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 2020.
? Results of Operations - an analysis of our consolidated statements of income
(loss) for the three years presented in our Consolidated Financial Statements.
? 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.
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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. Each Cracker
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 of September 16, 2020 , the Company operated 663 Cracker Barrel
stores located in 45 states. Effective October 19, 2019 , the Company acquired
100% ownership of MSBC, a breakfast and lunch fast casual concept. As of
September 16, 2020 , the Company operated 35 owned MSBC locations, and there were
an additional six franchised locations open, located in seven states.
COVID-19 Impact and Company Response
InMarch 2020 , theWorld Health Organization declared the novel coronavirus ("COVID-19") to be a pandemic. In an effort to contain and mitigate the spread of COVID-19, federal, state and local governmental authorities have imposed unprecedented restrictions on travel, group gatherings and non-essential activities, such as "social distancing" guidance, shelter-in-place orders and limitations on or full prohibitions of dine-in services.
In response to the business disruption caused by the COVID-19 pandemic, we have taken the following actions.
Operating Initiatives In response to the COVID-19 pandemic and the orders and guidance fromU.S. federal and applicable state and local governmental authorities, inMarch 2020 , we temporarily closed the dining rooms in all of our restaurants and operated with pick-up and delivery only. In order to support our off-premise business model, we implemented various changes to ourCracker Barrel offerings, including, among other actions, offering a limited menu and multi-serving takeout family meal baskets, expanding third-party delivery services and implementing various operating model changes, including contactless curbside delivery. For a portion of the third quarter of 2020, all of our restaurant operations were limited to pick-up and delivery orders with no dine-in service. Thereafter, we were able to resume dine-in services at a limited number of restaurants. Our dine-in services have been and continue to be limited to occupancy levels well below capacity, and some locations are not currently open at all for dine-in service. As ofSeptember 16, 2020 , thirteen of our restaurants had not opened dine-in services to some extent. We have taken a cautious approach to reopening dining rooms and have instituted operational protocols to comply with applicable regulatory requirements and to monitor developing health authority recommendations in order to protect the health and foster the confidence of employees and guests. The adverse impacts of the COVID-19 pandemic resulted in us testing our restaurant long-lived assets for recoverability. As a result of this analysis, we recorded impairment charges of$22,496 due to the deterioration in operating performance of certainCracker Barrel and MSBC locations. Expense Reductions We have made significant reductions in operating expenses to reflect reduced operations and sales levels as well as eliminated non-essential spending where feasible. We furloughed employees and eliminated a significant number of positions at all levels both at the corporate headquarters and in the field. We recorded severance expenses of$3,956 related to the elimination of 469 Company positions in 2020. We also implemented pay reductions in the third quarter for the remainder of the fiscal year for corporate officers, reduced cash retainers payable to the Company's Board of Directors and temporarily suspended matches to our defined contribution plans through the end of fiscal 2020. Additionally, we adapted our labor model, instituted inventory management measures and negotiated revised terms with landlords and vendors.
Liquidity Initiatives
As a precautionary measure and in order to increase our cash position and provide financial flexibility given the uncertainty in the market caused by the COVID-19 pandemic, inMarch 2020 , we borrowed the remaining availability under our revolving credit facility (approximately$471,700 , including$6,700 of standby letters of credit) and, inMay 2020 , we exercised the accordion feature under the revolving credit facility in order to borrow an additional amount of$39,395 . 34 -------------------------------------------------------------------------------- Table of Contents To further preserve available cash, the payment of the dividend that was declared onMarch 3, 2020 was deferred untilSeptember 2, 2020 . On that date, we paid an aggregate amount of$30,807 in respect of the deferred dividend. Other than the payment of the deferred dividend, we have suspended all further dividend payments until further notice. We also temporarily suspended all share repurchases under our previously announced$25,000 share repurchase program. In keeping with our strategy of concentrating our resources on our core business during the COVID-19 pandemic, we decided not to invest further resources or otherwise provide additional funding toPBS HoldCo, LLC (see Note 3, "Equity Method Investment " for further information regarding the Company's strategic relationship withPBS HoldCo, LLC ). OnMarch 27, 2020 , P.L. 116-136, the Coronavirus Aid, and Economic Security Act (the "CARES Act") was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, contains several provisions offering liquidity to businesses. We have benefited and will continue to benefit from two of these provisions that allowed us to recover a portion of qualifying retention pay and health expenses paid to furloughed employees and to defer a portion of employment taxes until calendar 2021 and calendar 2022. As a result of the foregoing actions, the Company had$436,996 in cash and cash equivalents atJuly 31, 2020 . In order to maintain and bolster our cash reserves and further strengthen our balance sheet in response to the COVID-19 pandemic, inJuly 2020 , the Company 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, and, inAugust 2020 , the Company completed a sale and leaseback transaction pursuant to which we sold a total of 62Cracker Barrel owned properties and received net proceeds, after fees and expenses, of$146,357 . See Note 11 to the Consolidated Financial Statements for additional information regarding these sale and leaseback transactions.
