FRANCHISE GROUP, INC. Overview
We are a retailer, franchisor operator and acquirer of franchised and franchisable businesses that can be scaled using our operating expertise. We currently operate four reportable segments:Liberty Tax , Buddy's,Sears Outlet , andVitamin Shoppe . OurLiberty Tax segment is one of the leading providers of tax preparation services inthe United States andCanada . Our tax preparation services and related tax settlement products are offered primarily through franchised locations with a limited number of Company-owned stores. See "Note 1 - Organization and Significant Accounting Policies" in the notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year endedApril 30, 2019 , for details of theU.S. office activity and the number ofCanadian and Company -owned offices for the years endedApril 30, 2019 , 2018 and 2017. OnJuly 10, 2019 , we completed the Buddy's Acquisition. Our Buddy's segment franchises or operates rent-to-own stores that lease household durable goods, such as electronics, residential furniture, appliances and household accessories, to customers on a rent-to-own basis. Merchandise is also offered for immediate purchase or an installment sales basis. OnOctober 23, 2019 , we completed the Sears Outlet Acquisition. OurSears Outlet segment provides in-store and online access to purchase outlet-value products across a broad assortment of merchandise categories, including home appliances, mattresses, lawn and garden equipment and other household goods at value-oriented prices. OnDecember 16, 2019 , we completed our acquisition of theVitamin Shoppe Acquisition. OurVitamin Shoppe segment is an omni-channel specialty retailer of vitamins, minerals, herbs, specialty supplements, sports nutrition and other health and wellness products. Our revenue is primarily derived from merchandise sales, rental revenue, and service revenues comprised of loans and fee charges in our Company-owned stores, royalties and other required fees from our franchisees and financial products related to refund transfers. In evaluating our performance, management focuses on several metrics that we believe are key to our success: • Net change in retail and franchise locations. The change in retail and
franchise locations from year to year is a function of the opening of new
locations, offset by locations that we or our franchisees close. Please
see "Item 2. Properties" in this Transition Report on Form 10-K/T for the
number of locations as of
• Systemwide revenue. Systemwide revenue, which is an operating measure not
in accordance with GAAP, includes sales by both Company-owned and
franchised locations. We believe systemwide revenue data is useful in
assessing consumer demand for our products and services and our
performance. In addition, systemwide revenue reflects the size of our
business, and because the size of our business drives our management and
infrastructure needs, systemwide revenue data helps us assess those needs
in comparison to other companies in our industry and other franchise
operators.
Acquisitions
On
On
OnOctober 23, 2019 , we completed the Sears Outlet Acquisition. For a complete description of the Sears Outlet Acquisition, refer to "Note 2 - Acquisitions" in the Notes to the Consolidated Financial Statement.
On
On
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OnJuly 10, 2019 (the "Buddy's Acquisition Date"), we completed the Buddy's Acquisition. At the Buddy's Acquisition Date, each outstanding unit of Buddy's was converted into the right to receive 0.459315 units of New Holdco ("New Holdco units") and 0.091863 shares of Preferred Stock. The Buddy's Members may elect, following an initial six-month lockup period, which has expired, to redeem one New Holdco unit and one-fifth of a share of Preferred Stock in exchange for one share of our common stock. As of the Buddy's Acquisition Date, on an as-converted basis, the Buddy's Members' aggregate ownership of New Holdco units and share of Preferred Stock represent approximately 36.44% of our outstanding common stock, which implies an enterprise value of Buddy's of approximately$122 million and an equity value of$12.00 per share of Common Stock. We are the sole managing member of New Holdco and it will be consolidated for financial reporting purposes. New Holdco units held by the Buddy's Members will be recorded as a non-controlling interest on the consolidated financial statements. We and the Buddy's Members also entered into an income tax receivable agreement (the "TRA"), pursuant to which, subject to certain exceptions set forth in the TRA, we will pay the Buddy's Members 40% of the cash savings, if any, in federal, state and local taxes that we realize or are deemed to realize as a result of any increases in tax basis of the assets of New Holdco resulting from future redemptions or exchanges of New Holdco units and Preferred Stock held by the Buddy's Members in exchange for common stock. Refer to the liquidity section below for further discussion. For a complete description of the Buddy's Acquisition, refer to "Note 2 - Acquisitions" in the Notes to the Consolidated Financial Statement.
