CRACKER BARREL OLD COUNTRY STORE, INC. Cracker Barrel Old Country Store, Inc. and its subsidiaries (collectively, the "Company," "our" or "we") are principally engaged in the operation and development inthe United States of the Cracker Barrel Old Country Store® ("Cracker Barrel") concept. AtJanuary 31, 2020 , we operated 661Cracker Barrel stores in 45 states. Additionally, effectiveOctober 10, 2019 , we acquiredMaple Street Biscuit Company ("MSBC"). As ofJanuary 31, 2020 , MSBC had 28 company-owned and five franchised fast casual locations across seven states. As ofJanuary 31, 2020 , we are in the process of converting our existing six Holler & Dash Biscuit HouseTM locations ("Holler & Dash") into MSBC locations. Our Holler & Dash locations operate in the same states as MSBC. All dollar amounts reported or discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") are shown in thousands, except per share amounts and certain statistical information (e.g., number of stores). References to years in MD&A are to our fiscal year unless otherwise noted. MD&A provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. MD&A should be read in conjunction with the (i) condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and (ii) audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year endedAugust 2, 2019 (the "2019 Form 10-K"). Except for specific historical information, many of the matters discussed in this report may express or imply projections of items such as revenues or expenditures, estimated capital expenditures, compliance with debt covenants, plans and objectives for future operations, inventory shrinkage, growth or initiatives, expected future economic performance or the expected outcome or impact of pending or threatened litigation. These and similar statements regarding events or results which we expect will or may occur in the future are forward-looking statements that, by their nature, involve risks, uncertainties and other factors which may cause our actual results and performance to differ materially from those expressed or implied by such statements. All forward-looking information is provided pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 and should be evaluated in the context of these risks, uncertainties and other factors. Forward-looking statements generally can be identified by the use of forward-looking terminology such as "trends," "assumptions," "target," "guidance," "outlook," "opportunity," "future," "plans," "goals," "objectives," "expectations," "near-term," "long-term," "projection," "may," "will," "would," "could," "expect," "intend," "estimate," "anticipate," "believe," "potential," "should," "projects," "forecasts" or "continue" (or the negative or other derivatives of each of these terms) or similar terminology. We believe the assumptions underlying any forward-looking statements are reasonable; however, any of the assumptions could be inaccurate, and therefore, actual results may differ materially from those projected in or implied by the forward-looking statements. In addition to the risks of ordinary business operations, and those discussed or described in this report or in information incorporated by reference into this report, factors and risks that may result in actual results differing from this forward-looking information include, but are not limited to, those contained in Part I, Item 1A of the 2019 Form 10-K, as well as the factors described under "Critical Accounting Estimates" on pages 28-30 of this report or, from time to time, in our filings with theSecurities and Exchange Commission ("SEC"), press releases and other communications. Readers are cautioned not to place undue reliance on forward-looking statements made in this report because the statements speak only as of the report's date. Except as may be required by law, we have no obligation or intention to update or revise any of these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events. Readers are advised, however, to consult any future public disclosures that we may make on related subjects in reports that we file with or furnish to theSEC or in our other public disclosures. 20
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Overview
Management believes that the Cracker Barrel brand remains one of the strongest and most differentiated brands in the restaurant industry, and we plan to continue to leverage that strength throughout 2020 to grow sales and profits. Our priorities for 2020 consist of the following:
• Enhancing the core business by introducing craveable, signature food,
accelerating our off-premise business, improving the employee and guest
experience and by achieving ongoing cost reductions through business model
improvements;
• Expanding the footprint in new and developing markets while replenishing our
store opening pipeline. We anticipate opening six
2020, one of which opened in the first six months of 2020; and
• Extending the brand to further drive shareholder value by developing new
platforms to drive growth, such as our acquisition of Maple Street Biscuit
Company ("MSBC") and through our strategic relationship with Punch Bowl Social
("PBS").
We remain focused on the delivery of our three-year strategic priorities.
