Fairway Group Holdings Corp
Fairway Group Holdings Corp (Form: 10-Q, Received: 08/07/2014 16:14:39)

  Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 29, 2014

 

OR

 

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from to

 

Commission File Number 001-35880

 

Fairway Group Holdings Corp.

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

 

74-1201087

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

2284 12th Avenue

New York, New York 10027

(646) 616-8000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1)   has filed all reports required to be filed by Section   13 or 15(d)   of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2)   has been subject to such filing req uirements for the past 90 days.     Yes      No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule   405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes      No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule   12b-2 of the Exchange Act.

 

 

 

 

Large accelerated filer  

 

Accelerated filer  

Non-accelerated filer  

 

Smaller reporting company  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule   12b-2 of the Act).     Yes      No

 

As of August 1, 2014, the registrant had 29,227,966   shares of Class A common stock and 14,225,455 shares of Class B common stock outstanding .

 

 

 


 

  Table of Contents

Fairway Group Holdings Corp.

Quarterly Report on Form 10-Q

For the thirteen weeks ended June 29, 2014

Table of Contents

 

 

 

 

 

Part I—Financial Information  

 

 

 

Item 1. Financial Statements (Unaudited)  

 

6

 

Consolidated Balance Sheets as of March 3 0 , 201 4 and June 29 , 201 4

 

6

 

Consolidated Statements of Operations for the thirteen weeks ended June 30, 2013 and June 29, 2014

 

7

 

Consolidated Statements of Cash Flows for the thirteen weeks ended June 30, 2013 and June 29, 2014

 

8

 

Consolidated Statements of Changes in Redeemable Preferred Stock and Stockholders’ Equity for the thirteen weeks ended June 29, 2014

 

9

 

Notes to Unaudited Consolidated Financial Statements

 

10

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  

 

19

Item 3. Quantitative and Qualitative Disclosures About Market Risk  

 

35

Item 4. Controls and Procedures  

 

35

 

 

 

Part II—Other Information  

 

 

 

Item 1. Legal Proceedings  

 

36

Item 1A. Risk Factors  

 

36

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  

 

36

Item 3. Defaults Upon Senior Securities  

 

37

Item 4. Mine Safety Disclosures  

 

37

Item 5. Other Information  

 

37

Item 6. Exhibits  

 

37

Signatures  

 

38

 

 

 

 

 

2


 

  Table of Contents

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this report are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “forecast,” “continue,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our estimated and projected store openings, costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives, strategies or the expected outcome or impact of pending or threatened litigation are forward-looking statements. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:

 

·

our ability to improve same store sales;

 

·

our ability to maintain or improve our operating margins;

 

·

our ability to compete effectively with other retailers;

 

·

our ability to maintain price competitiveness;

 

·

our ability to achieve the anticipated benefits of our centralized production facility;

 

·

our ability to open new stores on a timely basis;

 

·

our ability to achieve sustained sales and profitable operating margins at new stores;

 

·

the availability of financing to pursue our new store openings on satisfactory terms or at all;

 

·

the geographic concentration of our stores;

 

·

ongoing economic uncertainty;

 

·

our history of net losses;

 

·

rising costs of providing employee benefits, including increased healthcare costs and pension contributions due to u nfunded pension liabilities;

 

·

ordering errors or product supply disruptions in the delivery of perishable products;

 

·

negative effects to our reputation from real or perceived quality or health issues with our food products;

 

·

restrictions on our use of the Fairway name other than on the East Coast and in California and certain parts of Michigan and Ohio;

 

·

our ability to protect or maintain our intellectual property;

 

·

the failure of our information technology or administrative systems to perform as anticipated;

 

·

data security breaches and the release of confidential customer information;

3


 

  Table of Contents

 

·

our ability to retain and attract senior management, key employees and qualified store-level employees;

 

·

our ability to renegotiate expiring collective bargaining agreements and new collective bargaining agreements;

 

·

changes in law;

 

·

additional indebtedness incurred in the future;

 

·

our ability to satisfy our ongoing capital needs and unanticipated cash requirements;

 

·

claims made against us resulting in litigation, and the costs of defending, and adverse developments in, such litigation;

 

·

o ur ability to defend the purported securities class action and derivative lawsuits filed against us and other similar complaints that may be brought in the future, in a timely manner and within the coverage, scope and limits our insurance policies;

 

·

increases in commodity prices;

 

·

severe weather and other natural disasters in areas in which we have stores, warehouses and/or production facilities;

 

·

wartime activities, threats or acts of terror or a widespread regional, national or global health epidemic;

 

·

changes to financial accounting standards regarding store leases;

 

·

our high level of fixed lease obligations;

 

·

impairment of our goodwill; and

 

·

other factors discussed under “Item 1A—Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended March 30, 2014 .

 

We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from our expectations or cautionary statements are disclosed under the sections entitled “Item 1A—Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended March 30, 2014 and “Part I—Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements as well as other cautionary statements that are made from time to time in our other filings with the Securities and Exchange Commission (“SEC”) and public communications. You should evaluate all forward-looking statements made in this report in the context of these risks and uncertainties, and you should not rely upon forward-looking statements as predictions of future events.

 

We caution you that the important factors described in the Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations may not be all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It

4


 

  Table of Contents

is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially and adversely from those contained in any forward-looking statements we may make. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

 

Unless we state otherwise or the context otherwise requires, the terms “we,” “us,” “our,” “Fairway,” “Fairway Market,” “the Company,” “our business” and “our company” refer to Fairway Group Holdings Corp. and its consolidated subsidiaries as a combined entity.

 

 

5


 

  Table of Contents

Part   I — Financial Information

 

Item 1. FINANCIAL STATEMENTS

 

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 30,

 

June 29,

 

    

2014

    

2014

ASSETS

 

 

 

 

 

(unaudited)  

CURRENT ASSETS

 

 

 

 

 

 

Cash and cash equivalents

 

$

58,800 

 

$

49,285 

Accounts receivable, net

 

 

5,536 

 

 

5,740 

Merchandise inventories

 

 

28,061 

 

 

29,370 

Income tax receivable

 

 

894 

 

 

890 

Prepaid rent

 

 

892 

 

 

1,122 

Deferred financing fees

 

 

1,751 

 

 

1,749 

Prepaid expenses and other

 

 

2,701 

 

 

1,279 

Total current assets

 

 

98,635 

 

 

89,435 

PROPERTY AND EQUIPMENT, NET

 

 

144,529 

 

 

151,958 

GOODWILL

 

 

95,412 

 

 

95,412 

INTANGIBLE ASSETS, NET

 

 

25,435 

 

 

25,361 

OTHER ASSETS

 

 

16,333 

 

 

15,341 

Total assets

 

$

380,344 

 

$

377,507 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

 

Current portion of long-term debt

 

$

2,750 

 

$

2,750 

Accounts payable

 

 

33,971 

 

 

34,502 

Accrued expenses and other

 

 

20,455 

 

 

21,168 

Total current liabilities

 

 

57,176 

 

 

58,420 

NONCURRENT LIABILITIES

 

 

 

 

 

 

Long-term debt, net of current maturities

 

 

253,717 

 

 

253,867 

Deferred income taxes

 

 

24,574 

 

 

25,513 

Other long-term liabilities

 

 

33,334 

 

 

35,001 

Total liabilities

 

 

368,801 

 

 

372,801 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Class A common stock, $0.00001 par value per share, 150,000,000 shares authorized, 29,108,316 and 29,227,966 shares issued at March 30, 2014 and June 29, 2014, respectively

 

 

 —

 

 

 —

Class B common stock, $0.001 par value per share, 31,000,000 shares authorized, 14,225,455 shares issued and outstanding at March 30, 2014 and June 29, 2014

 

 

14 

 

 

14 

Treasury stock at cost, 2,965 shares at March 30, 2014 and June 29, 2014

 

 

 —

 

 

 —

Additional paid-in capital

 

 

369,883 

 

 

372,740 

Accumulated deficit

 

 

(358,354)

 

 

(368,048)

Total stockholders’ equity

 

 

11,543 

 

 

4,706 

Total liabilities and stockholders’ equity

 

$

380,344 

 

$

377,507 

 

The accompanying notes are an integral part of these consolidated financial statements

6


 

  Table of Contents

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

 

Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

June 30,

 

June 29,

 

2013

 

2014

 

 

 

    

 

 

Net sales

$

186,778 

 

$

198,268 

 

 

 

 

 

 

Cost of sales and occupancy costs (exclusive of depreciation and amortization)

 

125,378 

 

 

136,872 

 

 

 

 

 

 

Gross profit

 

61,400 

 

 

61,396 

 

 

 

 

 

 

Direct store expenses

 

44,132 

 

 

46,957 

 

 

 

 

 

 

General and administrative expenses

 

33,942 

 

 

15,295 

 

 

 

 

 

 

Store opening costs

 

2,986 

 

 

1,686 

 

 

 

 

 

 

Production center start-up costs

 

498 

 

 

1,429 

 

 

 

 

 

 

Loss from operations

 

(20,158)

 

 

(3,971)

 

 

 

 

 

 

Interest expense, net

 

(5,385)

 

 

(4,778)

 

 

 

 

 

 

Loss before income taxes

 

(25,543)

 

 

(8,749)

 

 

 

 

 

 

Income tax provision

 

(2,403)

 

 

(945)

 

 

 

 

 

 

Net loss

 

(27,946)

 

 

(9,694)

 

 

 

 

 

 

Preferred stock dividends

 