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. 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 also affects restaurant and retail sales adversely from time to time. Furthermore, we are not able to predict the impact that the COVID-19 pandemic may have on the seasonality of our business. 35 -------------------------------------------------------------------------------- Table of Contents 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 consist of restaurant sales of stores
open at least six full quarters at the beginning of the year and are measured on
comparable calendar weeks. This measure excludes the impact of new store
openings. This measure also excludes sales related to MSBC since MSBC was
acquired by the Company in the first quarter of 2020. Comparable store
restaurant sales are expressed as a percentage of an increase or decrease in
restaurant sales versus the same period in the prior year as well as an average
per store. Total comparable store restaurant sales for the current year period
are subtracted from total comparable store restaurant sales for the prior year
period to calculate the absolute dollar change. The absolute dollar change is
divided by the prior year comparable store restaurant sales. This amount,
expressed as a percentage, is the comparable store restaurant sales discussed in
MD&A. See the section below entitled "Total Revenue" for the comparable store
restaurant sales percentages for 2020 as well as the same periods in the prior
year. Additionally, the average dollar amount per store is provided for each
year presented. Management uses comparable store restaurant sales as a measure
of sales growth to evaluate how established stores have performed over time. We
believe this measure is useful for investors to provide a consistent comparison
of restaurant sales results and trends across periods within our core,
established restaurant base, unaffected by results of store openings, closings,
and other transitional changes.
? Comparable store retail sales consist of retail sales of stores open at
least six full quarters at the beginning of the year and are measured on
comparable calendar weeks. This measure excludes the impact of new store
openings. Comparable store retail sales are expressed as a percentage of an
increase or decrease in retail sales versus the same period in the prior year.
Total comparable store retail sales for the current year period are subtracted
from total comparable store retail sales for the prior year period to calculate
the absolute dollar change. The absolute dollar change is divided by the prior
year comparable store retail sales. This amount, expressed as a percentage, is
the comparable store retail sales discussed in MD&A. See the section below
entitled "Total Revenue" for the comparable store retail sales percentages for
2020 as well as the same periods in the prior year. Management uses comparable
store retail sales as a measure of sales growth to evaluate how established
stores have performed over time. We believe this measure is also useful for
investors to provide a consistent comparison of retail sales results and trends
across periods within our core, established store base, unaffected by results of
store openings, closings and other transitional changes.
? Comparable restaurant guest traffic reflects both dine-in and off-premise
occasions. Traffic growth is measured as the change in entrees sold, which
includes entrees sold in our dine-in and off-premise business. Comparable
restaurant guest traffic consists of entrees sold from stores open at least six
full quarters at the beginning of the year and are measured on comparable
calendar weeks. This measure excludes guest traffic related to MSBC since MSBC
was acquired by the Company in the first quarter of 2020. Comparable restaurant
guest traffic is expressed as a percentage of an increase or decrease in
restaurant guest traffic versus the same period in the prior year. This amount,
expressed as a percentage, is the guest traffic discussed in MD&A. See section
below entitled "Total Revenue" for the restaurant guest traffic percentages for
2020 as well as the same periods in the prior year. Management uses this
measure to evaluate how established stores have performed over time excluding
growth achieved through menu price and sales mix change. We believe this
measure is useful for investors because an increase in comparable restaurant
guest traffic represents an increase in guests purchasing from our established
restaurants as well as an increase in the likelihood of a retail sales
conversion for guests intending to dine, while also providing an indicator as to
the development of our brand and the effectiveness of our marketing strategy.
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? Average check per guest is an indicator which management uses to analyze
the dollars spent per guest in our stores on restaurant purchases. Average
check is calculated using the comparable store restaurant sales (as defined
above) divided by comparable restaurant guest traffic (as defined above).
Average check is expressed as a percentage of an increase or decrease in average
check versus the same period in the prior year. Average check for the current
year period is subtracted from average check for the prior year period to
calculate the absolute dollar change. The absolute dollar change is divided by
the prior year average check number. This amount, expressed as a percentage, is
the average check number discussed in MD&A. This measure aids management in
identifying trends in guest preferences as well as the effectiveness of menu
price increases and other menu changes. We believe this measure is useful for
investors to evaluate per guest expenditures as well as our pricing and menu
strategies. See the section below entitled "Total Revenue" for the average
check percentages for 2020 as well as the same periods in the prior year.
Company Performance in 2020
Management believes that the Cracker Barrel brand remains one of the strongest and most differentiated brands in the restaurant industry.
