PART I – FINANCIAL INFORMATION

CRACKER BARREL OLD COUNTRY STORE, INC.

Cracker Barrel Old Country Store, Inc. and its subsidiaries (collectively, the “Company,” “our” or “we”) are principally engaged in the operation and development in the United States of the Cracker Barrel Old Country Store® (“Cracker Barrel”) concept.  At October 29, 2021, we operated 664 Cracker Barrel stores in 45 states and 37 Maple Street Biscuit Company (“MSBC”) company-owned locations in eight states.  At October 29, 2021, MSBC had seven franchised locations.

 All dollar amounts reported or discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are shown in thousands, except per share amounts and certain statistical information (e.g., number of stores).  References to years in MD&A are to our fiscal year unless otherwise noted.

MD&A provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition.  MD&A should be read in conjunction with the (i) condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and (ii) audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 30, 2021 (the “2021 Form 10-K”).  Except for specific historical information, many of the matters discussed in this report may express or imply projections of items such as revenues or expenditures, estimated capital expenditures, compliance with debt covenants, plans and objectives for future operations, inventory shrinkage, growth or initiatives, expected future economic performance or the expected outcome or impact of pending or threatened litigation. These and similar statements regarding events or results which we expect will or may occur in the future are forward-looking statements that, by their nature, involve risks, uncertainties and other factors which may cause our actual results and performance to differ materially from those expressed or implied by such statements.  All forward-looking information is provided pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 and should be evaluated in the context of these risks, uncertainties and other factors. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “trends,” “assumptions,” “target,” “guidance,” “outlook,” “opportunity,” “future,” “plans,” “goals,” “objectives,” “expectations,” “near-term,” “long-term,” “projection,” “may,” “will,” “would,” “could,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “potential,” “should,” “projects,” “forecasts” or “continue”  (or the negative or other derivatives of each of these terms) or similar terminology.  We believe the assumptions underlying any forward-looking statements are reasonable; however, any of the assumptions could be inaccurate, and therefore, actual results may differ materially from those projected in or implied by the forward-looking statements.  In addition to the risks of ordinary business operations, and those discussed or described in this report or in information incorporated by reference into this report, factors and risks that may result in actual results differing from this forward-looking information include, but are not limited to risks and uncertainties associated with the novel coronavirus (“COVID-19”) pandemic, including the duration of the COVID-19 pandemic and its ultimate impact on our business, levels of consumer confidence in the safety of dine-in restaurants, restrictions (including occupancy restrictions) imposed by governmental authorities, the effectiveness of cost saving measures undertaken throughout our operations, disruptions to our operations as a result of the spread of COVID-19 in our workforce, general or regional economic weakness, business and societal conditions, and the weather impact on sales and customer travel; discretionary income or personal expenditure activity of our customers; information technology-related incidents, including data privacy and information security breaches, whether as a result of infrastructure failures, employee or vendor errors, or actions of third parties; our ability to identify, acquire and sell successful new lines of retail merchandise and new menu items at our restaurants; our ability to sustain or the effects of plans intended to improve operational or marketing execution and performance; uncertain performance of acquired businesses, strategic investments and other initiatives that we may pursue from time to time; changes in or implementation of additional governmental or regulatory rules, regulations and interpretations affecting tax, wage and hour matters, health and safety, pensions, insurance or other undeterminable areas; the effects of plans intended to promote or protect our brands and products; commodity price increases; the ability of and cost to us to recruit, train, and retain qualified hourly and management employees; the effects of increased competition at our locations on sales and on labor recruiting, cost, and retention; workers’ compensation, group health and utility price changes; consumer behavior based on negative publicity or changes in consumer health or dietary trends or safety aspects of our food or products or those of the restaurant industry in general, including concerns about outbreaks of infectious disease as well as the possible effects of such events on the price or availability of ingredients used in our restaurants; the effects of our indebtedness and associated restrictions on our financial and operating flexibility and ability to execute or pursue our operating plans and objectives; changes in interest rates, increases in borrowed capital or capital market conditions affecting our financing costs and ability to refinance all or portions of our indebtedness; the effects of business trends on the outlook for individual restaurant locations and the effect on the carrying value of those locations; our ability to retain key personnel; the availability and cost of suitable sites for restaurant development and our ability to identify those sites; our ability to enter successfully into new geographic markets that may be less familiar to us; changes in land, building materials and construction costs; the actual results of pending, future or threatened litigation or governmental investigations and the costs and effects of negative publicity or our ability to manage the impact of social media associated with these activities; economic or psychological effects of natural disasters or other unforeseen events such as terrorist acts, social unrest or war and the military or government responses to such events; disruptions to our restaurant or retail supply chain, including as a result of COVID-19; changes in foreign exchange rates affecting our future retail inventory purchases; the impact of activist shareholders; our reliance on limited distribution facilities and certain significant vendors;  implementation of new or changes in interpretation of existing accounting principles generally accepted in the United States of America (“GAAP”) and those factors contained in Part I, Item 1A of the 2021 Form 10-K, as well as the factors described under “Critical Accounting Estimates” on pages 26-28 of this report or, from time to time, in our filings with the Securities and Exchange Commission (“SEC”), press releases and other communications.