(44,130)

 

 

 —

 

 

 

 

 

 

Net loss attributable to common stockholders

$

(72,076)

 

$

(9,694)

 

 

 

 

 

 

Basic and diluted loss per common share

$

(2.11)

 

$

(0.22)

 

 

 

 

 

 

Weighted average common shares outstanding

 

34,198,047 

 

 

43,357,363 

 

The accompanying notes are an integral part of these consolidated financial statements

 

7


 

  Table of Contents

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

June 30,

 

June 29,

 

2013

 

2014

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

    

 

 

Net loss

$

(27,946)

 

$

(9,694)

Adjustments to reconcile net loss to net cash used in operating activities

 

 

 

 

 

Deferred income taxes

 

2,324 

 

 

939 

Deferred rent

 

1,997 

 

 

1,524 

Depreciation and amortization of property and equipment

 

6,238 

 

 

6,903 

Amortization of intangibles

 

73 

 

 

74 

Amortization of discount on term loans

 

775 

 

 

838 

Amortization of deferred financing fees

 

423 

 

 

438 

Amortization of prepaid rent

 

80 

 

 

79 

Non-cash stock compensation expense

 

2,055 

 

 

2,857 

Changes in operating assets and liabilities

 

 

 

 

 

Accounts receivable

 

(691)

 

 

(204)

Merchandise inventories

 

(847)

 

 

(1,309)

Insurance claims receivable

 

3,949 

 

 

 —

Prepaid expense and other

 

(440)

 

 

1,198 

Other assets

 

681 

 

 

480 

Accounts payable

 

(4,774)

 

 

531 

Accrued expenses and other

 

(3,664)

 

 

707 

Other long-term liabilities

 

 —

 

 

144 

Net cash (used in) provided by operating activities

 

(19,767)

 

 

5,505 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(8,969)

 

 

(14,332)

Net cash used in investing activities

 

(8,969)

 

 

(14,332)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Payments on long-term debt

 

(688)

 

 

(688)

Proceeds from shares issued in initial public offering, net of issuance costs

 

158,821 

 

 

 —

Cash dividends paid on preferred stock

 

(76,818)

 

 

 —

Issuance costs from debt re-pricing

 

(3,868)

 

 

 —

Net cash provided by (used in) financing activities

 

77,447 

 

 

(688)

Net increase (decrease) in cash and cash equivalents

 

48,711 

 

 

(9,515)

Cash and cash equivalents — beginning of period

 

21,723 

 

 

58,800 

Cash and cash equivalents — end of period

$

70,434 

 

$

49,285 

Cash paid during the period for

 

 

 

 

 

Interest

$

4,264 

 

$

3,721 

Income taxes

$

 —

 

$

 

The accompanying notes are an integral part of these consolidated financial statements

 

 

 

8


 

  Table of Contents

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

 

Consolidated Statements of Changes in Stockholders’ Equity

(In thousands, except share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

Class A

 

Class B

 

 

Additional 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Common Stock

 

 

Paid in

 

 

Treasury

 

Accumulated

 

 

 

 

 

    

Shares

    

 

Amount

    

Shares

    

 

Amount

    

 

Capital

    

 

Stock

    

Deficit

    

Total

Balance at March 30, 2014

 

 

29,108,316 

 

$

 —

 

14,225,455 

 

$

14 

 

$

369,883 

 

$

 —

 

$

(358,354)

 

$

11,543 

Non-cash stock compensation expense

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

2,857 

 

 

 —

 

 

 —

 

 

2,857 

Issuance of stock for vested RSUs

 

 

119,650 

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Net loss

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(9,694)

 

 

(9,694)

Balance at June 29, 2014

 

 

29,227,966 

 

$

 —

 

14,225,455 

 

$

14 

 

$

372,740 

 

$

 —

 

$

(368,048)

 

$

4,706 

 

 

 

 

 

 

9


 

  Table of Contents

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

 

1. D ESCRIPTION OF BUSINESS AND ORGANIZATION

 

Fairway Group Holdings Corp. was incorporated in the State of Delaware on September 29, 2006 and is controlled by investment funds managed by Sterling Investment Partners L.P. and affiliates (collectively, “Sterling”).

 

Fairway Group Holdings Corp. and subsidiaries (the “Company” or “Fairway”) operates in the retail food industry, selling fresh, natural and organic products, prepared foods and hard to find specialty and gourmet offerings along with a full assortment of conventional groceries.  The Company operates fifteen stores in the Greater New York metropolitan area, three of which include Fairway Wine & Spirits locations.  Twelve of the stores were open prior to the beginning of the fiscal year ended March 30, 2014  ( fiscal 2014”) ,   two stores were opened during fiscal 2014 subsequent to the thirteen weeks ended June 30, 2013 and one store was opened subsequent to the thirteen weeks ended June 29, 2014 Seven of the Company’s food stores, which the Company refers to as “urban stores,” are located in New York City and the remainder, which the Company refers to as “suburban stores,” are located in New York (outside of New York City), New Jersey and Connecticut. The Company has determined that it has one reportable segment.  Substantially all of the Company’s revenue comes from the sale of items at its retail food stores.

 

On April 22, 2013, the Company completed its initial public offering (“IPO”) of 15,697,500 shares of its Class A common stock at a price of $13.00 per share, which included 13,407,632 new shares sold by Fairway and the sale of 2,289,868 shares by existing stockholders (including 2,047,500 sold pursuant to the underwriters exercise of their over-allotment option). The Company received approximately $158.8 million in net proceeds from the IPO after deducting the underwriting discount and expenses related to the IPO. The Company used the net proceeds that it received from the IPO to (i) pay accrued but unpaid dividends on its Series A preferred stock totaling approximately $19.1 million, (ii) pay accrued but unpaid dividends on its Series B preferred stock totaling approximately $57.7 million, (iii) pay $9.2 million to an affiliate of Sterling Investment Partners in connection with the termination of the Company’s management agreement with such affiliate and (iv) pay contractual IPO bonuses to certain members of the Company’s management totaling approximately $8.1 million. During fiscal 2014 and the thirteen weeks ended June 29, 2014, the Company used the remaining $64.7 million of the net proceeds as follows: $15.4 million for capital expenditures and pre-opening costs in connection with our new store in the Chelsea neighborhood of Manhattan, which opened in July 2013, approximately $17.9 million for capital expenditures and pre-opening costs in connection with the store we opened in October 2013 in Nanuet, NY, approximately $6.1 for capital expenditures and pre-opening costs in connection with the store we opened in Lake Grove, NY in July 2014, approximately $8.8 million in connection with capital expenditures in our other stores and approximately $16.5 million in connection with capital expenditures and start-up costs at our new production facility. The Company did not receive any of the proceeds from the sale of shares by the selling stockholders. In connection with the IPO, the Company issued 15,504,296 shares of Class B common stock (of which 33,576 shares automatically converted into 33,576 shares of Class A common stock) in exchange for all outstanding preferred stock and all accrued dividends not paid in cash with the proceeds of the IPO.

 

 

2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“US GAAP”) for interim financial information, and do not include all of the information and footnotes required for complete financial statements in accordance with US GAAP pursuant to such rules and regulations. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 30, 2014 .

 

The accompanying unaudited consolidated financial statements as of June 29, 2014 , and for the thirteen weeks ended June 30, 2013 and June 29, 2014   reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and operating results of the Company. All material intercompany accounts and transactions have been eliminated in the unaudited consolidated

10


 

  Table of Contents

financial statements. The results of operations for the thirteen weeks ended June 29, 2014   may not necessarily be indicative of the results that may be expected for the entire fiscal year ending March 29, 2015 .

 

There have been no changes to the Company’s significant accounting policies described in our Annual Report on Form 10-K for the year ended March 30, 2014 that have had a material impact on the Company’s unaudited interim consolidated financial statements and related notes.

 

 

3. NET LOSS PER COMMON SHARE

 

Basic and diluted net loss per common share is calculated by dividing net loss attributable to common stockholders by the weighted average common shares outstanding for the fiscal period.  Diluted net loss per common share is calculated by dividing net loss attributable to common stockholders by the weighted average common shares outstanding for the fiscal period plus the effect of any potential common shares that have been issued if these additional shares are dilutive.  For all periods presented, basic and diluted net loss per common share are the same, as any additional common stock equivalents would be anti-dilutive.

 

For the   thirteen weeks ended June 30, 2013 , there were 5,469,186 additional potentially dilutive shares of Class A common stock, consisting of outstanding warrants to purchase 1,835,436   shares of Class A common stock and 1 34,495 shares of unvested restricted Class A common stock ,   1,129,692 options to purchase shares of Class A common stock and unvested restricted stock uni t s covering 2,369,563 shares of Class A common stock.

 

For the   thirteen weeks ended June 29, 2014 , there were 2,481,246 additional potentially dilutive shares of Class A common stock, consisting of   41,066 shares of unvested restricted Class A common stock   and unvested restricted stock units covering 2,4 40, 18 0 shares of Class A common stock.  All of the options to purchase shares of Class A common stock have exercise prices in excess of the Company’s publicly quoted stock price and therefore are not considered potentially dilutive.