Results of Operations
The following table highlights our operating results by percentage relationships
to total revenue for the quarter and six months ended
Quarter Ended Six Months Ended
January 31, February 1, January 31, February 1,
2020 2019 2020 2019
Total revenue 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold (exclusive of
depreciation and rent) 32.2 32.7 30.8 31.5
Labor and other related expenses 33.6 34.1 34.4 34.7
Other store operating expenses 20.3 19.3 21.0 20.0
General and administrative expenses 4.5 4.4 4.9 4.8
Operating income 9.4 9.5 8.9 9.0
Interest expense 0.5 0.6 0.4 0.6
Income before income taxes 8.9 8.9 8.5 8.4
Provision for income taxes 1.3 1.4 1.4 1.4
Net loss from unconsolidated subsidiary (0.4 ) - (0.6 ) -
Net income 7.2 % 7.5 % 6.5 % 7.0 %
The following table sets forth the number of Company-owned units in operation at
the beginning and end of the quarters and six months ended January 31, 2020 and
February 1, 2019 as well as the number of franchised units at end of the
quarters and six months ended January 31, 2020 and February 1, 2019 :
Quarter Ended Six Months Ended
January 31, February 1, January 31, February 1,
2020 2019 2020 2019
Company-owned units in operation:
Open at beginning of the period 695 663 667 660
MSBC units acquired during period - - 28 -
Opened during the period 1 2 1 5
Closed during the period (1 ) (1 ) (1 ) (1 )
Total Company -owned units at end of the
period 695 664 695 664
Total franchised MSBC units at end of
the period 5 - 5 -
Effective October 10, 2019 , we acquired MSBC. We are currently in the process
of converting our existing six Holler & Dash locations into MSBC locations and
expect to complete this conversion in the third quarter of 2020.
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Total Revenue
Total revenue for the second quarter and first six months of 2020 increased 4.2% and 3.2%, respectively, compared to the same periods in the prior year.
The following table highlights the key components of revenue for the quarter and six months endedJanuary 31, 2020 as compared to the quarter and six months endedFebruary 1, 2019 : Quarter Ended Six Months Ended January 31, February 1, January 31, February 1, 2020 2019 2020 2019 Revenue in dollars: Restaurant$ 663,043 $ 631,175 $ 1,270,122 $ 1,222,153 Retail 183,100 180,532 325,061 323,097 Total revenue$ 846,143 $ 811,707 $ 1,595,183 $ 1,545,250 Total revenue by percentage relationships: Restaurant 78.4 % 77.8 % 79.6 % 79.1 % Retail 21.6 % 22.2 % 20.4 % 20.9 % Average unit volumes(1): Restaurant$ 985.3 $ 950.4 $ 1,893.7 $ 1,843.9 Retail 274.6 271.8 487.4 487.5 Total revenue$ 1,259.9 $ 1,222.2 $ 2,381.1 $ 2,331.4 Comparable store sales increase (decrease) (2): Restaurant 3.8 % 3.8 % 3.0 % 2.7 % Retail 1.3 % (1.4 %) 0.4 % 1.1 % Restaurant and retail 3.2 % 2.6 % 2.5 % 2.3 %
(1) Average unit volumes include sales of all stores except for MSBC. (2) Comparable store sales exclude MSBC.
For the second quarter of 2020, our comparable store restaurant sales increase
resulted from a 4.0% average check increase (including a 2.2% average menu price
increase) partially offset by a 0.2% guest traffic decrease as compared to the
prior year second quarter. For the second quarter of 2020, our comparable store
retail sales increase resulted primarily from strong performance in the décor,
the kitchen and dining and the apparel merchandise categories partially offset
by lower performance in the bed and bath, licensed and media merchandise
categories as compared to the second quarter of 2019.
For the first six months of 2020, our comparable store restaurant sales increase
resulted from a 3.8% average check increase (including a 2.2% average menu price
increase) partially offset by a 0.8% guest traffic decline as compared to the
prior year period. For the first six months of 2020, our comparable store retail
sales increase resulted primarily from strong performance in the décor and the
kitchen and dining merchandise categories partially offset by lower performance
in the bed and bath, toys, licensed and media merchandise categories as compared
to the prior year period.
