CRACKER BARREL OLD COUNTRY STORE, INC.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("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
Consolidated Financial Statements and notes thereto. Readers should also
carefully review the information presented under the section entitled "Risk
Factors" and other cautionary statements in this report. All dollar amounts
(other than per share amounts) reported or discussed in this MD&A are shown in
thousands. References in MD&A to a year or quarter are to our fiscal year or
quarter unless expressly noted or the context clearly indicates otherwise.
This overview summarizes the MD&A, which includes the following sections:
• Executive Overview - a general description of our business, the restaurant and
retail industries, our key performance indicators and the Company's performance
in 2022.
• Results of Operations - an analysis of our consolidated statements of income
(loss) for the three years presented in our Consolidated Financial Statements.
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• Liquidity and Capital Resources - an analysis of our primary sources of
liquidity, capital expenditures and material commitments.
• Critical Accounting Estimates - a discussion of accounting policies that
require critical judgments and estimates.
EXECUTIVE OVERVIEW
Cracker Barrel Old Country Store, Inc. (the "Company," "our" or "we") is a publicly traded (Nasdaq: CBRL) company that, through its operations and those of certain subsidiaries, is principally engaged in the operation and development of the Cracker Barrel Old Country Store® ("Cracker Barrel") concept. EachCracker Barrel store consists of a restaurant with a gift shop. The restaurants serve breakfast, lunch and dinner. The gift shop offers a variety of decorative and functional items specializing in rocking chairs, holiday gifts, toys, apparel and foods. As ofSeptember 14, 2022 , the Company operated 664Cracker Barrel stores located in 45 states. EffectiveOctober 19, 2019 , the Company acquired 100% ownership ofMaple Street Biscuit Company ("MSBC"), a breakfast and lunch fast casual concept. As ofSeptember 14, 2022 , the Company operated 53 MSBC locations in nine states, none of which are franchised.
Company Performance in 2022
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 and build on that strength as a core component of our business strategy.
Our long-term strategy remains centered on driving sustainable sales growth, continued business model improvements, building profitableCracker Barrel and MSBC stores, and ultimately driving shareholder returns. Fiscal 2022 included challenges from historically high commodity and wage inflation, COVID-19 case count resurgences and record gas prices in the second half of the fiscal year (adversely impacting consumers' discretionary income). While navigating these challenges, we focused our efforts on maintaining a strong value proposition, continued growth in our off-premise business, delivering continued strong retail sales, marketing and culinary innovation to grow average check through introduction of add-ons and menu enhancements, thoughtful expansion of MSBC, and store-level operational excellence. While our overall performance was not where we expected at the outset of the fiscal year, and macro challenges worsened as the year progressed, we made significant progress on many of our key business initiatives, and we continued our focus on generating shareholder returns by paying$4.90 per share in dividends for fiscal 2022 and declaring a dividend of$1.30 per share that was subsequently paid onAugust 5, 2022 to shareholders of record onJuly 15, 2022 , totaling$143,744 dividends declared or paid in 2022, and repurchasing$131,542 in shares of our common stock.
Key Performance Indicators
Management uses a number of key performance measures to evaluate our operational and financial performance, including the following:
• Comparable store restaurant sales increase/(decrease): To calculate comparable
store restaurant sales increase/(decrease), we determine total restaurant sales
of stores open at least six full quarters before the beginning of the
applicable period, measured on comparable calendar weeks. We then subtract
total comparable store restaurant sales for the current year period from total
comparable store restaurant sales for the applicable historical period to
calculate the absolute dollar change. To calculate comparable store restaurant
sales increase/(decrease), which we express as a percentage, we divide the
absolute dollar change by the comparable store restaurant sales for the historical period.
• Comparable store average restaurant sales: To calculate comparable store
average restaurant sales, we determine total restaurant sales of stores open at
least six full quarters before the beginning of the applicable period, measured
on comparable calendar weeks, and divide by the number of comparable stores for
the applicable period.
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• Comparable store retail sales increase/(decrease): To calculate comparable
store retail sales increase/(decrease), we determine total retail sales of
stores open at least six full quarters before the beginning of the applicable
period, measured on comparable calendar weeks. We then subtract total
comparable store retail sales for the current year period from total comparable
store retail sales for the applicable historical period to calculate the
absolute dollar change. To calculate comparable store retail sales
increase/(decrease), which we express as a percentage, we divide the absolute
dollar change by the comparable store retail sales for the historical period.
• Comparable store retail average weekly sales: To calculate comparable store
average retail sales, we determine total retail sales of stores open at least
six full quarters before the beginning of the applicable period, measured on
comparable calendar weeks, and divide by the number of comparable stores for
the applicable period.
• Comparable restaurant guest traffic increase/(decrease): To calculate
comparable restaurant guest traffic increase/(decrease), we determine the
number of entrees sold in our dine-in and off-premise business from stores open
at least six full quarters at the beginning of the applicable period, measured
on comparable calendar weeks. We then subtract total entrees sold for the
current year period from total entrees sold for the applicable historical
period to calculate the absolute numerical change. To calculate comparable
restaurant guest traffic increase/(decrease), which we express as a percentage,
we divide the absolute numerical change by the total entrees sold for the
historical period.
• Average check increase per guest: To calculate average check per guest, we
determine comparable store restaurant sales, as described above, and divide by
comparable guest traffic (as described above). We then subtract average check
per guest for the current year period from average check per guest for the
applicable historical period to calculate the absolute dollar change. The
absolute dollar change is divided by the prior year average check number to
calculate average check increase per guest, which we express as a percentage.