Results of Operations
For the Transition Period as compared to the unaudited period
Unaudited results of operations for the periodMay 1, 2018 toDecember 29, 2018 are provided here for discussion and analysis purposes. The following table sets forth the results of our operations for the Transition Period and for the periodMay 1, 2018 toDecember 29, 2018 : For the Transition For the Period Change Period Ended May 1, 2018 - (In thousands) December 28, 2019 December 29, 2018 $ % Total revenues $ 149,510 $ 16,647$ 132,863 798 % Loss from operations (105,599 ) (60,965 ) (44,634 ) 73 % Net loss (104,466 ) (43,053 ) (61,413 ) 143 % Revenues. The table below sets forth the components and changes in our revenue for the Transition Period and for the periodMay 1, 2018 toDecember 29, 2018 : For the Transition For the Period Change Period Ended May 1, 2018 - (In thousands) December 28, 2019 December 29, 2018 $ % Product $ 96,139 $ -$ 96,139 - % Service and other 29,735 16,647 13,088 79 % Rental 23,636 - 23,636 - % Total revenue $ 149,510 $ 16,647$ 132,863 798 % Our total revenue increased by$132.9 million , or 798%, in the Transition Period compared to the periodMay 1, 2018 toDecember 29, 2018 . This increase was primarily due to the Buddy's Acquisition onJuly 10, 2019 which increased revenue by$35.7 million , the Sears Outlet Acquisition onOctober 23, 2019 which increased revenue by$68.2 million and the Vitamin Shoppe Acquisition onDecember 23, 2019 which increased revenue by$30.6 million during the Transition Period. Operating expenses. The following table details the amounts and changes in our operating expenses for the Transition Period and for the periodMay 1, 2018 toDecember 29, 2018 : 41
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For the Transition For the Period Change
Period Ended May 1, 2018 -
(In thousands) December 28, 2019 December 29, 2018 $ %
Cost of revenue:
Product $ 71,820 $ - $ 71,820 - %
Service and other 768 - 768 - %
Rental 8,661 - 8,661 - %
Total cost of revenue 81,249 - 81,249 - %
Selling, general and
administrative expenses 173,860 68,267 105,593 155 %
Restructuring expenses - 9,345 (9,345 ) (100 )%
Total operating
expenses $ 255,109 $ 77,612 $ 177,497 229 %
Total operating expenses increased $177.5 million , or 229%, in the Transition
Period compared to the period May 1, 2018 to December 29, 2018 . This increase
was primarily due to the Buddy's Acquisition on July 10, 2019 which increased
operating expenses by $32.6 million , the Sears Outlet Acquisition on October 23,
2019 which increased operating expenses by $86.8 million and the Vitamin Shoppe
Acquisition on December 23, 2019 which increased operating expenses by $44.1
million during the Transition Period.
Income Taxes. The following table sets forth certain information regarding our
income taxes for the Transition Period and for the period May 1, 2018 to
December 29, 2018 :
For the Transition For the Period Change
Period Ended May 1, 2018 -
(In thousands) December 28, 2019 December 29, 2018 $ %
Income (loss) before
income taxes $ (114,911 ) $ (62,779 ) $ (52,132 ) 83 %
Income tax (benefit)
expense (10,445 ) (19,726 ) 9,281 (47 )%
Effective tax rate 9.1 % 31.4 %
The decrease in our income tax benefit in the Transition Period compared to the
period May 1, 2018 to December 29, 2018 relates primarily to a valuation
allowance of $11.2 million for deferred tax assets related to certain federal
and state net operating losses which are more likely not to be realized due to
limitations on utilization.
Net income. In the Transition Period, we had a net loss of $104.5 million
compared to a net loss of $43.1 million in the period May 1, 2018 to December
29, 2018 , primarily as a result of larger operating expenses in relation to the
increases in revenue as noted above.
For a discussion of the 2019 Results of Operations, including a discussion of
the financial results for the fiscal year ended April 30, 2019 compared to the
fiscal year ended April 30, 2018 , refer to Part II, Item 7 of our Form 10-K
filed with the SEC on June 27, 2019 .