Readers are cautioned not to place undue reliance on forward-looking statements made in this report because the statements speak only as of the report’s date.  Except as may be required by law, we have no obligation or intention to update or revise any of these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events.  Readers are advised, however, to consult any future public disclosures that we may make on related subjects in reports that we file with or furnish to the SEC or in our other public disclosures.

Overview

 

Management believes that the Cracker Barrel’s core competitive advantages include our authentic experiential brand, our culture of hospitality, and our homestyle food and retail assortments. We remain focused on these core strengths, and we believe they will continue to drive the long-term success and outperformance of our brand. We plan to leverage these core strengths in fiscal 2022 to drive additional frequency from our core guests, attract new customers, and strengthen our operating and business model.

During the first quarter, we continued to make progress on key strategic initiatives such as continuing the rollout of beer and wine to our stores and investments in our digital capabilities. We also expanded our virtual brand, Chicken ‘n Biscuits, to a total of 500 stores in the first quarter, and we launched a second virtual brand, The Pancake Kitchen. Finally, we launched Cracker Barrel Kitchen, a ghost kitchen that marks our entrance to the Los Angeles market.

For the full fiscal year, we currently anticipate adding three new Cracker Barrel locations and 15 new Maple Street Biscuit Company locations.

Key Performance Indicators

Management uses a number of key performance measures to evaluate our operational and financial performance, including the following:

 

 

 

 

 

 

 

These performance indicators exclude the impact of new store openings and sales related to MSBC.

We use comparable store sales metrics as indicators of sales growth to evaluate how our established stores have performed over time. We use comparable restaurant guest traffic increase/(decrease) to evaluate how established stores have performed over time, excluding growth achieved through menu price and sales mix change. Finally, we use average check per guest to identify trends in guest preferences, as well as the effectiveness of menu changes. We believe these performance indicators are useful for investors by providing a consistent comparison of sales results and trends across comparable periods within our core, established store base, unaffected by results of store openings, closings, and other transitional changes.

Results of Operations

The following table highlights our operating results by percentage relationships to total revenue for the quarter ended October 29, 2021 as compared to the same period in the prior year:

The following table sets forth the change in the number of Company-owned and franchised units in operation at the beginning and end of the quarters ended October 29, 2021 and October 30, 2020 as well as the number of Company-owned and franchised units at the end of the quarters ended October 29, 2021 and October 30, 2020:

Total Revenue

Total revenue for the first quarter of 2022 increased 21.4% as compared to the same period in the prior year. The Company continues to recover from the COVID-19 pandemic as all dining rooms were open to some extent during the first quarter of 2022. Dining room service was operational to varying degrees, yet in some locations continued to be impacted by capacity restrictions and social distancing guidelines. It is possible that renewed outbreaks or increases in cases, either as part of a national trend or on a more localized basis, could result in additional capacity restrictions or otherwise limit our dine-in services, or negatively affect consumer demand. Off-premise sales for the first quarter of 2022 represented approximately 20% of restaurant sales volumes compared to approximately 25% in the first quarter of 2021 when a large number of our restaurants were operating with limitations on or full prohibitions of dine-in services.