Our long-term strategy includes the following:
? Enhancing the Core business to drive sustainable sales growth and continued
business model improvements. During 2020, we focused on driving topline sales
by accelerating our off-premise business, which allowed for us to more safely
serve our guests during the COVID-19 pandemic and which provides us with the
ability to respond to long-term customer trends in favor of alternatives to
on-site dining. We also introduced craveable, signature food, and improved the
employee and guest experience. Additionally, in response to the COVID-19
pandemic, we instituted operational protocols to comply with applicable
regulatory requirements to protect the health and safety of our employees and
guests, we implemented various strategies to support the recovery of our
business as dining rooms reopened and traffic recovered, and we took steps to
maintain and bolster our cash position to navigate through the uncertain
environment presented by the COVID-19 pandemic.
? Expanding the Footprint by building profitable new stores in core and
developing markets. In 2020, we opened four new
? Extending the Brand to further drive shareholder value creation by developing
new platforms to drive growth, such as our acquisition of Maple Street Biscuit
Company, a growth-stage fast casual concept that we believe provides us with a
vehicle to drive growth in a complementary segment of the restaurant industry.
RESULTS OF OPERATIONS
The following table highlights operating results over the past three years:
Relationship to Total Revenue
2020 2019 2018
Total revenue 100.0 % 100.0 % 100.0 %
Cost of goods sold (exclusive of depreciation and rent) 30.9 30.3 30.9
Labor and other related expenses 36.7 35.1 34.8
Other store operating expenses 24.4 20.4 19.9
General and administrative 5.8 5.0 4.7
Gain on sale and leaseback transaction (2.8 ) - -
Impairment 0.9 - -
Operating income 4.1 9.2 9.7
Interest expense 0.9 0.5 0.5
Income before income taxes 3.2 8.7 9.2
Provision for income taxes (income tax benefit) (1.1 ) 1.4 1.0
Net loss from unconsolidated subsidiary (5.6 ) - -
Net income (loss) (1.3 ) 7.3 8.2
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Total Revenue
The following table highlights the key components of revenue for the past three
years:
2020 2019 2018
Revenue in dollars(1):
Restaurant $ 2,032,030 $ 2,482,377 $ 2,439,389
Retail 490,762 589,574 591,056
Total revenue $ 2,522,792 $ 3,071,951 $ 3,030,445
Total revenue percentage increase (decrease) (1) (17.9 %) 1.4 % 3.6 %
Total revenue by percentage relationships:
Restaurant 80.5 % 80.8 % 80.5 %
Retail 19.5 % 19.2 % 19.5 %
Comparable number of stores 646 640 635
Comparable store averages per store: (2)
Restaurant $ 3,065 $ 3,784 $ 3,762
Retail 737 891 903
Total $ 3,802 $ 4,675 $ 4,665
Restaurant average weekly sales (3) $ 58.4 $ 72.4 $ 70.8
Retail average weekly sales (3) 14.3 17.2 17.2
Average check increase 2.7 % 3.3 % 2.5 %
(1) 2018 consists of 53 weeks while the other periods presented consist of 52
weeks.
(2) 2018 is calculated on a 53-week basis while the other periods are calculated
on a 52-week basis. Comparable store averages exclude MSBC.
(3) Average weekly sales are calculated by dividing net sales by operating weeks
and include all stores except for MSBC and Holler & Dash.
Total revenue benefited from the opening of five new units in 2020, eight new
units in 2019 and eleven new units in 2018, partially offset by the closing of
two units in 2020 and one unit in 2019. In 2018, total revenue also benefited
by the additional week in 2018, which resulted in an increase in revenues of
$58,353 . The total revenue decrease for 2020 as compared to 2019 was primarily
the result of all of our restaurant operations being limited to pick-up and
delivery orders with no dine-in service for a portion of the third quarter of
2020, the related significant decline in restaurant guest traffic, restrictions
mandated by federal, state and local governments in the United States to
mitigate the spread of COVID-19 and the related changes in consumer behavior.
The total revenue decrease was partially offset by our subsequent resumption of
dine-in services at a number of our Cracker Barrel stores and the acceleration
of our off-premise business.
The following table highlights comparable store sales* results over the past two
years:
Period to Period
Increase (Decrease)
2020 vs 2019 2019 vs 2018
(646 Stores) (640 Stores)
Restaurant (18.9)% 2.6%
Retail (17.1) 0.1
Restaurant & Retail (18.6)% 2.1%
*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.
