l

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 27, 2015

OR

For the transition period from to

Commission File Number 001-35880

Fairway Group Holdings Corp.

(Exact name of registrant as specified in its charter)

2284 12th Avenue

New York, New York 10027

(646) 616-8000

(Registrant’s telephone number, including area code)

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

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

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

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

As of October 23, 2015, the registrant had 29,873,347 shares of Class A common stock and 14,225,455 shares of Class B common stock outstanding.

Fairway Group Holdings Corp.

Quarterly Report on Form 10-Q

For the quarterly period ended September 27, 2015

Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. Although we believe that our assumptions are reasonable, we caution that it is difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from our expectations or cautionary statements are disclosed under the sections entitled “Item 1A—Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended March 29, 2015 and “Part I—Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements as well as other cautionary statements that are made from time to time in our other filings with the Securities and Exchange Commission (“SEC”) and public communications. You should evaluate all forward-looking statements made in this report in the context of these risks and uncertainties, and you should not rely upon forward-looking statements as predictions of future events.

We caution you that the important factors described in the Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations may not be all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially and adversely from those contained in any forward-looking statements we may make. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

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

Part I — Financial Information

Item 1. FINANCIAL STATEMENTS

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except per share amounts)

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

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

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

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

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

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Consolidated Statement of Changes in Stockholders’ Deficit

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these financial statements

FAIRWAY GROUP HOLDINGS CORP. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

1.DESCRIPTION OF BUSINESS AND ORGANIZATION

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

Fairway Group Holdings Corp. and subsidiaries (the “Company” or “Fairway”) operate in the retail food industry, selling fresh, natural and organic products, prepared foods and hard-to-find specialty and gourmet offerings along with a full assortment of conventional groceries.  The Company operates fifteen stores in the Greater New York metropolitan area, four of which include Fairway Wine & Spirits locations.  Fourteen of the stores (including three Wine & Spirits locations) were in operation prior to the beginning of the fiscal year ended March 29, 2015 (“fiscal 2015”), one store opened during the thirteen weeks ended September 28, 2014 and the Company’s fourth Wine & Spirits location was opened during fiscal 2015, subsequent to September 28, 2014.  The Company has determined that it has one reportable segment.  Substantially all of the Company’s revenue comes from the sale of items at its retail food stores. 

2.BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, these financial statements do not include all of the information and footnotes required for complete financial statements in accordance with US GAAP, pursuant to such rules and regulations. Therefore, these unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 29, 2015. 

The accompanying unaudited consolidated financial statements as of September 27, 2015, and for the thirteen and twenty-six weeks ended September 27, 2015 and September 28, 2014, reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and operating results of the Company. All material intercompany accounts and transactions have been eliminated in the unaudited consolidated financial statements. The results of operations for any interim period may not necessarily be indicative of the results that may be expected for the entire fiscal year or any interim period therein.

Certain amounts in the financial statements for prior periods have been reclassified to conform to the current year presentation and had no effect on previously reported consolidated net loss or stockholders’ deficit.

There have been no changes to the Company’s significant accounting policies described in the Company’s Annual Report on Form 10-K for the fiscal year ended March 29, 2015 that have had a material impact on the Company’s unaudited interim consolidated financial statements and related notes.

3.NET LOSS PER COMMON SHARE

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

The following table is a summary of the share amounts (in thousands) used in computing basic and diluted earnings per share and anti-dilutive shares excluded from the computation:

During the thirteen and twenty-six weeks ended September 27, 2015 and September 28, 2014 certain of the options to purchase shares of Class A common stock had exercise prices in excess of the Company’s publicly quoted stock price and therefore are not considered potentially dilutive.

4.GOODWILL AND INTANGIBLE ASSETS

The Company’s annual goodwill impairment test is conducted on the first day of the fourth quarter of each fiscal year and interim evaluations are performed when it is determined that events or changes in circumstances exist that would more likely than not reduce the fair value of goodwill below its carrying value.  During the thirteen weeks ended September 27, 2015, due to a continued decline in the market price of the Company’s stock price and revisions in expected operating performance, it was determined that an interim evaluation of goodwill for impairment was necessary. As a result of these developments, the Company performed an interim evaluation as of September 27, 2015.