The following table highlights the key components of revenue for the quarter ended October 29, 2021 as compared to the same period in the prior year:

⁽¹⁾ Average unit volumes include sales of all stores except for MSBC.

⁽²⁾ Comparable store sales and traffic consist of sales of stores open at least six full quarters at the beginning of the period and are measured on comparable calendar weeks.  Comparable store sales and traffic exclude MSBC.

For the first quarter of 2022, our comparable store restaurant sales increased as a result of a 12.1% guest traffic increase and a 6.9% average check increase (including a 5.5% average menu price increase) as compared to the prior year first quarter.

Our retail sales are made substantially to our restaurant guests.  For the first quarter of 2022, our comparable store retail sales increase resulted primarily from the guest traffic increase and strong performance in the toys, food and convenience, décor merchandise, apparel and accessories and licensed categories.

Cost of Goods Sold (Exclusive of Depreciation and Rent)

The following table highlights the components of cost of goods sold (exclusive of depreciation and rent) in dollar amounts and as percentages of revenues for the first quarter of 2022 as compared to the same period in the prior year:

The increase in restaurant cost of goods sold as a percentage of restaurant revenue in the first quarter of 2022 as compared to the same period in the prior year primarily resulted from higher food waste and commodity inflation of 7.3% partially offset by our menu price increase referenced above and a shift to lower cost menu items. Higher food waste accounted for an increase of 0.5% as a percentage of restaurant revenue for the first quarter of 2022 as compared to the same period in the prior year. Lower cost menu items accounted for a decrease of 0.5%.

We presently expect the rate of commodity inflation to be in the high single digits in 2022.

The decrease in retail cost of goods sold as a percentage of retail revenue in the first quarter of 2022 as compared to the first quarter of 2021 resulted from lower markdowns, a decrease in discounts and allowances, lower freight expense and lower shrinkage partially offset by lower initial margin and the change in the provision for obsolete inventory. Lower freight expense and lower shrinkage as a percentage of retail revenue in the first quarter of 2022 as compared to the same period in the prior year were primarily driven by the increase in retail revenue in 2022.

 

Labor and Related Expenses

Labor and related expenses include all direct and indirect labor and related costs incurred in store operations.  The following table highlights labor and related expenses as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year:

This percentage change resulted from the following:

 

The decrease in store management compensation as a percentage of total revenue in the first quarter of 2022 as compared to the same period in the prior year was primarily driven by the increase in total revenue in 2022 partially offset by wage inflation exceeding menu price increases.

The decrease in store bonus expense as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year resulted from lower performance against financial objectives for certain components of the incentive plan in the first quarter of 2022 as compared to the same period in the prior year.

The increase in store hourly labor expense as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year resulted primarily from wage inflation exceeding menu price increases and a reduction in productivity. We presently expect the rate of wage inflation to be in the high single digits in 2022.

Other Store Operating Expenses

Other store operating expenses include all store-level operating costs, the major components of which are operating supplies, utilities, repairs and maintenance, depreciation and amortization, advertising, rent, third party delivery fees, credit and gift card fees, real and personal property taxes and general insurance.

The following table highlights other store operating expenses as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year:

 

This percentage changes resulted primarily from the following:

The decreases in depreciation expense, rent expense, real and personal property taxes expense and utilities expense as a percentage of total revenue in the first quarter of 2022 as compared to the same period in the prior year were primarily driven by the increase in total revenue in the first quarter of 2022.

The decrease in supplies expense as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year was primarily driven by the increase in total revenue in the first quarter of 2022 partially offset by higher costs.  For the first quarter of 2022, we incurred higher costs associated with the growth in our off-premise business and increased operations in our dining rooms.

The increase in other store expenses as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year resulted primarily from costs associated with the growth in our off-premise business.

General and Administrative Expenses

 

The following table highlights general and administrative expenses as a percentage of total revenue for the first quarter of 2022 as compared to the same period in the prior year:

The decrease in general and administrative expenses as a percentage of total revenue in the first quarter of 2022 as compared to the same period in the prior year resulted primarily from expenses related to the proxy contest in the first quarter of 2021.