Segment Information
We, through our franchisees and Company-owned stores, operate a system of tax preparation, rent-to-own and point of sale retail locations. Our operations are conducted in four reporting business segments:Liberty Tax , Buddy's,Sears Outlet andVitamin Shoppe . We define our segments as those operations whose results our chief operating decision maker ("CODM") regularly reviews to analyze performance and allocate resources. We measure the results of our segments using, among other measures, each segment's net sales, operating expenses and operating income (loss). We may revise the measurement of each segment's operating income, including the allocation of overhead costs, as determined by the information regularly reviewed by the CODM. When the measurement of a segment changes, previous period amounts and balances are reclassified to be comparable to the current period's presentation. Because the Buddy's Acquisition, Sears Outlet Acquisition and Vitamin Shoppe Acquisition occurred in the Transition Period, comparable information is not available; therefore, Buddy's,Sears Outlet andVitamin Shoppe segment information is not provided in this discussion. 42
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As our Transition Period excludes the tax season, ourLiberty Tax segment results reflect minimal revenue activity consistent with the highly seasonal nature of the segment. The following table summarizes the operating results of ourLiberty Tax segment: For the Transition For the Period Change Period Ended December May 1, 2018 - (In thousands) 28, 2019 December 29, 2018 $ % Total revenues $ 14,984 $ 16,647$ (1,663 ) (10 )% Loss from operations (69,590 ) (60,965 ) (8,625 ) 14 % Net loss (71,579 ) (43,053 ) (28,526 ) 66 % Total revenue for ourLiberty Tax segment decreased$1.7 million , or 10%, for the Transition Period as compared to the period fromMay 1, 2018 toDecember 29, 2018 . The decrease in revenue is primarily driven by the following:
•a decrease of
•a
•a decrease of
•a
These decreases were offset by a
Loss from operations for ourLiberty Tax segment increased$8.6 million , or 14%, for the Transition Period as compared to the period fromMay 1, 2018 toDecember 29, 2018 . The increase in loss from operations is primarily driven by the following:
• an increase in impairment expense of
impairment charge for internally developed software that is no longer in
use;
•a decrease of
•a
These decreases in expenses were offset by a
Adjusted EBITDA.
To provide additional information regarding our financial results, we have
disclosed Adjusted EBITDA in the table below and within this Transition Report
on Form 10-K/T. Adjusted EBITDA represents net income (loss), before income
taxes, interest expense, depreciation and amortization, and certain other items
specified below. We have provided a reconciliation below of Adjusted EBITDA to
net loss, the most directly comparable GAAP financial measure.
We have included Adjusted EBITDA in this Transition Report on Form 10-K/T
because we seek to manage our business to achieve higher levels of Adjusted
EBITDA and to improve the level of Adjusted EBITDA as a percentage of revenue.
In addition, it is a key basis upon which we assess the performance of our
operations and management. We also use Adjusted EBITDA for business planning and
the evaluation of acquisition opportunities. In particular, the exclusion of
certain expenses in calculating Adjusted EBITDA can provide a useful measure for
period-to-period comparisons. We believe the presentation of Adjusted EBITDA
enhances an overall understanding of the financial performance of and prospects
for our business. Adjusted EBITDA is not a recognized financial measure under
GAAP and may not be comparable to similarly titled measures used by other
companies in our industry. Adjusted EBITDA should not be considered in isolation
from or as an alternative to net income (loss), operating income (loss), or any
other performance measures derived in accordance with GAAP.
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The following table presents a reconciliation of Adjusted EBITDA for each of the
periods indicated.
For the Transition For the Period
Period Ended May 1, 2018 -
(In thousands) December 28, 2019 December 29, 2018
Net loss $ (104,466 ) $ (43,053 )
Add back:
Interest expense 9,349 1,802
Income tax benefit (10,445 ) (19,726 )
Depreciation, amortization and impairment
charges 32,401 8,429
Total Adjustments 31,305 (9,495 )
EBITDA (73,161 ) (52,548 )
Adjustments to EBITDA
Executive severance and related costs
including stock-based compensation 952 933
Executive recruitment costs - 725
Shareholder litigation costs 707 472
Restructuring expense - 9,345
Corporate governance costs 188 439
Tender Offer 645 -
Accrued judgments and settlements, net of
estimated revenue 980 743
Divestiture of year-round accounting offices - 625
Acquisition costs 17,392 -
Total Adjustments to EBITDA 20,864 13,282
Adjusted EBITDA $ (52,297 ) $ (39,266 )
Included in restructuring expense on the condensed consolidated statement of
operations for the period May 1, 2018 to December 29, 2018 is $1.3 million of
depreciation, amortization, and impairment charges. EBITDA is a loss of $51.2
million for the period May 1, 2018 to December 29, 2018 with these expenses
included.