These performance indicators exclude the impact of new store openings and sales
related to MSBC and Holler & Dash Biscuit HouseTM ("Holler & Dash"), since we
acquired MSBC in the first quarter of 2020 and converted our Holler & Dash
locations into MSBC locations.
We use comparable store sales metrics as indicators of sales growth to evaluate
how our established stores have performed over time. We use comparable
restaurant guest traffic increase/(decrease) to evaluate how established stores
have performed over time, excluding growth achieved through menu price and sales
mix change. Finally, we use average check per guest to identify trends in guest
preferences, as well as the effectiveness of menu changes. We believe these
performance indicators are useful for investors to provide a consistent
comparison of sales results and trends across comparable periods within our
core, established store base, unaffected by results of store openings, closings,
and other transitional changes.
COVID-19 Impact and Company Response
During 2022, the Company continued to recover from the COVID-19 pandemic
(notwithstanding new variant outbreaks), and all dining rooms were open to some
extent during 2022. While all our dining rooms are currently operating without
COVID-19-related restrictions, it is possible that renewed outbreaks or
increases in cases and/or further new variants of the disease, either as part of
a national trend or on a more localized basis, could result in COVID-19-related
restrictions including capacity restrictions or otherwise limit our dine-in
services, or negatively affect consumer demand.
In response to the COVID-19 pandemic, we instituted operational protocols to
comply with applicable regulatory requirements to protect the health and safety
of employees and guests, and we implemented and continually adapted a number of
strategies to support the recovery of our business and navigate through the
uncertain environment. We continue to focus on growing our off-premise business
and investing in our digital infrastructure to improve the guest experience in
the face of these ongoing challenges.
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Restaurant and
Our stores operate in both the restaurant and retail industries inthe United States . The restaurant and retail industries are highly competitive with respect to quality, variety and price of the food products, availability of carryout and home delivery, internet and mobile ordering capabilities and retail merchandise offered. We compete with a significant number of national and regional restaurant and retail chains. Additionally, there are many segments within the restaurant industry, such as family dining, casual dining, full-service, fast casual and quick service, which often overlap and provide competition for widely diverse restaurant concepts.Cracker Barrel primarily operates in the full-service segment of the restaurant industry, and our growing MSBC concept operates in the fast casual segment. Competition also exists in securing prime real estate locations for new stores, in hiring qualified employees, in advertising, in the attractiveness of facilities and with competitors having similar menu offerings or convenience features. The restaurant and retail industries are often affected by changes in consumer taste and preference; national, regional or local economic conditions; demographic trends; traffic patterns; the type, number and location of competing restaurants and retailers; and consumers' discretionary purchasing power. Additionally, economic, seasonal and weather conditions affect the restaurant and retail industries. Adverse economic conditions and unemployment rates affect consumer discretionary income and dining and shopping habits. Historically, interstate tourist traffic and the propensity to dine out have been much higher during the summer months, thereby contributing to higher profits in our fourth quarter. Retail sales, which are made substantially to our restaurant guests, are historically strongest in the second quarter, which includes the holiday shopping season. Severe weather events such as hurricanes, floods, tornadoes, and winter storms may prevent or dissuade guests from visiting our stores, impair our ability to staff our stores or force us to temporarily close affected stores, adversely impacting our restaurant and retail sales. Additionally, severe drought conditions (such as the severe drought affecting much of the southwesternUnited States ) and associated restrictions on water use may impair restaurant operations or increase costs in locations affected by such conditions. Climate change, changing weather patterns or unpredictable weather patterns may increase the incidence of any of these events and otherwise also impact guest visitation patterns on a macro scale. In addition to its impact on store operations, severe weather may also disrupt our supply chain, both in distribution to ports and central warehouses and in distribution to local stores. In general, we believe that the geographic dispersion of our stores and multiple sources of distribution adequately mitigate the potential impact of severe weather and changing weather patterns on our stores, but our board of directors and management team continually monitor and reexamine these considerations in light of ongoing trends. RESULTS OF OPERATIONS
The following table highlights operating results over the past three years:
Relationship to Total Revenue
2022 2021 2020
Total revenue 100.0 % 100.0 % 100.0 %
Cost of goods sold (exclusive of depreciation and rent) 32.1 30.7 30.9
Labor and other related expenses 35.2 34.8 36.7
Other store operating expenses 23.2 24.0 24.4
General and administrative 4.8 5.2 5.8
Gain on sale and leaseback transactions - (7.7 ) (2.8 )
Impairment - - 0.9
Operating income 4.7 13.0 4.1
Interest expense 0.3 2.0 0.9
Income before income taxes 4.4 11.0 3.2
Provision for income taxes (income tax benefit) 0.4 2.0 (1.1 )
Net loss from unconsolidated subsidiary - - (5.6 )
Net income (loss) 4.0 9.0 (1.3 )
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Total Revenue
The following table highlights the key components of revenue for the past three
years:
2022 2021 2020
Revenue in dollars(1):
Restaurant $ 2,565,628 $ 2,227,246 $ 2,032,030
Retail 702,158 594,198 490,762
Total revenue $ 3,267,786 $ 2,821,444 $ 2,522,792
Total revenue percentage increase (decrease) 15.8 % 11.8 % (17.9 %)