Restaurant and retail sales from newly opened stores and the revenue from MSBC
accounted for the remainder of the total revenue increase in the second quarter
and first six months of 2020 as compared to the same periods in the prior year.
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Cost of Goods Sold (Exclusive of Depreciation and Rent)
The following table highlights the components of cost of goods sold (exclusive
of depreciation and rent) in dollar amounts and as percentages of revenues for
the second quarter and first six months of 2020 as compared to the same periods
in the prior year:
Quarter Ended Six Months Ended
January 31 , February
1,
2020 2019 2020 2019
Cost of Goods Sold in dollars:
Restaurant $ 172,676 $ 165,861 $ 322,133 $ 315,049
Retail 99,531 99,318 169,888 172,423
Total Cost of Goods Sold $ 272,207 $ 265,179 $ 492,021 $ 487,472
Cost of Goods Sold by percentage of revenue:
Restaurant 26.0 % 26.3 % 25.4 % 25.8 %
Retail 54.4 % 55.0 % 52.3 % 53.4 %
The decreases in restaurant cost of goods sold as a percentage of restaurant
revenue in the second quarter and first six months of 2020 as compared to the
same periods in the prior year primarily resulted from the recognition of
favorable vendor allowances.
We presently expect the rate of commodity inflation to be approximately 1.5% to 2.0% in 2020 as compared to 2019.
The decrease in retail cost of goods sold as a percentage of retail revenue in the second quarter and first six months of 2020 as compared to the second quarter and first six months of 2019 resulted primarily from higher initial margin partially offset by higher markdowns.
Second Quarter First Six Months
(Decrease) Increase (Decrease) Increase
as a Percentage of as a Percentage of
Total Revenue Total Revenue
Higher initial margin (1.8 %) (1.6 %)
Markdowns 1.1 % 0.5 %
Labor and Related Expenses
Labor and related expenses include all direct and indirect labor and related
costs incurred in store operations. The following table highlights labor and
related expenses as a percentage of total revenue for the second quarter and
first six months of 2020 as compared to the same periods in the prior year:
Quarter Ended Six Months Ended
January 31, February 1, January 31, February 1,
2020 2019 2020 2019Labor and related expenses 33.6 % 34.1 % 34.4 % 34.7 %
This percentage change resulted primarily from the following:
Second Quarter
(Decrease) Increase as a
Percentage of Total Revenue
Store hourly labor (0.2 %)
Store management compensation (0.1 %)
Miscellaneous wages (0.1 %)
Workers' compensation expense (0.1 %)
Employee health care expenses 0.1 %
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This percentage change resulted primarily from the following:
First Six Months
(Decrease) Increase as a
Percentage of Total Revenue
Miscellaneous wages (0.1 %)
Store bonus expense (0.1 %)
Preopening labor expense (0.1 %)
Employee health care expenses 0.1 %
The decrease in store hourly labor costs as a percentage of total revenue for
the second quarter of 2020 as compared to the second quarter of 2019 resulted
primarily from improvements in productivity.
The decrease in store management compensation as a percentage of total revenue
for the second quarter of 2020 as compared to the second quarter of 2019
resulted primarily from the increase in revenue in the second quarter of 2020 as
compared to the prior year period.
The decreases in miscellaneous wages as a percentage of total revenue for the
second quarter and first six months of 2020 as compared to the same periods in
the prior year resulted primarily from the non-recurrence of costs associated
with a store closure in the prior year.
The decrease in workers' compensation expense as a percentage of total revenue for the second quarter of 2020 as compared to the second quarter of 2019 resulted primarily from revised actuarial estimates.
