Fairway Group Holdings Corp
Fairway Group Holdings Corp (Form: 10-K, Received: 05/29/2014 16:10:28)

Table of Contents

 

17

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

W ashington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

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

 

For the fiscal year ended March 3 0 , 201 4

 

OR

 

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

 

For 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 of incorporation)

 

(I.R.S. Employer

 

 

Identification No.)

 

 

 

 

 

2284 12th Avenue

 

 

New York, New York

 

10027

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (646) 616-8000

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

 

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Class A Common Stock, $0.00001 par value per share

 

The NASDAQ Stock Market LLC

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes    No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes    No

 

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 requirements for the past 90 days.   Yes No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

 

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 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 Exchange Act). Yes No

 

The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant as of September 27, 2013, the last business day of the registrant’s most recently completed second quarter, was $502,064,178 based upon the closing price of $25.13 reported for such date on the NASDAQ Global Market .

 

As of May  23 , 2014, the registrant had 29,205,245 shares of Class A common stock and 14,225,455 shares of Class B common stock outstanding.

 

Documents Incorporated by Reference

 

Portions of the registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held on July 29, 2014 (hereinafter referred to as the Proxy Statement) are incorporated by reference into Part III of this report.

 

 

 

 

 

 

 

 


 

Table of Contents

 

 

Fairway Group Holdings Corp.

FORM 10-K For the Fiscal Year Ended March 30, 2014

Table of Contents

 

 

 

 

 

Part I  

Item 1.  

Business

Item 1A.  

Risk Factors

15 

Item 1B.  

Unresolved Staff Comments

34 

Item 2.  

Properties

34 

Item 3.  

Legal Proceedings

35 

Item 4.  

Mine S afety Disclosures

35 

Part II  

Item 5 .

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

36 

Item 6.  

Selected Financial Data

38 

Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

45 

Item 7A.  

Quantitative and Qualitative Disclosures About Market Risk

67 

Item 8.  

Financial Statements and Supplementary Data

68 

Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

103 

Item 9A.  

Controls and Procedures

103 

Item 9B.  

Other Information

103 

Part III  

Item 10.  

Directors, Executive Officers and Corporate Governance

104 

Item 11.  

Executive Compensation

104 

Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

104 

Item 13.  

Certain Relationships and Related Transactions, and Director Independence

104 

Item 14.  

Principal Accounting Fees and Services

104 

Part IV  

Item 15.  

Exhibits, Financial Statement Schedules

105 

 

Signatures

106 

 

Index to Exhibits

107 

 

 

 

 

1

 


 

Table of Contents

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K 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 open new stores on a timely basis or at all;

·

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;

·

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;

·

the geographic concentration of our stores;

·

ongoing economic uncertainty;

·

our ability to maintain or improve our operating margins;

·

our history of net losses;

·

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

·

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;

·

our 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 of 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.”

 

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” and “Item 7—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

2

 


 

Table of Contents

 

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 sections in this report entitled “Item 1A—Risk Factors” and “Item 7—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 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 Annual Report on Form 10-K 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.

 

 

 

3

 


 

Table of Contents

 

PART I

 

ITEM 1—BUSINESS

 

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.

 

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 in this report by reference to the calendar year in which the fiscal year ends. Accordingly, “fiscal 2010” refers to our fiscal year ended March 28, 2010, “fiscal 201 1 ” refers to our fiscal year ended April 3, 2011 ,   “fiscal 201 2 ” refers to our fiscal year ended April 1, 2012 , “fiscal 201 3 ” refers to our fiscal year ended March 31, 2013 and “fiscal 201 4 ” refers to our fiscal year ended March 30, 2014 .

 

As used in this Annual Report on Form 10-K, the term “Greater New York City metropolitan area” means New York City and the New York, New Jersey and Connecticut suburbs within a 50 mile radius of New York City. References to “stores in suburban areas” or similar expressions refer to stores located in the Greater New York City metropolitan area outside of New York City. We define “store contribution margin” as gross profit less direct store expenses (excluding depreciation and amortization included in direct store expenses). References to “Sterling Investment Partners” are to the investment funds managed by affiliates of Sterling Investment Partners that own shares of our common stock.

 

Our Company

 

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 1 4 locations in the Greater New York City metropolitan area, three of which includ e   Fairway Wines & Spirits location s. Twelve of the stores were open prior to the beginning of fiscal 2014 and two stores were opened during fiscal 2014 : our store located in the Chelsea neighborhood of Manhattan that we opened on July 24, 2013 and a store in Nanuet, NY which we opened on October 10, 2013. S even of our food stores, which we refer to as our “urban stores,” are located in New York City, and the remainder, which we refer to as our “suburban stores,” are located in New York (outside of New York City), New Jersey and Connecticut. Our Brooklyn, NY location (“Red Hook”) was temporarily closed from October 29, 2012 through February 28, 2013 due to substantial damage sustained during Hurricane Sandy and reopened March 1, 2013. We expect to open a new store in Lake Grove in Suffolk County, Long Island, NY in Summer 2014, a new store in the TriBeCa neighborhood of Manhattan in early calendar 201 5   and a new store in the Hudson Yards neighborhood in west midtown Manhattan in late calendar 2015 or early calendar 2016 .   W e have made significant investments in infrastructure required to support our growth, and, since March 2009, have opened ten food stores, three of which includ e   Fairway Wines & Spirits locations .

 

Our History

 

Fairway began in the 1930s as a fruit and vegetable stand located at our Broadway store’s current location on Broadway and 74th Street in Manhattan under the name “74th Street Market.” In 1954, we expanded the 74th Street location, adding groceries, meat, cheese, dairy products and frozen foods, and renamed the store “FAIRWAY” to convey the concept of “fair prices.”

 

In the mid-1970s, Fairway began expanding into gourmet and specialty categories, transforming its retail grocery operations into a full service food superstore known for high quality and value pricing. During this transformation, we also began hiring the team of ambitious, hardworking “foodies” who would eventually become our category experts and senior merchants. In the late 1970s, we adopted the slogan “Like No Other Market” in recognition of our distinctive format.

 

In January 2007, Sterling Investment Partners acquired 80.1% of Fairway. With Sterling Investment Partners’ support, we made significant investments in infrastructure required to accelerate our future growth and, in early 2009, began to execute our successful new store expansion program.

 

4

 


 

Table of Contents

 

In April 2013, we completed an i nitial p ublic o ffering (“IPO”) of our Class A common stock.  As of May 23 , 2014, Sterling Investment Partners owned approximately   49. 0 % of our outstanding common stock and approximately 81.1 % of the voting power of our outstanding common stock .

 

Fairway Group Holdings Corp. was incorporated as a Delaware corporation on September 29, 2006. Each of our stores is owned by a separate Delaware subsidiary.

 

Our Competitive Strengths

 

We believe the following strengths contribute to our success as a premier destination food retailer and position us for sustainable growth:

 

Iconic brand. We believe our Fairway brand has a well established reputation for delivering high-quality, value-priced fresh, specialty and conventional groceries. Fairway has served millions of passionate customers in the Greater New York City metropolitan area for more than 75 years. We recorded approximately 1 9.0 million customer transactions in fiscal 201 4 , compared to 16.0 million customer transactions in fiscal 201 3 , and believe the Fairway brand is widely recognized throughout the Greater New York City metropolitan area. Our food experts regularly appear on nationally syndicated food and cooking programs. We believe the strength of the Fairway brand enhances our ability to: (i) attract a broad demographic of customers from a wider geographic radius than a conventional supermarket; (ii) source hard-to-find, unique gourmet and specialty foods; (iii) build a trusted connection with our customers that results in a high degree of loyalty; (iv) attract and retain highly talented employees; (v) secure attractive real estate locations; and (vi) successfully open new stores.

 

Destination food shopping experience “Like No Other Market”. We provide our customers a differentiated one-stop shopping experience by offering a unique mix of product breadth, quality and value in a visually appealing in-store environment. Fairway creates a fun and engaging atmosphere in which customers select from an abundance of fresh foods and other high-quality products while interacting with our attentive and knowledgeable employees throughout the store. When customers enter a Fairway, they are immediately greeted by our signature towering displays of fresh produce. As they continue through the store, customers will find a “specialty shop” orientation designed to recreate the best features of local specialty markets, such as a gourmet cheese purveyor, full service butcher shop, seafood market and bakery, all in one location. Our stores provide a sensory experience, including aromas of fresh coffee roasts and freshly baked bread, an array of vibrant colors across our produce displays, cheese experts describing selections of our over 600 artisanal cheeses, samples of our approximately 15 0 varieties of olive oil and free tastings of our delicious prepared foods. Our stores feature whimsical and informative signs designed to educate customers about the quality, origin and characteristics of our products, and offer tips and suggestions on food preparation and pairings. We encourage a high level of interaction among our employees and customers, which results in a more informed, engaged and satisfied customer. We believe the distinctive Fairway food shopping experience drives loyalty, referrals and repeat business.

 

Distinctive merchandising strategy. Our merchandising strategy is the foundation of our highly differentiated, one-stop shopping experience. We offer a unique product assortment generally not found in either conventional grocery stores or natural / specialty stores, consisting of a large variety of high-quality produce, meats and seafood, as well as gourmet, specialty and prepared foods and a full selection of everyday conventional groceries. High-quality perishables and prepared foods account for approximately 65 % of our sales, compared to the more typical one-quarter to one-third of a conventional grocer’s sales. Fairway stores also showcase hard-to-find specialty and gourmet items that expand our customers’ culinary interests, and we believe we are often one of the first retailers to carry or import a new product. Our Fairway-branded products represent a high-quality, value-oriented specialty alternative unlike the more typical generic, low-cost option presented by conventional food retailers. In product lines where we offer a Fairway-branded alternative, it is typically among the store’s top sellers in the category. Fairway’s prices typically are lower than natural / specialty food stores and competitive with conventional grocery stores. Our dedicated merchandising team focuses on continuously enhancing the Fairway experience for our loyal customers. We believe that our distinctive merchandising strategy has enabled us to build a trusted connection with our customers, who value the quality and fair prices of our food, our merchandising teams’ expertise and our one-stop shopping convenience.

 

Powerful store format with industry leading productivity. We believe our stores are generally among the most productive in the industry in net sales per store, net sales per square foot and store contribution margin. During fiscal 201 4 , for food stores open more than 1 4 full months, our net sales per store and net sales per selling square foot averaged $ 59.1 million and $1, 75 4 , respectively. In addition, during fiscal 201 4 , the contribution margin of our food stores open more than 1 4 full months was 1 1.9 %. Our highly productive store format delivers attractive returns on investment due to the following key characteristics:

 

High-volume one-stop shopping destination. Our distinctive merchandising strategy, locations in high density markets and iconic brand drive strong customer traffic to our stores. Our high volumes result in operating efficiencies that provide us with a greater ability to offer competitive prices while maintaining or improving our

5

 


 

Table of Contents

 

operating margins. In addition, our strong per store volumes generate high inventory turnover, which enables us to maintain a fresher selection of quality perishables than most of our competitors, in turn helping to drive customer traffic and sales.

 

Attractive product mix. Our broad assortment of high-quality fresh, natural and organic products and prepared foods, which account for approximately 65 % of our sales, specialty items, which account for approximately 7 % of our sales and Fairway-branded products, which account for approximately 8 % of our sales , enhance gross margins and store productivity.

 

Direct-store delivery. We believe that our “farm-to-shelf” time is shorter than that of many of our competitors. Given our large store volumes, our ability to utilize direct-store delivery for a greater portion of our perishables than other food retailers helps us to ensure the highest quality and fastest delivery from our suppliers. Direct-store distribution eliminates multiple logistical layers, reducing supply chain costs while enhancing product freshness.

 

Strong vendor relationships. We have built valued, long-standing relationships with both large and small vendors that enable us to achieve attractive pricing on our broad merchandise offering. Fairway is viewed as an important strategic partner by many of our smaller suppliers, helping them to build scale. We source our perishable products locally whenever possible to ensure freshness. As we grow our sales, we expect that we and our vendors will benefit from increasing economies of scale.

 

Maximum merchandising flexibility. We generally enable our merchandising teams to control our on-shelf product selection and positioning, rather than permitting vendors to do so through slotting fees. This permits us to offer the products customers want most and provides us with the flexibility to expand or contract our product offerings as demand warrants.

 

Proven ability to replicate store model. Since March 2009, we have successfully opened ten new food stores, three of which includ e Fairway Wines & Spirits locations, more than tripling   our store base. In aggregate, the t wo stores we opened in July  and Octo ber 201 3 added $ 40.7 million of net sales in fiscal 201 4 . We leverage our well-developed corporate infrastructure, including   our dedicated store opening team and flexible supply chain, to open in desirable locations using a disciplined approach to new store site selection. We benefit from economies of scale and expect to enhance our operating efficiency as we expand our store footprint, further reinforcing our competitive position and ability to grow our sales profitably. As a result of our iconic brand and customer traffic, many landlords seek us out as a tenant.

 

Our urban food store operating model for new stores is based primarily on a store size of approximately 40,000 gross square feet (approximately 25,000 selling square feet), a net cash investment, including store opening costs, of approximately $16 to $18 million, not all of which requires an immediate cash outlay, targeted net sales after two years of approximately $ 5 0 million to $85 million, a targeted contribution margin at maturity of approximately 1 2 % to 17 %, and a targeted average payback period on our initial investment of approximately two to three years.

 

Our suburban food store operating model for new stores is based primarily on a store size of approximately 60,000 gross square feet (approximately 40,000 selling square feet), a net cash investment, including store opening costs, of approximately $13 to $15 million, not all of which requires an immediate cash outlay, targeted net sales after two years of approximately $4 0 million to $55 million, a targeted contribution margin at maturity of approximately 7 % to 1 0 %, and a target e d average payback period on our initial investment of approximately three to four years.

 

The required cash investment for new stores will var y depending on the size, geographic location, degree of work performed by the landlord and the complexity of site development issues. As a result, the average cost per square foot may vary significantly from project to project and from year to year.

 

We may elect to opportunistically open stores in desirable locations that differ from our prototypical new store model in square footage and/or net sales but that we believe will provide similar contribution margins and returns on invested capital.

 

Passionate and experienced management team. We are led by a management team with a proven track record, complemented by hands-on senior merchants and store operations managers who have broad responsibility for merchandising and store operations. We believe that our senior merchants for each broad merchandising category (e.g., produce, meat, deli, cheese) are widely recognized as authorities in their area and are more invested in the success of their product categories than employees of most conventional food retailers because they provide significant merchandising input. We also believe our management and senior merchants’ depth of experience and continuity as a team have significantly contributed toward our success in offering customers a compelling food shopping experience. Over the past several years we have made significant additions to our company’s personnel,

6

 


 

Table of Contents

 

including experienced industry executives and the next generation management and merchandising teams to support our long-term growth objectives.

 

Our Growth Strategy

 

We plan to pursue the following growth strategies:

 

Open stores in existing and new markets. We operate in the Greater New York City metropolitan area, an approximately $30 billion food retail market that is the largest in the United States. Although we have significantly grown our sales in the Greater New York City metropolitan area, we believe our existing market presents a significant opportunity for our continued growth.

 

In fiscal 201 4 we opened two additional store s : the store in the Chelsea neighborhood of Manhattan, NY, which opened in late July 2013, and the store in Nanuet, NY, which opened in mid-October 2013 . We expect to open additional store s in Lake Grove in Suffolk County, Long Island, NY in Summer 2014, the TriBeCa neighborhood of Manhattan in early calendar 201 5   and the Hudson Yards neighborhood in west midtown Manhattan in late calendar 2015 or early calendar 2016 . For the next several years, we intend to grow our store base in the Greater New York City metropolitan area at a rate of t wo to four stores annually. 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.

 

As we continue to open new stores in our existing markets, we expect these stores to be the primary driver of our sales, operating profit and market share gains. 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, 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.