Total revenue by percentage relationships:
Restaurant 78.5 % 78.9 % 80.5 %
Retail 21.5 % 21.1 % 19.5 %
Comparable number of stores 659 655 646
Comparable store sales averages per store: (1)
Restaurant $ 3,804 $ 3,312 $ 3,065
Retail 1,052 890 737
Total $ 4,856 $ 4,202 $ 3,802
Restaurant average weekly sales (2) $ 72.9 $ 63.4 $ 58.4
Retail average weekly sales (2) 20.3 17.2 14.3
Average check increase 7.0 % 3.1 % 2.7 %
Comparable restaurant guest traffic
increase/(decrease) (3) 8.0 % 5.3 % (21.6 %)
(1) Comparable store averages exclude MSBC and Holler & Dash. (2) Average weekly sales are calculated by dividing net sales by operating weeks and include all stores except for MSBC and Holler & Dash. (3) Comparable store sales and traffic consist of sales of stores open at least six full quarters at the beginning of the period and are measured on comparable calendar weeks. Comparable store sales and traffic exclude MSBC and Holler & Dash. Total revenue benefited from the opening of seven new MSBC units in 2022, two new units for bothCracker Barrel and MSBC in 2021, and four newCracker Barrel units and one new MSBC unit in 2020, partially offset by the closing of oneCracker Barrel unit in 2021 and one unit each forCracker Barrel and Holler & Dash in 2020. Additionally, in the fourth quarter of 2022, the Company acquired direct ownership of MSBC's seven franchised units from their respective franchisees. During 2020 and 2021, the COVID-19 pandemic negatively impacted our sales and traffic as a result of both changes in consumer behavior and federal, state and local governmental authorities' continuation of various restrictions on travel, group gatherings and dine-in services. Dining room service was operational to varying degrees, yet most locations were impacted at times by capacity restrictions, social distancing guidelines, and decreased consumer demand for in-person dining. In 2022, the Company continued to recover from the COVID-19 pandemic; however, we believe outbreaks of new variants adversely impacted consumer demand in 2022. All dining rooms were open to some extent during 2022 and most dining rooms operated with few, if any, restrictions. Going forward it is possible that renewed outbreaks, increases in cases and/or new variants of the disease, either as part of a national trend or on a more localized basis, could result in COVID-19-related restrictions including capacity restrictions or otherwise limit our dine-in services, or negatively affect consumer demand. The following table highlights comparable store sales* results over the past two years: Period to Period Increase (Decrease) 2022 vs 2021 2021 vs 2020 (659 Stores) (655 Stores) Restaurant 15.0 % 8.4 % Retail 18.2 20.9 Restaurant & Retail 15.7 % 10.8 %
*Comparable store sales consist of sales of stores open at least six full quarters at the beginning of the year, are measured on comparable calendar weeks and exclude MSBC and Holler & Dash.
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Our comparable store restaurant sales increase in 2022 as compared to 2021 resulted from an average check increase of 7.0% (including a 5.9% average menu price increase) and an increase in guest traffic of 8.0%.
Our comparable store restaurant sales increase in 2021 as compared to 2020 resulted from an average check increase of 3.1% (including a 2.1% average menu price increase) and an increase in guest traffic of 5.3%.
Our retail sales are made substantially to our restaurant guests. The increase in our comparable store retail sales in 2022 as compared to 2021 resulted primarily from the guest traffic increase and strong performance in the apparel and accessories, food and convenience, toys, décor, and bed and bath merchandise categories. The increase in our comparable store retail sales in 2021 as compared to 2020 resulted primarily from the guest traffic increase and strong performance in the toys, apparel and accessories, food and convenience and décor merchandise categories.
Cost of Goods Sold (Exclusive of Depreciation and Rent)
The following table highlights the components of cost of goods sold in dollar amounts for the past three years:
2022 2021 2020
Cost of Goods Sold:
Restaurant $ 706,125 $ 567,825 $ 515,663
Retail 343,759 297,436 264,274
Total Cost of Goods Sold $ 1,049,884 $ 865,261 $ 779,937 The following table highlights restaurant cost of goods sold as a percentage of restaurant revenue for the past three years:
2022 2021 2020
Restaurant Cost of Goods Sold 27.5 % 25.5 % 25.4 %
The increase in restaurant cost of goods sold as a percentage of restaurant revenue in 2022 as compared to 2021 was primarily the result of commodity inflation of 13.1% partially offset by our menu price increase referenced above.
The increase in restaurant cost of goods sold as a percentage of restaurant revenue in 2021 as compared to 2020 was primarily the result of commodity inflation of 2.4% partially offset by lower food waste and a decrease in employee discounts. Lower food waste and the decrease in employee discounts both accounted for decreases of 0.1%.
We continue to partially offset inflationary pressures through menu price increases and operational improvements, and we presently expect the rate of commodity inflation to be approximately 8% in 2023 as compared to 13.1% in 2022.
The following table highlights retail cost of goods sold as a percentage of retail revenue for the past three years:
2022 2021 2020
Retail Cost of Goods Sold 49.0 % 50.1 % 53.8 %
2022 Compared to 2021
(Decrease) Increase as a
Percentage of Total Revenue
Markdowns (1.4 %)
Provision for obsolete inventory 0.4 %
The decrease in retail cost of goods sold as a percentage of retail revenue in 2022 as compared to 2021 resulted primarily from lower markdowns partially offset by the change in the provision for obsolete inventory.
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2021 Compared to 2020
(Decrease) Increase as a
Percentage of Total Revenue
Markdowns (2.9 %)
Higher initial margin (0.3 %)
Freight expense (0.3 %)
Provision for obsolete inventory (0.2 %)
Inventory shrinkage (0.2 %)
Discounts and allowances 0.2 %
The decrease in retail cost of goods sold as a percentage of retail revenue in
2021 as compared to 2020 resulted from lower markdowns, higher initial margin,
lower freight expense, the change in the provision for obsolete inventory and
lower inventory shrinkage partially offset by an increase in discounts and
allowances.