The decrease in store bonus expense as a percentage of total revenue for the first six months of 2020 as compared to the same period in the prior year resulted from lower performance against financial objectives in the first six months of 2020 as compared to the same period in the prior year. The decrease in preopening labor expense as a percentage of total revenue for the first six months of 2020 as compared to the same period in the prior year resulted primarily from the timing of new unit openings. Higher employee health care expenses as a percentage of total revenue for the second quarter and first six months of 2020 as compared the same periods in the prior year resulted primarily from higher claims activity.
Other Store Operating Expenses
Other store operating expenses include all store-level operating costs, the
major components of which are utilities, preopening expenses excluding labor,
operating supplies, repairs and maintenance, depreciation and amortization,
advertising, rent, credit and gift card fees, real and personal property taxes,
general insurance and costs associated with our bi-annual manager conference and
training event.
The following table highlights other store operating expenses as a percentage of
total revenue for the second quarter and first six months of 2020 as compared to
the same periods in the prior year:
Quarter Ended Six Months Ended
January 31, February 1, January 31, February 1,
2020 2019 2020 2019
Other store operating expenses 20.3 % 19.3 % 21.0 % 20.0 %
These percentage changes resulted primarily from the following:
Second Quarter First Six Months
Increase as a Percentage Increase as a Percentage
of Total Revenue of Total Revenue
Advertising expense 0.5 % 0.4 %
Depreciation expense 0.3 % 0.3 %
Other store expenses 0.2 % 0.2 %
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The increases in advertising expense as a percentage of total revenue for the second quarter and first six months of 2020 as compared to the same periods in the prior year resulted primarily from higher media spending. The increases in depreciation expense as a percentage of total revenue for the second quarter and first six months 2020 as compared to the same periods in the prior year resulted primarily from capital expenditures with accelerated depreciation methods. The increases in other store expenses as a percentage of total revenue for the second quarter and first six months of 2020 as compared to the same periods in the prior year resulted from costs associated with the growth in our off-premise business.
General and Administrative Expenses
General and administrative expenses as a percentage of total revenue increased slightly to 4.5% in the second quarter of 2020 as compared to 4.4% in the second quarter of 2019. General and administrative expenses as a percentage of total revenue increased slightly to 4.9% in the first six months of 2020 as compared to 4.8% in the same period in the prior year.
Interest Expense, net
The following table highlights interest expense, net in dollars for the second
quarter and first six months of 2020 as compared to the same periods in the
prior year:
Quarter Ended Six Months Ended
January 31, February 1, January 31, February 1,
2020 2019 2020 2019
Interest expense, net $ 3,505 $ 4,177 $ 7,085 $ 8,526
Both period-over-period decreases resulted primarily from the interest income on
the PBS promissory notes and lower weighted average interest rates partially
offset by higher debt levels. Additionally, as part of our debt refinancing in
the first quarter of 2019, we incurred additional interest expense of $166
related to the write-off of deferred financing costs.
Provision for Income Taxes
The following table highlights the provision for income taxes as a percentage of
income before income taxes ("effective tax rate") for the second quarter and
first six months of 2020 as compared to the same periods in the prior year:
Quarter Ended Six Months Ended
January 31, February 1, January 31, February 1,
2020 2019 2020 2019
Effective tax rate 14.4 % 16.2 % 15.9 % 16.9 %
The decrease in the effective tax rate from the second quarter of 2019 to the
second quarter of 2020 resulted primarily from the tax benefits generated from
our investment in PBS and the retroactive reinstatement of the Work Opportunity
Tax Credit through December 31, 2020 . The decrease in the effective tax rate
from the first six months of 2019 to the first six months of 2020 resulted from
the tax benefit generated from our investment in PBS .
We presently expect our effective tax rate for 2020 to be approximately 16%.
Liquidity and Capital Resources
Our primary sources of liquidity are cash generated from our operations and our borrowing capacity under our revolving credit facility. Our internally generated cash, along with cash on hand atAugust 2, 2019 and borrowings under our revolving credit facility, was sufficient to finance all of our growth, dividend payments, share repurchases, working capital needs and other cash payment obligations in the first six months of 2020. 25
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We believe that cash on hand atJanuary 31, 2020 , along with cash generated from our operating activities and the borrowing capacity under our revolving credit facility, will be sufficient to finance our continuing operations, expected dividend payments and our continuing expansion plans for at least the next twelve months.
