primary beneficiary of these VIEs, we evaluate whether we have (i) the power to direct the activities that most significantly impact the IO’s economic performance and (ii) the obligation to absorb losses or the right to receive benefits of the IO that could potentially be significant to the IO. Our evaluation includes identification of significant activities and an assessment of its ability to direct those activities.

Activities that most significantly impact the IO economic performance relate to sales and labor. Sales activities that significantly impact the IO’s economic performance include determining what merchandise the IO will order and sell and the price of such merchandise, both of which the IO controls. The IO is also responsible for all of their own labor. Labor activities that significantly impact the IO’s economic performance include hiring, training, supervising, directing, compensating (including wages, salaries and employee benefits) and terminating all of the employees of the IO, activities which the IO controls. Accordingly, the IO has the power to

 

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direct the activities that most significantly impact the IO’s economic performance. Furthermore, the mutual termination rights associated with the Operator Agreements do not give the Company power over the independent operator.

Our maximum exposure to the IOs is generally limited to the gross receivable due from these entities, which was $27.8 million and $33.1 million as of December 29, 2018 and June 29, 2019, respectively. Additional information can be found in Note 2 to our audited consolidated financial statements included elsewhere in this prospectus.

Recently Issued Accounting Standards

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13, which was further updated and clarified by the FASB through issuance of additional related ASUs, amends the guidance surrounding measurement and recognition of credit losses on financial assets measured at amortized cost, including trade receivables and debt securities, by requiring recognition of an allowance for credit losses expected to be incurred over an asset’s lifetime based on relevant information about past events, current conditions, and supportable forecasts impacting its ultimate collectability. This “expected loss” model will result in earlier recognition of credit losses than the current “as incurred” model, under which losses are recognized only upon an occurrence of an event that gives rise to the incurrence of a probable loss. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and is to be adopted on a modified retrospective basis. We will adopt ASU 2016-13 beginning in the first quarter of fiscal 2020 and are currently evaluating the impact on our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective retrospectively for fiscal years and interim periods within those years beginning after December 15, 2019. We will adopt ASU 2018-15 beginning in the first quarter of fiscal 2020. We do not expect the adoption of ASU 2018-15 to have a material effect on our consolidated financial statements.

Recently Adopted Accounting Standards

We adopted ASU 2016-02, Leases (Topic 842), on December 30, 2018, using the modified retrospective approach with the cumulative effect of transition. The modified retrospective approach provides a method for recording existing leases at adoption with the comparative reporting periods being presented in accordance with ASU No. 2018-11, Leases (Topic 840). We elected a number of the practical expedients permitted under the transition guidance within the new standard. This included the election to apply the practical expedient package upon transition, which comprised the following:

 

   

we did not reassess whether expired or existing contracts are or contain a lease;

 

   

we did not reassess the classification of existing leases; and

 

   

we did not reassess the accounting treatment for initial direct costs.

In addition, we elected the practical expedient related to short-term leases, which allows us not to recognize a right-of-use asset and lease liability for leases with an initial expected term of 12 months or less.

Adoption of the new standard resulted in the recordation of additional lease assets of $646 million and lease liabilities of $709 million on the consolidated balance sheet as of December 30, 2018, which includes the reclassification of amounts presented in comparative periods as deferred rent as a reduction to the right-of-use

 

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assets. The adoption of the new standard did not result in a material cumulative-effect adjustment to the opening balance of retained earnings. The standard did not materially impact the consolidated statement of operations and other comprehensive income (loss) or the consolidated statement of cash flows. See Note 3 of our unaudited condensed consolidated financial statements appearing elsewhere in this prospectus for further discussion on the adoption of ASU 2016-02.

For additional information on recently issued and recently adopted accounting pronouncements, see Note 1 to our unaudited condensed consolidated financial statements included elsewhere in this prospectus.

Quantitative and Qualitative Disclosures About Market Risks

Interest Rate Risk

Our operating results are subject to risk from interest rate fluctuations on our credit facilities, which carry variable interest rates. As of June 29, 2019, our credit facilities included a term loan and a revolving credit facility under the First Lien Credit Agreement which provides for revolving loans of up to $100.0 million, with a sub-commitment for issuance of letters of credit of $35.0 million and a sub-commitment for $20.0 million of swingline loans. Because the loans under our First Lien Credit Agreement bear interest at a variable rate, we are exposed to market risks relating to changes in interest rates. As of June 29, 2019, we had $475.2 million variable rate loans outstanding under term loans under the First Lien Credit Agreement and no outstanding variable rate debt under our revolving credit facility under the First Lien Credit Agreement. Based on our June 29, 2019 credit facility balance, an increase or decrease of 1% in the effective interest rate would cause an increase or decrease in interest cost of approximately $4.8 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 believe the effects of inflation, if any, on our historical results of operations and financial condition have been immaterial. We cannot be assured that our results of operations and financial condition will not be materially impacted by inflation in the future.