Liquidity and Capital Resources
We believe that we have sufficient liquidity to support our ongoing operations and maintain a sufficient liquidity position to meet our obligations and commitments. Our liquidity plans are established as part of our financial and strategic planning processes and consider the liquidity necessary to fund our operating, capital expenditure and debt service needs. We primarily fund our operations and acquisitions through operating cash flows and, as needed, a combination of borrowings under various credit agreements, availability under our revolving credit facilities and the issuance of equity securities, which has included the sale of securities to affiliates ofVintage and B. Riley FBR, Inc. , among others. Cash generation can be subject to variability based on many factors, including seasonality, receipt of prepaid payments from area developers, timing of repayment of loans to franchisees and the effects of changes in end markets.
Subsequent to
• On
affiliate of Vintage, pursuant to which the affiliate of Vintage purchased
from the Company 2,354,000 shares of common stock for an aggregate
purchase price of $28.2 million in cash.
• On February 7, 2020 , in connection with our repurchases of Vitamin
Shoppe's outstanding 2.25% Convertible Senior Notes due 2020 (the "VSI
Convertible Notes"), certain investors provided the Company with an
aggregate of approximately $65.9 million of equity financing to fund the
repurchase or redemption of the VSI Convertible Notes, make interest
payments on the VSI Convertible Notes that are not so repurchased orredeemed until their maturity and to also fund general, working capital
and cash needs of the Company.
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• On
which was used to fund the American Freight Acquisition and repay the
existing Sears Outlets and Buddy's term loans.
• The outbreak of the coronavirus (COVID-19) pandemic has affected economic
conditions, including macroeconomic conditions and levels of business
confidence and has created economic disruption. Mitigation efforts,
including federal, state and local government restrictions, including
travel restrictions, restrictions on public gatherings, closing of
nonessential businesses and quarantining of people who may have been
exposed to the coronavirus, may have an impact on our cash flow from
operations and our ability to raise capital from financial institutions.
Currently, there is significant uncertainty surrounding the potential
impact on our business and we are actively managing our business to
respond to the impact and increase our liquidity.
Sources and uses of cash
Operating activities
In the Transition Period, cash used in operating activities decreased
• a
million in inventory, a
and a $5.6 million increase in restricted cash;
• a
the impairment of internally developed software that is no longer in use;
• a
allowance related to the ability to utilize net operating loss
carryforwards; and
• a
In the fiscal year ended
• a decrease of
closures of Company-owned and year-round accounting stores, partially
offset by; and
• a
in the fiscal year ended April 30, 2019 compared to the fiscal year ended
April 30, 2018 .
Investing activities
In the Transition Period, cash used for investing activities increased $315.0
million compared to the period from May 1, 2018 to December 29, 2018 . This
increase is primarily due to the Vitamin Shoppe Acquisition, the Sears Outlet
Acquisition and the acquisition of franchisees from A-Team Leasing .
In the fiscal year ended
• a
AD rights and customer lists, net of sales, partially offset by; and
• a
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Financing activities
In the Transition Period, cash from financing activities increased
• a
agreements and revolving credit facilities, primarily under the Vitamin
Shoppe Credit Agreement, Sears Outlet Credit Agreement and Buddy's Credit
Agreement;
• a
• an increase of
• an increase of
the revolving credit facilities; and
• an increase of
stock in connection with a tender offer.