 

Capitalize on consumer trends. We believe that our differentiated format positions us to capitalize on evolving consumer preferences and other key trends currently shaping the food retail industry, which include:

 

Increasing focus on the customer shopping experience. Fairway’s merchandise breadth, quality and value, market-style store layout and personalized customer service cater to shoppers looking for a differentiated shopping experience.

 

Increasing consumer focus on healthy eating. Fairway offers a large variety of high-quality natural and organic foods at prices that are typically lower than natural / specialty food stores. Our merchandise mix of high-quality fresh and prepared foods, which accounts for approximately 65 % of our sales, and broad array of specialty items appeals to customers seeking healthier eating choices.

 

Increasing consumer interest in private label product offerings. Fairway’s branded - products represent a high-quality, value-oriented specialty alternative unlike the more typical generic, low-cost option presented by conventional food retailers. In product lines where we offer a Fairway-branded alternative it is typically the store’s top seller in the category. We will continue to expand our Fairway-branded product portfolio, selectively offering new high-quality specialty alternatives designed to strengthen our relationship with our customers.

 

Improve our operating margins. We intend to improve our operating margins by the following key initiatives:

 

Leverage our well-developed and scalable infrastructure. We have made significant investments in management, information technology systems, infrastructure, compliance and marketing to enable us to pursue our growth plans without a significant increase in infrastructure spending. We have upgraded our systems and enhanced our new store development and training processes. We have also developed a robust, proprietary daily reporting portal that enables us to effectively manage our growing number of new stores and have implemented initiatives to improve labor productivity and reduce shrink throughout our operations. We believe we can leverage these investments to improve our operating margins as we grow our store base.

7

 


 

Table of Contents

 

 

Continue implementing our operating initiatives. As we grow our store base, we will continue to use proprietary analytical, data driven techniques to optimize sales and profitability across our network. We will continue to focus on: (i) price optimization, where we refine the pricing and balance of our promotional activities across our mix of higher-margin perishable items and everyday value oriented conventional grocery items; (ii) labor productivity, where we utilize Fairway’s intelligence portal to more effectively manage store labor; and (iii) shrink reduction, where we identify and capture opportunities to reduce waste and inventory loss.   In the fourth quarter of fiscal 2014 w e   began to implemen t an organizational realignment to remove redundant costs and streamlin e our business model to enhance overall productivity , and we expect to complete this realignment by the end of fiscal 2015 .

 

Utilize a centralized production facility. We will begin operations   in our centralized production facility in the Hunt’s Point section of the Bronx, NY in the first quarter of fiscal 2015 to serve our current and future stores in the Greater New York City metropolitan area. T his facility w ill contain a centralized commissary/kitchen and bakery as well as a large refrigerated storage   area and an expanded cross-dock facility. We believe this centralized production facility will increase labor efficiency, improve product quality and consistency and increase the amount of   selling space in our stores, as we w ill be able to devote less of our store space to these operations, which is particularly important in our Manhattan stores. We expect to spend approximately $ 20 million to complete this facility , of which $ 7.7 million was spent in f iscal 2014 .

 

Industry Overview and Trends

 

The U.S. retail grocery market includes a variety of distribution channels, from small grocery shops and convenience stores to supermarkets, natural / specialty food stores, warehouse clubs and supercenters. According to Willard Bishop’s June 201 3 publication, The Future of Food Retailing , the U.S. retail market for groceries and consumables was approximately $1 trillion in 201 2 . We operate in the supermarket channel, which accounted for nearly 50% of the retail grocery and consumables market in 201 2 , with approximately $500 billion in sales.

 

The supermarket segment is comprised of Conventional, Supercenter, Limited Assortment (under 1,500 items), Natural / Specialty and Other. Conventional stores are defined as full-line, self-service retail stores that sell dry groceries, perishable items and some non-food items. Despite being the largest segment of the supermarket category, conventional grocers have seen their overall share shrink from 73.2% in 2005 to 66.7% in 201 3 , according to the Progressive Grocer , as consumers have migrated towards other grocery retail formats. Supercenters such as Wal-Mart and Target have gained significant market share from traditional supermarkets through competitive pricing while specialty, natural / organic and gourmet grocers have continued to attract customers away from conventional grocers based on their unique product offering and differentiated shopping experience.  In addition, supercenters have begun expanding their offerings of natural / organic products.

 

Key trends impacting our industry include:

 

Increasing focus on the customer shopping experience. Consumers are increasingly focused on their shopping experience a ccording to the 201 2   Food M arketing Institute ’s   US Grocery Shopper Trends 2012   (the “2012 FMI Study”) .     V ariety, price and higher-quality produce and meats are the primary drivers for customers travelling further to shop for food. The combination of a deep selection of center store items, a wide variety of perishables, better customer service and a cleaner store environment all contribute to this trend. Along with shoppers’ willingness to devote time to shopping in their primary location, they are also more loyal to their primary store, with 69% of their total grocery budget spent at that location according to the   2012 FMI Study .

 

To address this shift in consumer focus, supermarkets are striving to be more responsive to consumer preferences through their consumer interactions and product offerings. Retailers are using these expanded product ranges along with added service offering and updated store design to create differentiated shopping experiences. According to the Progressive Grocer , approximately 68% of consumers said it s important to be able to buy what they want when they want it and 63% said they want to be able to customize the product or service to be exactly what they want. .

 

Increasing consumer focus on healthy eating. A growing consumer focus on healthy eating has prompted food retailers to offer an enhanced assortment of fresh and minimally processed foods and natural and organic products. The increased popularity of farmers’ markets over the past few years is also indicative of a consumer preference for fresh food items. Additionally, the growing consumer demand for fresh, quality offerings has improved the infrastructure for, and increased supply of, these items, resulting in improved sourcing, distribution and pricing.

 

The percentage of natural and organic food sales has been rising. According to data in the September 2013   Nutrition Business Journal , natural and organic food sales grew 1 2.7 % in 201 2 and are expected to grow at a compound annual growth rate of

8

 


 

Table of Contents

 

approximately 10% through 201 5 and, according to the 201 2   FMI Study ,   fresh format food retail is expected to grow at a compound annual growth rate of 13.4% from 2012 to 2017 . We believe the strength of a food retailer’s natural and organic product offering attracts customers increasingly focused on health and wellness who are willing to pay a premium for high-quality, natural and organic products.  

 

Increasing private label offerings. Consumers continue to purchase private label alternatives as part of their focus on quality products at value pricing and private label brands typically present a strong value proposition to both consumers and retailers. Rather than product emulation of national brands, selected retailers have increased their own-brand development, particularly in the area of health and wellness related offerings. According to the 201 2  F MI Study ,   how customers use private label brands also reflects changes in consumer views of value and quality . In the past, private label brands were deemed as “okay for everyday” but not for “special occasions or guests”. Today , nearly half of consumers disagree with this concept.

 

Our Products

 

We have a significant focus on perishable product categories, which include produce, natural and organic, deli, specialty, cheese, butcher, seafood, bakery, coffee and kosher foods. Our non-perishable product categories consist of conventional groceries as well as specialty foods. We emphasize fresh items that are of premium quality as compared to our conventional competitors.

 

Our in-house merchants are the “authority” on their respective departments and actively seek high-quality products from a wide range of vendors. Our stores are designed in a market-style “specialty shop” orientation with portions of each store allocated to specific specialty categories.

 

Produce. When customers walk into a Fairway, they are immediately greeted by our signature towering displays of fresh produce, carefully and methodically stacked high. We also offer our shoppers a wide assortment of organic fruits and vegetables. Fairway sources fruits and vegetables directly from the growers, who deliver their produce to our stores directly from the fields, groves, orchards and hothouses daily. We believe this makes Fairway’s fruits and vegetables days fresher than produce at other stores.

 

Natural and organic. Fairway offers a large variety of high-quality natural and organic foods at prices that are typically lower than natural / specialty food stores and that appeal to customers seeking healthier eating choices. Our extensive natural and organic product categories include: fruits and vegetables, natural and fresh juices, organic OBE beef and organic chicken, fresh organic peanut butter and natural almond butter, fresh roasted coffees and loose teas, dried fruits and nuts, full assortment of natural and organic groceries, cold cuts and cheeses, breads, supplements (homeopathy, vitamins, herbs), nutritional bars and protein powders, health and beauty aids, dairy, including Fairway-branded organic milk, eggs, including Fairway-branded organic eggs, vegetarian dairy alternatives, frozen foods, extensive gluten-free selections, baby food and baby care items and environmentally friendly cleaning products.

 

Deli. We offer a classic New York deli counter. We carry smoked salmon prepared using our own recipe and hand-craft our own fresh mozzarella daily. Our employees are frequent contributors to our prepared foods recipes. We offer authentic tastes from many different cultures and backgrounds, and a variety that will please a range of appetites. Our stores offer full displays of many possibilities for delicious sandwiches, side dishes, toppings, platters, snacks and main dishes.

 

Specialty. Our Specialty Imports and Specialty Grocery departments provide shoppers with hard-to-find specialty and gourmet items, such as Lapalisse pure and virgin nut oils; authentic Sicilian foodstuffs; Burgundy’s   organic La Trinquelinette fruit preserves made in small batches using only unrefined raw cane sugar; ready-to-eat vacuum-packed beets from the Loire Valley; L’Herbier de Milly La Forêt verbena, hibiscus, peppermint and linden blossom infusions; La Quiberonnaise Vintage Sardines from Brittany, France; Pruneaux d’Agen (stuffed prunes); Royal Medjool dates, Quercy’s soft dried figs and apricots. We carry over   1 00 varieties of specialty olive oil, including numerous imported unfiltered olive oils, and offer all-day, every day tasting of olive oils in each of our stores.

 

Cheese. At any of our locations, on any day of the week, consumers will find more than 600 artisanal cheeses at affordable prices. Our cheese experts can help customers design cheese platters to suit their needs.

 

Butcher. Our meat department team sources and selects each of our cuts of meat. We have meat delivered every day and it is cut and packaged at each of our stores within 24 hours of receipt. We also receive daily deliveries of fresh ice-packed chicken. This ensures peak freshness of the meat and chicken and proper packaging for discerning customers. We carry a full range of prime beef cuts at everyday low prices and grind our own beef. We also dry age our prime beef on the premises of many of our stores, which improves the flavor, texture and tenderness of the meat.

 

9

 


 

Table of Contents

 

Seafood. We receive the majority of our fish whole and fillet them in our stores, reminiscent of the way fish was sold from an outdoor fresh market in Europe or an old-time fish market in New York City. We typically offer 50 to 7 0 different selections of fresh fish and seafood in each store every day. We employ high freshness, taste and safety standards in selecting our seafood.

 

Bakery. We utilize a combination of on-site and centralized bakeries to produce our baked goods. The presence of on-site baking enhances our customer’s shopping experience and reinforces the freshness of our hand-crafted products. When consumers walk through a Fairway, they will encounter aromas of fresh-baked bagels and baguettes, similar to a European marketplace. Our full-service bakery prepares our signature cookies, tarts, cupcakes, baguettes and bagels.

 

Coffee. All of our coffees are 100 % Arabica beans, grown in the high mountains. We buy directly from farmers and from select specialty brokers and roast the coffee ourselves, or have it roasted on our behalf, in small batches six days a week. We offer over 100 types of artisanal coffee beans sold by the pound, as well as over a dozen varieties of Fair Trade certified and organic coffee. Our decaffeinated coffee is water-processed, not chemically processed, which protects the flavor.

 

Kosher. We offer an extensive array of kosher options, including Fairway’s branded products, our conventional and specialty groceries, our coffee, as well as our baked goods, dairy, organic, gluten-free, imported, and frozen items. We offer a variety of cuts of kosher poultry, red meat and seafood.

 

Conventional grocery. We carry a full range of conventional grocery items. Our grocery aisles are stacked high with the most recognized national brand names—Tide, Bounty, Kleenex, Charmin, Lysol, Poland Spring, Oreo, Cheerios, Lipton, Hershey’s, Coke, Green Giant, and many more. In addition, we offer an extensive array of ethnic groceries that cater to each store’s local demographic.

 

Fairway-branded products

 

Fairway’s branded products represent a high-quality, value-oriented specialty alternative unlike the more typical generic, low-cost option presented by conventional food retailers. Our Fairway-branded products are designed to strengthen our relationship with our customers through high-quality gourmet offerings. We display our own brands prominently in our stores, and in product lines where we offer a Fairway-branded alternative it is typically among the store’s top sellers in the category. In fiscal 201 4 , our portfolio of Fairway-branded items, including prepared foods, represented approximately 8.0 % of our net sales. We maintain direct relationships with numerous producers with whom we work to develop and provide our Fairway   -branded product offerings. These include rare barrel olive oils from Spain, Italy, and France that are exclusive to Fairway. At our stores you will also find, among other items, Fairway golden honey, organic maple syrup, organic jams in five flavors, chocolates, a   wide selection of spices, olive, artichoke and sundried tomato pastes, pasta and pizza sauces and coffees from exotic coffee-growing regions.

 

Pricing Strategy

 

Our original store was named “FAIRWAY” in 1954 to convey the concept of “fair prices.” 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. We believe that the unique combination of our extensive product selection, our in-store experience, and our value pricing creates a premier food shopping experience that appeals to a broad demographic.

 

Seasonality

 

The food retail industry and our sales are affected by seasonality. 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.

 

Our Stores

 

Our stores are designed to recreate the best features of local specialty markets, such as the butcher shop, fish market, bakery and cheese monger, all in one location. When customers enter a Fairway, they are immediately greeted by our signature towering displays of fresh produce, carefully and methodically stacked high. As they continue through the store, customers will find a market-style “specialty shop” orientation, with sections of each store devoted to categories such as our world class cheese department, full service butcher shop and seafood market that are designed to bring the best of traditional local merchants to our stores. Each individual department is run by an expert who can answer any customer questions and provide the level of service found in a specialty shop. Most stores also have an in-house production bakery, full kitchen and coffee roaster. Our stores typically include sit-down eating areas where food is prepared to order.

 

10

 


 

Table of Contents

 

Our stores provide a sensory experience, including aromas of fresh coffee roasts and freshly baked bread, an array of vibrant colors across our produce displays, cheese experts describing selections of our over 600 artisanal cheeses, samples of our approximately 1 5 0 varieties of olive oil and free tastings of our delicious prepared foods. Fairway creates a fun and engaging atmosphere in which customers select from an abundance of fresh foods and other high-quality products while interacting with our attentive and knowledgeable employees throughout the store. Our stores feature whimsical and informative signs designed to educate customers about the quality, origin and characteristics of our products, and offer tips and suggestions on food preparation and pairings.

 

Each of our stores is organized around distinct departments with engaging merchandise displays that reinforce our emphasis on freshness and service. We position our full-service departments around the perimeter of the store and adjacent to each other to provide a “market feel” and foster interaction between employees and customers. We generally enable our merchandising teams to control our on-shelf product selection and positioning, rather than permitting vendors to do so through slotting fees. This permits Fairway to offer the products customers want most and provides us with the flexibility to expand or contract our product offerings as demand warrants.

 

Our Fairway Wines & Spirits locations offer a full assortment of wines and spirits at everyday low prices, and are designed with the same general themes of our food stores, emphasizing abundance, variety and hard to find   products from around the world. Our wine stores also offer a full selection of kosher, organic and low sulfite wines. Each store has certified wine specialists. We believe our Fairway Wines & Spirits locations complement our food stores and enhance the shopping experience we offer to consumers.