Our comparable store restaurant sales, comparable retail sales and comparable restaurant guest traffic were negatively affected by the COVID-19 pandemic as all dining rooms were closed beginning the week ofMarch 27, 2020 and only certain restaurants resumed dine-in operations with limited capacity beginning at the end ofApril 2020 . Our comparable store restaurant sales decrease from 2019 to 2020 resulted from a decrease in guest traffic of 21.6% partially offset by higher average check of 2.7% (including a 1.8% average menu price increase). Our comparable store restaurant sales increase from 2018 to 2019 resulted from a higher average check of 3.3%, primarily attributable to a 2.1% average menu price increase and 1.2% of favorable check impact from changes in mix, partially offset by a decrease in guest traffic of 0.7%. 38 -------------------------------------------------------------------------------- Table of Contents Our retail sales are made substantially to our restaurant guests. The decrease in our comparable store retail sales from 2019 to 2020 resulted from the impact of the COVID-19 pandemic which caused a decline in guest traffic. The slight increase in our comparable store retail sales from 2018 to 2019 resulting primarily from strong performance in the apparel and accessories merchandise category was partially offset by the decrease in guest traffic and lower performance in the décor merchandise category. 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:
2020 2019 2018
Cost of Goods Sold:
Restaurant $ 515,663 $ 628,761 $ 625,999
Retail 264,274 302,316 309,398
Total Cost of Goods Sold $ 779,937 $ 931,077 $ 935,397 The following table highlights restaurant cost of goods sold as a percentage of restaurant revenue for the past three years:
2020 2019 2018
Restaurant Cost of Goods Sold 25.4% 25.3% 25.7%
Restaurant cost of goods sold as a percentage of restaurant revenue increased slightly from 2019 to 2020. The decrease from 2018 to 2019 was primarily the result of our menu price increase referenced above, lower food waste and a shift to lower cost menu items partially offset by food commodity inflation of 1.6%. Lower food waste and lower cost menu items both accounted for a decrease of 0.1% in restaurant cost of goods sold as a percentage of restaurant revenue.
We presently expect the rate of commodity inflation to be approximately 1.5 to 2.0% in 2021 as compared to 0.8% in 2020.
The following table highlights retail cost of goods sold as a percentage of retail revenue for the past three years:
2020 2019 2018
Retail Cost of Goods Sold 53.8% 51.3% 52.3%
The increase in retail cost of goods sold as a percentage of retail revenue in 2020 as compared to 2019 resulted primarily from higher markdowns, higher employee discounts, higher freight expense and lower retail credits.
2019 to 2020
Increase as a Percentage of
Total Revenue
Markdowns 1.2%
Employee discounts 0.6%
Freight expense 0.4%
Retail credits 0.2%
The decrease in retail cost of goods sold as a percentage of retail revenue in
2019 as compared to 2018 resulted primarily from lower markdowns and a decrease
in the provision for obsolete inventory partially offset by lower initial
margin.
2018 to 2019
(Decrease) Increase as a
Percentage of Total Revenue
Markdowns (0.8%)
Provision for obsolete inventory (0.6%)
Lower initial margin 0.3%
39-------------------------------------------------------------------------------- Table of Contents 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:
2020 2019 2018
Labor and other related expenses 36.7% 35.1% 34.8%
The year-to-year percentage change from 2019 to 2020 resulted from the
following:
2019 to 2020
Increase (Decrease) as a
Percentage of Total Revenue
Store management compensation 1.4%
Miscellaneous wages 0.4%
Employee health care expenses 0.3%
Store hourly labor (0.3%)
Store bonus expense (0.2%)
In general, in 2020, labor and other related expenses as a percentage of total
revenue were materially increased by the impact of the COVID-19 pandemic. In
particular, the increases in store management compensation and miscellaneous
wages as a percentage of total revenue in 2020 were all primarily driven by this
decrease in revenue.
Higher employee health care expenses in 2020 as compared to 2019 resulted primarily from higher claims activity.
The decrease in store hourly labor in 2020 as compared to 2019 resulted primarily from lower usage of hourly employees due to reduced operations caused by the COVID-19 pandemic.
The decrease in store bonus expense in 2020 as compared to 2019 resulted from
lower performance against financial objectives in 2020 as compared to 2019 due
to the impact of the COVID-19 pandemic.
The year-to-year percentage change from 2018 to 2019 resulted primarily from the
following:
2018 to 2019
Increase (Decrease) as a
Percentage of Total Revenue
Store hourly labor 0.2%
Store bonus expense 0.2%
Employee health care expenses (0.2%)
The increase in store hourly labor in 2019 as compared to 2018 resulted primarily from wage inflation exceeding menu price increases.
The increase in store bonus expense in 2019 as compared to 2018 resulted from better performance against financial objectives in 2019 as compared to 2018.
The decrease in employee health care expenses in 2019 as compared to 2018 resulted primarily from lower claims activity.