 

 

4. LONG-TERM DEBT

 

A summary of long-term debt is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 30,

 

June 29,

 

    

2014

    

2014

Credit facility, gross

 

$

271,563 

 

$

270,875 

Less unamortized discount

 

 

(15,096)

 

 

(14,258)

Credit facility, net

 

 

256,467 

 

 

256,617 

Less current maturities

 

 

(2,750)

 

 

(2,750)

Long-term debt, net of current maturities

 

$

253,717 

 

$

253,867 

 

A summary of interest expense is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

June 30,

 

June 29,

 

2013

        

2014

Interest on senior credit facility

$

4,168 

 

$

3,727 

Amortization of original issue discount

 

775 

 

 

838 

Amortization of deferred financing fees

 

423 

 

 

438 

Other interest (income) expense, net

 

19 

 

 

(225)

Total

$

5,385 

 

$

4,778 

 

11


 

  Table of Contents

2013 Senior Credit Facility

 

In February 2013, Fairway Group Holdings Corp. and its wholly-owned subsidiary, Fairway Group Acquisition Company, as the borrower, entered into a senior secured credit facility consisting of a $275 million term loan (the “2013 Term Facility”) and a $40 million revolving credit facility, which includes a $40 million letter of credit sub-facility (the “2013 Revolving Facility” and together with the 2013 Term Facility, the “2013 Senior Credit Facility”) with the 2013 Term Facility maturing in August 2018 and the 2013 Revolving Facility maturing in August 2017. The Company used the proceeds from the 2013 Term Facility to repay the $264.5 million of outstanding borrowings (including accrued interest) under its 2012 S enior C redit F acility and pay fees and expenses.  On May 3, 2013, the 2013 Senior Credit Facility was amended to, among other things, lower the interest rate margins and eliminate the interest coverage ratio financial covenant.

 

Borrowings under the 2013 Senior Credit Facility, as amended, bear interest, at the option of the Company, at (i )   adjusted LIBOR  ( subject to a 1.0% floor) plus 4.0% or (ii) an alternate base rate   p lus 3.0% . In addition, there is a fee payable quarterly in an amount equal to 1% per annum of the undrawn portion of the 2013 Revolving Facility, calculated based on a 360 -day year. Interest is payable quarterly in the case of base rate loans and on the maturity dates or every three months, whichever is shorter, in the case of adjusted LIBOR loans. The 4.0% and 3.0% margins will each be reduced by 50   basis points at any time when the Company’s corporate family rating from Moody’s Investor Services Inc. is B2 or higher and the Company’s corporate rating from Standard & Poors Rating Service is B or higher, in each case with a stable outlook, and as long as certain events of default have not occurred.  Prior to the May 2013 amendment, borrowings under the 2013 Senior Credit Facility bore interest, at the option of the Company, at (i)   adjusted LIBOR   (subject to a 1.25% floor) plus 5.50% or (ii) an   alternate base rate plus 4.50% .

 

All of the borrower’s obligations under the 2013 Senior Credit Facility, as amended, are unconditionally guaranteed (the “Guarantees”) by Fairway Group Holdings Corp. and subsidiaries (other than the borrower and any future unrestricted subsidiaries as the Company may designate, at its discretion, from time to time) (the “Guarantors”). Additionally, the 2013 Senior Credit Facility and the Guarantees are secured by a first-priority perfected security interest in substantially all present and future assets of the borrower and each Guarantor, including accounts receivable, property and equipment, merchandise inventories, general intangibles, leases, intellectual property, investment property and intercompany notes among Guarantors.

 

Mandatory prepayments under the 2013 Senior Credit Facility, as amended, are required with: (i)  50% of adjusted excess cash flow (which percentage shall be reduced to 25% upon achievement and maintenance of a leverage ratio   of less than   5.0:1 .0, and to 0% upon achievement and maintenance of a leverage ratio  o f less than 4.0 :1.0); (ii)  100% of the net cash proceeds of asset sales or other dispositions of property by the Company and certain of its subsidiaries (subject to certain exceptions and reinvestment provisions); and (iii)  100% of the net cash proceeds of issuances, offerings or placements of debt obligations (subject to certain exceptions).

 

The 2013 Senior Credit Facility, as amended, contains negative covenants, including restrictions on: (i) the incurrence of additional debt; (ii) liens and sale-leaseback transactions; (iii) loans and investments; (iv) guarantees and hedging agreements; (v) the sale, transfer or disposition of assets and businesses; (vi) dividends on, and redemptions of, equity interests and other restricted payments, including dividends and distributions to the Company by its subsidiaries; (vii) transactions with affiliates; (viii) changes in the business conducted by the Company; (ix) payment or amendment of subordinated debt and organizational documents; and (x)   maximum capital expenditures. The Company is also required to comply with a maximum total leverage ratio financial covenant .

 

The Company was in compliance with all applicable affirmative, negative and financial covenants of the 2013 Senior Credit Facility at June 29, 2014 .

 

The 2013 Senior Credit Facility resulted in the Company capitalizing new deferred financing fees of approximately $800,000   in fiscal 2013, to be amortized over the life of the loan on the effective interest method. These costs included administrative fees, advisory fees, title fees, and legal and accounting fees.

 

12


 

  Table of Contents

The Company reviewed the terms of the 2013 Senior Credit Facility and ascertained that the conditions ha d been met, pursuant to the FASB’s guidance, to treat the transaction as a debt modification .   In connection with the modification of the 2012 senior credit facility, (i)   the unamortized original issue discount of approximately $11.8 million relating to the 2012 senior credit facility and (ii) debt placement fees of approximately $3.6 million in connection with the 2013 Senior Credit Facility are collectively reflected as original issue discount, to be amortized over the life of the loan on the effective interest method.

 

The amendment of the 2013 Senior Credit Facility in May 2013 resulted in the Company capitalizing new deferred financing fees of approximately $500,000   in fiscal 2014, to be amortized over the remaining life of the loan using the effective interest method.  Additionally, as a result of the accounting treatment applied to this amendment of debt modification , (i) the unamortized original issue discount of approximately $14.7 million relating to the 2013 Senior Credit Facility and (ii) debt placement fees of approximately $3.4 million in connection with the amendment, are collectively reflected as original issue discount, to be amortized over the life of the loan using the effective interest method.

 

At June 29, 2014 , the Company had $ 16 .4 million of availability under the 2013 Revolving Facility, all of which was available for letters of credit .  At June 29, 2014 , the Company had $2 3 .6 million of letters of credit outstanding.

 

5. REDEEMABLE PREFERRED STOCK, COMMON STOCK AND WARRANTS

 

On April 12, 2013, the Company amended and restated its certificate of incorporation to increase the number of shares the Company is authorized to issue to 150,000,000 shares of Class A common stock, 31,000,000 shares of Class B common stock and 5,000,000 shares of preferred stock. The amendment and restatement of the certificate of incorporation implemented an internal recapitalization pursuant to which the Company effected a 118.58 -for-one stock split on its outstanding common stock and reclassified its outstanding common stock into shares of Class A common stock. The Class A common stock and Class B common stock have identical rights, except voting and conversion rights. Each share of Class A common stock is entitled to one vote. Each share of Class B common stock is entitled to ten votes and is convertible at any time into one share of Class A common stock.

 

On April 22, 2013, the Company completed its IPO of 15,697,500 shares of its Class A common stock at a price of $13.00 per share, which included 13,407,632 new shares sold by Fairway and the sale of 2,289,868 shares (including 95,386 shares issued upon exercise of outstanding warrants) by existing stockholders (including 2,047,500 sold pursuant to the underwriters exercise of their over-allotment option). In connection with the Company’s IPO, the Company issued 15,504,296 shares of Class B common stock (of which 33,576 shares automatically converted into 33,576 shares of Class A common stock) in exchange for all outstanding preferred stock and all accrued dividends not paid in cash with the proceeds of the IPO.The Company used a portion of the net proceeds from its IPO to repay approximately   $19.1 million of accrued but unpaid dividends on its Series A preferred stock and approximately $57.7 million of accrued but unpaid dividends on its Series B preferred stock.  Because the Company and the preferred stockholders had entered into an agreement to exchange the preferred stock for a fixed number of shares of Class B common stock based on (i) an assumed IPO price of $11.00 per share, (ii) an assumption that $65.0 million of accrued dividends would be paid in cash with the proceeds of the IPO and (iii) the fact that the number of shares of Class B common stock to be issued in the exchange would not change if the Company decreased or increased the amount of accrued dividends that it paid in cash with the net proceeds of the offering, and because the IPO price was greater than $11.00 per share and the amount of dividends paid in cash with the proceeds of the offering increased, the Company recognized an incremental dividend of approximately $42.8 million, consisting of approximately   $11.8 million, representing the additional cash proceeds used to pay dividends, and approximately   $31.0 million, representing an amount equal to the number of shares of Class B common stock the Company issued multiplied by $2.00 , the difference between the $13.00 IPO price and the $11.00 price the Company used to calculate the number of shares of Class B common stock to be issued by the Company in exchange for the preferred stock and accrued but unpaid dividends.

 

As of June 29, 2014 there were no warrants outstanding.

 

13


 

  Table of Contents

6. SHARE-BASED COMPENSATION

 

The Company accounts for share-based compensation awards in accordance with the provisions of FASB Accounting Standards Codification (“ASC”) Topic 718 — Compensation — Stock Compensation (“ASC 718”), which requires companies to estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the awards ultimately expected to vest is recognized as expense over the requisite service period. The Company recognized total stock-based compensation of $2.1   million and $ 2.9 million for the thirteen weeks ended June 30, 2013 and June 29, 2014 , respectively, as general and administrative expenses in the Company’s Consolidated Statements of Operations.  This amount includes approximately $ 96,000 representing the value of restricted stock units issued to certain directors in the thirteen weeks ended June 29, 2014 in payment of the directors’ fees for the calendar quarter ended June 30, 2014, approximately   $ 41,000 representing the value of restricted stock units issued in the thirteen weeks ended June 29, 2014 to our executive chairman in payment of his fees for serving as executive chairman for the calendar quarter and $187,500 representing the value of restricted stock units issued in the thirteen weeks ended June 29, 2014 to an executive officer in partial payment of his salary for the calendar quarter ended March 31, 2014.  All of these restricted stock units are vested but will be settled in shares of Class A common stock in the future.