 

We believe that our success and our growth are dependent upon hiring, training, retaining and promoting qualified and enthusiastic employees who share our passion for delivering an extraordinary food shopping experience. Each of our stores is managed by a store manager and one or two assistant managers who oversee full-time and part-time employees within each store. Each store manager is responsible for the day-to-day operations of his or her store, including the unit’s operating results, maintaining a clean and appealing store environment and the hiring, training and development of personnel. Many of our store managers are promoted from within, and we actively track and reward mobility to ensure a sufficient pipeline of store managers and assistant store managers. We have well-established store operating policies and procedures and an in-store training program for new store managers, assistant managers and staff. Our customer service and store procedure training programs are designed to enable our employees to assist customers in a friendly manner and to help to create a positive sales-driven environment and culture as well as teach successful operating practices and procedures.

 

We employ numerous analytical tools and metrics to monitor “the Fairway customer experience” and ensure that our execution is consistent and predictable. We also receive significant feedback from customers via social media, such as Facebook, Twitter , Yelp and the growing number of food “blogs” in the local New York market. We have a dedicated team of customer service employees who monitor the social media sites and respond to comments about Fairway and distribute important customer comments to key Fairway managers.

 

Store Growth and Site Selection

 

We employ a detailed, analytical process to identify new store locations. We target locations based on demographic characteristics, including income and education levels, drive times and population density, as well as other key characteristics including convenience for customers, visibility, access, signage and parking availability and availability of attractive lease terms.   As a result of our iconic brand and customer traffic, many landlords seek us out as a tenant. After we have selected a target site, our development group conducts a comprehensive site study and sales projection and develops construction and operating cost estimates.

 

We have a dedicated new store opening team, including a new store operations manager, which is exclusively focused on ensuring a consistent new store opening process and training our new store employees. We generally hire employees for our new stores several months in advance and provide them with extensive training at existing stores prior to the store opening. A new store is typically staffed by a combination of new employees and experienced employees from other Fairway locations being promoted into new store jobs.

 

Although we have a prototypical layout we prefer, our first priority is the quality of the location, and we will creatively work to fit our departments into any potential layout. Our urban food store operating model for new stores is based primarily on a store size of approximately 40,000 gross square feet (approximately 25,000 selling square feet), a net cash investment, including store opening costs, of approximately $16 to $18 million, not all of which requires an immediate cash outlay, targeted net sales after two years of approximately $ 5 0 million to $85 million, a targeted contribution margin at maturity of approximately 1 2 % to 17 %, and a targeted average payback period on our initial investment of approximately two to three years.

 

11

 


 

Table of Contents

 

Our suburban food store operating model for new stores is based primarily on a store size of approximately 60,000 gross square feet (approximately 40,000 selling square feet), a net cash investment, including store opening costs, of approximately $13 to $15 million, not all of which requires an immediate cash outlay, targeted net sales after two years of approximately $4 0 million to $55 million, a targeted contribution margin at maturity of approximately 7 % to 1 0 %, and a targeted average payback period on our initial investment of approximately three to four years.

 

The required cash investment for new stores varies depending on the size of the store, geographic location, degree of work performed by the landlord and complexity of site development issues. As a result, the average cost per square foot may vary significantly from project to project and from year to year.

 

We may elect to opportunistically open stores in desirable locations that differ from our prototypical new store model in square footage and/or net sales but that we believe will provide similar contribution margins and returns on invested capital.

 

New store openings may negatively impact our financial results in the short-term due to the effect of store opening costs and lower sales and contribution margin during the initial period following opening. A new store builds its sales volume and 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 a year or more 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.

 

Marketing and Advertising

 

We believe that the distinct and superior food shopping experience we offer our customers, and our customers’ association of that shopping experience with Fairway, are major drivers of our comparable store sales and enable us to spend less on advertising than our conventional competitors. We employ various advertising and promotional strategies to reinforce the quality, value and appeal of our products and services. We promote these core values using many of the traditional advertising vehicles including radio, television, newspaper, and sponsorship. We also connect and engage with our customers through social media websites, in addition to e-newsletters, and our own website. Our stores spend most of their marketing budgets on in-store merchandising-related activities, including promotional signage and events such as taste fairs, classes, tours, cooking demonstrations and product samplings. We use in-store signage to highlight new products and any differentiated aspects of our products.

 

Sourcing and Distribution

 

We source our products from approximately 1,000 vendors and suppliers. Our in-house merchants source only those products that meet our high specifications for quality, and we maintain strict control over the products that are sold in our stores. We have built longstanding vendor relationships that enable us to achieve attractive pricing on our broad offering of hard-to-find fresh, specialty and natural / organic offerings. Fairway is viewed as an important strategic partner to many of these small businesses.

 

Substantially all of our products are delivered directly to our stores by our suppliers and vendors. Direct-store-distribution eliminates multiple logistical layers, further compressing the supply chain and reducing costs. We use a refrigerated cross-docking facility that supports this flexible supply chain.

 

Our single largest third-party supplier in fiscal 2012 , fiscal 2013 and fiscal 2014 was White Rose, Inc. , accounting for approximately 1 3 %, 1 5 % and 1 6 % of our total purchases, respectively. Under our agreement with White Rose, we are obligated to purchase substantially all our requirements for specified products, principally conventional grocery, dairy, frozen food and ice cream products, which are available from White Rose, for our existing stores. In addition, United Natural Foods, Inc. (“UNFI”), which is our primary supplier of specified natural and organic products, principally dry grocery, frozen food, vitamins/supplements and health, beauty and wellness, accounted for approximately 9 % of our total purchases in each of fiscal 201 2 , 201 3 and 201 4 . The use of White Rose and UNFI gives us purchasing power   through the volume discounts they receive from manufacturers. See “Item 1A—Risk Factors—Risks Relating to Our Business—Disruption of significant supplier relationships could negatively affect our business.”

 

Employees

 

As of May  23 , 201 4 , we had approximately 4,200 employees, of which approximately 900 are full-time employees and 3,300 are part-time employees. Under our collective bargaining agreements, employees working 35 hours or less Monday through Friday are considered part-time employees, even if such employees also work during the weekend.

 

Approximately 18 .3 %   of our employees were not subject to a collective bargaining agreement as of May  23 , 201 4 . With respect to our unionized employees, we ha ve four collective bargaining agreements in effect covering 84 .4 %, 9.4 %, 5 .4 % and 0.8 % of

12

 


 

Table of Contents

 

our unionized employees and scheduled to expire March 29, 201 5 , April 2 6 , 201 5 , March 29, 201 5 and February 28, 2015 , respectively. We consider our employee relations to be good. We have never experienced a strike or significant work stoppage.

 

Information Technology

 

Our management information systems provide a full range of business process assistance and timely information to support our merchandising strategy, warehouse management, stores and operating and financial teams. We currently use a combination of off-the-shelf and custom software running on clusters of commodity computers.

 

We believe our current systems provide us with competitive advantages, operational efficiencies, scalability, management control and timely reporting that allow us to identify and respond to merchandising, pricing, cost and operating trends in our business. We use a combination of internal and external resources and systems to support store point-of-sale, merchandise planning and buying, inventory management, financial reporting, customer contact and administrative functions. We believe that our information systems have the capacity to accommodate our growth plans. We constantly evaluate new hardware alternatives and software techniques to help further reduce our costs and enhance our competitive advantage through innovation.

 

Intellectual Property

 

We maintain registered trademarks such as FAIRWAY®, FAIRWAY “Like No Other Market”®, LIKE NO OTHER MARKET® and FAIRWAY WINES & SPIRITS®. Trademarks are generally renewable on a 10 year cycle. We consider our trademarks to be valuable assets that reinforce our customers’ favorable perception of our stores and an important way to establish and protect our brands in a competitive environment.

 

From time to time, third parties have used names similar to ours, have applied to register trademarks similar to ours and, we believe, have infringed or misappropriated our intellectual property rights. We respond to these actions on a case-by-case basis, including, where appropriate, by sending cease and desist letters and commencing opposition actions and litigation. The outcomes of these actions have included both negotiated out-of-court settlements as well as litigation. We are currently party to an agreement with a midwestern company, Fareway, with respect to the use of the Fairway name and trademarks which prohibits us from using the Fairway name other than on the East Coast and in California and certain parts of Michigan and Ohio, and prohibits that company from using the Fareway name on the East Coast and in California and certain parts of Michigan and Ohio. Our inability to use the Fairway name in these prohibited areas could adversely affect our growth strategy. We are also party to a settlement agreement that prohibits us from opening any new stores under the Fairway name in the New Jersey counties of Bergen, Essex, Hudson and Passaic. We believe this agreement will preclude us from opening one store that we otherwise might have opened in this territory. See “Item 1A—Risk Factors—Risks Relating to Our Business—We may be unable to protect or maintain our intellectual property, which could result in customer confusion, a negative perception of our brand and adversely affect our business.”  

 

Competition

 

The food retail industry as a whole, particularly in the Greater New York City metropolitan area, is highly competitive. We compete with various types of retailers, including alternative food retailers, such as natural foods stores, smaller specialty stores and farmers’ markets, conventional supermarkets, supercenters and membership warehouse clubs. Our principal competitors include alternative food retailers such as Whole Foods and Trader Joe’s, traditional supermarkets such as Stop & Shop, ShopRite, Food Emporium and A&P, retailers with “big box” formats such as Target and Wal-Mart and warehouse clubs such as Costco and BJ’s Wholesale Club. These businesses compete with us for customers, products and locations. In addition, some are expanding aggressively in marketing a range of natural and organic foods, prepared foods and quality specialty grocery items. Some of these potential competitors have more experience operating multiple store locations or have greater financial or marketing resources than we do and are able to devote greater resources to sourcing, promoting and selling their products. As competition in certain areas intensifies, our operating results may be negatively impacted through a loss of sales, reduction in margin from competitive price changes, and/or greater operating costs such as marketing. We also face limited competition from restaurants and fast-food chains. In addition, other established food retailers could enter our markets, increasing competition for market share.

 

Regulation

 

We are subject to federal, state and local laws and regulations relating to zoning, land use, environmental protection, workplace safety, food safety, public health, community right-to-know and alcoholic beverage and tobacco sales. In particular, the states in which we operate and several local jurisdictions regulate the licensing of supermarkets and the sale of alcoholic beverages. Under current law we are only able to have one Fairway Wines & Spirits location in New York State, two locations in New Jersey and three locations in Connecticut, and accordingly will not be able to open another Fairway Wines & Spirits location in New York State and will only be able to open one additional Fairway Wines & Spirits location in New Jersey and two additional Fairway Wines &

13

 


 

Table of Contents

 

Spirits locations in Connecticut. In addition, certain local regulations may limit our ability to sell alcoholic beverages at certain times. We are also subject to laws governing our relationship with employees, including minimum wage requirements, overtime, working conditions, immigration, disabled access and work permit requirements. Our stores are subject to regular but unscheduled inspections. Certain of our parking lots and warehouses and our bakery either have only temporary certificates of occupancy or are awaiting a certificate of occupancy. Additionally, a number of federal, state and local laws impose requirements or restrictions on business owners with respect to access by disabled persons. We believe that we are in material compliance with such laws and regulations. See “Item 1A—Risk Factors—Risks Relating to Our Business—Various aspects of our business are subject to federal, state and local laws and regulations. Our compliance with these regulations may require additional capital expenditures and could materially adversely affect our ability to conduct our business as planned.”

 

Corporate Information

 

Fairway Group Holdings Corp. was incorporated as a Delaware corporation on September 29, 2006. Our corporate headquarters is located at 2284 12 th Avenue, New York, New York 10027. Our telephone number is (646) 616-8000. Our website address is http://www.fairwaymarket.com. The information on, or that can be accessed through, our website is not part of this report. This report includes our trademarks and service marks, FAIRWAY®, FAIRWAY “Like No Other Market”®, LIKE NO OTHER MARKET® and FAIRWAY WINES & SPIRITS®, which are protected under applicable intellectual property laws and are the property of Fairway. This report also contains trademarks, service marks, trade names and copyrights of other companies, which are the property of their respective owners. Solely for convenience, trademarks and trade names referred to in this report may appear without the ® or TM symbols. We do not intend our use or display of other parties’ trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.

 

Executive Officers of the Registrant

 

The disclosure regarding executive officers is set forth in our Proxy Statement under the caption “Directors and Executive Officers” and is incorporated herein by reference.

 

Available Information

 

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a), 14 and 15(d) of the Securities Exchange Act of 1934, as amended. The public may obtain these filings at the SEC’s Public   Reference Room at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy and information statements and other information regarding Fairway and other companies that file materials with the SEC electronically. Copies of our reports on Form 10-K, Forms 10-Q and Forms 8-K, may be obtained, free of charge, electronically through our website, http://investors.fairwaymarket.com/sec.cfm.

14

 


 

Table of Contents

 

ITEM 1A—RISK FACTORS

 

Certain factors may have a material adverse effect on our business, financial condition and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment.

 

Risks Relating to Our Business

 

Our continued growth depends on new store openings and on increasing same store sales, and our failure to achieve these goals could negatively impact our results of operations and financial condition.

 

Our growth strategy depends, in large part, on opening new stores in existing and new areas and operating those stores successfully. Successful implementation of this strategy is dependent on finding suitable locations and negotiating acceptable lease terms for store sites, and we face competition from other retailers for such sites , and having available capital to finance the build-out, opening and initial operations of such stores . There can be no assurance that we will continue to grow through new store openings. We may not be able to open new stores timely or within budget or operate them successfully, and there can be no assurance that store opening costs for, net sales of, contribution margin of and average payback period on initial investment for new stores will conform to our operating model for new urban and suburban stores discussed elsewhere in this report. New stores, particularly those we open outside the Greater New York City metropolitan area, may not achieve sustained sales and operating levels consistent with our mature store base on a timely basis or at all. Lower contribution margins from new stores, along with the impact of related store opening and store management relocation costs, may have an adverse effect on our financial condition and operating results. In addition, if we acquire stores in the future, we may not be able to successfully integrate those stores into our existing store base and those stores may not be as profitable as our existing stores.

 

Also, we may not be able to successfully hire, train and retain new store employees or integrate those employees into the programs, policies and culture of Fairway. We, or our third party vendors, may not be able to adapt our distribution, management information and other operating systems to adequately supply products to new stores at competitive prices so that we can operate the stores in a successful and profitable manner. We may not have the level of cash flow or financing necessary to support our growth strategy.

 

Additionally, our opening of new stores will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our existing business less effectively, which in turn could cause a deterioration in the financial performance of our existing stores. If we experience a decline in performance, we may slow or discontinue store openings, or we may decide to close stores that we are unable to operate in a profitable manner.

 

Additionally, some of our new stores may be located in areas where we have little experience or a lack of brand recognition. Those markets may have different competitive conditions, market conditions, consumer tastes and discretionary spending patterns than our existing markets, which may cause these new stores to be less successful than stores in our existing markets.  

 

Our operating results may be materially impacted by fluctuations in our same store sales, which have fluctuated in the past and will likely fluctuate in the future. A variety of factors affect our same-store sales, including:

 

our openings of new stores that cannibalize store sales in existing stores;

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

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;

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

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;

the number of stores we open in any period ; and

15

 


 

Table of Contents

 

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 .

 

Adverse changes in these factors may cause our same-store sales results to be materially lower than in recent periods, which would harm our business and could result in a decline in the price of our Class A common stock. Further, 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 new, closer locations.

 

Our operating results and stock price will be adversely affected if we fail to implement our growth strategy or if we invest resources in a growth strategy that ultimately proves unsuccessful.

 

Our newly opened stores may negatively impact our financial results in the short-term and may not achieve sales and operating levels consistent with our mature store base on a timely basis or at all.

 

We have actively pursued new store growth and plan to continue doing so in the future. We cannot assure you that our new store openings will be successful or result in greater sales and profitability. New store openings generally negatively impact our financial results in the short-term due to the effect of store opening costs and lower sales and contribution margin during the initial period following opening. New stores build their sales volume and their customer base over time and, as a result, generally have lower margins and higher operating expenses, as a percentage of net 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. Further, 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 new, closer locations.