Based upon the results of this interim impairment test, it was preliminarily determined that the fair values of the Company’s indefinite-lived intangible assets and reporting unit exceed the carrying values, and no impairment existed as of September 27, 2015. There were no goodwill or indefinite-lived intangible asset impairment charges recorded in the twenty-six weeks ended September 27, 2015 and September 28, 2014.   As of September 27, 2015 the carrying values of goodwill and tradenames were $95.4 million and $23.6 million, respectively.

The Company believes the assumptions used in the evaluations are consistent with the plans and estimates used to manage the business; however, if actual results are not consistent with these estimates or assumptions and if the market price of the Company’s stock continues to decline, the Company may be exposed to a non-cash impairment charge that could be material.

5.LONG-TERM DEBT

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

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

Other interest (income) expense, net includes approximately $302,000 and $250,000 of capitalized interest for the thirteen weeks ended September 27, 2015 and September 28, 2014, respectively and $530,000 and $471,000 of capitalized interest for the twenty-six weeks ended September 27, 2015 and September 28, 2014, respectively.

2013 Senior Credit Facility

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

Borrowings under the 2013 Senior Credit Facility, as amended, bear interest, at the option of the Company, at (i) adjusted LIBOR (subject to a 1.0% floor) plus 4.0% or (ii) an alternate base rate plus 3.0%. In addition, there is a fee payable quarterly in an amount equal to 1.0% per annum of the undrawn portion of the 2013 Revolving Facility, calculated based on a 360-day year. Interest is payable quarterly in the case of base rate loans and on the maturity dates or every three months, whichever is shorter, in the case of adjusted LIBOR loans. The 4.0% and 3.0% margins will each

be reduced by 50 basis points at any time when the Company’s corporate family rating from Moody’s Investor Services Inc. is B2 or higher and the Company’s corporate rating from Standard & Poors Rating Service is B or higher, in each case with a stable outlook, and as long as certain events of default have not occurred.

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

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

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

The Company was in compliance with all applicable affirmative, negative and financial covenants of the 2013 Senior Credit Facility, as amended, at September 27, 2015. At the time the Company entered into the 2013 Senior Credit Facility, as amended, new levels for the maximum total leverage ratio financial covenant were established. The level at the end of the second and third fiscal quarters is 6.0:1, before stepping down to 5.75:1 prior to the end of fiscal 2016. The Company’s current operating performance has been below expectations at the time that the financial covenant levels were established, and if the Company’s financial performance does not improve, it is possible that the Company will not be in compliance with the maximum total leverage ratio financial covenant at some point within the next twelve months. In the event of a covenant violation that remains uncured, the lenders have the right to declare all outstanding debt under the 2013 Senior Credit Facility, as amended, immediately due and payable. The Company has the ability to exercise equity cure rights, which allows for the issuance of additional equity and for the proceeds to be treated as EBITDA for purposes of the covenant, subject to certain restrictions, including that the amount of equity that can be used as EBITDA cannot exceed the EBITDA shortfall, the proceeds must be used to repay debt, and the equity cure can only be used twice within a four quarter period and only four times during the term of the loan.

Although the Company believes that it has sufficient liquidity and capital resources to meet its current operating requirements and to open the stores currently scheduled to open in calendar 2016, in light of the Company’s leverage profile and the constraints that places on its longer-term growth strategy, the Company is currently exploring alternatives to raise additional capital to allow the Company to de-lever the balance sheet and fund additional growth initiatives, including investments to rebuild sales and pursuing new stores opportunistically.  Any new growth capital investment, or capital raised in the context of an equity cure, is likely to be in the form of equity or equity linked securities, and is likely to be dilutive to existing stockholder ownership. There can be no assurance that the Company will be successful in obtaining additional capital on favorable terms or at all. If the Company is unable to raise additional capital, the ability to expand would be materially adversely affected and, if the Company’s performance does not improve, make it more difficult to remain in compliance with the net leverage covenant.