In the fiscal year ended
Long-term debt borrowings
American Freight Term Loan. OnFebruary 14, 2020 , in connection with the American Freight Acquisition, we, through direct and indirect subsidiaries, entered into a$675 million credit facility, which included a$575 million senior secured term loan (the "AF Term Loan") and a$100 million senior secured asset based term loan (the "ABL Term Loan"), to finance the American Freight Acquisition and to repay the existingSears Outlets and Buddy's term loans for an amount of$106.6 million and$104.6 million , respectively. The AF Term Loan will mature onFebruary 14, 2025 and the ABL Term Loan will mature onSeptember 30, 2020 . We are required to repay the AF Term Loan in equal quarterly installments of$6.25 million on the last day of each fiscal quarter, commencing onJune 30, 2020 . Vitamin Shoppe Term Loan. OnDecember 16, 2019 in connection with the Vitamin Shoppe Acquisition, we, through direct and indirect subsidiaries, entered into a Loan and Security Agreement (the "Vitamin Shoppe Term Loan Agreement") that provides for a$70.0 million senior secured term loan (the "Vitamin Shoppe Term Loan") which matures onDecember 16, 2022 . Our obligations under the Vitamin Shoppe Term Loan are secured by substantially all of the assets of ourVitamin Shoppe segment. We are required to repay the term loan in equal quarterly installments of$4.25 million on the last business day of each fiscal quarter, commencing onMarch 28, 2020 . The Vitamin Shoppe Term Loan Agreement includes customary affirmative, negative, and financial covenants binding on us and our subsidiaries, including delivery of financial statements, borrowing base certificates and other reports. Vitamin Shoppe ABL Revolver. OnDecember 16, 2019 , we, through direct and indirect subsidiaries, entered into a Second Amended and Restated Loan and Security Agreement (the " Vitamin Shoppe ABL Agreement") providing for a senior secured revolving loan facility (the "Vitamin Shoppe ABL Revolver") with commitments available to us of the lesser of (i)$100.0 million and (ii) a specified borrowing base based on our eligible credit card receivables, accounts and inventory, less certain reserves, and as to each of clauses (i) and (ii), less a$10.0 million availability block. The Vitamin Shoppe ABL Revolver will mature onDecember 16, 2022 . We borrowed$70.0 million onDecember 16, 2019 , which was used to consummate the Vitamin Shoppe Acquisition. Subject to the Intercreditor Agreement, we are required to repay borrowings under the Vitamin Shoppe ABL Revolver with the net cash proceeds of certain customary events (subject to certain customary reinvestment rights). Further, if the outstanding principal amount of the borrowings under the Vitamin Shoppe ABL Revolver at any time exceeds the lesser of$100.0 million and the borrowing base, less, in each case, a$10.0 million availability block, we must prepay any such excess. In addition, the Vitamin Shoppe ABL Agreement includes customary affirmative and negative covenants binding on us and our subsidiaries, including delivery of financial statements, borrowing base certificates and other reports. Sears Outlet Credit Agreement. OnOctober 23, 2019 in connection with the Sears Outlet Acquisition, we, through indirect subsidiaries, entered into the Sears Outlet Credit Agreement that provides for a$105.0 million first priority senior secured term loan (the "Sears Outlet Term Loan"), net of financing costs of$2.8 million , which matures onOctober 23, 2023 . We repaid the Sears Outlet Term Loan onFebruary 14, 2020 in connection with the financing of the American Freight Acquisition. Buddy's Credit Agreement. OnJuly 10, 2019 , in connection with the Buddy's Acquisition, we, through an indirect subsidiary, entered into the Buddy's Credit Agreement that provides for an$82.0 million first priority senior secured term loan which matures onJuly 10, 2024 . OnAugust 23, 2019 as part of the 41 stores acquisition from A-Team, the Buddy's Credit Agreement was 46
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amended. The amendment provides for a$23.0 million first priority senior secured loan (the "Buddy's Additional Term Loan"), net of financing costs of$0.4 million . We repaid the amounts outstanding under the Buddy's Credit Agreement onFebruary 14, 2020 in connection with the financing of the American Freight Acquisition. Liberty Tax Credit Agreement. OnMay 16, 2019 , we entered into a new credit agreement (the "Liberty Tax Credit Agreement") which provides for a$135.0 million senior revolving credit facility (the "Revolving Credit Facility"), a$10.0 million sub-facility for the issuance of letters of credit, and a$20.0 million swingline loan sub-facility. OnOctober 2, 2019 , we amended the Liberty Tax Credit Agreement to extend the maturity date toOctober 2, 2022 , from the original maturity date ofMay 31, 2020 and decrease the aggregate amount of commitments from$135.0 million to$125.0 million as ofOctober 2, 2019 . The Liberty Tax Credit Agreement includes customary affirmative, negative, and financial covenants, including delivery of financial statements and other reports and maintenance of existence. OnFebruary 14, 2020 , we amended certain provisions of the Liberty Tax Credit Agreement to provide for the gradual reduction of the commitments under the Liberty Tax Credit Agreement and a maturity date ofApril 30, 2020 .
For more information on the long-term obligations, refer to "Note 10 - Long-Term Obligations", to the Consolidated Financial Statements in Item 8.