Gain on Sale and Leaseback Transaction

On August 4, 2020, the Company completed a sale and leaseback transaction involving 62 of its owned Cracker Barrel stores and recorded a gain of $217,722 which is recorded in the gain on sale and leaseback transaction line in the Condensed Consolidated Statement of Income in the first quarter of 2021.  See Note 8 to the Condensed Consolidated Financial Statements for additional information regarding this sale and leaseback transaction.

 

Interest Expense, net

The following table highlights interest expense, net in dollars for the first quarter of 2022 as compared to the same period in the prior year:

The decrease in interest expense for the first quarter of 2022 as compared to the same period in the prior year resulted primarily from lower debt levels and lower average weighted interest rates.

 

Provision for Income Taxes

The following table highlights the provision for income taxes as a percentage of income before income taxes (“effective tax rate”) for the first quarter of 2022 as compared to the same period in the prior year:

The decrease in the effective tax rate is primarily the result of an increase in tax credits and taxes on the sale and leaseback transaction in the first quarter of 2021.  We presently expect our effective tax rate for 2022 to be approximately 17%.

Our primary sources of liquidity are cash generated from our operations and our borrowing capacity under our 2019 Revolving Credit Facility.  Our internally generated cash, along with cash on hand at July 30, 2021, were sufficient to finance all of our growth, dividend payments, working capital needs, interest payments under our revolving credit facility and other cash payment obligations in the first three months of 2022. We believe that cash at October 29, 2021, along with cash expected to be generated from our operating activities and the borrowing capacity under our revolving credit facility, will be sufficient to finance our continuing operations, our continuing expansion plans and working capital needs over the next twelve months.

Cash Generated From Operations

Our operating activities provided net cash of $23,023 for the first three months of 2022, representing a decrease from the $56,991 net cash provided during the first three months of 2021. This decrease primarily reflected the timing of payments for accounts payable.

Borrowing Capacity, Debt Covenants and Notes

On September 5, 2018, we entered into the 2019 Revolving Credit Facility, a five-year $950,000 revolving credit facility, which also contains an option to increase the revolving credit facility by $300,000, of which $260,605 remains. In the third quarter of 2021, we entered into an amendment to the 2019 Revolving Credit Facility which reduced the commitment amount from $950,000 to $800,000.

 

At October 29, 2021, we had $85,000 of outstanding borrowings under the 2019 Revolving Credit Facility and $31,896 of standby letters of credit related to securing reserved claims under our workers’ compensation insurance and our July 29, 2020 and August 4, 2020 sale and leaseback transactions, which reduce our borrowing availability under the 2019 Revolving Credit Facility. At October 29, 2021, we had $683,104 in borrowing availability under our 2019 Revolving Credit Facility. See Note 4 to our Condensed Consolidated Financial Statements for further information on our long-term debt.

 

The 2019 Revolving Credit Facility contains customary financial covenants, which include maintenance of a maximum consolidated total leverage ratio and a minimum consolidated interest coverage ratio. We were in compliance with the 2019 Revolving Credit Facility’s financial covenants at October 29, 2021, and we expect to be in compliance with the 2019 Revolving Credit Facility’s financial covenants for the remaining term.

 

On June 18, 2021, the Company entered into an issuance and sale of $300,000 aggregate principal amount of 0.625% Convertible Senior Notes due 2026.  The Notes are senior, unsecured obligations of the Company and bear cash interest at a rate of 0.625% per annum, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on December 15, 2021. The Notes mature on June 15, 2026, unless earlier converted, repurchased or redeemed.  Net proceeds from the Notes were $291,125, after deducting the initial purchasers’ discounts and commissions and the Company’s offering fees and expenses.