Labor and Other Related Expenses
Labor and other related expenses include all direct and indirect labor and related costs incurred in store operations. The following table highlights labor and other related expenses as a percentage of total revenue for the past three years:
2022 2021 2020
Labor and other related expenses 35.2 % 34.8 % 36.7 %
The year-to-year percentage change in 2022 as compared to 2021 resulted from the
following:
2022 Compared to 2021
Increase (Decrease) as a
Percentage of Total Revenue
Store hourly labor 1.1 %
Store management expenses (0.7 %)
The increase in store hourly labor in 2022 as compared to 2021 as a percentage
of total revenue resulted primarily from wage inflation exceeding menu price
increases and lower productivity, i.e., fewer guests served per labor hours
incurred. In addition to menu price increases, we continue to partially offset
inflationary pressures through labor productivity initiatives, and we presently
expect the rate of wage inflation to be approximately 5% in 2023.
The decrease in store management expenses as a percentage of total revenue in
2022 as compared to 2021 was primarily driven by lower bonus expense in 2022 and
the increase in total revenue in 2022 partially offset by wage inflation. The
lower bonus expense resulted from lower performance against financial objectives
for certain components of the incentive plan in 2022 as compared to 2021.
The year-to-year percentage change in 2021 as compared to 2020 resulted
primarily from the following:
2021 Compared to 2020
(Decrease) Increase as a
Percentage of Total Revenue
Store management compensation (1.5 %)
Miscellaneous wages (0.8 %)
Employee health care expenses (0.2 %)
Store bonus expense (0.1 %)
co hourly labor 0.8 %
In general, during 2021 as compared to 2020, certain expenses as a percentage of
total revenue materially decreased as a function of the significant increase in
total revenue and increased operations. In particular, the decreases in store
management compensation, miscellaneous wages, and store bonus expense as a
percentage of total revenue in 2021 as compared to 2020 were primarily driven by
the increases in total revenue in 2021.
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Lower employee health care expenses as a percentage of total revenue in 2021 as compared to 2020 resulted primarily from both lower claims activity and the increase in total revenue in 2021.
The increase in store hourly labor in 2021 as compared to 2020 as a percentage of total revenue resulted primarily from wage inflation exceeding menu price increases.
Other Store Operating Expenses
Other store operating expenses include all store-level operating costs, the
major components of which are operating supplies, repairs and maintenance,
utilities, depreciation and amortization, advertising, rent, credit card and
gift card fees, real and personal property taxes and general insurance. The
following table highlights other store operating expenses as a percentage of
total revenue for the past three years:
2022 2021 2020
Other store operating expenses 23.2 % 24.0 % 24.4 %
The year-to-year percentage change in 2022 as compared to 2021 resulted primarily from the following:
2022 Compared to 2021
(Decrease) Increase as a
Percentage of Total Revenue
Depreciation (0.6 %)
Rent (0.3 %)
Advertising (0.2 %)
Maintenance 0.2 %
Other store expenses 0.2 %
The decreases in depreciation expense, rent and advertising expenses as a percentage of total revenue for 2022 as compared to 2021 were primarily driven by the increase in total revenue in 2022.
The increase in maintenance expense as a percentage of total revenue for 2022 as
compared to 2021 resulted primarily from higher expenditures, which were the
result of increased repair costs associated with limited availability of
replacement equipment.
The increase in other store expenses as a percentage of total revenue for 2022
as compared to the same period in the prior year resulted primarily from costs
associated with the expansion of our off-premise business.
The year-to-year percentage change from 2021 as compared to 2020 resulted from
the following:
2021 Compared to 2020
(Decrease) Increase as a
Percentage of Total Revenue
Depreciation (0.8 %)
Real and personal property taxes (0.2 %)
Utilities (0.1 %)
Pre-opening expenses (0.1 %)
Loss on asset disposition (0.1 %)
Advertising (0.1 %)
Rent 0.6 %
Other store expenses 0.4 %
In general, during 2021 as compared to 2020, certain expenses as a percentage of
total revenue materially decreased by the significant increase in total revenue
and increased operations. In particular, the decreases in depreciation expense,
real and personal property taxes, and advertising expense as a percentage of
total revenue for 2021 as compared to 2020 were primarily driven by the increase
in total revenue in 2021.
The decrease in utilities expense as a percentage of total revenue for 2021 as
compared to 2020 was primarily driven by the increase in total revenue in 2021
partially offset by higher natural gas, electricity, and water rates.
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The decrease in pre-opening expenses as a percentage of total revenue for 2021 as compared to 2020 resulted primarily from the timing of new store openings.
The decrease in loss on asset disposition as a percentage of total revenue for 2021 as compared to 2020 resulted primarily from increased repair and maintenance activity for equipment as opposed to asset disposal.
The increase in rent expense as a percentage of total revenue for 2021 as compared to 2020 resulted primarily from the sale and leaseback transaction involving 62 of our ownedCracker Barrel stores completed onAugust 4, 2020 . The aggregate initial annual rent payment for these properties is approximately$10,393 . Additionally, the related rent expense includes$12,735 recorded in 2021 for the non-cash amortization of the asset recognized from the gain on the Company's sale and leaseback transactions. See Note 9 to the Consolidated Financial Statements for additional information regarding the Company's sale and leaseback transactions.