 

The Company’s 2007 Equity Compensation Plan (the “2007 Plan”), which provided for the grant of stock options and restricted shares, and the 2013 Long-Term Incentive Plan (the “2013 Plan”), which provides for the grant of stock options, restricted stock units, restricted stock, other stock-based awards and other cash-based awards, are more fully described in the Company’s Annual Proxy Statement for its 2014 annual meeting of stockholders filed with the Securities and Exchange Commission on June 26, 2014 under the caption “ Executive Compensation— Equity Compensation Plans.”  Changes in equity awards outstanding under the 2007 Plan and 2013 Plan during the thirteen weeks ended June 29, 2014 are summarized as follows:

 

2007 Equity Compensation Plan

 

As of June 29, 2014 , there was $340,000 of unrecognized compensation expense related to the restricted stock compensation awards granted under the 2007 Plan.

 

The status of the Company’s unvested restricted stock grants for the   thirteen weeks ended June 29, 2014 is summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

Restricted

 

Average Grant

 

    

Stock

    

Date Fair Value

Outstanding unvested awards at March 30, 2014

 

109,920 

 

$

3.55 

Granted

 

 —

 

 

Vested

 

(68,854)

 

 

0.87 

Forfeited

 

 —

 

 

Outstanding unvested awards at June 29, 2014

 

41,066 

 

 

8.04 

 

14


 

  Table of Contents

2013 Long-Term Incentive Plan

 

Restricted Stock Units

 

As of June 29, 2014 , there was $20.5 million of unrecognized compensation expense related to the restricted stock unit compensation awards granted under the 2013 Plan.

 

The status of the Company’s unvested restricted stock units for the thirteen weeks ended June 29, 2014 is summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

Restricted

 

Average Grant

 

    

Stock Units

    

Date Fair Value

Outstanding unvested awards at March 30, 2014

 

2,367,659 

 

$

13.55 

Granted

 

283,796 

 

 

6.85 

Forfeited

 

(47,829)

 

 

13.00 

Vested

 

(163,446)

 

 

13.01 

Outstanding unvested awards at June 29, 2014

 

2,440,180 

 

 

12.82 

 

Stock Options

 

As of June 29, 2014 , there was $3.3 million of unrecognized compensation expense related to the stock option compensation awards granted under the 2013 Plan.

 

A summary of stock option activity for   the thirteen weeks ended June 29, 2014 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Weighted

 

Average

 

 

 

 

 

Average

 

Remaining

 

 

 

Stock

 

Exercise

 

Contractual

 

 

    

Options

    

Price

    

Life (years)

 

Outstanding awards at March 30, 2014

 

1,096,362 

 

$

13.68 

 

9.3 

 

Granted

 

 —

 

 

 —

 

 

Forfeited

 

(32,833)

 

 

13.00 

 

8.8 

 

Exercised

 

 —

 

 

 —

 

 —

 

Outstanding awards at June 29, 2014

 

1,063,529 

 

 

13.70 

 

9.0 

 

 

 

 

 

 

 

 

 

 

Exercisable at June 29, 2014

 

200,336 

 

$

14.18 

 

8.8 

 

 

S tock options outstanding as of June 29, 2014   had no aggregate intrinsic value .  Aggregate intrinsic value represents the value of the Company’s stock based on the closing stock price on the last trading day of the fiscal period in excess of the weighted average exercise price multiplied by the number of options outstanding or exercisable.  No options were exercised during the thirteen weeks ended June 29, 2014 .

 

7. RELATED PARTY TRANSACTIONS

 

Operating Leases and Utility Services

 

A director and executive officer of the Company:

 

·

owns 33.33% of certain entities from which the Company leases certain stores, a production bakery, and warehouses; these leases expire on January 31, 2032.

 

15


 

  Table of Contents

·

owns 16.67% of an entity from which the Company leases its Red Hook, Brooklyn, NY (“Red Hook”) store; this lease expires on October 31, 2016, although the Company has several renewal options.

 

·

owns 16.67% of an entity from which the Company obtains utility services for its Red Hook store.

 

Management Agreement

 

Prior to the Company’s IPO, pursuant to a management agreement, the Company paid Sterling Investment Partners Advisers, LLC, an affiliate of the Company’s controlling stockholders, an annual management advisory fee and fees in connection with certain debt and equity financings (other than the IPO).  The management agreement was terminated as part of the IPO in exchange for a payment of $9.2 million.

 

 

8. INCOME TAXES

 

The reconciliation of the U.S. statutory rate with the Company’s effective tax rate for the thirteen weeks ended June 30, 2013 and June 29, 2014 is summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

 

June 30,

 

June 29,

 

    

2013

        

2014

Federal statutory rate

 

34.0 

%

 

34.0 

%

Effect of:

 

 

 

 

 

 

State income taxes (net of federal tax benefit)

 

8.5 

 

 

8.7 

 

Permanent differences

 

(0.3)

 

 

(0.4)

 

Valuation Allowance

 

(51.8)

 

 

(53.1)

 

Effective rate

 

(9.6)

%

 

(10.8)

%

 

As a result of historical net operating losses (“NOLs”), the Company currently provides a full valuation allowance against its net deferred tax assets.  For the thirteen weeks ended June 30, 2013 and June 29, 2014, income tax expense was computed at the estimated annual effective rate based on the total estimated annual tax provision which included state income taxes and a deferred tax provision related to amortization of certain indefinite-lived intangible assets.   Based on management’s assessment, the Company has placed a valuation reserve against its deferred tax assets as it is more likely than not that the Company may not generate sufficient taxable i ncom e during the carryforward period to utilize the NOLs.  The Company regularly reviews the net deferred tax valuation allowance to determine if available evidence continues to support the position that it is more likely than not that a portion of or the entire deferred tax asset will not be realized in the future. As of June 29, 2014, management could not conclude that it is more likely than not that the deferred tax assets will be realized. As a result, the Company will continue to maintain a full valuation allowance against its deferred tax assets. The Company will continue to assess its position in future periods to determine if it is appropriate to reduce a portion of its valuation allowance in the future.

 

For more information regarding the Company’s valuation allowance against its deferred tax assets, please see note 13 to the Company’s audited financial statements included in its Annual Report on Form 10-K for the fiscal year ended March 30, 2014.

 

The valuation allowance was $90.7 million and $95.3 million as of March 30, 201 4 and June 29, 2014, respectively.

 

16


 

  Table of Contents

9. COMMITMENTS AND CONTINGENCIES

 

Operating Leases

 

The Company occupies premises pursuant to non-cancelable lease agreements, including the lease agreements with related parties as described in Note 7, which were assigned to the Company as of January 18, 2007.  These leases expire through 2039.  Rent under these lease agreements, except for certain lease years when the rent is determined by arbitration, increases annually by either 50% of the percentage increase in the consumer price index or by the percentage increase in the consumer price index of up to 5% .  Lease agreements with non-related parties include various escalation clauses.

 

T he aggregate minimum rental commitments under all operating leases, for which the Company ha s possession, as of June 29, 2014 are as follows for the fiscal years ending (in thousands):

 

 

 

 

 

 

 

 

 

 

March 29, 2015

    

 

25,508 

April 3, 2016

 

 

34,644 

April 2, 2017

 

 

34,635 

April 1, 2018

 

 

33,306 

March 31, 2019

 

 

33,474 

Thereafter

 

 

550,886 

 

 

$

712,453 

 

In addition, the Company has signed certain leases for which the Company’s obligation is not yet established because the Company does not yet have possession of the site. 

 

Rent expense for the thirteen weeks ended June 30, 2013 and June 29, 2014   was approximate ly   $8.8 million and $10.2  m i llion, respectively .

 

Other Contingencies

 

The Company obtains its utility services for the Red Hook store from an entity which is 16.67% owned by an individual who is a Company director and executive officer.  The Company believes that the entity has overcharged for utilities since its initial occupancy of the premises.  Since November 2008, with the exception of the post-Hurricane Sandy period through fiscal 2014, when the Company received utilities from the local utility provider because the co-generation plant was not operational, the Company has taken deductions from the utility invoices based on the methodology that the Company believes represents the parties’ original intentions with respect to the utility calculations.  The Company believes that it will be successful in negotiating an amicable resolution of this matter between the parties.  The Company also believes that the resolution of this matter will not have a material adverse effect on its financial condition and results of operations.

 

In February and March 2014, three purported securities class action lawsuits alleging violation of the federal securities laws were filed in the United States District Court for the Southern District of New York against the Company and certain of its current and former officers, certain of its directors and the underwriters for its initial public offering. The actions were consolidated on June 3, 2014 under the caption In re Fairway Group Holdings Corp. Securities Litigation , No. 14-cv-0950. On July 18, 2014, an amended class action complaint was filed, adding affiliates of Sterling Investment Partners as defendants. The complaint seeks unspecified damages and alleges misleading statements in the registration statement and prospectus for the Company’s initial public offering and in subsequent communications regarding its business and financial results. In April 2014, a purported stockholder derivative action was filed against certain of the Company’s directors in New York state court, asserting claims for breach of fiduciary duties and gross mismanagement based on substantially similar allegations as in the securities class action. In June 2014, the Company and defendants moved to dismiss the derivative complaint. On July 30, 2014, plaintiffs filed an amended complaint, adding affiliates of Sterling Investment Partners as defendants and asserting claims against them for breach of fiduciary duty and unjust enrichment. While the Company believes the claims are without merit and intends to defend these lawsuits vigorously, the Company cannot predict the outcome of these lawsuits.