 

In connection with the issuance of the Notes, the Company entered into privately negotiated convertible note hedge transactions (the “Convertible Note Hedge Transactions”) with certain of the initial purchasers of the Notes and/or their respective affiliates and other financial institutions (in this capacity, the “Hedge Counterparties”), which cover, subject to customary anti-dilution adjustments, the aggregate number of shares of the Company’s common stock that initially underlie the Notes. Concurrently with the Company’s entry into the Convertible Note Hedge Transactions, the Company also entered into separate, privately negotiated warrant transactions with the Hedge Counterparties collectively relating to the same number of shares of the Company’s common stock underlying the Notes, subject to customary anti-dilution adjustments, and for which the Company received premiums that partially offset the cost of entering into the Convertible Note Hedge Transactions (the “Warrant Transactions”).  The portion of the net proceeds to the Company from the offering of the Notes that was used to pay the premium on the Convertible Note Hedge Transactions, net of the proceeds to the Company from the Warrant Transactions, was approximately $30,300.

 

Capital Expenditures and Proceeds from Sale of Property and Equipment

Capital expenditures (purchase of property and equipment) net of proceeds from insurance recoveries were $14,053 for the first three months of 2022 as compared to $11,214 for the same period in the prior year.  Our capital expenditures consisted primarily of capital investments for existing stores, new store locations and capital expenditures for strategic initiatives.  The increase in capital expenditures during the first three months of 2022 as compared to the first three months of 2021 resulted primarily from higher capital expenditures for existing stores partially offset by lower capital expenditures for strategic initiatives. We estimate that our capital expenditures during 2022 will be approximately $120,000.  This estimate includes the acquisition of sites and construction costs of new Cracker Barrel stores and new MSBC locations that have opened or that we expect to open during 2022, as well as for acquisition and construction costs for store locations that we plan to be opened in 2023.  We intend to fund our capital expenditures with cash generated by operations and borrowings under our 2019 Revolving Credit Facility, as necessary.

The proceeds from sale of property and equipment were $14 for the first three months of 2022 as compared to $149,829 for the same period in the prior year.  This decrease primarily relates to the sale and leaseback transaction entered into during the first quarter of 2021.  See Note 8 to the Condensed Consolidated Financial Statements for additional information regarding this sale and leaseback transaction.

 

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.  Under the 2019 Revolving Credit Facility, provided there is no default existing and the total of our availability under the 2019 Revolving Credit Facility plus our cash and cash equivalents on hand is at least $100,000 (the “Cash Availability”), we may declare and pay cash dividends on shares of our common stock and repurchase shares of our common stock (1) in an unlimited amount if at the time the dividend or the repurchase is made our consolidated total leverage ratio is 3.00 to 1.00 or less and (2) in an aggregate amount not to exceed $100,000 in any fiscal year if our consolidated total leverage ratio is greater than 3.00 to 1.00 at the time the dividend or repurchase is made; notwithstanding (1) and (2), so long as immediately after giving effect to the payment of any such dividends, Cash Availability is at least $100,000, we may declare and pay cash dividends on shares of our common stock in an aggregate amount not to exceed in any fiscal year the product of the aggregate amount of dividends declared in the fourth quarter of the immediately preceding fiscal year multiplied by four.

 

During the first three months of 2022, we paid a regular dividend of $1.00 per share and declared a dividend of $1.30 per share that was subsequently paid on November 9, 2021, to shareholders of record on October 22, 2021.

 

We have been authorized by our Board of Directors to repurchase shares of the Company’s outstanding common stock at management’s discretion up to a total value of $100,000.  We did not repurchase any shares of our common stock during the first three months of 2022.

During the first three months of 2022, we issued 22,691 shares of our common stock resulting from the vesting of share-based compensation awards. Related tax withholding payments on these share-based compensation awards resulted in a net use of cash of $2,309.

Working Capital

In the restaurant industry, virtually all sales are either for third-party credit or debit card or cash.   Restaurant inventories purchased through our principal food distributor are on terms of net zero days, while restaurant inventories purchased locally are generally financed from normal trade credit.  Because of our retail gift shops, which have a lower product turnover than the restaurant business, we carry larger inventories than many other companies in the restaurant industry.  Retail inventories purchased domestically are generally financed from normal trade credit, while imported retail inventories are generally purchased through wire transfers.  These various trade terms are aided by the rapid turnover of the restaurant inventory.  Employees generally are paid on weekly or semi-monthly schedules in arrears for hours worked except for bonuses that are paid either quarterly or annually in arrears.  Many other operating expenses have normal trade terms and certain expenses, such as certain taxes and some benefits, are deferred for longer periods of time.