At September 27, 2015, the Company had $33.0 million of outstanding letters of credit, and $7.0 million of availability under the 2013 Revolving Facility, all of which was available for letters of credit. Subsequent to September 27, 2015, the Company increased its outstanding letters of credit by $0.5 million in the aggregate, decreasing its availability under the 2013 Revolving Facility to $6.5 million.

6.STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation awards in accordance with the provisions of FASB Accounting Standards Codification (“ASC”) Topic 718 — Compensation — Stock Compensation  which requires companies to estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the awards ultimately expected to vest is recognized as expense over the requisite service period. The Company recognized total stock-based compensation of $2.1 million and $4.2 million for the thirteen weeks ended September 27, 2015 and September 28, 2014, respectively, and $4.5 million and $7.0 million for the twenty-six weeks ended September 27, 2015 and September 28, 2014, respectively, as general and administrative expenses in the Company’s Consolidated Statements of Operations.

Included in the amounts recorded for the thirteen and twenty-six weeks ended September 28, 2014 are: (i) approximately $96,000 and $192,000, respectively, representing the value of restricted stock units issued to certain directors during such period in payment of the directors’ fees for each of the corresponding calendar quarters ended June 30, 2014 and September 30, 2014; (ii) approximately $41,000 and $82,000, respectively, representing the value of restricted stock units issued during such period to the Company’s chairman in payment of his fees for serving as executive chairman for each of the corresponding calendar quarters; and (iii) $187,500 and $375,000, respectively, representing the value of restricted stock units granted in such period to a former executive officer in partial payment of his salary for each of the corresponding calendar quarters.  All of these restricted stock units are vested upon issuance but will be settled in shares of Class A common stock in the future. No such items were included in stock-based compensation expense during the thirteen and twenty-six weeks ended September 27, 2015.

The Company’s 2007 Equity Compensation Plan (the “2007 Plan”), which provided for the grant of stock options and restricted shares, and the 2013 Long-Term Incentive Plan (the “2013 Plan”), which provides for the grant of stock options, restricted stock units, restricted stock, other stock-based awards and other cash-based awards, are more fully described in the Company’s Annual Proxy Statement for its 2015 annual meeting of stockholders filed with the Securities and Exchange Commission on June 23, 2015 under the caption “Executive Compensation—Equity Compensation Plans.”  Changes in equity awards outstanding under the 2007 Plan and 2013 Plan during the twenty-six weeks ended September 27, 2015 are summarized as follows:

2007 Equity Compensation Plan

As of September 27, 2015, there was $32,000 of unrecognized compensation expense related to the restricted stock awards granted under the 2007 Plan.

The status of the Company’s unvested restricted stock grants for the twenty-six weeks ended September 27, 2015  is summarized as follows:

2013 Long-Term Incentive Plan

Restricted Stock Units

As of September 27, 2015, there was $9.0 million of unrecognized compensation expense related to the restricted stock unit awards (“RSU”s) granted under the 2013 Plan.

The status of the Company’s unvested restricted stock units for the twenty-six weeks ended September 27, 2015  is summarized as follows:

During the twenty-six weeks ended September 27, 2015 40,181 RSUs with a grant-date fair value of approximately $187,000 were granted related to executive separation agreements, which were charged to expense during fiscal 2016. As of  September 27, 2015, approximately $203,000 is included in accrued expenses related to separation payments to be made in RSUs in future periods.

Stock Options

As of September 27, 2015, there was $1.1 million of unrecognized compensation expense related to the stock option compensation awards granted under the 2013 Plan.

A summary of stock option activity for the twenty-six weeks ended September 27, 2015 is as follows:

Stock options outstanding as of September 27, 2015 had no intrinsic value.  Aggregate intrinsic value represents the value of the Company’s stock based on the closing stock price on the last trading day of the fiscal period in excess of the weighted average exercise price multiplied by the number of options outstanding or exercisable.  