Cash Generated From Operations
Our operating activities provided net cash of$184,004 for the first six months of 2020, representing a decrease from the$190,863 net cash provided during the first six months of 2019. This decrease primarily reflected the timing of payments for accounts payable.
Borrowing Capacity and Debt Covenants
OnSeptember 5, 2018 , we entered into a five-year$950,000 revolving credit facility ("2019 Revolving Credit Facility") which replaced our$750,000 revolving credit facility of which$400,000 in borrowings was outstanding. The 2019 Revolving Credit Facility also contains an option to increase the revolving credit facility by$300,000 . In the first quarter of 2019, we paid$3,022 in deferred financing costs related to the debt refinancing. During the six months endedJanuary 31, 2020 , we borrowed$215,000 under the 2019 Revolving Credit Facility to fund our dividend payments, acquisition of MSBC and other working capital needs, and repaid$155,000 of the borrowings. AtJanuary 31, 2020 , we had$460,000 of outstanding borrowings under the 2019 Revolving Credit Facility and we had$6,879 of standby letters of credit related to securing reserved claims under our workers' compensation insurance which reduce our borrowing availability under the 2019 Revolving Credit Facility.
At
The 2019 Revolving Credit Facility contains customary financial covenants, which include maintenance of a maximum consolidated total leverage ratio and a minimum consolidated interest coverage ratio. We presently are in compliance with all financial covenants. Capital Expenditures Capital expenditures (purchase of property and equipment) net of proceeds from insurance recoveries were$58,289 for the first six months of 2020 as compared to$69,829 for the same period in the prior year. Our capital expenditures consisted primarily of capital investments for existing stores, new store locations and capital expenditures for strategic initiatives. The decrease in capital expenditures from the first six months of 2020 to the first six months of 2019 resulted primarily from lower capital expenditures for strategic initiatives partially offset by higher capital expenditures for existing stores. We estimate that our capital expenditures during 2020 will be approximately$125,000 . This estimate includes the acquisition of sites and construction costs of six newCracker Barrel stores and one MSBC location that we expect to open during 2020, as well as for acquisition and construction costs for store locations to be opened in 2021. We intend to fund our capital expenditures with cash flows from operations and borrowings under our 2019 Revolving Credit Facility, as necessary.
EffectiveOctober 10, 2019 , we acquired 100% ownership of MSBC, a breakfast and lunch fast casual concept, for a purchase price of$36,000 , of which$32,000 was paid to the sellers in cash with the remaining$4,000 being held as security for the satisfaction of indemnification obligations. The unused portion of the amounts held for security, if any, will be paid in two installments with$1,500 due to the principal seller on the one-year anniversary of closing and the remaining amount due to the sellers on the two-year anniversary of closing.
We
also incurred acquisition-related costs of$1,269 . We are currently converting our existing six Holler & Dash locations into MSBC locations and expect this conversion to be completed during the third quarter of 2020. We believe that the investment in MSBC supports our strategic initiative to extend the brand by becoming a market leader in the breakfast and lunch-focused fast casual dining segment of the restaurant industry and by providing a platform for growth. 26
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Punch Bowl Social
EffectiveJuly 18, 2019 , we entered into a strategic relationship withPBS , a food, beverage and entertainment concept, by purchasing a non-controlling interest in the concept. As part of the transaction, we agreed to fundPBS up to$51,000 through calendar 2020 of which we funded$33,000 during the first six months of 2020, for a total of$45,500 . The terms of the Company's investment inPBS provide us with a call right beginning in 2023 to purchase the remaining ownership interest inPBS , subject to terms and conditions governed by thePBS operating agreement, and, after the expiration of that call right, provide us with the right to demand thatPBS initiate a sale process to sellPBS to an unaffiliated third party. We believe the investment inPBS provides us with another growth vehicle to deliver shareholder value and drive continued growth.