General and Administrative Expenses
The following table highlights general and administrative expenses as a percentage of total revenue for the past three years:
2022 2021 2020
General and administrative expenses 4.8 % 5.2 % 5.8 %
The year-to-year percentage change in 2022 as compared to 2021 resulted from
lower incentive compensation. The decrease in incentive compensation as a
percentage of total revenue in 2022 as compared to 2021 was primarily the result
of lower performance against financial objectives in 2022 as compared to 2021.
The year-to-year percentage change in 2021 as compared to 2020 resulted from the
following:
2021 Compared to 2020
(Decrease) Increase as a
Percentage of Total Revenue
Payroll and related expenses (0.5 %)
Professional fees (0.2 %)
Depreciation expense (0.1 %)
Travel expense (0.1 %)
Incentive compensation expense 0.3 %
The decreases in payroll and related expense and travel expense as a percentage
of total revenue in 2021 as compared to 2020 were primarily driven by cost
savings initiatives implemented in response to the COVID-19 pandemic and the
increase in total revenue in 2021.
The decrease in professional fees as a percentage of total revenue in 2021 as
compared to 2020 was primarily driven by lower fees related to sale and
leaseback transactions partially offset by additional proxy expenses related to
the proxy contest initiated by affiliates of Sardar Biglari in connection with
the Company's 2020 annual shareholders meeting held on November 19, 2020 . The
reduction in total professional fees as a percentage of total revenue in 2021
was the result of higher fees associated with the initial sale and leaseback
transaction in the fourth quarter of 2020, when compared to the 2021 sale and
leaseback transactions and additional professional fees related to the proxy
contest in connection with the 2020 annual meeting of shareholders (held in the
second fiscal quarter of 2021).
The decrease in depreciation expense as a percentage of total revenue in 2021 as compared to 2020 was primarily driven by the increase in total revenue in 2021.
The increase in incentive compensation as a percentage of total revenue in 2021
as compared to 2020 was primarily driven by better performance against financial
objectives in 2021 as compared to 2020.
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Gain on Sale and Leaseback Transactions
OnJuly 29, 2020 , we entered into a sale and leaseback transaction involving 64 of our ownedCracker Barrel properties and recorded a gain of$69,954 . OnAugust 4, 2020 , we entered into a second sale and leaseback transaction involving 62 of our ownedCracker Barrel stores and recorded a gain of$217,722 . See Note 9 to the Consolidated Financial Statements for additional information regarding these sale and leaseback transactions.
Impairment
During the third and fourth quarters of 2020, we determined that certainCracker Barrel and MSBC locations were impaired, resulting in impairment charges of$22,496 . These locations were impaired because of declining operating performance and resulting negative cash flow projections as a result of the impact of the COVID-19 pandemic. The Company did not incur similar impairment charges in 2022 or 2021. It is possible that we may recognize future additional impairment charges as a result of the unknown impacts of the COVID-19 pandemic and our response or for other business reasons.
Interest Expense
The following table highlights interest expense for the past three years:
2022 2021 2020
Interest expense $ 9,620 $ 56,108 $ 22,327
The year-to-year decrease in 2022 as compared to 2021 resulted primarily from
lower weighted average debt levels, lower weighted average interest rates and
the prior year including costs associated with the termination of the Company's
interest rate swaps.
The year-to-year increase in 2021 as compared to 2020 resulted primarily from
the costs associated with termination of interest rate swaps, higher weighted
average debt levels caused by our borrowing under our 2019 Revolving Credit
Facility in response to the COVID-19 pandemic, higher weighted average interest
rates, and the cessation of interest income on Punch Bowl Social ("PBS")
promissory notes written off in the third quarter of 2020. Additionally, as
part of our amendment to the 2019 Revolving Credit Facility in the third quarter
of 2021, we incurred additional interest expense of $452 related to the
write-off of deferred financing costs and we incurred interest expense of $768
related to the amortization of the original issue discount on our Notes.
Provision for Income Taxes (Income Tax Benefit)
The following table highlights the provision for income taxes (income tax benefit) as a percentage of income before income taxes ("effective tax rate") for the past three years:
2022 2021 2020
Effective tax rate 8.0 % 18.0 % (35.3 %)
The decrease in our effective tax rate in 2022 as compared to 2021 is primarily the result of the decrease in income before income tax and the benefit of higher income tax credits. The increase in our effective tax rate in 2021 as compared to 2020 is primarily the result of the increase in income before income tax.
We presently expect our effective tax rate for 2023 to be approximately 10% to 15%.