7.RELATED PARTY TRANSACTIONS

Operating Leases and Utility Services 

A director who is a former executive officer of the Company:

Total amounts related to the foregoing included $1.5 million and $1.5 million in cost of sales and $0.4 million and $0.4 million in general and administrative expenses for the thirteen weeks ended September 27, 2015 and September 28, 2014, respectively and $3.0 million and $2.9 million in cost of sales and $0.8 million and $0.9 million in general and administrative expenses for the twenty-six weeks ended September 27, 2015 and September 28, 2014, respectively.  At September 27, 2015 and March 29, 2015, amounts payable to related parties included in accrued expenses were $0.1 million and $0.1 million, respectively, and receivables from related parties of $0.3 million and $0.2 million, respectively, were included in accounts receivable.

Executive Separations

In connection with the separation of the Company’s then Chief Executive Officer in February 2014, its then Interim Chief Executive Officer in September 2014, and the retirement of an individual who served as an executive officer in November 2014 (although this individual remains a director), the Company entered into separation agreements with the departed individuals.  Under certain of these agreements, the Company entered into consulting arrangements with the departed individuals and was obligated to provide salary and benefit continuation, which required the payment of cash and the grant of restricted stock units.  Under these agreements, the Company paid cash of approximately $462,000 and $374,000 for the thirteen weeks ended September 27, 2015 and September 28, 2014, respectively, and $1.5 million and $452,000 for the twenty-six weeks ended September 27, 2015 and September 28, 2014, respectively.  During the thirteen and twenty-six weeks ended September 27, 2015, the Company granted approximately 26,334 and 40,181 restricted stock units, respectively, with a grant date fair value of approximately $94,000  and $187,000 related to these agreements.  No restricted stock units related to these agreements were granted during the twenty-six weeks ended September 28, 2014.

As of September 27, 2015 and March 29, 2015, amounts related to executive separation included in accrued expenses were approximately $723,000 and $2.4 million, respectively.

8.INCOME TAXES

The reconciliation of the U.S. statutory rate with the Company’s effective tax rate for the thirteen and twenty-six weeks ended September 27, 2015 and September 28, 2014 is summarized as follows:

As a result of historical net operating losses (“NOLs”), the Company currently provides a full valuation allowance against its net deferred tax assets.  For the thirteen and twenty-six weeks ended September 27, 2015 and September 28, 2014, income tax expense was computed at the estimated annual effective rate based on the total estimated annual tax provision which included state income taxes and a deferred tax provision related to amortization of certain indefinite-lived intangible assets.  

Based on management’s assessment, the Company has placed a valuation reserve against its deferred tax assets, as it is more likely than not that the Company may not generate sufficient taxable income during the carryforward period to utilize the NOLs.  The Company regularly reviews the net deferred tax valuation allowance to determine if available evidence continues to support the position that it is more likely than not that a portion of or the entire deferred tax asset will not be realized in the future. As of September 27, 2015, management could not conclude that it is more likely than not that the deferred tax assets will be realized. As a result, the Company continues to maintain a full valuation allowance against its deferred tax assets. The Company will continue to assess its position in future periods to determine if it is appropriate to reduce a portion of its valuation allowance in the future.

For more information regarding the Company’s valuation allowance against its deferred tax assets, see Note 13 to the Company’s audited financial statements included in its Annual Report on Form 10-K for the fiscal year ended March 29, 2015.

The valuation allowance was $121.7 million and $110.8 million as of September 27, 2015 and March 29, 2015, respectively.

9.COMMITMENTS AND CONTINGENCIES

Operating Leases

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

The Company has signed certain leases for which the Company’s obligation is not yet established because the Company does not yet have possession of the site. The aggregate minimum rental commitments under all operating leases, for which the Company has possession, as of September 27, 2015 are as follows for the fiscal years ending (in thousands):

Rent expense for the twenty-six weeks ended September 27, 2015 and September 28, 2014 was approximately $22.4 million and $21.7 million, respectively. Rent expense for the thirteen weeks ended September 27, 2015 and September 28, 2014 was approximately $11.2 million and $11.4 million,  respectively.