Dividends, Share Repurchases and Share-Based Compensation Awards
The 2019 Revolving Credit Facility imposes restrictions on the amount of dividends we are permitted to pay and the amount of shares we are permitted to repurchase. Under the 2019 Revolving Credit Facility, provided there is no default existing and the total of our availability under the 2019 Revolving Credit Facility plus our cash and cash equivalents on hand is at least$100,000 (the "cash availability"), we may declare and pay cash dividends on shares of our common stock and repurchase shares of our common stock (1) in an unlimited amount if, at the time the dividend or the repurchase is made, our consolidated total leverage ratio is 3.00 to 1.00 or less and (2) in an aggregate amount not to exceed$100,000 in any fiscal year if our consolidated total leverage ratio is greater than 3.00 to 1.00 at the time the dividend or repurchase is made; notwithstanding (1) and (2), so long as immediately after giving effect to the payment of any such dividends cash availability is at least$100,000 , we may declare and pay cash dividends on shares of our common stock in an aggregate amount not to exceed in any fiscal year the product of the aggregate amount of dividends declared in the fourth quarter of the immediately preceding fiscal year multiplied by four. During the first six months of 2020, we paid a regular dividend of$2.60 per share and declared a dividend of$1.30 per share that was paid onFebruary 5, 2020 to shareholders of record onJanuary 17, 2020 . We have been authorized by our Board of Directors to repurchase shares at management's discretion up to$50,000 during 2020. During the first six months of 2020, we repurchased 129,325 shares of our common stock in the open market at an aggregate cost of$20,000 . During the first six months of 2020, we issued 23,333 shares of our common stock resulting from the vesting of share-based compensation awards. Related tax withholding payments on these share-based compensation awards resulted in a net use of cash of$1,994 . Working Capital In the restaurant industry, virtually all sales are either for cash or third-party credit or debit card. Restaurant inventories purchased through our principal food distributor are on terms of net zero days, while restaurant inventories purchased locally are generally financed from normal trade credit. Because of our retail gift shops, which have a lower product turnover than the restaurant business, we carry larger inventories than many other companies in the restaurant industry. Retail inventories purchased domestically are generally financed from normal trade credit, while imported retail inventories are generally purchased through wire transfers. These various trade terms are aided by the rapid turnover of the restaurant inventory. Employees generally are paid on weekly or semi-monthly schedules in arrears for hours worked except for bonuses that are paid either quarterly or annually in arrears. Many other operating expenses have normal trade terms and certain expenses, such as certain taxes and some benefits, are deferred for longer periods of time. We had negative working capital of$158,814 atJanuary 31, 2020 versus negative working capital of$150,094 atAugust 2, 2019 . The change in working capital fromAugust 2, 2019 toJanuary 31, 2020 primarily resulted from the recognition of lease liabilities due to the adoption atAugust 3, 2019 of accounting guidance for leases partially offset by the increase in cash and an increase in real estate deposits.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
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Material Commitments
There have been no material changes in our material commitments other than in the ordinary course of business since the end of 2019. Refer to the sub-section entitled "Material Commitments" under the section entitled "Liquidity and Capital Resources" presented in the MD&A of our 2019 Form 10-K for additional information regarding our material commitments.
Recent Accounting Pronouncements Adopted
See Note 1 to the accompanying Condensed Consolidated Financial Statements for a discussion of recent accounting guidance adopted. With the exception of the accounting guidance for leases, the adopted accounting guidance discussed in Note 1 did not have a significant impact on our consolidated financial position or results of operations. Regarding the accounting guidance for leases, the adoption of the accounting guidance had a material impact on our consolidated balance sheet. See Notes 1 and 11 for additional information regarding leases. Regarding the accounting guidance not yet adopted, we are still evaluating the impact of adopting the accounting guidance.