LIQUIDITY AND CAPITAL RESOURCES
The following table presents a summary of our cash flows for the last three years:
2022 2021 2020
Net cash provided by operating activities $ 205,253 $ 301,903 $ 161,002
Net cash provided by (used in) investing activities (98,499 ) 78,330 (157,226 )
Net cash provided by (used in) financing activities (206,242 ) (672,636 ) 396,336
Net increase (decrease) in cash and cash equivalents $ (99,488 ) $ (292,403 ) $ 400,112
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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 atJuly 30, 2021 and borrowings under our revolving credit facility, were sufficient to finance all of our growth, share repurchases, dividend payments, working capital needs, interest payments on long-term debt obligations and other cash payment obligations in 2022. We believe that cash atJuly 29, 2022 , along with cash expected to be generated from our operating activities and the borrowing capacity under our revolving credit facility, will be sufficient to finance our continuing operations, our continuing expansion plans, debt service, dividend payments, share repurchases and working capital needs for the next twelve months. Furthermore, we believe that cash expected to be generated from our operating activities and the borrowing capacity under our revolving credit facility will be sufficient to finance our continuing operations, capital expenditures, interest expense on long-term debt obligations, operating lease obligations, continuing expansion plans, share repurchases and working capital needs beyond the next twelve months. A summary of our contractual cash obligations and commitments as ofJuly 29, 2022 , is as follows: Payments due by Years Contractual Obligations (a) Total 2023 2024-2025 2026-2027 After 2027 2022 Revolving Credit Facility (b)$ 130,000 $ - $ -$ 130,000 $ - Convertible Debt (c) 307,500 1,875 3,750 301,875 - Leases (d) 1,187,392 90,446 135,474 128,985 832,487 Purchase obligations (e) 79,280 68,364 9,625 1,291 - Other long-term obligations (f) 33,946 -- 3,887 50 30,009 Total contractual cash obligations$ 1,738,118 $ 160,685 $ 152,736 $ 562,201 $ 862,496 Amount of Commitment Expirations by Years Total 2023 2024-2025 2026-2027 After 2027 2022 Revolving Credit Facility(b)$ 700,000 $ - $ -$ 700,000 $ - Convertible Debt (c) 300,000 - - 300,000 - Standby letters of credit(g) 31,896 - 31,896 - - Total commitments$ 1,031,896 $ -$ 31,896 $ 1,000,000 $ -
(a) At
penalties and interest) is classified as a long-term liability. At this
time, we are unable to make a reasonably reliable estimate of the amounts and
timing of payments in individual years because of uncertainties in the timing
of the effective settlement of tax positions. As such, the liability for
uncertain tax positions of
obligations and commitments table above.
(b) Our 2022 Revolving Credit Facility expires on
weighted average interest rate of 3.49% and the outstanding borrowings at
outstanding borrowings and our standby letters of credit at
our current unused commitment fee as defined in the 2022 Revolving Credit
Facility, our unused commitment fees in 2023, 2024-2025 and 2026-2027 would
be
differ based on actual usage of the 2022 Revolving Credit Facility.
(c) Our $300,000 aggregate principal amount of 0.625% Convertible Senior Notes mature onJune 15, 2026 . The Notes bear cash interest at an annual rate of 0.625%, payable semi-annually in arrears onJune 15 andDecember 15 of each year. (d) Includes base lease terms and certain optional renewal periods for which, at
the inception of the lease, it is reasonably certain that we will exercise.
(e) Purchase obligations consist of purchase orders for food and retail
merchandise; purchase orders for capital expenditures, supplies, other
operating needs and other services; and commitments under contracts for
maintenance needs and other services. We have excluded contracts that do not
contain minimum purchase obligations. We excluded long-term agreements for
services and operating needs that can be cancelled within 60 days without
penalty. We included long-term agreements and certain retail purchase orders
for services and operating needs that can be cancelled with more than 60
days' notice without penalty only through the term of the notice. We
included long-term agreements for services and operating needs that only can
be cancelled in the event of an uncured material breach or with a penalty
through the entire term of the contract. Because of the uncertainties of
seasonal demands and promotional calendar changes, our best estimate of usage
for food, supplies and other operating needs and services is ratably over
either the notice period or the remaining life of the contract, as
applicable, unless we had better information available at the time related to
each contract.
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(f) Other long-term obligations include our Non-Qualified Savings Plan (
with a corresponding long-term asset to fund the liability; see Note 12 to
the Consolidated Financial Statements), Deferred Compensation Plan (
and our long-term incentive plans (
(g) Our standby letters of credit relate to securing reserved claims under
workers' compensation insurance and securing certain sale and leaseback
transactions. Our standby letters of credit reduce our borrowing availability
under our revolving credit facility.
Cash Generated from Operations
The decrease in net cash flow provided by operating activities in 2022 as compared to 2021 primarily reflected higher retail inventory, the timing of payments for certain taxes and higher bonus payments made in 2022 as a result of the prior year's performance. The higher retail inventory in 2022 as compared to 2021 was driven by unusually low retail inventory in 2021 resulting from market constraints on the availability of goods. The increase in net cash flow provided by operating activities in 2021 as compared to 2020 primarily reflected the timing of payments for accounts payable and certain taxes and lower bonus payments made in 2021 as a result of the prior year impact of the COVID-19 pandemic on our operations in 2020.
Capital Expenditures and Proceeds from Sale of Property and Equipment
The following table presents our capital expenditures (purchase of property and equipment), net of proceeds from insurance recoveries, for the last three years:
2022 2021 2020
Capital expenditures, net of proceeds from insurance recoveries$ 97,104 $ 70,130 $ 296,008 Our capital expenditures consisted primarily of capital investments for existing stores, new store locations and strategic initiatives. The increase in capital expenditures in 2022 from 2021 resulted primarily from higher capital expenditures for existing stores and an increase in the number of new store locations partially offset by lower capital expenditures for strategic initiatives. OnJuly 29, 2020 , we entered into an agreement with the original lessor and a third-party financier to obtain ownership of 64Cracker Barrel properties and simultaneously entered into a sale and leaseback transaction with the financier. The decrease in capital expenditures in 2021 from 2020 resulted primarily from a similar transaction in 2021 as well as decreases in new store construction, store remodels and other similar cost-saving measures in response to the COVID-19 pandemic and lower capital expenditures for existing stores partially offset by higher capital expenditures for strategic initiatives. We estimate that our capital expenditures during 2023 will be approximately$125,000 . This estimate includes existing store maintenance and aging equipment replacement, the acquisition of sites and construction costs of three to four newCracker Barrel stores and fifteen to twenty MSBC locations that we plan to open during 2023, as well as acquisition and construction costs for store locations to be opened in 2024, investments in digital and technology infrastructure and the development of a loyalty program. We intend to fund our capital expenditures with cash generated by operations and cash on hand as the result of borrowings under our revolving credit facility, as necessary. The following table presents our proceeds from sale of property and equipment for the last three years: 2022 2021 2020
Proceeds from sale of property and equipment
In 2021 and 2020, we completed sale and leaseback transactions. The decrease in proceeds from sale of property and equipment in 2022 from 2021 resulted from the sale and leaseback transaction in 2021. The decrease in proceeds from sale of property and equipment in 2021 from 2020 primarily relates to the proceeds from theAugust 4, 2020 sale and leaseback transactions being lower than theJuly 29, 2020 sale and leaseback transaction. See Note 9 to the Consolidated Financial Statements for additional information regarding our sale and leaseback transactions. 41
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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, if any. The first installment of$1,500 , to be held as security, was paid to the principal seller in the first quarter of 2021, and the second installment of$1,500 was paid to the principal seller in the first quarter of 2022. We also incurred acquisition-related costs of$1,269 . During 2020, we converted our six Holler & Dash locations into MSBC locations. 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.