During the twenty-six weeks ended September 27, 2015, the Company entered into an agreement terminating its lease of a site in the new Hudson Yards development in west midtown Manhattan where the Company had expected to open a store in late calendar 2015 or early calendar 2016. In connection with the lease termination, the Company recorded a charge of $3.7 million during the twenty-six weeks ended September 27, 2015, which has been included in general and administrative expenses. The amount recorded includes $3.5 million paid in cash to the landlord during the twenty-six weeks ended September 27, 2015, and the impairment of $0.2 million of previously capitalized investments in the store site.

Other Contingencies

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

In February and March 2014, three purported securities class action lawsuits alleging the violation of the federal securities laws were filed in the United States District Court for the Southern District of New York against the Company and certain of the Company’s current and former officers and directors and the underwriters for the Company’s initial public offering. The actions were consolidated on June 3, 2014 under the caption In re Fairway Group Holdings Corp. Securities Litigation, No. 14-cv-0950. On July 18, 2014, an amended class action complaint was filed, adding affiliates of Sterling Investment Partners as defendants. The complaint sought unspecified damages and alleged misleading statements in the registration statement and prospectus for the Company’s initial public offering and in subsequent communications regarding the Company’s business and financial results. On September 9, 2015, the district judge to whom the case was assigned granted the Company’s motion to dismiss the case.

In April 2014, a purported stockholder derivative action was filed against certain of the Company’s current and former directors in New York state court, asserting claims for breach of fiduciary duties and gross mismanagement based on substantially similar allegations as in the securities class action. In June 2014, the Company and the other defendants moved to dismiss the derivative complaint. On July 30, 2014, plaintiffs filed an amended complaint, adding affiliates of Sterling Investment Partners as defendants and asserting claims against them for breach of fiduciary duty and unjust enrichment. On September 29, 2014, the Company and the other defendants moved to dismiss the amended derivative complaint. On November 10, 2014, the court granted the Company and the other defendants’ motion to dismiss on the grounds that under the Company’s certificate of incorporation the derivative action must be brought in the State of Delaware. On June 18, 2015, the court denied the plaintiffs’ motion for reconsideration, and the plaintiffs’ opportunity to appeal the decision has expired. A similar case was filed in the Delaware Chancery Court in February 2015. On October 15, 2015, the plaintiff voluntarily dismissed this case.

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

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

10.RECENTLY ISSUED ACCOUNTING STANDARDS

The Company does not believe that any recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying consolidated financial statements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers.  ASU 2014-09 amends existing revenue recognition requirements and provides a new comprehensive revenue recognition model requiring entities to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This ASU was amended by ASU No. 2015-14, issued in August 2015, which deferred the original effective date by one year; the effective date is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2017.  The Company does not expect this adoption to have a material impact on its financial statements.

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.  ASU 2014-15 requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. ASU 2014-15 is effective for the fiscal years ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted.  The Company does not expect this adoption to have a material impact on its financial statements.

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs.  ASU 2015-03 amends existing requirements for debt issuance costs, requiring entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  ASU 2015-03 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015, and requires retrospective application.  Early adoption is permitted for financial statements that have not been previously issued.  The Company does not expect this adoption to have a material impact on its financial statements.

In April 2015, the FASB issued ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.  ASU 2015-05 provides clarification about a customer’s accounting for fees paid in a cloud computing arrangement, and provides guidance to customers about whether a cloud computing arrangement includes a software license, and the portion of the arrangement that should be accounted for as a service contract. ASU 2015-05 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015 and may be applied either prospectively or retrospectively, and early adoption is permitted. The Company does not expect this adoption to have a material impact on its financial statements. 