17


 

  Table of Contents

 

In May 2014, a purported wage and hour class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company and certain of its current and former officers and employees.  This suit alleges, among other things, that certain of the Company’s past and current employees were not properly compensated in accordance with the overtime provisions of the Fair Labor Standards Act.  While the Company believes that these claims are without merit and intends to defend the matter vigorously, the Company cannot predict the outcome of this litigation.

 

The Company, from time to time, is and may be subject to legal proceedings and claims which arise in the ordinary course of its business.   The Company has not accrued any amounts in connection with these uncertainties , including those discussed above, as the Company has determined that losses from these uncertainties are not probable.  For all matters, including unasserted claims, where a loss is reasonably possible, the aggregate range of estimated losses is not material to the financial position, results of operations, liquidity or cash flows of the Company.

 

Regardless of the outcome, these matters or future litigation may require significant attention from management and could result in significant legal expenses, settlement costs or damage awards that could have a material impact on the Company’s financial position, results of operations and cash flows.

 

 

10 RECENTLY ISSUED ACCOUNTING STANDARDS

 

In May 2014, the FASB issued authoritative guidance under ASU 2014-09, Revenue from Contracts with Customers.  ASU 2014-09 supersedes existing revenue recognition requirements and provides a new comprehensive revenue recognition model requiring entities to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. The amendments in this Update are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  This guidance will be effective for the Company in the first quarter of its fiscal year ending March 2018.  The Company is currently evaluating the potential impact of ASU No. 2014-09 on its financial statements.

 

 

 

 

 

 

 

18


 

  Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended March 30, 2014 , as filed with the Securities and Exchange Commission. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q.  See “Special Note on Forward Looking Statements” above. The results of operations for the thirteen weeks ended June 29, 2014 may not necessarily be indicative of the results that may be expected for the entire fiscal year ending March 29, 2015 .

 

Our fiscal year is the 52- or 53-week period ending on the Sunday closest to March 31. For ease of reference, we identify our fiscal years by reference to the calendar year in which the fiscal year ends. Accordingly, “fiscal 2014” refers to our fiscal year ended on March 30, 2014 and “fiscal 2015 refers to our fiscal year ending March 29, 2015 .

 

Overview

 

Fairway Market is a growth-oriented food retailer offering customers a differentiated one-stop shopping experience “Like No Other Market”. Since beginning as a small neighborhood market in the 1930s, Fairway has established itself as a leading food retailing destination in the Greater New York City metropolitan area, an approximately $30 billion food retail market that is the largest in the United States. Our stores emphasize an extensive selection of fresh, natural and organic products, prepared foods and hard-to-find specialty and gourmet offerings, along with a full assortment of conventional groceries. Our prices typically are lower than natural / specialty stores and competitive with conventional supermarkets. We believe that the combination of our broad product selection, in-store experience and value pricing creates a premier food shopping experience that appeals to a broad demographic.

 

We operate 15 locations in New York, New Jersey and Connecticut, three of which include Fairway Wines & Spirits locations.  Twelve of the stores were open prior to the beginning of fiscal 2014, two stores were opened during fiscal 2014 subsequent to the thirteen weeks ended June 30, 2013 and our Lake Grove, Long Island store was opened on July 23, 2014, subsequent to the thirteen weeks ended June 29, 2014.  Seven of our food stores, which we refer to as “urban stores,” are located in New York City, and the remainder, which we refer to as “suburban stores,” are located in New York (outside of New York City), New Jersey and Connecticut .  We expect to open a new store in the TriBeCa neighborhood of Manhattan in early calendar 2015 and a new store in the Hudson Yards neighborhood in west midtown Manhattan in late calendar 2015 or early calendar 2016.

 

Outlook

 

We intend to continue our growth by expanding our store base in our existing and new markets, capitalizing on consumer trends and improving our operating margins.  Over the next few years, we intend to grow our store base in the Greater New York City metropolitan area at a rate of one to two stores annually.  Our revised outlook is primarily due to our current real estate pipeline and our desire to insure that we have adequate capital resources to fund our expansion. Over time, we also plan to expand Fairway’s presence into new, high-density metropolitan markets. Based on demographic research conducted for us in 2012 by the Buxton Company, a customer analytics research firm, we believe, based on these demographics, we have the opportunity to more than triple the number of stores in our existing marketing region of the Greater New York City metropolitan area, the Northeast market (from New England to the District of Columbia) can support up to 90 stores and the U.S. market can support more than 300 additional stores (including stores in the Northeast) operating under our current format.

 

We believe that we are well positioned to capitalize on evolving consumer preferences and other key trends currently shaping the food retail industry. These trends include an increasing consumer focus on the shopping experience and on healthy eating choices and fresh, quality offerings, including locally sourced products, as well as growing interest in high-quality, value-oriented private label product offerings.

19


 

  Table of Contents

 

We also intend to improve our operating margins over time through scale efficiencies, improved systems, continued cost discipline and enhancements to our merchandise offerings. We expect store growth will also permit us to benefit from economies of scale in sourcing products and will enable us to leverage our existing infrastructure.

 

Factors Affecting Our Operating Results

 

Various factors affect our operating results during each period, including:

 

Store Openings

 

We expect the new stores we open to be the primary driver of our net sales, operating profit and market share gains. Our results of operations have been and will continue to be materially affected by the timing and number of new store openings and the amount of new store opening costs. For example, we typically incur higher than normal employee costs at the time of a new store opening associated with set-up and other opening costs. Operating margins are also affected by promotional discounts and other marketing costs and strategies associated with new store openings, as well as higher shrink, primarily due to overstocking, and costs related to hiring and training new employees. Additionally, promotional activities may result in higher than normal net sales in the first several weeks following a new store opening. A new store builds its sales volume and its customer base over time and, as a result, generally has lower margins and higher operating expenses, as a percentage of sales, than our more mature stores. A new store can take more than a year to achieve a level of operating performance comparable to our similarly existing stores. Stores that we have opened in higher density urban markets typically have generated higher sales volumes and margins than stores in suburban areas.

 

We believe our differentiated format and destination one-stop shopping appeal attracts customers from as far as 25 miles away. As we open new stores in closer proximity to our customers who currently travel longer distances to shop at our stores, we expect some of these customers to take advantage of the convenience of our new locations. As a result, we have experienced in the past, and expect to experience in the future, some sales volume transfer from our existing stores to our new stores as some of our existing customers switch to these new, closer locations. Consequently, while we expect our new stores will impact sales at our existing stores in close proximity,   which adversely affects same store sales comparisons, we believe that by making shopping at our stores for those customers who travel longer distances more convenient, our overall sales to these customers will increase as they increase the frequency and amount of purchases from our stores.

 

Infrastructure Investment

 

Our historical operating results reflect the impact of our ongoing investments in infrastructure to support our growth. We have made significant investments in management, information technology systems, infrastructure, compliance and marketing. These investments include significant additions to our company’s personnel, including experienced industry executives and the next generation management and merchandising teams to support our long-term growth objectives.

 

Pricing Strategy

 

Our strategy is to price our broad selection of fresh, natural and organic foods, hard-to-find specialty and gourmet items and prepared foods at prices typically lower than those of natural / specialty stores. We price our full assortment of conventional groceries at prices competitive with those of conventional supermarkets.

 

Changes in Interest Expense

 

Our interest expense in any particular period is impacted by our overall level of indebtedness during that period and changes in the interest rates payable on such indebtedness. In February 2013, we refinanced our $300 million credit facility with a new senior credit facility, consisting of $275 million of term debt and a revolving credit facility of $40 million, principally to lower the interest rate we pay.  In May 2013, we amended our senior credit facility to lower the

20


 

  Table of Contents

interest rate we pay, which reduced our annualized cash interest payments by approximately $4.8 million. The fees and expenses incurred in connection with the amendment were recovered through reduced interest payments by the end of fiscal 2014.

 

Effect of Hurricane Sandy

 

We temporarily closed all of our stores as a result of Hurricane Sandy, which struck the Greater New York City metropolitan area on October 29, 2012.  While all but one of our stores were able to reopen within a day or two following the storm, we experienced business disruptions due to inventory delays as a result of transportation issues, loss of electricity at certain of our locations and the inability of some of our employees to travel to work due to transportation issues.  Our Red Hook, Brooklyn, NY store sustained substantial damage from the effects of Hurricane Sandy, and did not reopen until March 1, 2013. We experienced higher than normal sales at the Red Hook store during   the thirteen weeks ended June 30, 2013 , which may affect the comparability of our results of operations for the thirteen weeks ended June 30, 2013 and June 29, 2014 .

 

Following Hurricane Sandy we have seen increases in the market rate for insurance and our insurance premiums increased.