 

All of our existing stores are located in the Greater New York City metropolitan area and, as a result, new store openings can cannibalize sales in our stores in close proximity to the new store and our financial results can be effected by economic and competitive conditions in this area .

 

All of our existing stores are located in a concentrated market area in the Greater New York City metropolitan area, and we intend to grow our store base in this area in the near term at a rate of t wo to four stores annually. 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, our new stores will adversely impact sales at our existing stores in close proximity.  

 

In addition, since substantially all of our revenues are derived from stores in the Greater New York City metropolitan area, any material change in economic and competitive conditions in this area or in legislation or regulation in the States of New York, New Jersey or Connecticut and in the local jurisdictions in which we operate within those states could adversely affect our business or financial performance.

 

Part of our growth strategy is to expand our stores into new markets outside the Greater New York City metropolitan area. We do not have experience opening and operating stores in other areas and there can be no assurance we can successfully open Fairway stores in other markets or that Fairway stores will be successful in other markets.

 

We operate in a highly competitive industry .

 

The food retail industry as a whole, particularly in the Greater New York City metropolitan area, is highly competitive. Because we offer a full assortment of fresh, natural and organic products, prepared foods and hard-to-find specialty and gourmet offerings, along with a full assortment of conventional groceries, we compete with various types of retailers, including alternative food retailers, such as natural foods stores, smaller specialty stores and farmers’ markets, conventional supermarkets, supercenters and membership warehouse clubs. Our principal competitors include alternative food retailers such as Whole Foods and Trader Joe’s, traditional supermarkets such as Stop & Shop, ShopRite, Food Emporium and A&P, retailers with “big box” formats such as Target and Wal-Mart and warehouse clubs such as Costco and BJ’s Wholesale Club. These businesses compete with us for customers, products and locations. In addition, some are expanding aggressively in marketing a range of natural and organic foods, prepared foods and quality specialty grocery items. Some of these potential competitors have more experience operating multiple store locations or have greater financial or marketing resources than we do and are able to devote greater resources to sourcing, promoting and selling their products. Due to the competitive environment in which we operate, our operating results may be negatively impacted through a loss of sales, reduction in margin from competitive price changes and/or greater operating costs such as marketing. We also

16

 


 

Table of Contents

 

face limited competition from restaurants and fast-food chains. In addition, other established food retailers could enter our markets, increasing competition for market share.

 

We rely on a combination of product offerings, customer service, store format, location and pricing to compete.

 

We compete with other food retailers on a combination of factors, primarily product selection and quality, customer service, store format, location and price. Our success depends on our ability to offer products that appeal to our customers’ preferences. Failure to offer such products, or to accurately forecast changing customer preferences, could lead to a decrease in the number of customer transactions at our stores and in the amount customers spend at our stores. We also attempt to create a convenient and appealing shopping experience for our customers in terms of customer service, store format and location.

 

Pricing in particular is a significant driver of consumer choice in our industry and we expect competitors to continue to apply pricing and other competitive pressures. To the extent that our competitors lower prices, our ability to maintain gross profit margins and sales levels may be negatively impacted. Some of our competitors have greater resources than we do and do not have unionized work forces, which may result in lower labor and benefit costs. These competitors could use these advantages to take measures, including reducing prices, which could adversely affect our competitive position, financial condition and results of operations.

 

If we do not succeed in offering attractively priced products that consumers want to buy or are unable to provide a convenient and appealing shopping experience, our sales, operating margins and market share may decrease, resulting in reduced profitability.

 

Economic conditions that impact consumer spending could materially affect our business.

 

Ongoing economic uncertainty continues to negatively affect consumer confidence and discretionary spending. Our operating results may be materially affected by changes in economic conditions nationwide or in the regions in which we operate that impact consumer confidence and spending, including discretionary spending. This   risk may be exacerbated if customers choose lower-cost alternatives to our product offerings in response to economic conditions. In particular, a decrease in discretionary spending could adversely impact sales of certain of our higher margin product offerings. Future economic conditions affecting disposable consumer income, such as employment levels, business conditions, changes in housing market conditions, the availability of consumer credit, interest rates, tax rates and fuel and energy costs, could reduce overall consumer spending or cause consumers to shift their spending to lower-priced competitors. In addition, inflation or deflation can impact our business. Food deflation could reduce sales growth and earnings, while food inflation, combined with reduced consumer spending, could reduce gross profit margins. As a result, our results of operations could be materially adversely affected.

 

The geographic concentration of our stores creates an exposure to the Greater New York City metropolitan area economy and any downturn in this region could materially adversely affect our financial condition and results of operations.

 

We reported net losses in fiscal 201 2 , fiscal 201 3 and fiscal 201 4 , and we expect to incur net losses through at least fiscal 201 8 .

 

We reported a net loss of $11.9 million in fiscal 2012 ,   $62.9 million in fiscal 2013 and $ 80.3 million in fiscal 2014 , and we expect to incur net losses through at least fiscal 201 8 . Our net losses are primarily attributable to the costs associated with new store openings, increased production and corporate overhead and associated costs of capital, as well as in fiscal 2012 re-financing and pre-IPO related costs , in fiscal 2013 re-financing and pre-IPO related costs and a partial valuation allowance against our deferred tax asset and in fiscal 2014 expenses related to our IPO , compensation related charges due to equity incentive grants , the commencement of an organizational realignment to remove redundant costs and streamline parts of our business model to enhance overall productivity and a full valuation allowance against the remainder of our deferred tax asset . 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, 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. Our growth strategy depends, in large part, on opening new stores in existing and new areas and, as a result, our results of operations will continue to be materially affected by the timing and number of new store openings and the amount of new store opening costs. Other factors that have affected and may in the future affect our results of operations include general economic conditions and changes in consumer behavior that can affect our sales, inflation and deflation trends, the extent of our infrastructure investments in the applicable period, the effectiveness of our price optimization and productivity initiatives, competitive developments and the extent of our debt service obligations. While we believe that we will generate future taxable income sufficient to utilize all prior years’ net operating losses, we cannot assure you that we will not continue to incur net losses or if and when we will report net income. See Note 13 to our financial statements included elsewhere in this report for information about our net operating losses.

17

 


 

Table of Contents

 

 

We will incur compensation related charges against our earnings due to equity incentive grants to our employees under our 2013 Long-Term Incentive Plan and our   organizational realignment that we began in the fourth quarter of fiscal 2014 .

 

During fiscal 2014 , we granted to our directors and employees an aggregate of 2, 620,163 restricted stock units in respect of Class A common stock, or RSUs, and options to purchase 1, 424,691 shares of Class A common stock. These RSUs will vest on April 22, 2016 (or earlier in certain circumstances) in the case of our non-employee directors, and in the case of members of our senior management team, contingent upon the executive’s continued employment, generally half on the third anniversary of the date of grant and the remainder on the fourth anniversary of the date of grant (or earlier in certain circumstances) . The RSUs issued to employees who are not members of our senior management team will vest, contingent upon the employee’s continued employment, generally in three equal annual installments commencing on the first anniversary of the date of grant (or earlier in certain circumstances) . The options will vest in four equal annual installments commencing on the first anniversary of the date of grant (or earlier in certain circumstances) . We recorded compensation expense for these grants of $ 10.8 million in fiscal 2014, and we estimate that we will record compensation expense associated with these grants, resulting in a reduction in net earnings, of approximately $10.6 million for fiscal 2015 ,   approximately $10.8 million for fiscal 2016, approximately $3. 6 million for fiscal 2017 and approximately $0. 6 million for fiscal 2018, in each case net of tax, based on the stock price on the date of grant as it relates to RSUs and based on the fair value at the date of grant as it relates to options . We will from time to time in the future make additional restricted stock unit awards, option grants and restricted stock awards under our 2013 Long-Term Incentive Plan, which will result in additional compensation expense in future periods. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations for more information.

 

In connection with our organizational realignment to remove redundant costs and streamline part of our business model to enhance overall productivity, during the fourth quarter of fiscal 2014 we incurred charges, primarily   severance costs , of $ 3. 3 million and expect to incur additional charges, primarily severance costs , of approximately $ 3.5 million in fiscal 2015.

 

We may be unable to improve our operating margins, which could adversely affect our financial condition and ability to grow.

 

We intend to improve our operating margins in an environment of increased competition through various initiatives, including increased sales of perishables and prepared foods , continued cost discipline focused on improving labor productivity and reducing shrink, and our centralized production facility to serve our current and future stores in the Greater New York City metropolitan area. Some of our competitors do not have unionized work forces, which may result in lower labor and benefit costs. If competitive pressures cause us to lower our prices, our operating margins may decrease. If the percentage of our net sales represented by perishables decreases, our operating margins may be adversely affected. Any failure to achieve gains in labor productivity, particularly the reduction of overtime, or to reduce inventory shrink may adversely impact our operating margins. In addition, changes in federal and state minimum wage and overtime laws could cause us to incur additional wage costs, which could adversely affect our operating margin. There can be no assurance that our centralized production facility will result in labor efficiencies or improve product quality and consistency. If we encounter operational problems at our centralized production facility, the delivery of products to, and sales at, our stores, could be adversely affected. If our operating margins stagnate or decline, our financial condition and ability to generate cash to fund our growth could be adversely affected.

 

Perishable products make up a significant portion of our sales, and ordering errors or product supply disruptions may have an adverse effect on our profitability and operating results.

 

We have a significant focus on perishable products. Sales of perishable products accounted for approximately 65% of our net sales in fiscal 201 4 . We rely on various suppliers and vendors to provide and deliver our product inventory on a continuous basis. We could suffer significant perishable product inventory losses in the event of the loss of a major supplier or vendor, disruption of our supply chain, extended power outages, natural disasters or other catastrophic occurrences. While we have implemented certain systems to ensure our ordering is in line with demand, we cannot assure you that our ordering systems will always work efficiently, in particular in connection with the opening of new stores, which have no, or a limited, ordering history. If we were to over-order, we could suffer inventory losses, which would negatively impact our operating results.

 

Disruption of significant supplier relationships could negatively affect our business.

 

Our single largest third-party supplier in fiscal 2012 , fiscal 2013 and fiscal 201 4 was White Rose, Inc. , accounting for approximately 1 3 %, 1 5 % and 1 6 % of our total purchases, respectively. Under our agreement with White Rose, we are obligated to purchase substantially all our requirements for specified products, principally conventional grocery, dairy, frozen food and ice cream products, which are available from White Rose, for our existing stores. In addition, United Natural Foods, Inc. (“UNFI”), which is our primary supplier of specified natural and organic products, principally dry grocery, frozen food, vitamins/supplements and health,

18

 


 

Table of Contents

 

beauty and wellness, accounted for approximately 9 % of our total purchases in each of fiscal 201 2 , fiscal 201 3 and fiscal 201 4 . Due to this concentration of purchases from White Rose and UNFI, the cancellation of our supply arrangement with either White Rose or UNFI or the disruption, delay or inability of White Rose or UNFI to deliver product to our stores may materially and adversely affect our operating results while we establish alternative distribution channels. We also depend on third-party suppliers for our private label products, and the cancellation of our supply arrangement with any of these suppliers or the disruption, delay or inability of these suppliers to provide our private label products, particularly private label organic products, could adversely affect our private label sales. If our suppliers fail to comply with food safety or other laws and regulations, or face allegations of non-compliance, their operations may be disrupted. We cannot assure you that we would be able to find replacement suppliers on commercially reasonable terms.  

 

Our success depends upon our ability to source and market new products that meet our high standards and customer preferences and our ability to offer our customers an aesthetically pleasing shopping environment.

 

Our success depends on our ability to source and market new products that meet our standards for quality and appeal to our customers’ preferences. Failure to source and market such products, or to accurately forecast changing customer preferences, could lead to a decrease in the number of customer transactions at our stores and in the amount customers spend at our stores. In addition, the sourcing of our products is dependent, in part, on our relationships with our vendors. We rely on a large number of small vendors in order to offer a broad array of products, and as we expand it may become more difficult to manage and maintain these relationships. If we are unable to maintain these relationships we may not be able to continue to source products at competitive prices that both meet our standards and appeal to our customers. We also attempt to create a pleasant and appealing shopping experience. If we are not successful in creating a pleasant and appealing shopping experience, we may lose customers to our competitors. If we do not succeed in maintaining good relationships with our vendors, introducing and sourcing new products that consumers want to buy or are unable to provide a pleasant and appealing shopping environment or maintain our level of customer service, our sales, operating margins and market share may decrease, resulting in reduced profitability.

 

We may experience negative effects to our brand and reputation from real or perceived quality or health issues with our food products, which could lead to product liability claims or have an adverse effect on our operating results.

 

We believe that our reputation for providing our customers with fresh, high-quality food products is an important component of our customer value proposition and that maintaining our brand is critical to our success. Brand value is based in large part on perceptions of subjective qualities, and even isolated incidents can erode trust and confidence, particularly if they result in adverse publicity, especially in social media outlets, governmental investigations or litigation, which can have an adverse impact on these perceptions and lead to adverse effects on our business. Concerns regarding the safety or quality of our food products or of our food supply chain could cause consumers to avoid purchasing certain products from us, or to seek alternative sources of food, even if the basis for the concern is unfounded, has been addressed or is outside of our control. Food products containing contaminants or allergens could be inadvertently manufactured, prepared or distributed by us and, if processing at the consumer level does not eliminate them, these contaminants could result in illness or death. Adverse publicity about these concerns, whether or not ultimately based on fact, and whether or not involving products sold at our stores, could discourage consumers from buying our products, which could have an adverse effect on our brand, reputation and operating results. In addition, our stores are subject to unscheduled inspections on a regular basis, which, if violations are found, could result in the assessment of fines, suspension of one or more needed licenses and, in the case of repeated “critical” violations, closure of the store until a re-inspection demonstrates that we have remediated the problem.

 

Furthermore, the sale of food products entails an inherent risk of product liability claims, product recall and the resulting negative publicity. Any such claims, recalls or adverse publicity with respect to our private-label products may have an even greater negative effect on our sales and operating results, in addition to generating adverse publicity for our brand. Moreover, product liability claims of this sort may not be covered by insurance or any rights to indemnity or contribution we have against others.

 

Any lost confidence in us on the part of our customers would be difficult and costly to re-establish. Any such adverse effect could significantly reduce our brand value. Issues regarding the safety of any food items sold by us, regardless of the cause, could have a substantial and adverse effect on our sales and operating results.  

 

We may be unable to protect or maintain our intellectual property, which could result in customer confusion, a negative perception of our brand and adversely affect our business.

 

We believe that our intellectual property has substantial value and has contributed significantly to the success of our business. In particular, our trademarks and servicemarks, including our FAIRWAY ® , FAIRWAY “Like No Other Market” ® , LIKE NO OTHER MARKET ® and FAIRWAY WINES & SPIRITS ® trademarks, are valuable assets that reinforce our customers’ favorable perception of our stores.

19

 


 

Table of Contents

 

 

From time to time, third parties have used names similar to ours, have applied to register trademarks similar to ours and, we believe, have infringed or misappropriated our intellectual property rights. We respond to these actions on a case-by-case basis, including, where appropriate, by sending cease and desist letters and commencing opposition actions and litigation. The outcomes of these actions have included both negotiated out-of-court settlements as well as litigation. We are currently party to a settlement with a midwestern grocery company, “Fareway,” with respect to the use of the Fairway name and trademarks which prohibits us from using the Fairway name other than on the East Coast and in California and certain parts of Michigan and Ohio, and prohibits that company from using the Fareway name on the East Coast and in California and certain parts of Michigan and Ohio. Our inability to use the Fairway name in these prohibited areas could adversely affect our growth strategy. We are also party to a settlement agreement that prohibits us from opening any new stores under the Fairway name in certain parts of the New Jersey counties of Bergen, Essex, Hudson and Passaic. We believe this agreement will preclude us from opening one store that we otherwise might have opened in this territory.