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

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended March 29, 2015, as filed with the Securities and Exchange Commission. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q.  See “Special Note on Forward Looking Statements” above. The results of operations for the thirteen and twenty-six weeks ended September 27, 2015 may not necessarily be indicative of the results that may be expected for the entire fiscal year ending April 3, 2016.

Our fiscal year is the 52- or 53-week period ending on the Sunday closest to March 31. For ease of reference, we identify our fiscal years by reference to the calendar year in which the fiscal year ends. Accordingly, “fiscal 2015” refers to our fiscal year ended on March 29, 2015 and “fiscal 2016” refers to our fiscal year ending April 3, 2016.  The thirteen week periods ended September 28, 2014 and September 27, 2015 are the second fiscal quarters of fiscal 2015 and fiscal 2016, respectively.

Overview

Fairway Market is a growth-oriented food retailer offering customers a differentiated one-stop shopping experience “Like No Other Market”. Since beginning as a small neighborhood market in the 1930s, Fairway has established itself as a leading food retailing destination in the Greater New York City metropolitan area, which we estimate is the largest food retail market 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 fifteen locations in New York, New Jersey and Connecticut, four of which include Fairway Wines & Spirits locations.  Fourteen of the stores were in operation prior to the beginning of fiscal 2015; one store was opened during the thirteen weeks ended September 28, 2014 and one Wine & Spirits location was opened during fiscal 2015, subsequent to September 28, 2014.  

We believe our stores are among the most productive in the industry in net sales per store and net sales per square foot as a result of our distinctive merchandising strategies and value positioning.

We intend to continue our growth by expanding our store base in the Greater New York City metropolitan area, improving our operating margins and increasing sales at existing stores.  For the next several years, we intend to grow our store base in the Greater New York City metropolitan area and, over time, we also plan to expand Fairway’s presence into new, high-density metropolitan markets.

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

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

Factors Affecting Our Operating Results

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

Store Openings

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

We believe our differentiated format and destination one-stop shopping appeal attracts customers from as far as twenty-five miles away. As we open new stores in closer proximity to our customers who currently travel longer distances to shop at our stores, we expect some of these customers to take advantage of the convenience of our new locations. As a result, we have experienced in the past, and expect to experience in the future, some sales volume transfer from our existing stores to our new stores as some of our existing customers switch to these new, closer locations. Consequently, while we expect our new stores will impact sales at our existing stores in close proximity, 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.

General Economic Conditions and Changes in Consumer Behavior

The overall economic environment in the Greater New York City metropolitan area and related changes in consumer behavior have a significant impact on our business. In general, positive conditions in the broader economy promote customer spending in our stores, while economic weakness results in a reduction in customer spending. Macroeconomic factors that can affect customer spending patterns, and thereby our results of operations, include employment rates, business conditions, changes in the housing market, the availability of consumer credit, interest rates, tax rates and fuel and energy costs.

Inflation and Deflation Trends

Inflation and deflation can impact our financial performance. During inflationary periods, our financial results can be positively impacted in the short term as we sell lower-priced inventory in a higher price environment. Over the longer term, the impact of inflation is largely dependent on our ability to pass price increases to our customers, which is subject to competitive market conditions.

Infrastructure Investment

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

Pricing Strategy

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

Productivity Initiatives

We have undertaken a number of initiatives to improve our gross margin and operating costs, including (i) business process improvements, (ii) labor productivity, (iii) supply chain management and (iv) shrink reduction.

Developments in Competitive Landscape

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,   warehouse clubs such as Costco and BJ’s Wholesale Club and online food retailers. 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 increasingly competitive environment in which we operate, our operating results have been, and in the future may be, negatively impacted through a loss of sales, reduction in margin from competitive price changes, and/or greater operating costs such as marketing. In addition, other established food retailers could enter our markets, increasing competition for market share.

Changes in Interest Expense

Our interest expense in any particular period is impacted by our overall level of indebtedness during that period and changes in the interest rates payable on such indebtedness.