Punch Bowl Social
EffectiveJuly 18, 2019 , we entered into a strategic relationship withPBS , a food, beverage and entertainment concept, by purchasing a non-controlling equity interest in the concept. ThePBS concept was developed to focus on made-from-scratch food, a craft beverage program and social gaming. At the time of our investment, we believed the investment inPBS would provide a growth vehicle to deliver additional shareholder value and extend our footprint into a complementary market segment. During the onset of the COVID-19 pandemic; however, PBS Holdco's wholly-owned subsidiary and principal operating company,PBS BrandCo, LLC ("Brandco") suffered unsustainable disruption to its business across the chain and suspended all operations. OnMarch 20, 2020 , the primary lender under Brandco's secured credit facility ("Lender") provided notice of the Lender's intention to foreclose on its collateral interest in Brandco unlessCracker Barrel repaid or unconditionally guaranteed the indebtedness. For reasons previously disclosed in our public filings, we determined not to invest further resources to prevent foreclosure or otherwise provide additional capital toPBS and recorded a non-cash impairment charge on our investment of$132,878 . During the course of the pandemic, the Lender unsuccessfully sought a buyer for Brandco and its assets, culminating in Brandco filing a petition for reorganization under Chapter 11 of the United States Bankruptcy Code inDecember 2020 . InApril 2021 , theUnited States Bankruptcy Court for the District ofDelaware approved a plan of liquidation of Brandco, pursuant to which the Lender purchased Brandco and certain of its assets and liabilities for a purchase price of approximately$32,000 , none of which proceeds were attributable to the Company's interest inPBS . Following the completion of this sale transaction, the Company's remaining interest inPBS was determined to have no remaining value.
Borrowing Capacity, Debt Covenants and Notes
OnJune 17, 2022 , we entered into a five-year$700,000 revolving credit facility (the "2022 Revolving Credit Facility") with substantially the same terms and financial covenants as our previous amended$800,000 revolving credit facility (the "2019 Revolving Credit Facility"). The 2022 Revolving Credit Facility also contains an option for the Company to increase the revolving credit facility by$200,000 . The following table highlights our borrowing capacity and outstanding borrowings under the 2022 Revolving Credit Facility, our standby letters of credit and our borrowing availability under the 2022 Revolving Credit Facility as ofJuly 29, 2022 :July 29, 2022 Borrowing capacity under the 2022 Revolving Credit Facility $
700,000
Less: Outstanding borrowings under the 2022 Revolving Credit Facility
130,000
Less: Standby letters of credit*
31,896
Borrowing availability under the 2022 Revolving Credit Facility $
538,104
*Our standby letters of credit relate to securing reserved claims under workers' compensation insurance and securing certain sale and leaseback transactions. Our standby letters of credit reduce our borrowing availability under the 2022 Revolving Credit Facility. During 2022, in addition to the refinancing of the revolving credit facility, we borrowed$100,000 and repaid$55,000 of borrowings under the 2019 Revolving Credit Facility. During 2021, we repaid$924,395 under the 2019 Revolving Credit Facility and borrowed an additional$60,000 under the 2019 Revolving Credit Facility. During 2020, we borrowed$801,395 under the 2019 Revolving Credit Facility to fund our dividend payments, acquisition of MSBC, other working capital needs and to provide flexibility as a result of the uncertainty caused by the COVID-19 pandemic. During 2020, we repaid$252,000 of the borrowings. 42
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Our 2022 Revolving Credit Facility contains customary financial covenants, which include maintenance of a maximum consolidated total senior secured leverage ratio and a minimum consolidated interest coverage ratio. We were in compliance with the 2022 Revolving Credit Facility's financial covenants atJuly 29, 2022 , and we expect to be in compliance with the 2022 Revolving Credit Facility's financial covenants for the remaining term of the facility. OnJune 18, 2021 , the Company entered into an issuance and sale of$300,000 aggregate principal amount of 0.625% Convertible Senior Notes due 2026. The Notes are senior, unsecured obligations of the Company and bear cash interest at a rate of 0.625% per annum, payable semi-annually in arrears onJune 15 andDecember 15 of each year, beginning onDecember 15, 2021 . The Notes mature onJune 15, 2026 , unless earlier converted, repurchased or redeemed. Net proceeds from the Notes were$291,125 , after deducting the initial purchasers' discounts and commissions and the Company's offering fees and expenses. In connection with the issuance of the Notes, the Company entered into privately negotiated convertible note hedge transactions (the "Convertible Note Hedge Transactions") with certain of the initial purchasers of the Notes and/or their respective affiliates and other financial institutions (in this capacity, the "Hedge Counterparties"), which cover, subject to customary anti-dilution adjustments, the aggregate number of shares of the Company's common stock that initially underlie the Notes. Concurrently with the Company's entry into the Convertible Note Hedge Transactions, the Company also entered into separate, privately negotiated warrant transactions with the Hedge Counterparties collectively relating to the same number of shares of the Company's common stock underlying the Notes, subject to customary anti-dilution adjustments, and for which the Company received premiums that partially offset the cost of entering into the Convertible Note Hedge Transactions (the "Warrant Transactions"). The portion of the net proceeds to the Company from the offering of the Notes that was used to pay the premium on the Convertible Note Hedge Transactions, net of the proceeds to the Company from the Warrant Transactions, was approximately$30,300 .