 

We cannot assure you that the steps we have taken to protect our intellectual property rights are adequate, that our intellectual property rights can be successfully defended and asserted in the future or that third parties will not infringe upon or misappropriate any such rights. In addition, our trademark rights and related registrations may be challenged in the future and could be canceled or narrowed. Failure to protect our trademark rights could prevent us in the future from challenging third parties who use names and logos similar to our trademarks, which may in turn cause consumer confusion or negatively affect consumers’ perception of our brand and products, which could, in turn, adversely affect our sales and profitability. Moreover, intellectual property disputes and proceedings and infringement claims may result in a significant distraction for management and significant expense, which may not be recoverable regardless of whether we are successful. Such proceedings may be protracted with no certainty of success, and an adverse outcome could subject us to liabilities, force us to cease use of certain trademarks or other intellectual property or force us to enter into licenses with others. Any one of these occurrences may have a material adverse effect on our business, results of operations and financial condition.

 

We rely on information technology and administrative systems and any inadequacy, failure, interruption or security breach of those systems may harm our ability to effectively operate our business.

 

We rely extensively on our information technology and administrative systems to effectively manage our business data, communications, supply chain, order entry and fulfillment and other business processes. The failure of our information technology or administrative systems to perform as we anticipate could disrupt our business and result in transaction errors, processing inefficiencies and the loss of sales and customers, causing our business to   suffer. In addition, our information technology and administrative systems may be vulnerable to damage or interruption from circumstances beyond our control, including fire, natural disasters, systems failures, cyber-attacks, viruses and security breaches, including breaches of our transaction processing or other systems that could result in the compromise of confidential customer data. Any such damage or interruption could have a material adverse effect on our business, cause us to face significant fines, customer notice obligations or costly litigation, harm our reputation with our customers, require us to expend significant time and expense developing, maintaining or upgrading our information technology or administrative systems, or prevent us from paying our suppliers or employees, receiving payments from our customers or performing other information technology or administrative services on a timely basis. Any material interruption in our information systems may have a material adverse effect on our operating results.

 

If we experience a data security breach and confidential customer information is disclosed, we may be subject to penalties and experience negative publicity, which could affect our customer relationships and have a material adverse effect on our business.

 

We and our customers could suffer harm if customer information were accessed by third parties due to a security failure in our systems. The collection of data and processing of transactions require us to receive, transmit and store a large amount of personally identifiable and transaction related data. This type of data is subject to legislation and regulation in various jurisdictions. Recently, data security breaches suffered by well-known companies and institutions have attracted a substantial amount of media attention, prompting state and federal legislative proposals addressing data privacy and security. If some of the current proposals are adopted, we may be subject to more extensive requirements to protect the customer information that we process in connection with the purchases of our products. We may become exposed to potential liabilities with respect to the data that we collect, manage and process, and may incur legal costs if our information security policies and procedures are not effective or if we are required to defend our methods of collection, processing and storage of personal data. Future investigations, lawsuits or adverse publicity relating to our methods of handling personal data could adversely affect our business, results of operations, financial condition and cash flows due to the costs and negative market reaction relating to such developments. Additionally, if we suffer data breaches one or more of the credit card processing companies that we rely on may refuse to allow us to continue to participate in their network, which would limit our ability to accept credit cards at our stores and could adversely affect our business, results of operations, financial condition and cash flows.

20

 


 

Table of Contents

 

 

Data theft, information espionage or other criminal activity directed at the retail industry or computer or communications systems may materially adversely affect our business by causing us to implement costly security measures in recognition of actual or potential threats, by requiring us to expend significant time and expense developing, maintaining or upgrading our information technology systems and by causing us to incur significant costs to reimburse third parties for damages. Such activities may also materially adversely affect our financial condition, results of operations and cash flows by reducing consumer confidence in the marketplace and by modifying consumer spending habits. Over the past 12 months several retailers have been subject to data theft, which has adversely affected their business.

 

We lease certain of our stores and related properties from a related party.

 

Howard Glickberg, one of our directors and executive officers, owns a one-third interest in entities which lease to us the premises at which a portion of our Broadway store is located, the premises at which our Harlem store, Harlem bakery and Harlem warehouse are located and the premises at which the parking lot for our Harlem store is located. The remainder of these entities is owned by Mr. Glickberg’s former business partners (the “Former Partners”). Mr. Glickberg also owns a 16.67% interest in the landlord for the premises where our Red Hook store is located. During fiscal 201 2 , fiscal 201 3 and fiscal 201 4 , rental payments (excluding maintenance and taxes that we are obligated to pay) under the leases for the Harlem properties and portion of the Broadway store aggregated $2,5 69 , 403 , $ 4 , 433 , 500 and $4,4 55 , 087 , respectively, of which, based on his ownership and before giving effect to any expenses, Mr. Glickberg is entitled to $ 856 , 468 ,  $ 1,477,833 and $1,4 85 , 029 , respectively. During fiscal 201 2 , fiscal 201 3 and fiscal 201 4 , rental payments (excluding maintenance and taxes that we are obligated to pay) under the lease for the Red Hook store aggregated $1,421,151, $1, 386,180 and $1, 421 , 151 , respectively, of which, based on his ownership and before giving effect to any expenses, Mr. Glickberg is entitled to $236,859, $ 231,030 and $23 6 , 859 , respectively. The leases for each of these properties provides for a periodic reset of base rent to fair market rent based upon the highest and best retail use of the premises (without reference to the lease). The leases provide that if we and these entities cannot agree on the fair market rent, the fair market rent will be determined by arbitration. We and the landlord for the Red Hook store are currently in discussions regarding the reset of the base rent to fair market rent. We cannot predict the outcome of these discussions or any arbitration; however, if the arbitrator chooses the amount proposed by our landlord, it could have an adverse effect on our results of operations and gross margin. In addition, our Red Hook store is required to obtain its electricity, heated/chilled water, hot and cold potable water and sewer services from an entity owned by the owners of the premises where our Red Hook store is located. We believe that the owner of the co-generation plant has overcharged us for utilities since our initial occupancy of the premises in December 2005. Since November 2008, with the exception of the post-Hurricane Sandy period through fiscal 2014, when we received utilities from the local utility provider because the co-generation plant was not operational,   we have not fully paid the utility invoices, but instead remitted lesser amounts based on the methodology that we believe represents the parties’ original intentions with respect to the utility charge calculations. There can be no assurance that we will not be required to pay the amounts we withheld.

 

Failure to retain our senior management and other key personnel may adversely affect our operations.

 

Our success is substantially dependent on the continued service of our senior management and other key personnel. These executives have been primarily responsible for determining the strategic direction of our business and for executing our growth strategy and are integral to our brand and culture, and the reputation we enjoy with suppliers and consumers. The loss of the services of any of these executives and other key personnel could have a material adverse effect on our business and prospects, as we may not be able to find suitable individuals to replace them on a timely basis, if at all. In addition, any such departure could be viewed in a negative light by investors and analysts, which may cause our stock price to decline. The loss of key employees could negatively affect our business.

 

If we are unable to attract, train and retain employees, we may not be able to grow or successfully operate our business.

 

The food retail industry is labor intensive, and our success depends in part upon our ability to attract, train and retain a sufficient number of employees who understand and appreciate our culture and are able to represent our brand effectively and establish credibility with our business partners and consumers. Our ability to meet our labor needs, while controlling wage and labor-related costs, is subject to numerous external factors, including the availability of a sufficient number of qualified persons in the work force in the markets in which we are located, unemployment levels within those markets, unionization of the available work force, prevailing wage rates, changing demographics, health and other insurance costs and changes in employment legislation. In the event of increasing wage rates, if we fail to increase our wages competitively, the quality of our workforce could decline, causing our customer service to suffer, while increasing our wages could cause our earnings to decrease. If we are unable to hire and retain employees capable of meeting our business needs and expectations, our business and brand   image may be impaired. Any failure to meet our staffing needs or any material increase in turnover rates of our employees may adversely affect our business, results of operations and financial condition.

 

21

 


 

Table of Contents

 

Changes in and enforcement of immigration laws could increase our costs and adversely affect our ability to attract and retain qualified store-level employees.

 

Federal and state governments from time to time implement laws, regulations or programs that regulate our ability to attract or retain qualified employees. Some of these changes may increase our obligations for compliance and oversight, which could subject us to additional costs and make our hiring process more cumbersome, or reduce the availability of potential employees. Although we have implemented, and are in the process of enhancing, procedures to ensure our compliance with the employment eligibility verification requirements, there can be no assurance that these procedures are adequate and some of our employees may, without our knowledge, be unauthorized workers. The employment of unauthorized workers may subject us to fines or civil or criminal penalties, and if any of our workers are found to be unauthorized we could experience adverse publicity that negatively impacts our brand and makes it more difficult to hire and keep qualified employees. We have from time to time been required to terminate the employment of certain of our employees who were determined to be unauthorized workers. For example, following an audit by the Department of Homeland Security of the work authorization documents of our employees in our Pelham Manor, NY store that began in February 2011, we were notified in May 2012 that approximately 55 employees may not have had valid employment authorization documents, and we then terminated the approximately 35 employees still working for us who could not then provide valid documentation, resulting in a temporary increase in labor costs and disruption of our operations as we hired and trained new employees. We may be subject to fines or other penalties as a result of this audit. There can be no assurance that any future audit will not require us to terminate employees and pay fines or other penalties. The termination of a significant number of employees may disrupt our operations, cause temporary increases in our labor costs as we train new employees and result in additional adverse publicity. Our financial performance could be materially harmed as a result of any of these factors.

 

Prolonged labor disputes with unionized employees and increases in labor costs could adversely affect our business.

 

Our largest operating costs are attributable to labor costs and, therefore, our financial performance is greatly influenced by increases in wage and benefit costs, including pension and health care costs. As a result, we are exposed to risks associated with a competitive labor market and, more specifically, to any disruption of our unionized work force. As of May  23 , 201 4 , approximately 81 .7 % of our employees were represented by unions and covered by collective bargaining agreements that are subject to periodic renegotiation. One of our current collective bargaining agreements expire s in February  201 5 ,   two expire in March  201 5 and one expires in   April  2015.

 

In the renegotiation of our current contracts and the negotiation of our new contracts, rising health care and pension costs and the nature and structure of work rules w ere and w ill be important issues. The terms of any renegotiated collective bargaining agreements could create either a financial advantage or disadvantage for us as compared to our major competitors and could have a material adverse effect on our results of operations and financial condition. Our labor negotiations may not conclude successfully or may result in a significant increase in labor costs, and work stoppages or labor disturbances could occur. A prolonged work stoppage could have a material adverse effect on our financial condition, results of operations and cash flows. We also expect that in the event of a work stoppage or labor disturbance, we could incur additional costs and face increased competition.

 

There have recently been a number of proposals both at the Federal level and in the s tates we operate to increase the minimum wage and increase the number of employees eligible for overtime wages. Any such increase in wages and overtime costs may adversely affect our business, results of operations and financial condition.

 

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 us and certain of our current and former officers and employees.  This suit alleges, among other things, that certain of our past and current employees were not properly compensated in accordance with the overtime provisions of the Fair Labor Standards Act.  While we believe that these claims are without merit and intend to defend the matter vigorously, we cannot predict the outcome of this litigation.

 

The cost of providing employee benefits continues to increase and is subject to factors outside of our control.

 

We provide health benefits to substantially all of our full-time employees and, under our collective bargaining agreements, contribute to the cost of health benefits provided by the unions. Even though employees generally pay a portion of the cost, our cost of providing these benefits has increased steadily over the last several years. We anticipate future increases in the cost of health benefits, partly, but not entirely, as a result of the implementation of federal health care reform legislation. We currently pay most of the healthcare insurance premiums for our unionized employees. At May  23 , 201 4 , we had approximately 3,4 00   unionized employees. We cannot at this time predict the financial impact of the Patient Protection and Affordable Care Act, or PPACA , on our financial condition and results of operations, as it will depend on many factors, including finalization of rules   implementing the law , how many employees elect coverage under the union and Compan y’ s PPACA plan and , if so, the cost of such plans as well as the number of unionized employees we have who work at least 30 hours per week, although the financial impact could be material. If we are unable

22

 


 

Table of Contents

 

to control healthcare costs, we will experience increased operating costs, which may adversely affect our financial condition and results of operations.

 

We participate in one underfunded multiemployer pension plan on behalf of most of our union-affiliated employees, and we are required to make contributions to this plan under our collective bargaining agreement. This multiemployer pension plan is currently underfunded in part due to increases in the costs of benefits provided or paid under the plan as well as lower returns on plan assets. The unfunded liabilities of this plan may require increased future payments by us and other participating employers. As of December 31, 201 3 , this multiemployer plan was deemed by its plan actuary to be “endangered” because the plan is less than 80 % funded. As a result, the plan has adopted a funding improvement plan to increase the plan’s funding percentage. In the future, our required contributions to this multiemployer plan could increase as a result of many factors, including the outcome of collective bargaining with the union, actions taken by trustees who manage the plan, government regulations, the actual return on assets held in the plan and the payment of a withdrawal liability if we choose to exit the plan. Our risk of future increased payments may be greater if other participating employers withdraw from the plan and are not able to pay the total liability assessed as a result of such withdrawal, or if the pension plan adopts surcharges and/or increased pension contributions as part of a rehabilitation plan. Increased pension costs may adversely affect our financial condition and results of operations. See Note 12 to our consolidated financial statements included elsewhere in this report.

 

Various aspects of our business are subject to federal, state and local laws and regulations. Our compliance with these regulations may require additional capital expenditures and could materially adversely affect our ability to conduct our business as planned.

 

We are subject to federal, state and local laws and regulations relating to zoning, land use, environmental protection, workplace safety, food safety, public health, community right-to-know and alcoholic beverage and tobacco sales. In particular, the states in which we operate and several local jurisdictions regulate the licensing of supermarkets and the sale of alcoholic beverages. In addition, certain local regulations may limit our ability to sell alcoholic beverages at certain times. We are also subject to laws governing our relationship with employees, including minimum wage requirements, overtime, working conditions, immigration, disabled access and work permit requirements. Compliance with new laws in these areas, or with new or stricter interpretations of existing requirements, could reduce the revenue and profitability of our stores and could otherwise materially adversely affect our business, financial condition or results of operations. Our new store openings could be delayed or prevented or our existing stores could be impacted by difficulties or failures in our ability to obtain or maintain required approvals or licenses. Our stores are subject to unscheduled inspections on a regular basis, which, if violations are found, could result in the assessment of fines, suspension of one or more needed licenses and, in the case of repeated “critical” violations, closure of the store until a re-inspection demonstrates that we have remediated the problem. Certain of our parking lots and warehouses either have only temporary certificates of occupancy or are awaiting a certificate of occupancy which, if not granted, would require us to stop using such property. Our central bakery does not have a certificate of occupancy and, due to the age and structure of the building, we do not believe we would be able to obtain one without substantial modifications to the building. We are in the process of relocating the central bakery; however, until we do so, if we are not permitted to continue our central bakery operations at our current facility, our results of operations could be adversely affected. The buildings in which our Broadway and Harlem stores are located are old and therefore require greater maintenance expenditures by us in order to maintain them in compliance with applicable building codes. If we are unable to maintain these stores in compliance with applicable building codes, we could be required by the building department to close them. Additionally, a number of federal, state and local laws impose requirements or restrictions on business owners with respect to access by   disabled persons. Our compliance with these laws may result in modifications to our properties, or prevent us from performing certain further renovations. We cannot predict the nature of future laws, regulations, interpretations or applications, or determine what effect either additional government regulations or administrative orders, when and if promulgated, or disparate federal, state and local regulatory schemes would have on our business in the future.

 

The terms of our senior credit facility may restrict our current and future operations, which could adversely affect our ability to respond to changes in our business and to manage our operations.