Critical Accounting Estimates
We prepare our Consolidated Financial Statements in conformity with accounting principles generally accepted inthe United States of America . The preparation of these financial statements requires us to make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We base our estimates and judgments on historical experience, current trends, outside advice from parties believed to be experts in such matters, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. However, because future events and their effects cannot be determined with certainty, actual results could differ from those assumptions and estimates, and such differences could be material. Our significant accounting policies are discussed in Note 2 to the Consolidated Financial Statements contained in the 2019 Form 10-K with the exception of the newly adopted lease accounting guidance and the valuation of goodwill and other intangibles. See Notes 1 and 11 above for further information regarding the accounting policies for leases under the newly adopted accounting guidance. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions.
Critical accounting estimates are those that:
• management believes are most important to the accurate portrayal of both our
financial condition and operating results, and
• require management's most difficult, subjective or complex judgments, often as
a result of the need to make estimates about the effect of matters that are
inherently uncertain.
We consider the following accounting estimates to be most critical in understanding the judgments that are involved in preparing our Consolidated Financial Statements:
• Impairment of Long-Lived Assets
• Insurance Reserves
• Retail Inventory Valuation
• Lease Accounting
•
Management has reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board of Directors.
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Impairment of Long-Lived Assets
We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying value of the asset to the undiscounted future cash flows expected to be generated by the asset. If the total expected future cash flows are less than the carrying amount of the asset, the carrying value is written down, for an asset to be held and used, to the estimated fair value or, for an asset to be disposed of, to the fair value, net of estimated costs of disposal. Any loss resulting from impairment is recognized by a charge to income. Judgments and estimates that we make related to the expected useful lives of long-lived assets and future cash flows are affected by factors such as changes in economic conditions and changes in operating performance. The accuracy of such provisions can vary materially from original estimates and management regularly monitors the adequacy of the provisions until final disposition occurs. We have not made any material changes in our methodology for assessing impairments during the first six months of 2020, and we do not believe that there is a reasonable likelihood that there will be a material change in the estimates or assumptions used by us in the future to assess impairment of long-lived assets. However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and fair values of long-lived assets, we may be exposed to losses that could be material. During the first quarter of 2020, we recorded an impairment charge of$664 related to the transition from Holler & Dash locations to MSBC locations.
Insurance Reserves
We self-insure a significant portion of our expected workers' compensation and general liability insurance programs. We purchase insurance for individual workers' compensation claims that exceed$250 ,$750 or$1,000 depending on the state in which the claim originated. We purchase insurance for individual general liability claims that exceed$500 . We record a reserve for workers' compensation and general liability for all unresolved claims and for an estimate of incurred but not reported ("IBNR") claims. These reserves and estimates of IBNR claims are based upon a full scope actuarial study which is performed annually at the end of our third quarter and is adjusted by the actuarially determined losses and actual claims payments for the fourth quarter. Additionally, we perform limited scope actuarial studies on a quarterly basis to verify and/or modify our reserves. The reserves and losses in the actuarial study represent a range of possible outcomes within which no given estimate is more likely than any other estimate. As such, we record the losses in the lower half of that range and discount them to present value using a risk-free interest rate based on projected timing of payments. We also monitor actual claims development, including incurrence or settlement of individual large claims during the interim periods between actuarial studies as another means of estimating the adequacy of our reserves. Our group health plans combine the use of self-insured and fully-insured programs. Benefits for any individual (employee or dependents) in the self-insured group health program are limited. We record a liability for the self-insured portion of our group health program for all unpaid claims based upon a loss development analysis derived from actual group health claims payment experience. Additionally, we record a liability for unpaid prescription drug claims based on historical experience. Our accounting policies regarding insurance reserves include certain actuarial assumptions and management judgments regarding economic conditions, the frequency and severity of claims and claim development history and settlement practices. We have not made any material changes in the methodology used to establish our insurance reserves during the first six months of 2020 and do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to calculate the insurance reserves. However, changes in these actuarial assumptions, management judgments or claims experience in the future may produce materially different amounts of expense that would be reported under these insurance programs.