We had negative working capital of $92,424 at October 29, 2021 versus negative working capital of $111,666 at July 30, 2021.  The change in working capital from July 30, 2021 to October 29, 2021 primarily resulted from higher inventory levels and lower incentive compensation accruals resulting from the payment of annual bonuses partially offset by a decrease in cash.

Off-Balance Sheet Arrangements

We have no material off-balance sheet arrangements.

Material Commitments

There have been no material changes in our material commitments other than in the ordinary course of business since the end of 2021.  Refer to the sub-section entitled “Material Commitments” under the section entitled “Liquidity and Capital Resources” presented in the MD&A of our 2021 Form 10-K for additional information regarding our material commitments.

See Note 1 to the accompanying Condensed Consolidated Financial Statements for a discussion of recent accounting guidance adopted.  The adoption of the accounting guidance on income taxes discussed in Note 1 did not have a significant impact on our consolidated financial position or results of operations. See Note 1 regarding the impact of the adoption of the convertible instruments guidance.

We prepare our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires us to make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures.  We base our estimates and judgments on historical experience, current trends, outside advice from parties believed to be experts in such matters, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  However, because future events and their effects cannot be determined with certainty, actual results could differ from those assumptions and estimates, and such differences could be material.

 

Our significant accounting policies are discussed in Note 2 to the Consolidated Financial Statements contained in the 2021 Form 10-K.  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:

We consider the following accounting estimates to be most critical in understanding the judgments that are involved in preparing our Consolidated Financial Statements:

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 first three months of 2022, and we do not believe that there is a reasonable likelihood that there will be a material change in the estimates or assumptions used by us in the future to assess impairment of long-lived assets.  However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and fair values of long-lived assets, we may be exposed to losses that could be material.  It is possible that we may recognize impairment as a result of the unknown impacts of the COVID-19 pandemic and our response.

 

Insurance Reserves

We self-insure a significant portion of our expected workers’ compensation and general liability insurance programs.  We purchase insurance for individual workers’ compensation claims that exceed $250, $750 or $1,000 depending on the state in which the claim originated.  We purchase insurance for individual general liability claims that exceed $500.  We record a reserve for workers’ compensation and general liability for all unresolved claims and for an estimate of incurred but not reported (“IBNR”) claims.  These reserves and estimates of IBNR claims are based upon a full scope actuarial study which is performed annually at the end of our first quarter and is adjusted by the actuarially determined losses and actual claims payments for the fourth quarter.  Additionally, we perform limited scope actuarial studies on a quarterly basis to verify and/or modify our reserves.  The reserves and losses in the actuarial study represent a range of possible outcomes within which no given estimate is more likely than any other estimate.  As such, we record the losses in the lower half of that range and discount them to present value using a risk-free interest rate based on projected timing of payments.  We also monitor actual claims development, including incurrence or settlement of individual large claims during the interim periods between actuarial studies as another means of estimating the adequacy of our reserves.

 

Our group health plans combine the use of self-insured and fully-insured programs.  Benefits for any individual (employee or dependents) in the self-insured group health program are limited.  We record a liability for the self-insured portion of our group health program for all unpaid claims based upon a loss development analysis derived from actual group health claims payment experience.  Additionally, we record a liability for unpaid prescription drug claims based on historical experience.

Our accounting policies regarding insurance reserves include certain actuarial assumptions and management judgments regarding economic conditions, the frequency and severity of claims and claim development history and settlement practices.  We have not made any material changes in the methodology used to establish our insurance reserves during the first three months of 2022 and do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to calculate the insurance reserves.  However, changes in these actuarial assumptions, management judgments or claims experience in the future may produce materially different amounts of expense that would be reported under these insurance programs.