Effect of Weather-related and Other Emergencies

During any fiscal period, events of extreme weather and other emergencies such as mass utility outages can cause changes in consumer behavior, labor availability, suppliers’ ability to meet our demand and in some cases our ability to keep our stores open immediately before, during, and immediately following such events, which can have a  significant impact on our operating results.  

How We Assess the Performance of Our Business

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

Net Sales

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

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

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

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

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

Gross Profit

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

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

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

Direct Store Expenses

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

General and Administrative Expenses

General and administrative expenses consist primarily of personnel costs that are not store specific, depreciation and amortization expense as well as other expenses associated with our corporate headquarters, management expenses and expenses for accounting, information systems, legal, business development, human resources, purchasing and other administrative departments.

The components of our general and administrative expenses may not be identical to those of our competitors. As a result, data regarding our general and administrative expenses may not be comparable to similar data made available by our competitors.

Store Opening Costs

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

Production Center Start-up Costs

Production center start-up costs include rent expense incurred during construction of a new facility and costs related to the location opening, including costs associated with hiring and training personnel, supplies and other miscellaneous costs. Rent expense is recognized upon receiving possession of the site. Production center start-up costs are expensed as incurred.

Income from Operations

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

Adjusted EBITDA

We present Adjusted EBITDA, a non-GAAP measure, in this report to provide investors with a supplemental measure of our operating performance. We believe that Adjusted EBITDA is a useful performance measure to evaluate our core on-going operations and we use it to facilitate a comparison of our core on-going operating performance on a consistent basis from period-to-period and to provide for a more complete understanding of factors and trends affecting our business than GAAP measures alone can provide. We also use Adjusted EBITDA as one of the primary methods for planning and forecasting overall expected performance and for evaluating on a quarterly and annual basis actual results against such expectations, and as a performance evaluation metric in determining achievement of certain compensation programs and plans for employees, including our senior executives. Management and our board also use Adjusted EBITDA as one of the key measures in determining the value of any strategic, investing or financing opportunity. In addition, the financial covenant in our senior credit facility is based on Adjusted EBITDA, subject to dollar limitations on certain adjustments. The adjustments and related amounts included in Adjusted EBITDA are in substantial accordance with Consolidated EBITDA as defined in our existing senior credit agreement, subject to dollar limitations on certain adjustments. Consolidated EBITDA as computed under our existing senior credit agreement for the four fiscal quarter period ended September 27, 2015 and September 28, 2014 was $40.4 million and $46.4 million, respectively, compared to Adjusted EBITDA for the four fiscal quarter period ended September 27, 2015 and September 28, 2014 of $38.7 million and $43.3 million,  respectively. Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

We define Adjusted EBITDA as earnings before interest expense, income taxes, depreciation and amortization expense, amortization of deferred financing costs, equity compensation charges, store opening costs (including pre-opening advertising costs), production center start-up costs, severance related expenses, organizational realignment costs, transaction expenses and bonuses, and other one-time charges and non-operating expenses which we believe may distort period-to-period comparison. Omitting interest, taxes and the other items provides a financial measure that facilitates comparisons of our results of operations with those of companies having different capital structures. Since the levels of indebtedness and tax structures that other companies have are different from ours, we omit these amounts to facilitate investors’ ability to make these comparisons. Similarly, we omit depreciation and amortization because other companies may employ a greater or lesser amount of owned property, and because in our experience, whether a store is new or one that is fully or mostly depreciated does not necessarily correlate to the contribution that such store makes to operating performance. Items such as production center start-up costs, severance-related expenses, non-recurring charges, organizational realignment costs and transaction expenses and bonuses were incurred and associated with discrete and different events not relating to our core on-going operations, including an organizational realignment to remove redundant costs and streamline parts of our business model to enhance overall productivity that we began in the fourth quarter of fiscal 2014 and completed in fiscal 2015. We also believe that investors, analysts and other interested parties view our ability to generate Adjusted EBITDA as an important measure of our operating performance and that of other companies in our industry. Adjusted EBITDA should not be considered as an alternative to net income for the periods indicated as a measure of our performance.

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

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