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Other Store Operating Expenses
Other store operating expenses include all store-level operating costs, the
major components of which are utilities, operating supplies, repairs and
maintenance, depreciation and amortization, advertising, rent, credit card 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 past three years:
2020 2019 2018
Other store operating expenses 24.4 % 20.4 % 19.9 %
The year-to-year percentage change from 2019 to 2020 resulted primarily from the
following:
2019 to 2020
Increase as a Percentage
of Total Revenue
Depreciation 1.0%
Other store expenses 0.6%
Rent 0.6%
Supplies 0.5%
Advertising 0.4%
Utilities 0.3%
Real and personal property taxes 0.3%
Maintenance 0.2%
In general, for 2020, other store operating expenses as a percentage of total
revenue were materially increased by the significant reduction in total revenue
and reduced operations caused by the impact of the COVID-19 pandemic. In
particular, the increases in rent expense, supplies expense, advertising
expense, utilities expense, real and personal property taxes and maintenance
expense as a percentage of total revenue for 2020 were all primarily driven by
this decrease in revenue.
The increase in depreciation expense as a percentage of total revenue for 2020
as compared to 2019 resulted primarily from higher capital expenditures with
accelerated depreciation methods.
The increase in other store expenses as a percentage of total revenue for 2020
as compared to 2019 resulted primarily from costs associated with the expansion
of our off-premise business.
The year-to-year percentage change from 2018 to 2019 resulted primarily from the
following:
2018 to 2019
Increase (Decrease) as a
Percentage of Total Revenue
Depreciation 0.4%
Loss on disposition of property and equipment 0.1%
Maintenance (0.1%)
The increase in depreciation expense as a percentage of total revenue for 2019
as compared to 2018 resulted primarily from higher capital expenditures with
accelerated depreciation methods.
The increase in loss on disposition of property and equipment as a percentage of
total revenue for 2019 as compared to 2018 resulted primarily from costs
associated with a store closure, higher disposal of assets related primarily to
discontinued projects and a reduction in the carrying value for a previously
closed store.
The decrease in maintenance expense as a percentage of total revenue for 2019 as compared to 2018 resulted primarily from improved management of expenses in 2019.
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General and Administrative Expenses
The following table highlights general and administrative expenses as a percentage of total revenue for the past three years:
2020 2019 2018
General and administrative expenses 5.8% 5.0% 4.7%
The year-to-year percentage change from 2019 to 2020 resulted primarily from the
following:
2019 to 2020
Increase (Decrease) as a
Percentage of Total Revenue
Payroll and related expenses 0.7%
Professional fees 0.4%
Incentive compensation expense (0.2%)
In general, for 2020, general and administrative expenses as a percentage of
total revenue were materially increased by the significant reduction in total
revenue and reduced operations caused by the impact of the COVID-19 pandemic.
In particular, the increases in payroll and related expense and professional
fees were all primarily driven by this decrease in revenue. The increase in
payroll and related expenses also resulted from severance expenses recorded in
2020 as part of the elimination of positions in the corporate headquarters and
in the field. The decrease in incentive compensation in 2020 as compared to 2019
resulted from lower performance against financial objectives in 2020 as compared
to 2019 due to the impact of the COVID-19 pandemic.
The year-to-year percentage change from 2018 to 2019 resulted primarily from
higher incentive compensation. Higher incentive compensation in 2019 as compared
to 2018 resulted from better performance against financial objectives as
compared to the prior year period.
Gain on Sale and Leaseback Transaction
OnJuly 29, 2020 , we entered into a sale and leaseback transaction involving 64Cracker Barrel properties and recorded a gain of$69,954 . See Note 11 to the Consolidated Financial Statements for additional information regarding this sale and leaseback transaction. Impairment
During the third and fourth quarters of 2020, we determined that certain
Interest Expense
The following table highlights interest expense for the past three years:
2020 2019 2018
Interest expense $ 22,327 $ 16,488 $ 15,169
The year-to-year increase from 2019 to 2020 resulted primarily from materially
higher debt levels caused by our borrowing of the remaining available amount
under our 2019 Revolving Credit Facility in March 2020 and exercising the
accordion feature under the 2019 Revolving Credit Facility to borrow an
additional amount in response to the COVID-19 pandemic and higher weighted
average interest rates. The year-to-year increase from 2018 to 2019 resulted
primarily from higher weighted average interest rates. Additionally, as part of
our debt refinancing in 2019, we incurred additional interest expense of $166
related to the write-off of deferred financing costs. We presently expect our
net interest expense for 2021 to be approximately $40,000 .