Other factors affecting our liquidity
Seasonality of cash flow. OurLiberty Tax segment's tax return preparation business is seasonal, and most of its revenues and cash flow are generated during the period from late January throughApril 30 each year. Following each tax season, fromMay 1 through late January of the following year, it relies significantly on excess operating cash flow from the previous season, from cash payments made by franchisees who purchase new territories prior to the next tax season, and on the use of its credit facility to fund its operating expenses and invest in the future growth of the business. Its business has historically generated a strong cash flow from operations on an annual basis. TheLiberty Tax segment devotes a significant portion of its cash resources during the off-season to finance the working capital needs of its franchisees, and expenditures for property, equipment and software. Franchisee lending and potential exposure to credit loss. A portion of our cash flow during the year is utilized to provide funding to our franchisees. AtDecember 28, 2019 , our total balance of loans to franchisees for working capital and equipment loans, representing cash we had advanced to the franchisees, was$25.2 million . In addition, at that date, our franchisees and ADs together owed us an additional$50.5 million , net of unrecognized revenue of$4.9 million , representing unpaid royalties, the unpaid purchase price for franchise territories and other amounts. OurLiberty Tax segment franchise agreements allow us to obtain repayment of amounts due to us from our franchisees through an electronic fee intercept program before our franchisees receive the net proceeds from tax preparation and other fees they have charged to their customers on tax returns associated with tax settlement products. Therefore, we are able to minimize the nonpayment risk associated with amounts outstanding from franchisees by obtaining direct electronic payment in the ordinary course throughout the tax season. The unpaid amounts owed to us from our franchisees and ADs are collateralized by the underlying franchise or area and, when the franchise or area owner is an entity, are generally guaranteed by the owners of the respective entity. Accordingly, to the extent a franchisee or AD does not satisfy its payment obligations to us, we may repossess the underlying franchise or area in order to resell it in the future. AtDecember 28, 2019 , we had an investment in impaired accounts and notes receivable and related interest receivable of approximately$13.4 million . We consider accounts and notes receivable to be impaired if the amounts due exceed the fair value of the underlying franchise and estimate an allowance for doubtful accounts based on that excess. Amounts due include the recorded value of the accounts and notes receivable reduced by the allowance for uncollected interest, amounts due to ADs for their portion of franchisee receivables, any related unrecognized revenue and amounts owed to the franchisee or AD by us. In establishing the fair value of the underlying franchise, we consider net fees of open territories and the number of unopened territories. AtDecember 28, 2019 , our allowance for doubtful accounts for impaired accounts and notes receivable was$6.1 million . Tax Receivable Agreement. We may be required to make TRA payments to the Buddy's Members. Under the terms of the TRA, we will pay the Buddy's Members 40% of the cash savings, if any, in federal, state and local taxes that we realize or are deemed to realize as a result of any increases in tax basis of the assets of New Holdco resulting from future redemptions or exchanges of New Holdco units held by the Buddy's Members. Any future obligations and the timing of such payments under the TRA, however, are subject to several factors, including (i) the timing of subsequent exchanges of New Holdco units by the Buddy's Members, (ii) the price of our common stock at the time of exchange, (iii) the extent to which such exchanges are taxable, (iv) the ability to generate sufficient future taxable income over the term of the TRA to realize the tax benefits and (v) any future changes in tax laws. If we do not generate sufficient taxable income in the aggregate over the term of the TRA to utilize the tax benefits, then we would not be required to make the related TRA payments. As a result of these uncertainties, we cannot estimate 47
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the amount of total potential TRA payments. Although the amount of the TRA payments would reduce the total cash flow to us and New Holdco, we expect the cash tax savings we will realize from the utilization of the related tax benefits would be sufficient to fund the required payments. Therefore, we do not believe the TRA payments would materially affect our liquidity.
Dividends. See "Item 5-Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Future cash needs and capital requirements
Operating and financing cash flow needs. Following the American Freight Acquisitions and other transactions completed subsequent toDecember 28, 2019 , our primary cash needs are expected to include the payment of scheduled debt and interest payments, capital expenditures and normal operating activities. We believe that the revolving credit facilities along with cash from operating activities, will be sufficient to support our cash flow needs for at least the next twelve months. AtDecember 28, 2019 , using the leverage ratio applicable under our loan covenants at the end of the period, our maximum unused borrowing capacity was$95.7 million .
Several factors could affect our cash flow in future periods, including the following:
• The extent to which we extend additional operating financing to our
franchisees and ADs, beyond the levels of prior periods.
• The extent and timing of capital expenditures.
• The extent and timing of future acquisitions.