 

How We Assess the Performance of Our Business

 

In assessing performance, we consider a variety of performance and financial measures, principally growth in net sales, gross profit and Adjusted EBITDA and Central Services as a percentage of net sales. The key measures that we use to evaluate the performance of our business are set forth below:

 

Net Sales

 

We evaluate sales because it helps us measure the impact of economic trends and inflation or deflation, the effectiveness of our merchandising, marketing and promotional activities, the impact of new store openings and the effect of competition over a given period. Our net sales comprise gross sales net of coupons and discounts. We do not record sales taxes as a component of retail revenues as we consider ourselves a pass-through conduit for collecting and remitting sales taxes.

 

We do not consider same store sales, which controls for the effects of new store openings, to be as meaningful a measure for us as it may be for other retailers because as a destination food retailer in a concentrated market area we have in the past experienced, and in the future expect to experience, sales transfer from our existing stores to our newly opened stores that are in closer proximity to some of our customers. Our practice is to include sales from a store (including its related wine and spirits locations), in same-store sales beginning on the first day of the fifteenth full month following the store’s opening.   This practice may differ from the methods that our competitors use to calculate same-store or “comparable” sales. As a result, data in this report regarding our same-store sales may not be comparable to similar data made available by our competitors.

 

·

Various factors may affect our same-store sales, including:

 

·

our competition, including competitor store openings or closings near our stores;

 

·

our opening of new stores in the vicinity of our existing stores;

 

·

our pricing strategy, including the effects of inflation or deflation and promotions;

 

·

the number and dollar amount of customer transactions in our stores;

 

·

overall economic trends and conditions in our markets;

 

·

consumer preferences, buying trends and spending levels;

21


 

  Table of Contents

 

·

our ability to provide product offerings that generate new and repeat visits to our stores;

 

·

the level of customer service that we provide in our stores;

 

·

our in-store merchandising-related activities;

 

·

our ability to source products efficiently;

 

·

whether a holiday falls in the same or a different fiscal period; and

 

·

the occurrence of severe weather conditions and other natural disasters during a fiscal period, which can cause store closures and/or consumer stocking of products.

 

As we continue to pursue our growth strategy, we expect that a significant percentage of our increase in net sales will continue to come from the opening of new stores rather than increased net sales at existing stores.

 

The food retail industry and our sales are affected by general economic conditions and seasonality, as well as the other factors discussed below, that affect store sales performance. Consumer purchases of high-quality perishables and specialty food products are particularly sensitive to a number of factors that influence the levels of consumer spending, including economic conditions, the level of disposable consumer income, consumer debt, interest rates and consumer confidence. In addition, our business is seasonal and, as a result, our average weekly sales fluctuate during the year and are usually highest in our third fiscal quarter, from October through December, when customers make holiday purchases, and typically lower during the summer months in our second fiscal quarter.

 

Gross Profit

 

We use gross profit to measure the effectiveness of our pricing and procurement strategies as well as initiatives to increase sales of higher margin items and to reduce shrink. We calculate gross profit as net sales less cost of sales and occupancy costs. Gross margin measures gross profit as a percentage of our net sales. Cost of sales includes the cost of merchandise inventory sold during the period (net of discounts and allowances), distribution costs, food preparation costs (primarily labor) and shipping and handling costs. Occupancy costs include store rental costs and property taxes. The components of our cost of sales and occupancy costs may not be identical to those of our competitors. As a result, data in this report regarding our gross profit and gross margin may not be comparable to similar data made available by our competitors.

 

Changes in the mix of products sold may impact our gross margin. Unlike natural / specialty stores, we also carry a full assortment of conventional groceries, which generally have lower margins than fresh, natural and organic foods, prepared foods and specialty and gourmet items. We expect to enhance our gross margins through:

 

·

economies of scale resulting from expanding the store base;

 

·

our pricing strategy, including the effects of inflation or deflation and promotions   ;

 

·

productivity gains through process and program improvements including the benefits we expect to derive over time from our production center;

 

·

reduced shrinkage as a percentage of net sales; and

 

·

leveraging our purchasing power and that of our suppliers to obtain volume discounts from vendors.

 

Stores that we operate in higher density urban markets typically have generated higher sales volumes and margins than stores that we operate in suburban areas. As the percentage of our sales volumes provided by our suburban stores increases, our overall gross margins may decline.

22


 

  Table of Contents

 

Direct Store Expenses

 

Direct store expenses consist of store-level expenses such as salaries and benefits for our store work force, supplies, store depreciation and store-specific advertising and marketing costs. Store-level labor costs are generally the largest component of our direct store expenses. Direct store expenses, as a percentage of net sales, at our new stores are typically higher than at our more established stores during the first few quarters of operations. The components of our direct store expenses may not be identical to those of our competitors. As a result, data in this report regarding our direct store expenses may not be comparable to similar data made available by our competitors.

 

General and Administrative Expenses

 

General and administrative expenses consist primarily of personnel costs that are not store specific, corporate sales advertising and marketing expenses (including pre-opening advertising and marketing costs), depreciation and amortization expense as well as other expenses associated with our corporate headquarters, management expenses and expenses for accounting, information systems, legal, business development, human resources, purchasing and other administrative departments. We have made significant investments in management, information technology systems, infrastructure, compliance and marketing to support our growth strategy. Our general and administrative expenses for   the thirteen weeks ended June 30, 2013 include management fees paid to an affiliate of Sterling Investment Partners, which ceased upon consummation of our IPO in April 2013.

 

The components of our general and administrative expenses may not be identical to those of our competitors. As a result, data regarding our general and administrative expenses may not be comparable to similar data made available by our competitors. We expect that our general and administrative expenses will increase in future periods due to additional legal, accounting, insurance and other expenses we expect to incur as a result of being a public company.

 

Store Opening Costs

 

Store opening costs include rent expense incurred during construction of new stores and costs related to new location openings, including costs associated with hiring and training personnel, supplies, the costs associated with our dedicated store opening team and other miscellaneous costs. Rent expense is recognized upon receiving possession of a store site, which generally ranges from three to six months before the opening of a store, although in some situations the possession period can exceed twelve months. Store opening costs vary among locations due to several key factors, including the length of time between possession date and the date on which the location opens for business along with the time designated as the training period for new staff for the store. Accordingly, we expect store opening costs to vary from period to period depending on the number of new stores opened in the period, whether such stores opened early or late in the period and whether new stores will open early in the following period. Store opening costs are expensed as incurred.

 

Income from Operations

 

Income from operations consists of gross profit minus direct store expenses, general and administrative expenses, store opening costs and production center start-up costs. Income from operations will vary from period to period based on a number of factors, including the number of stores open and the number of stores in the process of being opened in each period.

 

Adjusted EBITDA

 

We present Adjusted EBITDA, a non-GAAP measure, in this report to provide investors with a supplemental measure of our operating performance. We believe that Adjusted EBITDA is a useful performance measure to evaluate our core on-going operations and we use it to facilitate a comparison of our core on-going operating performance on a consistent basis from period-to-period and to provide for a more complete understanding of factors and trends affecting our business than GAAP measures alone can provide. Our board of directors and management also use Adjusted EBITDA as one of the primary methods for planning and forecasting overall expected performance and for evaluating on

23


 

  Table of Contents

a quarterly and annual basis actual results against such expectations, and as a performance evaluation metric in determining achievement of certain compensation programs and plans for employees, including our senior executives. Our board of directors and management also use Adjusted EBITDA as one of the key measures in determining the value of any strategic, investing or financing opportunity. In addition, the financial covenants in our senior credit facility are based on Adjusted EBITDA, subject to dollar limitations on certain adjustments. The adjustments and related amounts included in Adjusted EBITDA are in substantial accordance with Consolidated EBITDA as defined in our existing senior credit agreement, subject to dollar limitations on certain adjustments. Consolidated EBITDA as computed under our existing senior credit agreement for the four fiscal quarter period ended June 30, 2013 and June 29, 2014 was $50.4 million and $ 49.1 million, respectively, compared to Adjusted EBITDA for the four fiscal quarter period ended June 30, 2013 and June 29, 2014 of $48.7 million and $47.2 million, respectively. Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

 

We define Adjusted EBITDA as earnings before interest expense, income taxes, depreciation and amortization expense, amortization of deferred financing costs, equity compensation charges, store opening costs (including pre-opening advertising costs), production center start-up costs, gain on insurance recovery, severance related expenses, foundation funding, loss on early extinguishment of debt, IPO related expenses, transaction expenses and bonuses and management fees. Omitting interest, taxes and the other items provides a financial measure that facilitates comparisons of our results of operations with those of companies having different capital structures. Since the levels of indebtedness and tax structures that other companies have are different from ours, we omit these amounts to facilitate investors’ ability to make these comparisons. Similarly, we omit depreciation and amortization because other companies may employ a greater or lesser amount of owned property, and because in our experience, whether a store is new or one that is fully or mostly depreciated does not necessarily correlate to the contribution that such store makes to operating performance. We ceased paying management fees upon consummation of our IPO. Items such as production center start-up costs, gain on insurance recovery,   severance-related expenses, foundation funding, loss on early extinguishment of debt, IPO-related expenses and transaction expenses and bonuses were incurred and associated with discrete and different events not relating to our core on-going operations, including our initial public offering, which was consummated just after the end of fiscal 2013, an organizational realignment to remove redundant costs and streamline parts of our business model to enhance overall productivity that we began in the fourth quarter of fiscal 2014 and the refinancings of our senior credit facility and Hurricane Sandy. We also believe that investors, analysts and other interested parties view our ability to generate Adjusted EBITDA as an important measure of our operating performance and that of other companies in our industry. Adjusted EBITDA should not be considered as an alternative to net income for the periods indicated as a measure of our performance.