Retail Inventory Valuation

Cost of goods sold includes the cost of retail merchandise sold at our stores utilizing the retail inventory method (“RIM”).  Under RIM, the valuation of our retail inventories is determined by applying a cost-to-retail ratio to the retail value of our inventories.  Inherent in the RIM calculation are certain inputs, including initial markons, markups, markdowns and shrinkage, which may significantly impact the gross margin calculation as well as the ending inventory valuation.

Inventory valuation provisions are included for retail inventory obsolescence and retail inventory shrinkage.  Retail inventory is reviewed on a quarterly basis for obsolescence and adjusted as appropriate based on assumptions made by management and judgment regarding inventory aging and future promotional activities.  Retail inventory also includes an estimate of shrinkage that is adjusted upon physical inventory counts.  Annual physical inventory counts are conducted based upon a cyclical inventory schedule.  An estimate of shrinkage is recorded for the time period between physical inventory counts by using a two-year average of the physical inventories’ results on a store-by-store basis.

 

We have not made any material changes in the methodologies, estimates or assumptions related to our merchandise inventories during the first three months of 2022 and do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions in the future.  However, actual obsolescence or shrinkage recorded may produce materially different amounts than we have estimated.

Lease Accounting

We have ground leases for our leased stores and office space leases that are recorded as operating leases under various non-cancellable operating leases.  Additionally, we lease our retail distribution center, advertising billboards, vehicle fleets, and certain equipment under various non-cancellable operating leases.

We evaluate our leases at contract inception to determine whether we have the right to control use of the identified asset for a period of time in exchange for consideration.  If we determine that we have the right to obtain substantially all of the economic benefit from use of the identified asset and the right to direct the use of the identified asset, we recognize a right-of-use asset and lease liability.  Also, at contract inception, we evaluate our leases to estimate their expected term which includes renewal options that we are reasonably assured that we will exercise, and the classification of the lease as either an operating lease or a finance lease.  Additionally, as our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the time of commencement or modification date in determining the present value of lease payments. Assumptions used in determining our incremental borrowing rate include our implied credit rating and an estimate of secured borrowing rates based on comparable market data. We assess the impairment of the right-of-use asset 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.

There have been no material changes in our quantitative and qualitative market risks since July 30, 2021.  For a discussion of the Company’s exposure to market risk, refer to the Company’s market risk disclosures set forth in Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” of the 2021 Form 10-K.

 

Interest Rate Risk.  We have interest rate risk relative to our outstanding borrowings under our revolving credit facility.  At October 29, 2021, our outstanding borrowings totaled $85,000 under our revolving credit facility (see Note 4 to the Condensed Consolidated Financial Statements).  Loans under the 2019 Revolving Credit Facility bear interest, at our election, either at the prime rate or LIBOR plus a percentage point spread based on certain specified financial ratios.  Our policy has been to manage interest cost using a mix of fixed and variable rate debt (see Note 4 to our Condensed Consolidated Financial Statements).  In the fourth quarter of 2021, we issued and sold the Notes, which bear cash interest at a fixed rate of 0.625% per annum.

 

The impact of a one-percentage point increase or decrease in the $85,000 of our outstanding borrowings under our revolving credit facility is approximately $850 on a pre-tax annualized basis.

 

Credit Risk.  In the fourth quarter of 2021, the Company issued the Notes and entered into the Convertible Note Hedge Transactions and the Warrant Transactions with the Hedge Counterparties.  Subject to the changes in the market price of the Company’s common stock price, the Company could be exposed to credit risk arising out of the net settlement of the Convertible Note Hedge Transactions and the Warrant Transactions in its favor.  Based on the Company’s review of the possible net settlements and the creditworthiness of the Hedge Counterparties and their affiliates, the Company believes it does not have a material exposure to credit risk as a result of these transactions at this time.

 

Our management, including our principal executive and principal financial officers, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of the end of the period covered by this report.  Based upon this evaluation, our Chief Executive Officer and interim Chief Financial Officer each concluded that as of October 29, 2021, our disclosure controls and procedures were effective for the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e).

There have been no changes (including corrective actions with regard to significant deficiencies and material weaknesses) during the quarter ended October 29, 2021 in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in the risk factors previously disclosed in “Item 1A. Risk Factors” of our 2021 Form 10-K.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.