See Note 5 to our Consolidated Financial Statements for further information on our long-term debt.
Dividends, Share Repurchases and Share-Based Compensation Awards
Our 2022 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 2022 Revolving Credit Facility, provided there is no default existing and the total of our availability under the 2022 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 senior secured leverage ratio is 2.75 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 2.75 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. In 2022, we paid regular dividends of$4.90 per share and declared a dividend of$1.30 per share that was subsequently paid onAugust 5, 2022 to shareholders of record onJuly 15, 2022 of$1.30 per share. In 2021, in order to preserve available cash during the COVID-19 pandemic and in light of the uncertainties as to its duration and economic impact, we deferred the payment of the dividend of$1.30 per share declared in the third quarter of 2020 untilSeptember 2, 2020 to shareholders of record onAugust 14, 2020 and temporarily suspended future dividend payments. In the fourth quarter of 2021, in light of the ongoing recovery from the COVID-19 pandemic, our Board of Directors resumed our dividend program. The following table highlights the dividends per share we paid for the last three years: 2022 2021 2020 Dividends per share paid$ 4.90 $ 1.30 $ 3.90 43
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Our criteria for share repurchases are that they be accretive to expected net income per share and are within the limits imposed by our debt commitments.
In
2020, in response to the COVID-19 pandemic, we temporarily suspended all share repurchases until the fourth quarter of 2021. Subject to the limits imposed by our revolving credit facility, inSeptember 2021 , we were authorized by our Board of Directors to repurchase shares at the discretion of management up to$100,000 . In the fourth quarter of 2022, we were authorized by our Board of Directors to repurchase shares of the Company's outstanding common stock at management's discretion up to a total value of$200,000 ; this authorization replaced the previous unused portion of the previous$100,000 authorization.
The following table highlights our share repurchases for the last three years:
2022 2021 2020
Shares of common stock repurchased 1,248,184 232,543 378,974
Cost of shares repurchased $ 131,542 $ 35,000 $ 55,007
Working Capital
In the restaurant industry, substantially all sales are either for cash or
third-party credit card. Like many other restaurant companies, we are able to,
and often do, operate with negative working capital. Restaurant inventories
purchased through our principal food distributor are on terms of net zero days,
while other restaurant inventories purchased locally are generally financed
through trade credit at terms of 30 days or less. Because of our gift shop,
which has a lower product turnover than the restaurant, we carry larger
inventories than many other companies in the restaurant industry. Retail
inventories are generally financed through trade credit at terms of 60 days or
less. These various trade terms are aided by 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.
The following table highlights our working capital deficit:
2022 2021 2020
Working capital (deficit) $ (185,048 ) $ (111,666 ) $ 191,956
The change in working capital at July 29, 2022 compared to July 30, 2021
primarily reflected the decrease in cash, higher accounts payable and the timing
of payments for income taxes partially offset by higher inventory levels. The
decrease in cash resulted primarily from higher share repurchases partially
offset by net borrowings under of revolving credit facility. The change in
working capital at July 30, 2021 compared to July 31, 2020 primarily reflected
the decrease in cash and timing of payments for certain taxes. The decrease in
cash resulted primarily from higher debt repayments partially offset by lower
capex spending, cash generated from operations and lower dividend payments.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
Recent Accounting Pronouncements Adopted
See Note 2 to the accompanying Consolidated Financial Statements for a discussion of recent accounting guidance adopted. The adoption of accounting guidance on income taxes discussed in Note 2 did not have a significant impact on our consolidated financial position or results of operations. See Note 2 regarding the impact of the adoption of the convertible instruments guidance. The adoption of the accounting guidance for convertible instruments discussed in Note 2 resulted in an increase in long-term debt of$49,242 , a reduction in deferred income taxes of$12,286 and a decrease in equity of$36,956 on the Consolidated Balance Sheet. 44
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CRITICAL ACCOUNTING ESTIMATES
We prepare our Consolidated Financial Statements in conformity with GAAP. 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. 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.
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 past three years 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 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 2020, we recorded impairment charges of approximately$23,000 due to the deterioration in operating performance of certainCracker Barrel and MSBC locations as a result of the impact of the COVID-19 pandemic. It is possible that we may recognize future additional impairment charges as a result of the impacts of the COVID-19 pandemic and our response.
Insurance Reserves
We self-insure a significant portion of our expected workers' compensation and general liability programs. We purchase insurance for individual workers' compensation claims that exceed$300 ,$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. 45
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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. We also 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 past three years 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 or management judgments 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.
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 past three years
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.
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 at the asset group level whenever events or
changes in circumstances indicate that the carrying value of the asset may not
be recoverable.
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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.
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