 

The use of Adjusted EBITDA has limitations as an analytical tool and you should not consider this performance measure in isolation from, or as an alternative to, US GAAP measures such as net income (loss). Adjusted EBITDA is not a measure of liquidity under US GAAP or otherwise, and is not an alternative to cash flow from continuing operating activities. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by the expenses that are excluded from that term or by unusual or non-recurring items. The limitations of Adjusted EBITDA include: (i) it does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; (ii) it does not reflect changes in, or cash requirements for, our working capital needs; (iii) it does not reflect income tax payments we may be required to make; (iv) it does not reflect the cash requirements necessary to service interest or principal payments associated with indebtedness; and (v) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements.

 

To properly and prudently evaluate our business, we encourage you to review our consolidated financial statements included elsewhere in this report and the reconciliation to Adjusted EBITDA from net loss, the most directly comparable financial measure presented in accordance with US GAAP, set forth in the table below. All of the items included in the reconciliation from net loss to Adjusted EBITDA are either (i) non-cash items or (ii) items that management does not consider in assessing our on-going operating performance. In the case of the non-cash items, management believes that investors may find it useful to assess our comparative operating performance because the measures without such items are less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect operating performance. In the case of the other items that management does not consider in assessing our on-going operating performance,

24


 

  Table of Contents

management believes that investors may find it useful to assess our operating performance if the measures are presented without these items because their financial impact may not reflect on-going operating performance.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

 

 

June 30,

 

June 29,

 

 

 

2013

 

2014

 

 

    

 

 

    

% of

    

 

 

    

% of

 

 

 

 

 

Net Sales

 

 

 

 

Net Sales

 

 

 

(dollars in thousands)

Net loss

 

$

(27,946)

 

(15.0)

%

 

$

(9,694)

 

(4.9)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Management agreement termination (a)

 

 

9,200 

 

4.9 

 

 

 

 —

 

 —

 

 

Contractual IPO bonuses

 

 

8,105 

 

4.3 

 

 

 

 —

 

 —

 

 

Other IPO-related expenses

 

 

795 

 

0.4 

 

 

 

 —

 

 —

 

 

Sub-total IPO transaction expenses

 

 

18,100 

 

9.7 

 

 

 

 —

 

 —

 

 

Professional services (b)

 

 

670 

 

0.4 

 

 

 

599 

 

0.3 

 

 

Severance (c)

 

 

 —

 

 —

 

 

 

872 

 

0.4 

 

 

Non-operating expenses (d)

 

 

274 

 

0.1 

 

 

 

 —

 

 —

 

 

Management fees (e)

 

 

877 

 

0.5 

 

 

 

 —

 

 —

 

 

Interest expense, net (f)

 

 

5,385 

 

2.9 

 

 

 

4,778 

 

2.4 

 

 

Income tax provision

 

 

2,403 

 

1.3 

 

 

 

945 

 

0.5 

 

 

Store depreciation and amortization

 

 

5,278 

 

2.8 

 

 

 

6,020 

 

3.0 

 

 

Corporate depreciation and amortization

 

 

1,113 

 

0.6 

 

 

 

1,036 

 

0.5 

 

 

Equity compensation charge

 

 

2,055 

 

1.1 

 

 

 

2,857 

 

1.4 

 

 

Store opening costs

 

 

2,986 

 

1.6 

 

 

 

1,686 

 

0.9 

 

 

Production center start-up costs

 

 

498 

 

0.3 

 

 

 

1,429 

 

0.7 

 

 

Pre-opening advertising costs

 

 

989 

 

0.5 

 

 

 

604 

 

0.3 

 

 

Adjusted EBITDA

 

$

12,682 

 

6.8 

%

 

$

11,132 

 

5.6 

%

 

 


(a)

Represents the fee paid, in connection with our initial IPO in April 2013 to an affiliate of Sterling Investment Partners (“Sterling”) to terminate our management agreement with such affiliate .

 

(b)

Consists of charges that were incurred and associated with discrete and different events that do not relate to and are not indicative of our core on-going operations, primarily related to (i) litigation with respect to a lease and professional services related to the establishment of our new production center in the thirteen weeks ended June 30, 2013, and (ii) our organizational realignment and the purported stockholder class action litigation in the thirteen weeks ended June 29, 2014.

 

(c)

Represents severance charges related to our organizational realignment.

 

(d)

Consists of charges that were incurred and associated with discrete and different events that do not relate to and are not indicative of our core on-going operations not related to professional services.

 

(e)

Represents prepaid management fees expensed at the IPO date.

 

(f)

Includes amortization of deferred financing costs and original issue discount. See note 4 to our financial statements in Item 1 above.  

25


 

  Table of Contents

Central Services

 

We have made significant investments in management, information technology systems, infrastructure, compliance and marketing.  These investments include significant additions to our company’s personnel, including experienced industry executives and the next generation management and merchandising teams to support our long-term growth objectives.  We believe that Central Services as a percentage of net sales is a useful performance measure and we use it to facilitate an evaluation of our infrastructure investment without distortions that may result from general and administrative expenses that do not directly relate to the operation of our business.  We define Central Services as general and administrative expenses less: depreciation and amortization related to general and administrative activities, management fees, transaction expenses, equity compensation charges and other non-operating expenses.  To properly and prudently evaluate our business, we encourage you to review our consolidated financial statements included elsewhere in this report and the reconciliation to Central Services from general and administrative expenses, the most directly comparable financial measure presented in accordance with US GAAP.

 

Organizational Realignment

 

In the fourth quarter of fiscal 2014, we initiated an organizational realignment to remove redundant costs and streamline parts of the business model to enhance overall productivity.  Net of reinvestments back into the business, we expect to achieve annualized cost savings of approximately $3-4 million.  In connection with the plan, we incurred charges of $3.3 million in fiscal 2014 and expect to incur charges, primarily severance, of approximately $3.5 million in fiscal 2015.  In the thirteen weeks ended June 29, 2014 , we incurred approximately $0.9 million in severance charges in connection with the organizational realignment .

 

Results of Operations

 

The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of net sales and have been derived from our consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

 

June 30,

 

June 29,

 

 

2013

 

2014

 

(dollars in thousands)

Net sales

    

$

186,778 

    

100.0 

%

    

$

198,268 

    

100.0 

%

Cost of sales and occupancy costs (exclusive of depreciation and amortization)

 

 

125,378 

 

67.1 

%

 

 

136,872 

 

69.0 

%

Gross profit

 

 

61,400 

 

32.9 

%

 

 

61,396 

 

31.0 

%

Direct store expenses

 

 

44,132 

 

23.6 

%

 

 

46,957 

 

23.7 

%

General and administrative expenses

 

 

33,942 

 

18.2 

%

 

 

15,295 

 

7.7 

%

Store opening costs

 

 

2,986 

 

1.6 

%

 

 

1,686 

 

0.9 

%

Production center start-up costs

 

 

498 

 

0.3 

%

 

 

1,429 

 

0.7 

%

Loss from operations

 

 

(20,158)

 

(10.8)

%

 

 

(3,971)

 

(2.0)

%

Interest expense, net

 

 

(5,385)

 

(2.9)

%

 

 

(4,778)

 

(2.4)

%

Loss before income taxes

 

 

(25,543)

 

(13.7)

%

 

 

(8,749)

 

(4.4)

%

Income tax provision

 

 

(2,403)

 

(1.3)

%

 

 

(945)

 

(0.5)

%

Net loss

 

$

(27,946)

 

(15.0)

%

 

$

(9,694)

 

(4.9)

%

 

Thirteen Weeks Ended June 29, 2014 Compared With Thirteen Weeks Ended June 30, 2013

 

The comparability of the financial data for June 29, 2014 and June 30, 2013 may be affected by the fact that the Easter and Passover holidays occurred during the thirteen weeks ended June 29, 2014 but not during the thirteen weeks ended June 30, 2013 .

26


 

  Table of Contents

 

Net Sales

 

We had net sales of $198.3 million in the thirteen weeks ended June 29, 2014 , an increase of $11.5 million, or 6.2%, from $186.8 million in the thirteen weeks ended June 30, 2013 .  Th is increase was primarily attributable to net sales from the two stores which opened subsequent to June 3 0, 2013.  Net sales for the thirteen weeks ended June 30, 2013 were positively impacted by higher than normal sales at our Red Hook store following its re-opening on March 1, 2013 after being closed for 18 weeks due to damage sustained from Hurricane Sandy.  In addition, net sales for the thirteen weeks ended June 29, 2014 include sales related to the Easter and Passover holidays; however, these holidays occurred prior to the beginning of the thirteen weeks ended June 30, 2013 .

 

Comparable store sales decreased 1.7% in the thirteen weeks ended June 29, 2014 compared to the thirteen weeks ended June 30, 2013, in large part due to the decrease in sales at our Red Hook store .  Customer transactions in our comparable stores decreased by 3.0% ,   although the average transaction size at our comparable stores increased by 1.3%.  Comparable store sales were negatively impacted by sales transfer from existing Fairway locations to new stores,   the higher than normal sales at our Red Hook store following its re-opening on March 1, 2013 and increased competitive pressures , partially offset by the Easter / Passover holidays, which occurred in the thirteen weeks ended June 29, 2014 but not in the thirteen weeks ended June 30, 2013 .