 

Our senior credit facility includes a number of customary restrictive covenants that could impair our financing and operational flexibility and make it difficult for us to react to market conditions and satisfy our ongoing capital needs and unanticipated cash requirements. Specifically, such covenants may restrict our ability and, if applicable, the ability of our subsidiaries to, among other things:

 

incur additional debt;

make certain investments;

enter into certain types of transactions with affiliates;

limit dividends or other payments by our restricted subsidiaries to us;

use assets as security in other transactions;

23

 


 

Table of Contents

 

pay dividends on our common stock or repurchase our equity interests;

sell certain assets or merge with or into other companies;

guarantee the debts of others;

enter into new lines of business;

make capital expenditures;

prepay, redeem or exchange our other debt; and

form any joint ventures or subsidiary investments.

 

In addition, our senior credit facility requires us to maintain specified financial ratios.

 

Our ability to comply with the covenants and other terms of our senior credit facility will depend on our future operating performance and, in addition, may be affected by events beyond our control, and we cannot assure you that we will meet them. If we fail to comply with such covenants and terms, we would be required to obtain waivers from our lenders or agree with our lenders to an amendment of the facility’s terms to maintain compliance under such facility. If we are unable to obtain any necessary waivers and the debt under our senior credit facility is accelerated, it would have a material adverse effect on our financial condition and future operating performance.

 

Our senior credit facility requires us to use 50% of our annual adjusted excess cash flow (which percentage will decrease upon achievement and maintenance of specified leverage ratios) to prepay our outstanding term loans. This requirement will reduce the funds available to us for new store growth and working capital.

 

Our senior credit facility limits the amount of capital expenditures that we can make in any fiscal year that are not financed with proceeds from the sale of our equity securities. This limitation may adversely affect our ability to open new stores or result in additional dilution if we issue additional equity securities.

 

Our senior credit facility provides that if any person other than Sterling Investment Partners owns, directly or indirectly, beneficially or of record, shares representing more than 35% of the voting power of our outstanding common stock, the lenders can declare all borrowings under the senior credit facility to be immediately due and payable.

 

We have significant debt service obligations and may incur additional indebtedness in the future which could adversely affect our financial health and our ability to react to changes to our business.

 

As of March 30, 2014 , we had total debt of approximately $27 1.6 million (including unamortized original issue discount of approximately $15. 1 million on our senior debt). Our indebtedness, or any additional indebtedness we may incur, could require us to divert funds identified for other purposes for debt service and impair our liquidity position. If we cannot generate sufficient cash flow from operations to service our debt, we may need to refinance our debt, dispose of assets or issue equity to obtain necessary funds. We do not know whether we will be able to take any of such actions on a timely basis, on terms satisfactory to us or at all.

 

Our level of indebtedness has important consequences. For example, our level of indebtedness may:

 

require us to use a substantial portion of our cash flow from operations to pay interest and principal on our debt, which would reduce the funds available to us for working capital, new store growth and other general corporate purposes;

 

limit our ability to pay future dividends;

 

limit our ability to obtain additional financing for working capital, new store growth, capital expenditures and other investments, which may limit our ability to implement our business strategy;

 

heighten our vulnerability to downturns in our business, the food retail industry or the general economy and limit our flexibility in planning for, or reacting to, changes in our business and the food retail industry;

 

expose us to the risk of increased interest rates as our borrowings under our senior credit facility are at variable rates; or

 

prevent us from taking advantage of business opportunities as they arise or successfully carrying out our plans to expand our store base and product offerings.

 

We may incur substantial additional indebtedness in the future, subject to the restrictions contained in our senior credit facility. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify.

24

 


 

Table of Contents

 

 

We cannot assure you that our business will generate sufficient cash flow from operations or that future financing will be available to us in amounts sufficient to enable us to make payments on our indebtedness or to fund our operations.

 

Our plans to open new stores require us to spend capital, which must be allocated among various projects. Failure to use our capital efficiently could have an adverse effect on our profitability.

 

Our growth strategy depends on our opening new stores, which will require us to use cash generated by our operations and a portion of the net proceeds of our IPO, as well as borrowings under our senior credit facility. We cannot assure you that cash generated by our operations, the net proceeds of our IPO and borrowings under our senior credit facility will be sufficient to allow us to implement our growth strategy. If this cash is not allocated efficiently among our various projects, or if any of these initiatives prove to be unsuccessful, we may experience reduced cash flow and we could be required to delay, significantly curtail or eliminate planned store openings, which could have a material adverse effect on our financial condition and future operating performance and the price of our Class   A common stock.

 

Litigation may materially adversely affect our business, financial condition and results of operations.

 

Our operations are characterized by a high volume of customer traffic and by transactions involving a wide variety of product selections. These operations carry a higher exposure to consumer litigation risk when compared to the operations of companies operating in many other industries. Consequently, we may be a party to individual personal injury, product liability and other legal actions in the ordinary course of our business, including litigation arising from food-related illness. The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for   substantial periods of time. The cost to defend future litigation may be significant. There may also be adverse publicity associated with litigation that may decrease consumer confidence in our businesses, regardless of whether the allegations are valid or whether we are ultimately found liable. As a result, litigation may materially adversely affect our businesses, financial condition, results of operations and cash flows.

 

In February and March 2014, t hree purported 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 us and certain of our current and former officers, certain of our directors and the underwriters for our initial public offering. The suits assert claims for allegedly misleading statements in the registration statement for our initial public offering and in subsequent communications regarding our business and financial results. In April 2014, a purported stockholder derivat iv e action was filed against certain of our directors in New York state court asserting claims for breach of fiduciary duties and gross mismanagement arising from substantially similar allegations as in the securities class actions .   While we believe the claims are without merit and intend to defend these lawsuits vigorously, we cannot predict the outcome of these lawsuits. See “Item 3.  Legal Proceedings.”

 

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 us and certain of our current and former officers and employees.  This suit alleges, among other things, that certain of our past and current employees were not properly compensated in accordance with the overtime provisions of the Fair Labor Standards Act.  While we believe that these claims are without merit and intend to defend the matter vigorously, we cannot predict the outcome of this litigation.

 

Monitoring and defending against legal actions, whether or not meritorious, is time-consuming for our management and detracts from our ability to fully focus our internal resources on our business activities and we cannot predict how long it may take to resolve these matters. In addition, legal fees and costs incurred in connection with such activities may be significant and we could, in the future, be subject to judgments or enter into settlements of claims for significant monetary damages. A decision adverse to our interests on these actions or resulting from these matters could result in the payment of substantial damages and could have a material adverse effect on our cash flow, results of operations and financial position.

 

With respect to any litigation, our insurance may not reimburse us or may not be sufficient to reimburse us for the expenses or losses we may suffer in contesting and concluding such lawsuits. Substantial litigation costs or an adverse result in any litigation may adversely impact our business, operating results or financial condition.

 

Increased commodity prices and availability may impact profitability.

 

Many of our products include ingredients such as wheat, corn, oils, milk, sugar, cocoa and other commodities. Commodity prices worldwide have been increasing. While commodity price inputs do not typically represent the substantial majority of our product costs, any increase in commodity prices may cause our vendors to seek price increases from us. Although we typically are able to mitigate vendor efforts to increase our costs, we may be unable to continue to do so, either in whole or in part. In the event we

25

 


 

Table of Contents

 

are unable to continue mitigating potential vendor price increases, we may in turn consider raising our prices, and our customers may be deterred by any such price increases. Our profitability may be impacted through increased costs to us which may impact gross margins, or through reduced revenue as a result of a decline in the number and average size of customer transactions.

 

Severe weather, natural disasters and adverse climate changes may materially adversely affect our financial condition and results of operations.

 

Severe weather conditions and other natural disasters in areas where we have stores or from which we obtain the products we sell may materially adversely affect our retail operations or our product offerings and, therefore, our results of operations. Such conditions may result in physical damage to, or temporary or permanent closure of, one or more of our stores, an insufficient work force in our markets and/or temporary disruption in the supply of products, including delays in the delivery of goods to our stores or a reduction in the availability of products in our stores. In addition, adverse climate conditions and adverse weather patterns, such as drought or flood, that impact growing conditions and the quantity and quality of crops may materially adversely affect the availability or cost of certain products within our supply chain. Any of these factors may disrupt our businesses and materially adversely affect our financial condition, results of operations and cash flows.

 

For example, 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. In addition, our Red Hook store suffered substantial damage, including the loss of all inventory and a substantial portion of its equipment, and it was not reopened until March   1, 2013. The closure of this store impacted our operating results in fiscal 2013 due to lost revenue, pre and post-storm stock up and absorbed market share from competitors who were not immediately operational subsequent to the storm, and the fact that we retained substantially all of the employees of that store.

 

The occurrence of a widespread health epidemic may materially adversely affect our financial condition and results of operations.

 

Our business may be severely impacted by wartime activities, threats or acts of terror or a widespread regional, national or global health epidemic, such as pandemic flu. Such activities, threats or epidemics may materially adversely impact our business by disrupting production and delivery of products to our stores, by affecting our ability to appropriately staff our stores and by causing customers to avoid public gathering places or otherwise change their shopping behaviors.

 

Proposed changes to financial accounting standards could require our store leases to be recognized on the balance sheet.

 

In addition to our significant level of indebtedness, we have significant obligations relating to our current operating leases. Proposed changes to financial accounting standards could require such leases to be recognized on the balance sheet. All of our existing stores are subject to leases, which have remaining terms of up to 25 years, and as of March 30, 2014 , we had undiscounted operating lease commitments of approximately $ 720.3 million,   scheduled through 2039, related primarily to our stores, including the   leases for our Lake Grove store and production center, which are   in our possession but not yet open. These commitments represent the minimum lease payments due under our operating leases, excluding common area maintenance, insurance and taxes related to our operating lease obligations, and do not reflect fair market value rent reset provisions in the leases. These leases are classified as operating leases and disclosed in Note 14 to our consolidated financial statements included elsewhere in this report, but are not reflected as liabilities on our consolidated balance sheets. During fiscal 201 4 , our cash operating lease expense was approximately $ 29.5 million.

 

In May   2013, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued a revised joint discussion paper highlighting proposed changes to financial accounting standards for leases. Currently, Accounting Standards Codification 840 (“ASC 840”), Leases (formerly Statement of Financial Accounting Standards 13, Accounting for Leases) requires that operating leases are classified as an off-balance sheet transaction and only the current year operating lease expense is accounted for in the income statement. In order to determine the proper classification of our stores as either operating leases or capital leases, we must make certain estimates at the inception of the lease relating to the economic useful life and the fair value of an asset as well as select an appropriate discount rate to be used in discounting future lease payments. These estimates are utilized by management in making computations as required by existing accounting standards that determine whether the lease is classified as an operating lease or a capital lease. All of our store leases have been classified as operating leases, which results in rental payments being charged to expense over the terms of the related leases. Additionally, operating leases are not reflected in our consolidated balance sheets, which means that neither a leased asset nor an obligation for future lease payments is reflected in our consolidated balance sheets. The proposed changes to ASC 840 would require that substantially all operating leases be recognized as assets and liabilities on our balance sheet. The right to use the leased property would be capitalized as an asset and the expected lease payments over the life of the lease would be accounted for as a liability. The effective date, which has not been determined, could be as early as

26

 


 

Table of Contents

 

2016 and may require retrospective adoption. While we have not quantified the impact this proposed standard would have on our financial statements, if our current operating leases are instead recognized on the balance sheet, it will result in a significant increase in the liabilities reflected on our balance sheet and in the interest expense and depreciation and amortization expense reflected in our income statement, while reducing the amount of rent expense. This could potentially decrease our net income.

 

Our high level of fixed lease obligations could adversely affect our financial performance.

 

Our high level of fixed lease obligations will require us to use a significant portion of cash generated by our operations to satisfy these obligations, and could adversely impact our ability to obtain future financing to support our growth or other operational investments. We will require substantial cash flows from operations to make our payments under our operating leases, all of which provide for periodic increases in rent. If we are not able to make the required payments under the leases, the lenders or owners of the stores may, among other things, repossess those assets, which could adversely affect our ability to conduct our operations. In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under agreements governing our indebtedness, which could cause the counterparties under those agreements to accelerate the obligations due thereunder. Certain of our leases are with entities affiliated with our vice chairman of development and one of these leases is currently the subject of negotiation to reset the annual base rent for th is lease to fair market rent . See “—We lease certain of our stores and other properties from a related party” .

 

If our goodwill becomes impaired, we may be required to record a significant charge to earnings.

 

We have a significant amount of goodwill. As of March 30, 2014 , we had goodwill of approximately $95.4 million, which represented approximately 25.1 % of our total assets as of such date. Goodwill is reviewed for impairment on an annual basis ,   o n the first day of our fiscal fourth quarter   ( at the end of each fiscal year prior to fiscal 2014 ) or between annual tests if an event occur s or circumstances change that would  reduce the fair value of our reporting unit below its carrying amount. To the extent the carrying amount of a reporting unit exceeds the f air value of the reporting unit,   we are required to perform a second step, as this is an indication that the reporting unit goodwill may be impaired. In this step, we compare the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the r eporting unit goodwill. Based on this annual impairment analysis, there was no impairment of non-amortizable intangible assets, including goodwill , as of April 1, 2012, March 31, 2013 and March 30, 2014. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Goodwill and Other Intangible Assets.”

 

Our detailed impairment analysis involves the use of discounted cash flow models.  Significant management judgment is necessary to evaluate the impact of operating and macroeconomic changes on existing and forecasted results.  Determining market values using a discounted cash flow method requires that we make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate market rates.  Our judgments are based on historical experience, current market trends and other information.  In estimating future cash flows, we rely on internally generated forecasts for operating profits and cash flows, including capital expenditures.  Critical assumptions include projected comparable store sales growth, timing and number of new store openings, gross profit rates, general and administrative expenses, direct store expenses, capital expenditures, discount rates and terminal growth rates.  We determine discount rates based on the weighted average cost of capital of a market participant.  Such estimates are derived from our analysis of peer companies and considers the industry weighted average return on debt and equity from a market participant perspective.  We also use comparable market earnings multiple data and our market capitalization to corroborate our reporting unit valuation.  Factors that could cause us to change our estimates of future cash flows include a prolonged economic crisis, successful efforts by our competitors to gain market share in our core markets, our inability to compete effectively with other retailers or our inability to maintain price competitiveness.  We believe our assumptions are consistent with the plans and estimates used to manage the business; however, if actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.

 

Risks Relating to Ownership of Our Class   A Common Stock

 

We are controlled by investment funds managed by affiliates of Sterling Investment Partners, whose interests in our business may be different from yours.

 

Our Class   B common stock has ten votes per share, and our Class   A common stock, which is publicly traded, has one vote per share. At May   2 3, 201 4 Sterling Investment Partners owned 8,182,679 shares of Class   A common stock and 13,080,655 shares of Class   B common stock representing approximately 49. 0 % of our outstanding common stock and approximately 81. 1 % of the voting power of our outstanding common stock. As such, Sterling Investment Partners has significant influence over our reporting and corporate management and affairs, and, because of the ten-to-one voting ratio between our Class   B and Class   A common stock,

27

 


 

Table of Contents

 

Sterling Investment Partners controls a majority of the combined voting power of our common stock and therefore is able to control all matters submitted to our stockholders. Sterling Investment Partners will, for so long as the shares of Class   B common stock owned by it and its permitted transferees represent at least 5% of all outstanding shares of our Class   A and Class   B common stock, effectively control actions to be taken by us and our board of directors, including the election of directors, amendments to our certificate of incorporation and bylaws and approval of significant corporate transactions, including mergers and sales of substantially all of our assets. These actions may be taken even if other stockholders oppose them. Sterling Investment Partners’ control may have the effect of delaying or preventing a change in control of our company or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future.