• Our ability to integrate our acquisitions and implement business and cost
savings initiatives to improve profitability.
• The extent, if any, to which our Board of Directors elects to continue to
declare dividends on our common stock.
Compliance with debt covenants. Our revolving credit and long-term debt
agreements impose restrictive covenants on us, including requirements to meet
certain ratios. As of
Off Balance Sheet Arrangements
From time to time, we have been party to interest rate swap agreements. These swaps effectively changed the variable-rate of our credit facility into a fixed-rate credit facility. Under the swaps, we received a variable interest rate based on the one-month LIBOR and paid a fixed interest rate. We entered into an interest rate swap agreement in relation to our mortgage payable to a bank, during fiscal 2017. We also enter into forward contracts to eliminate exposure related to foreign currency fluctuations in connection with the short-term advances we make to our Canadian subsidiary in order to fund personal income tax refund discounting for our Canadian operations. AtDecember 28, 2019 , there were no forward contracts outstanding, but we expect to enter into forward contracts in the future during the Canadian tax season.
Critical Accounting Policies
The preparation of financial statements requires the use of estimates. Certain of our estimates require a high level of judgment and have the potential to have a material effect on the financial statements if actual results vary significantly from those estimates. Following is a discussion of the estimates that we consider critical. Inventory. Inventory for our Buddy's segment is recorded at cost, including shipping and handling fees. All lease merchandise is available for lease or sale. Upon purchase, merchandise is not initially depreciated until it is leased or three months after the purchase date. Non-leased merchandise is depreciated on a straight-line basis over a period of 24 months. Leased merchandise is depreciated over the lease term of the rental agreement. On a weekly basis, all damaged, lost, stolen, or unsalable merchandise identified is written off. Maintenance and repairs of lease merchandise are charged to operations as incurred. Inventory for ourSears Outlet segment is recorded at the lower of cost or market using the weighted-average cost method. Inventory includes the purchase price of the inventory plus costs of freight for moving merchandise from vendors to distribution 48
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centers as well as from distribution centers to stores. We maintain a provision for estimated shrinkage based on the actual historical results of our physical inventories. We compare our estimates to the actual results of the physical inventory counts as they are taken and adjust the shrink estimates accordingly. We also record adjustments to the value of inventory equal to the difference between the carrying value and the estimated market value, based on assumptions about future demand or when a permanent markdown indicates that the net realizable value of the inventory is less than cost. Inventory for ourVitamin Shoppe segment is recorded at the lower of cost or market value using the weighted-average cost method. Inventory includes costs directly incurred in bringing the product to its existing condition and location. In addition, the cost of inventory is reduced by purchase discounts and other allowances received from vendors. A markdown reserve is estimated based on a variety of factors, including, but not limited to, the amount of inventory on hand and its remaining shelf life, current and expected market conditions and product expiration dates. In addition, we have established a reserve for estimated inventory shrinkage based on the actual, historical shrinkage of our most recent physical inventories adjusted, and if necessary, for current economic conditions and business trends. Physical inventories and cycle counts are taken on a regular basis. These adjustments are estimates, which could vary significantly from actual results if future economic conditions, customer demand or competition differ from management expectations. Long-Lived Assets. We review our long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset group may not be recoverable. We measure recoverability by comparison of the carrying value of an asset to its estimated undiscounted future cash flows expected to be generated by the asset. We recognize and measure potential impairment at the lowest level where cash flows are individually identifiable. If the carrying amount of an asset exceeds its estimated future cash flows, we recognize an impairment charge equal to the amount by which the carrying value of the asset exceeds the fair value of the asset. We determine fair value through various valuation techniques, including discounted cash flow models, quoted market values, and third-party independent appraisals. If assets are to be disposed of, we separately present these assets in the balance sheet and report them at the lower of the carrying amount or fair value less selling costs, and no longer depreciate them. When we have assets classified as held for sale, we present them separately in the appropriate asset section of the balance sheet. Business Combinations-Purchase Price Allocation. For acquisitions we allocated the purchase price to the various tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values, which are preliminary as ofDecember 28, 2019 . Determining the fair value of certain assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions, which are inherently uncertain. Many of the estimates and assumptions used to determine fair values, such as those used for intangible assets are made based on forecasted information and discount rates. In addition, the judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations.
Recently Issued Accounting Standards
Refer to "Note 1. Organization and Significant Accounting Policies", in our consolidated financial statements.
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