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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:
2020 2019 2018
Effective tax rate (35.3%) 16.1% 11.1%
The decrease in our effective tax rate from 2019 to 2020 is primarily due to the tax benefits from the net loss recorded forPBS and a large reduction in income before income taxes relative to a modest reduction in the tax credits. OnMarch 27, 2020 , the CARES Act was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits net operating losses ("NOL") carryovers and carrybacks to offset 100% of taxable income for tax years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding tax years to generate a refund of previously paid income taxes. The CARES Act also contains modifications on the limitations of business interest for tax years beginning in 2019 and 2020. We are currently evaluating the impact of the CARES Act, but we currently do not expect that the NOL carryback provision or the interest limitations will result in a material cash impact to us. The increase in our effective tax rate from 2018 to 2019 reflected the significant impact of P.L. 115-97, the Tax Cuts and Jobs Act (the "Tax Act"), enacted onDecember 22, 2017 by theU.S. government. The Tax Act made broad and complex changes to theU.S. tax code, including, but not limited to, reducing theU.S. federal corporate tax rate from 35% to 21%. This rate reduction lowered deferred tax liabilities, the tax benefit of which was recognized in 2018.
We presently expect our effective tax rate for 2021 to be approximately 19%.
LIQUIDITY AND CAPITAL RESOURCES
The following table presents a summary of our cash flows for the last three years:
2020 2019 2018
Net cash provided by operating activities $ 161,002 $ 362,796 $ 330,620
Net cash used in investing activities (157,226 ) (241,574 ) (151,222 )
Net cash provided by (used in) financing activities 396,336 (198,994 ) (225,743 )
Net increase (decrease) in cash and cash equivalents $ 400,112 $ (77,772 ) $ (46,345 )
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 at August 2, 2019 and borrowings under
our 2019 Revolving Credit Facility, was sufficient to finance all of our growth,
share repurchases, dividend payments, working capital needs and other cash
payment obligations in 2020.
The impacts of the COVID-19 pandemic have adversely affected our results of
operations and cash flows. In response to the business disruption caused by
the COVID-19 pandemic, we took the following actions, which management
anticipates will allow the Company to meet our obligations over the next twelve
months.
? In
and operated with pick-up and delivery only. Thereafter, we were able to
resume dine-in operations in certain jurisdictions but with continuing
limitations on capacity. As of
had not opened dine-in services to some extent.
? We made significant reductions in operating expenses to reflect reduced
operations and sales levels as well as eliminated non-essential spending.
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Table of Contents ? We furloughed employees, eliminated a significant number of positions at all
levels of the Company, both at the corporate headquarters and in the field,
and, in the third quarter of 2020, reduced compensation payable to our
corporate officers and cash retainers payable to our Board of Directors for the
remainder of fiscal 2020.
? We have negotiated revised terms with landlords and vendors to reduce and/or
defer these expenses.
? We borrowed the remaining available amount under our 2019 Revolving Credit
Facility and drew down additional amounts from the accordion feature under our
2019 Revolving Credit Facility.
? We deferred payment of the dividend that was declared on
notice.
? We have temporarily suspended all share repurchases.
? In
? We continue to explore additional measures to enhance liquidity as the COVID-19
pandemic and related events develop.
Cash Generated from Operations
The decrease in net cash flow provided by operating activities from 2019 to 2020 primarily reflected the negative impact on our operations caused by the COVID-19 pandemic and the timing of payments for accounts payable.
The increase in net cash flow provided by operating activities from 2018 to 2019 primarily reflected the timing of payments for accounts payable, interest, payroll and advertising.
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:
2020 2019 2018
Capital expenditures, net of proceeds from insurance recoveries$ 296,008 $ 137,540 $ 151,633 Our capital expenditures consisted primarily of capital investments for existing stores, new store locations and 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 increase in capital expenditures from 2019 to 2020 resulted primarily from this transaction partially offset by lower capital expenditures for strategic initiatives. The increase in proceeds from sale of property and equipment from 2019 to 2020 also relates to the sale and leaseback transaction entered into onJuly 29, 2020 .
The decrease in capital expenditures from 2018 to 2019 resulted primarily from the timing of new unit construction partially offset by higher capital expenditures for strategic initiatives.