Retail Inventory Valuation
Cost of goods sold includes the cost of retail merchandise sold at our stores
utilizing the retail inventory method ("RIM"). Under RIM, the valuation of our
retail inventories is determined by applying a cost-to-retail ratio to the
retail value of our inventories. Inherent in the RIM calculation are certain
inputs, including initial markons, markups, markdowns and shrinkage, which may
significantly impact the gross margin calculation as well as the ending
inventory valuation.
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Inventory valuation provisions are included for retail inventory obsolescence and retail inventory shrinkage. Retail inventory is reviewed on a quarterly basis for obsolescence and adjusted as appropriate based on assumptions made by management and judgment regarding inventory aging and future promotional activities. Retail inventory also includes an estimate of shrinkage that is adjusted upon physical inventory counts. Annual physical inventory counts are conducted based upon a cyclical inventory schedule. An estimate of shrinkage is recorded for the time period between physical inventory counts by using a two-year average of the physical inventories' results on a store-by-store basis. We have not made any material changes in the methodologies, estimates or assumptions related to our merchandise inventories during the first six months of 2020 and do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions in the future. However, actual obsolescence or shrinkage recorded may produce materially different amounts than we have estimated. Lease Accounting We have ground leases for our leased stores and office space leases that are recorded as operating leases under various non-cancellable operating leases. Additionally, we lease our retail distribution center, advertising billboards, vehicle fleets, and certain equipment under various non-cancellable operating leases. EffectiveAugust 3, 2019 , we adopted lease accounting guidance which requires the recognition of lease assets and lease liabilities on the balance sheet. Adoption of the accounting guidance for leases resulted in the recognition of right-of-use operating lease assets of$464,394 and total operating lease liabilities of$506,406 as ofAugust 3, 2019 . We evaluate our leases at contract inception to determine whether we have the right to control use of the identified asset for a period of time in exchange for consideration. If we determine that we have the right to obtain substantially all of the economic benefit from use of the identified asset and the right to direct the use of the identified asset, we recognize a right-of-use asset and lease liability. Also, at contract inception, we evaluate our leases to estimate their expected term which includes renewal options that we are reasonably assured that we will exercise, and the classification of the lease as either an operating lease or a finance lease. Additionally, as our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the time of commencement or modification date in determining the present value of lease payments. Assumptions used in determining our incremental borrowing rate include our implied credit rating and an estimate of secured borrowing rates based on comparable market data. We assess the impairment of the right-of-use asset whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.
Changes in these assumptions and management judgments may produce materially different amounts in the recognition of the right-of-use assets and lease liabilities. Additionally, any loss resulting from an impairment of the right-of-use assets is recognized by a charge to income, which could be material.
EffectiveOctober 10, 2019 , the Company acquired 100% ownership of MSBC and recorded estimated amounts for goodwill and other intangibles.Goodwill represents the excess of the fair value of the consideration conveyed in the acquisition over the fair value of net assets acquired.Goodwill and other intangibles will be evaluated for impairment annually during each fourth quarter period and when an event occurs or circumstances change that, more likely than not, reduce the fair value of the reporting unit below its carrying value. See Notes 2 and 3 to the Condensed Consolidated Financial Statements for further information related to goodwill and other intangibles. The qualitative and quantitative assessments related to the valuation and any potential impairment of goodwill and other intangible assets are subject to judgements and assumptions regarding the determination of the fair value of the net assets acquired. Such judgments and assumptions may include projecting future cash flows, determining appropriate discount rates, applying the appropriate valuation techniques and the computation of the implied fair value of goodwill. Future cash flow projections are based on management's projections and represent best estimates taking into account recent financial performance, market trends, strategic plans and other available information. Changes in these estimates and assumptions could materially affect the determination of fair value or impairment. Future indicators of impairment could result in an asset impairment charge. If actual results are not consistent with our judgements and assumptions or if these judgement and assumptions are revised based on new information, we may be exposed to losses that could be material. 30
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