 

Our amended and restated certificate of incorporation provides that the doctrine of “corporate opportunity” will not apply to Sterling Investment Partners, or any of our directors who are associates of, or affiliated with, Sterling Investment Partners, in a manner that would prohibit them from investing in competing businesses. It is possible that the interests of Sterling Investment Partners and their affiliates may in some circumstances conflict with our interests and the interests of our other stockholders, including you, and Sterling Investment Partners may act in a manner that advances its best interests and not necessarily those of our other stockholders.

 

Future transfers by holders of Class   B common stock will generally result in those shares converting to Class   A common stock, subject to limited exceptions, such as certain transfers effected for estate planning purposes and transfers to members of Sterling Investment Partners. The conversion of Class   B common stock to Class   A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class   B common stock who retain their shares in the long term. All outstanding shares of Class   A common stock and Class   B common stock will automatically convert into a single class of common stock when Sterling Investment Partners and its permitted transferees no longer own any shares of Class   B common stock.  

 

Sterling Investment Partners is not subject to any contractual obligation to retain its controlling interest. There can be no assurance as to the period of time during which Sterling Investment Partners will in fact maintain its ownership of our common stock.

 

We have elected to take advantage of the “controlled company” exemption to the corporate governance rules   for publicly-listed companies, which could make our Class   A common stock less attractive to some investors or otherwise harm our stock price.

 

Because we qualify as a “controlled company” under the corporate governance rules   for NASDAQ-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors has determined not to have a majority of our board of directors be independent or have an independent nominating function and has chosen to have the full board of directors be directly responsible for nominating members of our board. Accordingly, should the interests of Sterling Investment Partners, as our controlling stockholder, differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules   for publicly-listed companies. Our status as a controlled company could make our Class   A common stock less attractive to some investors or otherwise harm our stock price.

 

Conflicts of interest may arise because some of our directors are representatives of our controlling stockholders.

 

Messrs.   Santoro, Selden and Barr, who are representatives of Sterling Investment Partners, serve on our board of directors, and Mr.   Santoro serves as our Executive Chairman. Sterling Investment Partners and affiliated funds may hold equity interests in entities that directly or indirectly compete with us, and companies in which they currently invest may begin competing with us. As a result of these relationships, when conflicts between the interests of Sterling Investment Partners and its affiliates, on the one hand, and the interests of our other stockholders, on the other hand, arise, these directors may not be disinterested. Although our directors and officers have a duty of loyalty to us under Delaware law and our certificate of incorporation, transactions that we enter into in which a director or officer has a conflict of interest are generally permissible so long as (i)   the material facts relating to the director’s or officer’s relationship or interest as to the transaction are disclosed to our board of directors and a majority of our disinterested directors, or a committee consisting solely of disinterested directors, approves the transaction, (ii)   the material facts relating to the director’s or officer’s relationship or interest as to the transaction are disclosed to our stockholders and a majority of our disinterested stockholders approves the transaction or (iii)   the transaction is otherwise fair to us. Under our amended and restated certificate of incorporation, representatives of Sterling Investment Partners are not required to offer to us any transaction opportunity of which they become aware and could take any such opportunity for themselves or offer it to other companies in which they have an investment, unless such opportunity is offered to them solely in their capacity as a director of ours.  

 

28

 


 

Table of Contents

 

Our stock price may be volatile or may decline regardless of our operating performance, and you may lose part or all of your investment.

 

The market price of our Class   A common stock may fluctuate significantly in response to a number of factors, most of which we cannot predict or control, including:

 

·

variations in our operating results, or the operating results of our competitors;

 

·

actual or anticipated growth rates relative to our competitors;

 

·

changes in our financial guidance to investors and analysts or our failure to achieve such expectations;

 

·

delays in, or our failure to provide, financial guidance;

 

·

changes in securities analysts’ estimates of our financial performance or our failure to achieve such estimates;

 

·

announcements of new store openings or initiatives, commercial relationships, acquisitions or other events by us or our competitors;

 

·

failure of any of our initiatives to achieve commercial success;

 

·

fluctuations in stock market prices and trading volumes of securities of similar companies;

 

·

general market conditions and overall fluctuations in U.S. equity markets;

 

·

sales of large blocks of our Class A common stock, including sales by Sterling Investment Partners or by our executive officers or directors;

 

·

additions or departures of any of our key personnel;

 

·

changes in accounting principles or methodologies;

 

·

economic, legal and regulatory factors unrelated to our performance;

 

·

changing legal or regulatory developments in the U.S.;

 

·

discussion of us or our stock price by the financial press and in online investor forums;

 

·

developments in the securities class action and stockholder derivative  l itigation pending against us ;   and

 

·

negative publicity about us in the media and online.

 

In addition, the stock market in general has experienced substantial price and volume volatility that is often seemingly unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our Class   A common stock to decline. In the past, securities class action litigation has often been brought against a company after a period of volatility in the market price of its common stock. We are currently, and may in the future become , involved in this type of litigation. Any securities litigation claims brought against us could result in substantial expenses and the diversion of our management’s attention from our business. See “ - Risks Relating to Our Business – Litigation May Materially Adversely Affect Our Business, Financial Condition and Results of Operations.”

 

Because we have no current plans to pay cash dividends on our Class   A common stock for the foreseeable future, you may not receive any return on investment unless you sell your Class   A common stock for a price greater than you paid.

 

We have never declared or paid cash dividends on our common stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class   A common stock if the market price of our Class   A common stock increases. In addition, our senior credit facility contains restrictions on our ability to pay dividends.

 

29

 


 

Table of Contents

 

Future sales of our Class   A common stock, or the perception in the public markets that these sales may occur, may depress our stock price.

 

The price of our Class   A common stock could decline if there are substantial sales of our Class   A common stock, particularly sales by our directors, executive officers, employees and significant stockholders, or when there is a large number of shares of our Class   A common stock available for sale. These sales, or the perception that these sales might occur, could depress the market price of our Class   A common stock and might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

 

At May   2 3, 201 4 ,   43, 43 0 , 700 shares of our common stock were outstanding , substantially all of which are freely tradeable . A large portion of our shares are held by Sterling Investment Partners , which has rights, subject to some conditions, to require us to file registration statements covering the shares they and certain of our other existing stockholders currently hold, or to include these shares in registration statements that we may file for ourselves or other stockholders.

 

  Also, in the future, we may issue shares of our Class   A common stock in connection with investments or acquisitions. The amount of shares of our Class   A common stock issued in connection with an investment or acquisition could constitute a material portion of our then-outstanding shares of common stock.

 

The market price of the shares of our Class   A common stock could decline as a result of the sale of a substantial number of our shares of Class   A common stock in the public market or the perception in the market that the holders of a large number of shares intend to sell their shares.

 

Our future operating results may fluctuate significantly and our current operating results may not be a good indication of our future performance. Fluctuations in our quarterly financial results could affect our stock price in the future.

 

Our operating results have historically varied from period-to-period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control. If our quarterly financial results   or our forecasts of future financial results fail to meet the expectations of securities analysts and investors, our Class   A common stock price could be negatively affected. Any volatility in our quarterly financial results may make it more difficult for us to raise capital in the future or pursue acquisitions that involve issuances of our stock. Our operating results for prior periods may not be effective predictors of our future performance.

 

Factors associated with our industry, the operation of our business and the markets for our products may cause our quarterly financial results to fluctuate, including:

 

·

our ability to open new stores on a timely basis or at all;

 

·

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;

 

·

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;

 

·

the geographic concentration of our stores;

 

·

ongoing economic uncertainty;

 

·

our ability to maintain or improve our operating margins;

 

·

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

 

30

 


 

Table of Contents

 

·

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;

 

·

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;

 

·

our ability to defend the purported securities class action and stockholder 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 of 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.”

 

Any one of the factors above or the cumulative effect of some of the factors referred to above may result in significant fluctuations in our quarterly financial and other operating results, including fluctuations in our key metrics. This variability and unpredictability could result in our failing to meet our internal operating plan or the   expectations of securities analysts or investors for any period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our shares could fall substantially and we could face costly lawsuits, including securities class action suits. In addition, a significant percentage of our operating expenses are fixed in nature and based on forecasted revenue trends. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate the negative impact on margins in the short term.

 

The supervoting rights of our Class   B common stock and other anti-takeover provisions in our organizational documents and Delaware law might discourage or delay attempts to acquire us that you might consider favorable.

 

Our amended and restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following:

 

·

any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class;

 

·

we have a dual class common stock structure, which provides Sterling Investment Partners with the ability to control the outcome of matters requiring stockholder approval, even if they own significantly less than a majority of the shares of our outstanding Class A and Class B common stock;

 

31

 


 

Table of Contents

 

·

when we no longer have outstanding shares of our Class B common stock, certain amendments to our amended and restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of common stock;

 

·

when we no longer have outstanding shares of our Class B common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders;

 

·

our board of directors is classified into three classes of directors with staggered three-year terms so that not all members of our board of directors are elected at one time and directors will only be able to be removed from office for cause;

 

·

when we no longer have outstanding shares of our Class B common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent;

 

·

only our chairman or a majority of our board of directors is authorized to call a special meeting of stockholders;

 

·

advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders;

 

·

our board of directors is expressly authorized to make, alter or repeal our amended and restated bylaws;

 

·

our amended and restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock; and

 

·

certain litigation against us can only be brought in Delaware.

 

In addition, we are governed by the provisions of Section   203 of the Delaware General Corporation Law, which limits the ability of certain stockholders owning in excess of 15% of our outstanding voting stock to merge or combine with us. Although we believe these provisions collectively provide for an opportunity to obtain greater value for stockholders by requiring potential acquirers to negotiate with our board of directors, they would apply even if an offer rejected by our board were considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.  

 

These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.

 

Failure to establish and maintain effective internal controls in accordance with Section   404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price.

 

Prior to our initial public offering in April   2013, we were not required to comply with the SEC rules   implementing Section   404 of the Sarbanes-Oxley Act and were therefore not required to make a formal assessment of the effectiveness of our internal control over financial reporting for that purpose. Although we are now required to comply with the SEC’s rules   implementing Sections 302 and 404 of the Sarbanes-Oxley Act, which requires management to certify financial and other information in our quarterly and annual reports and provide an annual management report on the effectiveness of controls over financial reporting, as an “emerging growth company,” as defined in the JOBS Act, our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section   404 until  the date we are no longer an emerging growth company. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating.

 

To comply with the requirements of being a public company, we may need to undertake various actions, such as implementing new internal controls and procedures and hiring additional accounting or internal audit staff. Testing and maintaining internal control can divert our management’s attention from other matters that are important to the operation of our business. In addition, when evaluating our internal control over financial reporting, we may identify material weaknesses that we may not be able to remediate in time to meet the applicable deadline imposed upon us for compliance with the requirements of Section   404. If we identify material weaknesses in our internal control over financial reporting or are unable to comply with the requirements of Section   404 in a timely manner or assert that our internal control over financial reporting is effective, or if our independent registered

32

 


 

Table of Contents

 

public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our Class   A common stock could be negatively affected, and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC or other regulatory authorities, which could require additional financial and management resources.

 

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our Class   A common stock less attractive to investors.

 

We qualify as an “emerging growth company” under the JOBS Act. As a result, we are rely ing on exemptions from certain disclosure requirements that are applicable to other public companies that are not emerging growth companies. Accordingly, we have included detailed compensation information for only our three most highly compensated executive officers and have not included a compensation discussion and analysis (CD&A) of our executive compensation programs in this report. For so long as we are an emerging growth company, we will not be required to:

 

·

have an auditor report on our internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act;

 

·

comply with any requirement that may be adopted by the PCAOB regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements ( i.e. , an auditor discussion and analysis);

 

·

submit certain executive compensation matters to shareholder advisory votes, such as “say-on-pay,” “say-on-frequency” and “say-on-golden parachutes”; and

 

·

disclose certain executive compensation related items such as the correlation between executive compensation and performance and comparisons of the CEO’s compensation to median employee compensation.

 

In addition, while we are an emerging growth company the JOBS Act will permit us to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to delay the adoption of new or revised accounting pronouncements applicable to public and private companies until such pronouncements become mandatory for private companies. As a result, our financial statements may not be comparable to the financial statements of issuers who are required to comply with the effective dates for new or revised accounting standards that are applicable to public and private companies.

 

We will remain an emerging growth company until the earliest to occur of: (i)   our reporting $1 billion or more in annual gross revenues; (ii)   the end of fiscal 2019; (iii)   our issuance, in a three year period, of more than $1 billion in non-convertible debt; and (iv)   the end of the fiscal year in which the market value of our common stock held by non-affiliates exceeds $700 million on the last business day of our second fiscal quarter.

 

We cannot predict if investors will find our Class   A common stock less attractive because we may rely on these exemptions. If some investors find our Class   A common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

 

We will incur significant increased costs as a result of operating as a public company, and our management will be required to divert attention from operational and other business matters to devote substantial time to public company requirements.

 

Until April 2013, w e operated as a private company. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. For example, we are required to comply with the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the rules   and regulations of the NASDAQ Global Market and the requirements of the Sarbanes-Oxley Act, as well as rules   and regulations subsequently implemented by the SEC and the NASDAQ Global Market, including the establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. C ompliance with these requirements has   increase d our legal and financial compliance costs and ma d e some activities more time-consuming and costly. In addition, we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. In particular, we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section   404 of the Sarbanes-Oxley Act. In that regard, we plan to support the internal audit function with a combination of in-house and outside resources to ensure that we deploy resources with the appropriate public company experience and technical accounting knowledge. We may not be successful in implementing these requirements, and implementing them could materially adversely affect our business, results of operations and financial condition. If we do not implement or comply with such requirements in a timely manner, we might be subject to sanctions or investigation by regulatory authorities. Any such action could harm our reputation and the

33

 


 

Table of Contents

 

confidence of investors and customers in our company, and could materially adversely affect our business and cause our Class   A common stock price to decline. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors or as executive officers.

 

I f securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business.  I f one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

 

ITEM 1B—UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2—PROPERTIES

 

We currently operate 1 4 locations in New York, New Jersey and Connecticut, three of which includ e   Fairway Wines   & Spirits locations . We lease all of our locations, most of them pursuant to long-term leases with initial terms of at least 15 years and several five to 10 year renewal options. We believe our portfolio of long-term leases is a valuable asset supporting our retail operations. Information regarding our stores is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling

 

Gross

 

Location 

 

Date Opened

 

Square Footage (1)

 

Square Footage

 

Broadway (Manhattan), New York(2)

 

1933

 

21,731 

 

59,468 

 

Harlem (Manhattan), New York(3)

 

December 1995

 

25,853 

 

52,005 

 

Plainview, New York

 

May 2001

 

36,579 

 

55,180 

 

Red Hook (Brooklyn), New York(3)(4)

 

May 2006

 

38,977 

 

75,814 

 

Paramus, New Jersey

 

March 2009

 

32,643 

 

50,307 

 

Pelham Manor, New York

 

April 2010

 

49,963 

(5)

75,310 

 

Stamford, Connecticut

 

November 2010

 

48,691 

(5)

86,062 

 

Upper East Side (Manhattan), New York

 

July 2011

 

22,109 

 

41,394 

 

Douglaston, New York

 

November 2011

 

38,239 

 

57,360 

 

Woodland Park, New Jersey

 

June 2012

 

41,452 

(5)

63,491 

 

Westbury, New York

 

August 2012

 

44,640 

 

68,357 

 

Kips Bay (Manhattan), New York

 

December 2012

 

24,129 

 

56,627 

 

Chelsea (Manhattan), New York

 

July 2013

 

15,390 

 

26,469 

 

Nanuet, New York

 

October 2013

 

45,360 

 

72,940 

 

Lake Grove, New York

 

Expected Summer 2014

 

39,920 

(6)

54,324 

(6)

TriBeCa (Manhattan), New York

 

Expected early calendar 2015

 

 

(7)

 

(7)

Hudson Yards (Manhattan), New York

 

Expected late calendar 2015 or early calendar 2016

 

26,381 

(6)

46,865 

(6)

 


(1)

Includes any outdoor produce areas, café and bakery areas, but excludes the square footage of the kitchen, bakery, meat department and produce coolers in our stores.