We estimate that our capital expenditures during 2021 will be approximately$100,000 . This estimate includes the acquisition of sites and construction costs of newCracker Barrel stores and MSBC locations that we plan to open during 2021, as well as acquisition and construction costs for store locations to be opened in 2022. 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. See the discussion below under "Borrowing Capacity and Debt Covenants" regarding a debt covenant restriction on our cash payment for capital expenditures. 44 -------------------------------------------------------------------------------- Table of ContentsMaple Street Biscuit Company 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 . 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 for$89,100 . At closing, we also purchased promissory notes of$6,900 along with the related interest on the notes and provided additional funding of$8,000 toPBS in exchange for a promissory note. As part of the transaction, we agreed to fundPBS up to$51,000 through calendar 2020 of which we funded$35,500 during 2020. We believed the investment inPBS provided us with a growth vehicle to deliver additional shareholder value and extend our footprint into a complementary market segment. However, during the onset of the COVID-19 pandemic, PBS Holdco's wholly-owned subsidiary,PBS BrandCo, LLC ("Brandco") suffered unsustainable disruption to its business across the chain and suspended all operations at each of its 19 locations and laid off substantially all restaurant and corporate employees. OnMarch 20, 2020 , the primary lender under Brandco's secured credit facility provided notice of the lender's intention to foreclose on its collateral interest in Brandco unlessCracker Barrel repaid or unconditionally guaranteed the indebtedness. In keeping with our strategy of concentrating our resources on our core business during the COVID-19 pandemic, and in light of the substantial uncertainties surroundingPBS business coming out of the COVID-19 pandemic, we decided not to invest further resources to prevent foreclosure or otherwise provide additional capital toPBS . In the third quarter of 2020, we recorded a loss of$132,878 , which represented our equity investment inPBS and the principal and accumulated interest under the outstanding unsecured indebtedness ofPBS held by the Company. This loss is recorded in the net loss in unconsolidated subsidiary line on our Consolidated Statement of Income (Loss) in 2020.
Borrowing Capacity and Debt Covenants
OnSeptember 5, 2018 , we entered into a five-year$950,000 revolving credit facility (the "2019 Revolving Credit Facility") with substantially the same terms and financial covenants as our previous$750,000 revolving credit facility, which it replaced. The 2019 Revolving Credit Facility also contains an option to increase the revolving credit facility by$300,000 . In the fourth quarter of 2020, we drew an additional$39,395 under this option for a one-year period. The following table highlights our borrowing capacity and outstanding borrowings under the 2019 Revolving Credit Facility, our standby letters of credit and our borrowing availability under the 2019 Revolving Credit Facility as ofJuly 31, 2020 :July 31, 2020 Borrowing capacity under the 2019 Revolving Credit Facility $
989,395
Less: Outstanding borrowings under the 2019 Revolving Credit Facility
949,395
Less: Standby letters of credit*
21,528
Borrowing availability under the 2019 Revolving Credit Facility $
18,472
*Our standby letters of credit relate to securing reserved claims under workers' compensation insurance and securing our sale and leaseback transaction entered into onJuly 29, 2020 . Our standby letters of credit reduce our borrowing availability 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. We did not borrow or make any debt payments in 2018. In 2019, we refinanced our debt as discussed above. 45
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Table of Contents See "Material Commitments" below and Note 7 to our Consolidated Financial Statements for further information on our long-term debt.
Our 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 were in compliance with the 2019
Revolving Credit Facility's financial covenants at the first, second and third
quarters of 2020. As a result of the negative impact of the COVID-19 pandemic
on our financial position and results of operations, we obtained a waiver for
the financial covenants for the fourth quarter of 2020 and the first and second
quarters of 2021 ("Covenant Relief Period"). During this covenant relief
period, we are required to maintain liquidity (defined as the availability under
the 2019 Revolving Credit Facility plus unrestricted cash and cash equivalents)
of at least $140,000 . Additionally, during this Covenant Relief Period, our
cash payments with respect to capital expenditures may not exceed $60,000 in the
aggregate.
Dividends, Share Repurchases and Share-Based Compensation Awards
Our 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. During the Covenant Relief Period described above, we are subject to restrictions on our ability to pay dividends (other than the deferred dividend payment that we paid onSeptember 2, 2020 ). Following the Covenant Relief Period, 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 each of the first three quarters of 2020, we declared a regular quarterly dividend of$1.30 per share of our common stock. The dividends declared in the first and second quarters of 2020 were paid in the immediately following quarter. 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 scheduled forMay 5, 2020 to shareholders of record onApril 17, 2020 untilSeptember 2, 2020 , to shareholders of record onAugust 14, 2020 and have suspended all future dividend payments until further notice. OnSeptember 2, 2020 , we paid$30,807 for the deferred dividend payment.
In 2019 and 2018, we paid special dividends of
The following table highlights the dividends per share we paid for the last
three years:
2020 2019 2018
Dividends per share paid $ 3.90 $ 8.00 $ 8.55
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.
Subject to the limits imposed by our revolving credit facility, in 2019 and
2018, we were authorized by our Board of Directors to repurchase shares at the
discretion of management up to $25,000 . Additionally, in the fourth quarter of
2019, our Board of Directors increased the share repurchase authorization to
$50,000 . In the third quarter of 2020, our Board of Directors approved the
repurchase of up to an additional $25,000 . This authorization was effective
immediately and replaced the $50,000 share repurchase authorization which had
been expended. In response to the COVID-19 pandemic, however, we have
temporarily suspended all share repurchases. In 2020, we repurchased 378,974
shares of our common stock in the open market at an aggregate cost of $55,007 .