 

Gross Profit

 

Gross profit was $61.4 million for both   the thirteen weeks ended June 30, 2013 and June 29, 2014 .  Our gross margin decreased approximately 190 basis points to 31.0% for the thirteen weeks ended June 29, 2014   from 32.9% for the thirteen weeks ended June 30, 2013 .  The decrease in gross margin is primarily due to lower merchandise margins as a result of targeted pricing reductions and increased cost inflation across several of our perishable departments , which for competitive reasons we were not able to fully pass on .  Gross margins were also negatively impacted by higher occupancy costs, as a percentage of sales, at new locations as well as increased occupancy costs at several locations open in both periods

 

Direct Store Expenses

 

Direct store expenses were $47.0 million in the thirteen weeks ended June 29, 2014 , an increase of $2.8 million, or 6.4%, from $44.1 million for the thirteen weeks ended June 30, 2013 .  The increase in direct store expenses was primarily attributable to the two new stores we opened subsequent to the thirteen weeks ended June 30, 2013 . With more stores in operation during the thirteen weeks ended June 29, 2014 , our store labor expenses increased $1.0 million and our other store operating expenses increased $1.1 million compared to the thirteen weeks ended June 30, 2013 .  The portion of our depreciation expense included in direct store expense s , which includes amortization of prepaid rent, increased $0.7 million, or 14.1%, to $6.0 million for the thirteen weeks ended June 29, 2014 , compared to direct store depreciation expense for the thirteen weeks ended June 30, 2013 of $5.3 million.  The increase in direct store depreciation expense for the thirteen weeks ended June 29, 2014 compared with the thirteen weeks ended June 30, 2013 is primarily attributable to the increase in the number of stores.

 

Direct store expenses, as a percentage of net sales, increased approximately 10 basis points to 23.7% in the thirteen weeks ended June 29, 2014 from 23.6% in the thirteen weeks ended June 30, 2013 , primarily due to higher store operating expenses at our two new locations that opened subsequent to June 30, 2013, which is typical for new stores during the first few quarters of operations.

 

General and Administrative Expenses

 

General and administrative expenses were $15.3 million for the thirteen weeks ended June 29, 2014 , a decrease of $18.6 million, or 54.9%, from $33.9 million for the thirteen weeks ended June 30, 2013 . The decrease in general and administrative expenses is primarily attributable to the expenses incurred in the thirteen weeks ended June 30, 2013 related to our IPO of $18.1 million, including $9.2 million to terminate the management agreement upon consummation of our IPO, $8.1 million of contractual bonuses paid to certain members of management upon consummation of our IPO

27


 

  Table of Contents

and $0.8 million of other IPO related expenses, the elimination of management fees paid to an affiliate Sterling, which was $0.9 million in the thirteen weeks ended June 30, 2013 and a $0.7 million reduction in expenses related to professional services, non-operating expenses and pre-opening advertising, collectively. The Central Services component of general and administrative expenses declined $0.5 million in the thirteen weeks ended June 29, 2014 compared to the same period in the prior year.

 

These cost reductions were partially offset by increases in equity compensation expenses and severance -related expenses of $0.8 million and $0.9 million, respectively, in the thirteen weeks ended June 29, 2014 compared to the same period of the prior year.  The portion of depreciation and amortization included in general and administrative expenses was $1.0 million for the thirteen weeks ended June 29, 2014 , a decrease of $0.1 million, or 6.9%, from $1.1 million for the thirteen weeks ended June 30, 2013 .  Excluding fees and expenses related to the IPO, general and administrative expenses declined $0.5 million, or 3.5%, to $15.3 million for the thirteen weeks ended June 29, 2014 , from $15.8 million for the thirteen weeks ended June 30, 2013 .

 

General and administrative expenses, as a percentage of net sales, decreased to 7.7% for the thirteen weeks ended June 29, 2014 , from 18.2% for the thirteen weeks ended June 30, 2013 .  Excluding fees and expenses related to the IPO and management fees, which terminated in connection with the IPO , general and administrative expenses, as a percentage of net sales, decreased approximately 3 0 basis points to 7.7% for the thirteen weeks ended June 29, 2014 from 8. 0 % for the thirteen weeks ended June 30, 2013 .

 

The following table sets forth a reconciliation to Central Services from general and administrative expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

 

June 30,

 

June 29,

 

 

2013

 

2014

 

 

 

 

 

% of

 

 

 

 

 

% of

 

 

 

 

 

Net Sales

 

 

 

 

Net Sales

 

 

 

(dollars in thousands)

General and administrative expenses

    

$

33,942 

    

18.2 

%

    

$

15,295 

    

7.7 

%

Management agreement termination

 

 

(9,200)

 

(4.9)

 

 

 

 —

 

 —

 

Contractual IPO bonuses

 

 

(8,105)

 

(4.3)

 

 

 

 —

 

 —

 

Other IPO-related expenses

 

 

(795)

 

(0.4)

 

 

 

 —

 

 —

 

Sub-total IPO transaction expenses

 

 

(18,100)

 

(9.7)

 

 

 

 —

 

 —

 

Management fees

 

 

(877)

 

(0.5)

 

 

 

 —

 

 —

 

Professional services

 

 

(670)

 

(0.4)

 

 

 

(599)

 

(0.3)

 

Severance

 

 

 —

 

 —

 

 

 

(872)

 

(0.4)

 

Non-operating expenses

 

 

(274)

 

(0.1)

 

 

 

 —

 

 —

 

Corporate depreciation and amortization

 

 

(1,113)

 

(0.6)

 

 

 

(1,036)

 

(0.5)

 

Equity compensation charge

 

 

(2,055)

 

(1.1)

 

 

 

(2,857)

 

(1.4)

 

Pre-opening advertising costs

 

 

(989)

 

(0.5)

 

 

 

(604)

 

(0.3)

 

Central services

 

$

9,864 

 

5.3 

%

 

$

9,327 

 

4.7 

%

 

Store Opening Costs

 

Store opening costs were $1.7 million for the thirteen weeks ended June 29, 2014 , a decrease of $1.3 million, or 43.5%, from $3.0 million for the thirteen weeks ended June 30, 2013 .  Store opening costs for the thirteen weeks ended June 29, 2014 relate to the store we opened in Lake Grove, Long Island on July 23, 2014.  Store opening costs for the thirteen weeks ended June 30, 2013 primarily consisted of approximately $2.9 million related to the store that opened in the Chelsea neighborhood of Manhattan on July 24, 2013 and $0.1 million for the store we opened in Nanuet, New York on October 10, 2013.  Approximately $0.4 million and $0.7 million of store opening costs for the thirteen weeks ended June 29, 2014 and June 30, 2013 , respectively, did not require the expenditure of cash in the period, primarily due to deferred rent.

 

28


 

  Table of Contents

Production Center Start-up Costs

 

Start-up costs for the new production center in the Hunts Point area of the Bronx were $1.4 million for the thirteen weeks ended June 29, 2014 , an increase of $0.9 million from $0.5 million for the thirteen weeks ended June 30, 2013 .  Approximately $0.4 million and $0.1 million of these costs for the thirteen weeks ended June 29, 2014 and June 30, 2013 , respectively, did not require the expenditure of cash in the period, primarily due to deferred rent.

 

Loss from Operations

 

For the thirteen weeks ended June 29, 2014 , our operating loss was $4.0 million, a decrease of $16.2 million from a loss of $20.2 million for the thirteen weeks ended June 30, 2013 .  The decrease in the loss from operations was primarily attributable to the $18.1 million of IPO-related expenses incurred during the thirteen weeks ended June 30, 2013 , lower store opening costs and the elimination of management fees, partially offset by increased direct store operating expense, primarily related to our new stores, increased stock compensation expenses, severance-related expense and production center start-up costs.

 

Interest Expense

 

Interest expense decreased 11.3%, or $0.6 million, to $4.8 million for the thirteen weeks ended June 29, 2014 , from $5.4 million for the thirteen weeks ended June 30, 2013 , primarily due to lower interest rates resulting from the May 2013 amendment to our existing senior credit facility to lower interest rates, partially offset by an increase in the amortization of deferred financing fees and original issue discount of approximately $0.1 million.  The cash portion of interest expense for the thirteen weeks ended June 29, 2014 and June 30, 2013 was $3.7 million and $4.2 million, respectively.

 

Income Taxes

 

We recorded an income tax provision of $0.9 million the thirteen weeks ended June 29, 2014 compared to a provision of $2.4 million the thirteen weeks ended June 30, 2013 .  We record an income tax provision although we incur pretax losses in both periods because we do not record any income tax benefit related to the operating losses and recognize income tax expense related to indefinite-lived intangible assets.

 

Net Loss

 

Our net loss was $9.7 million for the thirteen weeks ended June 29, 2014 , a decrease of $18.3 million, or 65.3%, from a net loss of $27.9 million for the thirteen weeks ended June 30, 2013 . The decrease in net loss was primarily attributable to the $18.1 million of IPO-related expenses incurred during the thirteen weeks ended June 30, 2013 , lower store opening costs, the elimination of the management fees and a reduction in the income tax provision, partially offset by increased direct store operating expenses, primarily related to our new stores, increased stock compensation expense , severance-related expense and production center start-up costs.

 

Our adjusted net loss was $3.1 million for the thirteen weeks ended June 29, 2014 , an increase of $0.8 million, or 32.8%, from the thirteen weeks ended June 30, 2013 .  We define adjusted net loss as net loss plus any transaction expenses, expenses that did not continue after the IPO, non-cash charges, one-time charges and non-operating expenses which we believe may distort period to period comparison.

 

29


 

  Table of Contents

The following table sets forth a reconciliation to adjusted net loss from net loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

 

June 30,

 

June 29,

 

 

2013

 

2014