(2)

We lease a portion of this property from an entity in which Howard Glickberg, our vice chairman of development and a director, owns an interest. See “Item 1A—Risk Factors—Risks Relating to Our Business—We lease certain of our stores and related properties from a related party.”

(3)

We lease this property from entities in which Howard Glickberg, our vice chairman of development and a director, owns an interest. See “Item 1A—Risk Factors—Risks Relating to Our Business—We lease certain of our stores and related properties from a related party.”

34

 


 

Table of Contents

 

(4)

This store was temporarily closed from October 29, 2012 through February 28, 2013 due to damage sustained during Hurricane Sandy.

(5)

Selling square footage includes adjacent (Pelham Manor, 4,808 sq. ft.; Stamford, 5,736 sq. ft.) or integrated (Woodland Park, 2,755 sq. ft.) Fairway Wines & Spirits location.

(6)

Estimated, as this location has not yet opened.

(7)

Not yet determined.

 

We lease our corporate headquarters, parking lots by certain of our stores, warehouse space and the facility where we are opening   a centralized production facility.

 

ITEM 3—LEGAL PROCEEDINGS

 

We are subject to various legal claims and proceedings which arise in the ordinary course of our business, including employment related claims, involving routine claims incidental to our business. Although the outcome of these routine claims cannot be predicted with certainty, we do not believe that the ultimate resolution of these claims will have a material adverse effect on our results of operations, financial condition or cash flows.

 

In February and March 2014, three purported 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 us and certain of our current and former officers, certain of our directors and the underwriters for our initial public offering. The suits assert claims for allegedly misleading statements in the registration statement for our initial public offering and in subsequent communications regarding our business and financial results. In April 2014, a purported stockholder derivat iv e action was filed against certain of our directors in New York state court asserting claims for breach of fiduciary duties and gross mismanagement arising from substantially similar allegations as in the securities class actions .   While we believe the claims are without merit and intend to defend these lawsuits vigorously, we cannot predict the outcome of these lawsuits.

 

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 us and certain of our current and former officers and employees.  This suit alleges, among other things, that certain of our past and current employees were not properly compensated in accordance with the overtime provisions of the Fair Labor Standards Act.  While we believe that these claims are without merit and intend to defend the matter vigorously, we cannot predict the outcome of this litigation.

 

Monitoring and defending against legal actions, whether or not meritorious, is time-consuming for our management and detracts from our ability to fully focus our internal resources on our business activities and we cannot predict how long it may take to resolve these matters. In addition, legal fees and costs incurred in connection with such activities may be significant and we could, in the future, be subject to judgments or enter into settlements of claims for significant monetary damages. A decision adverse to our interests on these actions or resulting from these matters could result in the payment of substantial damages and could have a material adverse effect on our cash flow, results of operations and financial position.

 

With respect to any litigation, our insurance may not reimburse us or may not be sufficient to reimburse us for the expenses or losses we may suffer in contesting and concluding such lawsuits. Substantial litigation costs or an adverse result in any litigation may adversely impact our business, operating results or financial condition.

 

ITEM 4—MINE SAFETY DISCLOSURES

 

Not applicable.

35

 


 

Table of Contents

 

 

PART   II

 

ITEM 5—MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our Class   A common stock has been listed on the NASDAQ Global Market under the symbol “FWM” since April   16, 2013. Prior to that time, there was no public market for our stock.

 

As of May   2 3 , 201 4 , there were approximately 60 holders of record of our Class   A common stock, and the closing price of our common stock was $ 5.94 per share as reported on the NASDAQ Global Market. Because many of our shares of Class   A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of May   2 3 , 201 4 , there were 6 holders of record of our Class   B common stock. For additional information related to ownership of our stock by certain beneficial owners and management, refer to “Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

 

Common Stock Price

 

The following table sets forth for the periods indicated the high and low intra-day sale prices per share of our Class A common stock as reported on the NASDAQ Global Market:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2014

 

High

 

Low

First Quarter (April 16 – June 30, 2013)

 

$

25.98 

 

$

13.00 

Second Quarter (July 1 – September 29, 2013)

 

$

28.87 

 

$

22.00 

Third Quarter (September 30 – December 29, 2013)

 

$

26.09 

 

$

15.37 

Fourth Quarter (December 30, 2013 – March 30, 2014)

 

$

18.87 

 

$

7.21 

 

Use of Proceeds

 

On April   22, 2013, we completed our IPO of 15,697,500 shares of our 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).

 

We received approximately $158.8 million in net proceeds from the IPO after deducting the underwriting discount and expenses related to our IPO.  We used the net proceeds that we received from the IPO to (i)   pay accrued but unpaid dividends on our Series   A preferred stock totaling approximately $19.1 million, of which $17,687,724 was paid to the funds affiliated with Sterling Investment Partners and $654,772 was paid to Howard Glickberg, a director and our vice chairman of development, (ii)   pay accrued but unpaid dividends on our Series   B preferred stock totaling approximately $57.7 million, of which $45,298,477 was paid to the funds affiliated with Sterling Investment Partners and $5,738,657 was paid to Howard Glickberg, (iii)   pay $9.2 million to an affiliate of Sterling Investment Partners in connection with the termination of our management agreement with such affiliate and (iv)   pay contractual initial public offering bonuses to certain members of our management totaling approximately $8.1 million .   D uring fiscal 2014 we used approximately $15.4 million of the proceeds in connection with the opening of our new store in the Chelsea neighborhood of Manhattan in July 2013, approximately $17.9 million of the proceeds in connection with the store we opened in October 2013 in Nanuet, NY, approximately $ 4.0 million of the proceeds in connection with the store we expect to open in Lake Grove, NY in Summer 2014, approximately $ 7.2 million of the proceeds in connection with capital expenditures for our other stores and approximately $ 10.9 million of the proceeds in connection with capital expenditures and start-up costs at our new production facility. We intend to use the remainder of the net proceeds, approximately $9.3 million, for new store growth and other general corporate purposes.  We did not receive any of the proceeds from the sale of shares by the selling stockholders. There has been no material change in the planned use of proceeds from our IPO as described in our final prospectus filed with the SEC on April   17, 2013 pursuant to Rule   424(b). Pending the uses described, we have invested the net proceeds in short-term, investment-grade interest-bearing securities such as money market funds, certificates of deposit, commercial paper, corporate debt, agencies and guaranteed obligations of the U.S. government.

 

 

Dividend Policy

 

We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay dividends in the foreseeable future. In addition, our senior credit facility contains restrictions on our ability to pay dividends.

36

 


 

Table of Contents

 

 

Sales of Unregistered Securities

 

During the fiscal year ended March 30, 2014, we issued 1, 930,820 shares of Class A common stock upon the exercise of outstanding warrants and under our 2013 Long-Term Incentive Plan granted to our officers, directors, employees and consultants an aggregate of 2,620,163 restricted stock units to be settled in shares of our Class A common stock and options to purchase 1,424,691 shares of our Class A common stock.

 

Issuer Purchases of Equity Securities

 

During the fourth fiscal quarter ended March 30, 2014 there were no issuer purchases of equity securities.

Performance Graph

This performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Securities Exchange Act of 1934, as amended,, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Fairway Group Holdings Corp. under the Securities Act of 1933, as amended, or the Exchange Act.

The following graph compares the cumulative total return to stockholders on our common stock relative to the cumulative total returns of the NASDAQ Composite Index and the S&P Food Retail Index .  An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our Class A common stock and in each index on April 16, 2013, the date our common stock began trading on the NASDAQ Global Market, and its relative performance is tracked through March 30, 2014. The returns shown are based on historical results and are not intended to suggest future performance.

 

PICTURE 1

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The information required by this item with respect to our equity compensation plans is incorporated by reference to our Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended March 30, 2014.

37

 


 

Table of Contents

 

ITEM 6—SELECTED FINANCIAL DATA

 

The following table s present selected historical consolidated statement of operations, balance sheet and other data for the periods presented and should only be read in conjunction with “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements and the related notes thereto. Each of our fiscal years ended March   28, 2010 (“fiscal 2010”) , April 1, 2012 (“fiscal 2012”) ,   March 31, 2013 (“fiscal 2013”) and March 30, 2014 (“fiscal 2014”) consists of 52 weeks; our fiscal year ended April 3, 2011 (“fiscal 2011”) consists of 53 weeks. The differing length of certain fiscal years , the effects of Hurricane Sandy (including   the temporary closure of all of our stores for one or two days and our Red Hook store for four months and the receipt of insurance proceeds related to Hurricane Sandy ) ,   and the opening of nine stores during these years, may affect the comparability of certain data for certain of these years . Our historical results are not necessarily indicative of our results in any future period.  

 

Statement of Operations Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended

 

 

March 28,

 

 

April 3,

 

 

April 1,

 

 

March 31,

 

 

March 30,

 

 

2010

 

 

2011

 

 

2012

 

 

2013

 

 

2014

 

 

(dollars in thousands, except for per share data)

Net sales(1)

 

$

401,167 

 

 

$

485,712 

 

 

$

554,858 

 

 

$

661,244 

 

 

$

775,986 

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

 

 

271,599 

 

 

 

326,207 

 

 

 

368,728 

 

 

 

445,379 

 

 

 

524,659 

Gross profit(2)

 

 

129,568 

 

 

 

159,505 

 

 

 

186,130 

 

 

 

215,865 

 

 

 

251,327 

Direct store expenses

 

 

85,840 

 

 

 

109,867 

 

 

 

132,446 

 

 

 

154,753 

 

 

 

186,537 

General and administrative expenses(3)

 

 

34,676 

 

 

 

40,038 

 

 

 

44,331 

 

 

 

60,192 

 

 

 

84,094 

Store opening costs(4)

 

 

3,949 

 

 

 

10,006 

 

 

 

12,688 

 

 

 

19,015 

 

 

 

10,187 

Production center start-up costs

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

4,519 

Income (loss) from operations

 

 

5,103 

 

 

 

(406)

 

 

 

(3,335)

 

 

 

(18,095)

 

 

 

(34,010)

Business interruption and gain on storm-related insurance recoveries(5)

 

 

 —

 

 

 

 —

 

 

 

 —

 

 

 

5,000 

 

 

 

3,089 

Interest expense, net

 

 

(13,787)

 

 

 

(19,111)

 

 

 

(16,918)

 

 

 

(23,964)

 

 

 

(20,205)

Loss on early extinguishment of debt(6)

 

 

(2,837)

 

 

 

(13,931)

 

 

 

 —

 

 

 

 —

 

 

 

 —

Loss before income taxes

 

 

(11,521)

 

 

 

(33,448)

 

 

 

(20,253)

 

 

 

(37,059)

 

 

 

(51,126)

Income tax benefit (provision)(7)

 

 

4,426 

 

 

 

14,860 

 

 

 

8,304 

 

 

 

(25,809)

 

 

 

(29,154)

Net loss

 

$

(7,095)

 

 

$

(18,588)

 

 

$

(11,949)

 

 

$

(62,868)

 

 

$

(80,280)

Net loss attributable to common stockholders(8)

 

$

(23,750)

 

 

$

(39,021)

 

 

$

(36,677)

 

 

$

(92,689)

 

 

$

(124,410)

Net loss per share attributable to common stockholders (basic and diluted)(8)

 

$

(1.95)

 

 

$

(3.22)

 

 

$

(3.01)

 

 

$

(7.52)

 

 

$

(3.10)

Net loss per share (pro forma basic and diluted) (8)

 

$

(0.34)

 

 

$

(0.84)

 

 

$

(0.52)

 

 

$

(2.52)

 

 

$

(2.00)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding (in 000s)(8)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

12,190 

 

 

 

12,122 

 

 

 

12,189 

 

 

 

12,326 

 

 

 

40,166 

Pro forma basic and diluted

 

 

20,945 

 

 

 

22,151 

 

 

 

23,137 

 

 

 

24,959 

 

 

 

40,166 

 

38

 


 

Table of Contents

 

Other Financial Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended

 

 

March 28,

 

April 3,

 

April 1,

 

March 31,

 

March 30,

 

 

2010

 

2011

 

2012

 

2013

 

2014

 

 

(dollars in thousands)

Adjusted EBITDA(9)

 

$

23,874 

 

 

$

29,309 

 

 

$

35,775 

 

 

$

47,364 

 

 

$

48,797 

 

Depreciation and amortization

 

$

10,233 

 

 

$

14,588 

 

 

$

19,202 

 

 

$

22,093 

 

 

$

27,056 

 

Capital expenditures

 

$

21,658 

 

 

$

27,797 

 

 

$

44,528 

 

 

$

57,916 

 

 

$

43,906 

 

Gross margin(10)

 

 

32.3 

%

 

 

32.8 

%

 

 

33.5 

%

 

 

32.6 

%

 

 

32.4 

%

Adjusted EBITDA margin(11)

 

 

6.0 

%

 

 

6.0 

%

 

 

6.4 

%

 

 

7.2 

%

 

 

6.3 

%

Pro forma Adjusted EBITDA margin(11)(12)

 

 

6.0 

%

 

 

6.0 

%

 

 

6.4 

%

 

 

6.9 

%

 

 

6.3 

%

 

S elected Operating Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Year Ended

 

  

March 28,

 

April 3,

 

April 1,

 

March 31,

 

March 30,

 

 

2010

 

2011

 

2012

 

2013

 

2014

Locations at end of period(13)

 

 

 

 

 

 

 

 

 

 

 

12 

 

 

 

14 

 

Total gross square feet at end of period

 

 

292,774 

 

 

 

454,146 

 

 

 

552,900 

 

 

 

741,375 

 

 

 

840,784 

 

Change in square footage for period

 

 

 —

%

 

 

55.1 

%

 

 

21.7 

%

 

 

34.1 

%

 

 

13.4 

%

Average store size

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross square feet

 

 

58,555 

 

 

 

64,878 

 

 

 

61,433 

 

 

 

61,781 

 

 

 

60,056 

 

Selling square feet(14)

 

 

31,157 

 

 

 

36,348 

 

 

 

34,976 

 

 

 

35,417 

 

 

 

34,697 

 

Average net sales per square foot

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross square foot(15)

 

$

1,370 

 

 

$

1,308 

 

 

$

1,029 

 

 

$

1,123 

 

 

$

996 

 

Selling square foot(15)

 

$

2,575 

 

 

$

2,459 

 

 

$

1,859 

 

 

$

1,963 

 

 

$

1,754 

 

Average net sales per store per week ($000)(16)

 

$

1,543 

 

 

$

1,473 

 

 

$

1,246 

 

 

$

1,252 

 

 

$

1,149 

 

Comparable store sales growth (decrease) per period(17)

 

 

0.5 

%

 

 

(4.4)

%

 

 

(7.5)

%

 

 

(1.7)

%

 

 

(0.4)

%

New stores opened in period (location/date)

 

 

 

 

Pelham Manor, NY

 

Upper East Side, NY

 

Woodland Park, NJ

 

Chelsea, NY

 

 

 

 

 

 

 

(4/2010);

 

 

 

(7/2011);

 

 

 

(6/2012)

 

 

 

(7/2013)

 

 

 

 

 

 

 

 

Stamford, CT

 

 

 

Douglaston, NY

 

 

 

Westbury, NY

 

 

 

Nanuet, NY

 

 

 

 

 

 

 

 

(11/2010)

 

 

 

(11/2011)

 

 

 

(8/2012)

 

 

 

(10/2013)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Kips Bay, NY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12/2012)

 

 

 

 

 

 

39

 


 

Table of Contents

 

 

Balance Sheet Data