In 2019, we did not repurchase any shares of our common stock. In 2018, we
repurchased 100,000 shares of our common stock in the open market at an
aggregate cost of $14,772 .
In 2020, 2019 and 2018, related tax withholding payments on the vesting of
certain share-based compensation awards resulted in a net use of cash of
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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:
2020 2019 2018
Working capital (deficit) $ 191,956 $ (150,094 ) $ (57,867 )
The change in working capital at July 31, 2020 compared to August 2, 2019
primarily reflected the increase in cash and timing of accounts payable
partially offset by the current portion of our long-term debt and the
recognition of lease liabilities due to the adoption at August 3, 2019 of
accounting guidance for leases. The increase in cash resulted from the actions
taken by management to increase and preserve liquidity during the COVID-19
pandemic such as borrowing under our revolving credit facility and the deferral
of our dividend payment from the fourth quarter of 2020 until the first quarter
of 2021.
The change in working capital at August 2, 2019 compared to August 3, 2018
primarily reflected the decrease in cash, higher accounts payable, higher
incentive compensation accruals and an increase in the sales of our gift cards
partially offset by the timing of payments for income taxes. The decrease in
cash resulted primarily from the purchase of our investment in PBS partially
offset by lower spending for capital expenditures. Higher incentive
compensation accruals resulted from better performance against financial
objectives in 2019 as compared to 2018.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
Material Commitments
Our contractual cash obligations and commitments as of
Payments due by Years
Contractual Obligations (a) Total 2021 2022-2023 2024-2025 After 2025
2019 Revolving Credit Facility(b) $ 949,395 $ 39,395 $ - $ 910,000 $ -
Leases (c) 1,044,430 71,184 109,968 100,654 762,624
Purchase obligations (d) 69,310 56,038 12,489 519 264
Other long-term obligations (e) 34,735 - 4,129 18 30,588
Total contractual cash obligations $ 2,097,870 $ 166,617 $ 126,586 $ 1,011,191 $ 793,476
Amount of Commitment Expirations by Years
Total 2021 2022-2023 2024-2025 After 2025
2019 Revolving Credit Facility(b) $ 989,395 $ 39,395 $ - $ 950,000 $ -
Standby letters of credit(f) 21,528 14,379 7,149 - -
Guarantees (g) 344 295 49 - -
Total commitments $ 1,011,267 $ 54,069 $ 7,198 $ 950,000 $ -
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(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 2019 Revolving Credit Facility expires on
projected interest rates and anticipated outstanding borrowings over the
remainder of the term of our revolving credit facility and interest rate
swaps, we anticipate having interest payments of
in 2021, 2022-2023 and 2024, respectively. The projected interest rates for
our swapped portion of our outstanding borrowings are our fixed rates under
our interest rate swaps (see Note 8 to the Consolidated Financial Statements)
plus our current credit spread of 3.00%. The projected interest rate for our
unswapped portion of our outstanding borrowings is the average of the
three-year and five-year swap rates at
current credit spread of 3.00%. Based on our outstanding borrowings and our
standby letters of credit at
fee as defined in the 2019 Revolving Credit Facility, our unused commitment
fees in 2021, 2022-2023 and 2024 would be
however, the actual amount will differ based on actual usage of the 2019
Revolving Credit Facility.
(c) 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.
(d) 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.
(e) Other long-term obligations include our Non-Qualified Savings Plan (
with a corresponding long-term asset to fund the liability; see Note 14 to
the Consolidated Financial Statements), Deferred Compensation Plan (
and our long-term incentive plans (
(f) Our standby letters of credit relate to securing reserved claims under
workers' compensation insurance and securing our sale and leaseback
transaction entered into on
reduce our borrowing availability under the 2019 Revolving Credit Facility.
(g) Consists solely of guarantees associated with lease payments for two
properties. During 2020, the Company received notice regarding
non-performance by the primary obligor under these lease agreements. As a
result, the Company has recorded a provision of
Balance Sheet as of July 31, 2020 for amounts to be paid as a result of
non-performance by the primary obligor.
Recent Accounting Pronouncements Adopted and Not Yet Adopted
See Note 2 to the accompanying Consolidated Financial Statements for a
discussion of recent accounting guidance adopted and not yet adopted. With the
exception of the accounting guidance for leases, the adopted accounting guidance
discussed in Note 2 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 2 and 11 to the Consolidated Financial
Statements for additional information regarding leases. Regarding the
accounting guidance not yet adopted, we do not expect the accounting guidance
will have a significant impact on the Company's financial position or results of
operations.
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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 additional impairment as a result of the impacts of the COVID-19 pandemic and our response. 49 -------------------------------------------------------------------------------- Table of Contents 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$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. 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. 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 . 50 -------------------------------------------------------------------------------- Table of Contents 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.
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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