Attached files
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EX-32.2 - EXHIBIT 32.2 - Franchise Group, Inc. | frg-03282020ex322.htm |
EX-32.1 - EXHIBIT 32.1 - Franchise Group, Inc. | frg-03282020ex321.htm |
EX-31.2 - EXHIBIT 31.2 - Franchise Group, Inc. | frg-03282020ex312.htm |
EX-31.1 - EXHIBIT 31.1 - Franchise Group, Inc. | frg-03282020ex311.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 28, 2020
OR
o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number 001-35588
Franchise Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 27-3561876 | |
(State of incorporation) | (IRS employer identification no.) |
1716 Corporate Landing Parkway
Virginia Beach, Virginia 23454
(Address of principal executive offices)
(757) 493-8855
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading symbol(s) | Name of each exchange on which registered | ||
Common stock, par value $.01 per share | FRG | NASDAQ Global Market |
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 ý No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | o | Accelerated filer | x |
Non-accelerated filer | o | Smaller reporting company | x |
Emerging growth company | o | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The number of shares outstanding of the registrant's common stock, par value $0.01 value per share, as of June 15, 2020 was 35,161,402 shares.
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Form 10-Q for the Quarterly Period Ended March 28, 2020
Table of Contents
Page | ||
Number | ||
PART I. FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS (UNAUDITED)
1
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share count and per share data) | March 28, 2020 | December 28, 2019 | ||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 147,028 | $ | 39,581 | ||||
Current receivables, net | 136,254 | 79,693 | ||||||
Inventories, net | 359,447 | 300,312 | ||||||
Other current assets | 28,279 | 20,267 | ||||||
Total current assets | 671,008 | 439,853 | ||||||
Property, equipment, and software, net | 154,713 | 150,147 | ||||||
Non-current receivables, net | 15,581 | 18,638 | ||||||
Goodwill | 469,459 | 134,301 | ||||||
Intangible assets, net | 148,779 | 77,590 | ||||||
Operating lease right-of-use assets | 535,092 | 462,610 | ||||||
Other non-current assets | 24,891 | 15,406 | ||||||
Total assets | $ | 2,019,523 | $ | 1,298,545 | ||||
Liabilities and Stockholders' Equity | ||||||||
Current liabilities: | ||||||||
Current installments of long-term obligations | $ | 257,466 | $ | 218,384 | ||||
Current operating lease liabilities | 126,701 | 107,680 | ||||||
Accounts payable and accrued expenses | 259,803 | 158,995 | ||||||
Other current liabilities | 36,444 | 16,409 | ||||||
Total current liabilities | 680,414 | 501,468 | ||||||
Long-term obligations, excluding current installments | 554,004 | 245,236 | ||||||
Non-current operating lease liabilities | 434,677 | 394,307 | ||||||
Other non-current liabilities | 21,408 | 5,773 | ||||||
Total liabilities | 1,690,503 | 1,146,784 | ||||||
Stockholders' equity: | ||||||||
Common stock, $0.01 par value per share, 180,000,000 and 180,000,000 shares authorized, 29,653,052 and 18,250,225 shares issued and outstanding at March 28, 2020 and December 28, 2019, respectively | 297 | 183 | ||||||
Preferred stock, $0.01 par value per share, 20,000,000 and 20,000,000 shares authorized, 1,099,122 and 1,886,667 shares issued and outstanding at March 28, 2020 and December 28, 2019, respectively | 11 | 19 | ||||||
Additional paid-in capital | 237,354 | 108,339 | ||||||
Accumulated other comprehensive loss, net of taxes | (2,306 | ) | (1,538 | ) | ||||
Retained earnings | 73,652 | 18,388 | ||||||
Total equity attributable to Franchise Group, Inc. | 309,008 | 125,391 | ||||||
Non-controlling interest | 20,012 | 26,370 | ||||||
Total equity | 329,020 | 151,761 | ||||||
Total liabilities and equity | $ | 2,019,523 | $ | 1,298,545 |
See accompanying notes to condensed consolidated financial statements.
2
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
Three Months Ended | ||||||||
(In thousands, except share count and per share data) | March 28, 2020 | March 31, 2019 | ||||||
Revenues: | ||||||||
Product | $ | 473,505 | $ | — | ||||
Service and other | 102,640 | 95,838 | ||||||
Rental | 16,420 | — | ||||||
Total revenues | 592,565 | 95,838 | ||||||
Operating expenses: | ||||||||
Cost of revenue: | ||||||||
Product | 287,818 | — | ||||||
Service and other | 756 | — | ||||||
Rental | 5,942 | — | ||||||
Total cost of revenue | 294,516 | — | ||||||
Selling, general, and administrative expenses | 252,212 | 40,965 | ||||||
Total operating expenses | 546,728 | 40,965 | ||||||
Income from operations | 45,837 | 54,873 | ||||||
Other income (expense): | ||||||||
Other | (4,056 | ) | 7 | |||||
Interest expense, net | (25,752 | ) | (1,055 | ) | ||||
Income before income taxes | 16,029 | 53,825 | ||||||
Income tax expense (benefit) | (45,869 | ) | 15,634 | |||||
Net income | 61,898 | 38,191 | ||||||
Less: Net income attributable to non-controlling interest | (2,359 | ) | — | |||||
Net income attributable to Franchise Group, Inc. | $ | 59,539 | $ | 38,191 | ||||
Net income per share of common stock: | ||||||||
Basic | $ | 2.55 | $ | 2.72 | ||||
Diluted | 2.51 | 2.71 | ||||||
Weighted-average shares outstanding: | ||||||||
Basic | 23,373,980 | 14,055,752 | ||||||
Diluted | 23,693,035 | 14,112,659 |
See accompanying notes to condensed consolidated financial statements.
3
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(In thousands) | Three Months Ended | |||||||
March 28, 2020 | March 31, 2019 | |||||||
Net income | $ | 61,898 | $ | 38,191 | ||||
Other comprehensive income (loss) | ||||||||
Unrealized loss on interest rate swap agreement, net of taxes of $(29) and $(8), respectively | (73 | ) | (21 | ) | ||||
Foreign currency translation adjustment | (872 | ) | 227 | |||||
Forward contracts related to foreign currency exchange rates | 2 | (18 | ) | |||||
Other comprehensive income (loss) | (943 | ) | 188 | |||||
Comprehensive income | 60,955 | 38,379 | ||||||
Less: comprehensive income attributable to non-controlling interest | (2,184 | ) | — | |||||
Comprehensive income attributable to Franchise Group, Inc. | $ | 58,771 | $ | 38,379 |
See accompanying notes to condensed consolidated financial statements.
4
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders' Equity (Unaudited)
Three Months Ended March 28, 2020 | |||||||||||||||||||||||||||||||||||||
(In thousands) | Common stock shares | Common stock | Preferred stock shares | Preferred stock | Additional paid-in-capital | Accumulated other comprehensive loss | Retained earnings | Total Franchise Group equity | Non-controlling interest | Total equity | |||||||||||||||||||||||||||
Balance at December 28, 2019 | 18,250 | $ | 183 | 1,887 | $ | 19 | $ | 108,339 | $ | (1,538 | ) | $ | 18,388 | $ | 125,391 | 26,370 | $ | 151,761 | |||||||||||||||||||
Changes and distributions of non-controlling interest in New Holdco LLC | — | — | — | — | 3,826 | — | — | 3,826 | (6,184 | ) | (2,358 | ) | |||||||||||||||||||||||||
Net income | — | — | — | — | — | — | 59,539 | 59,539 | 2,359 | 61,898 | |||||||||||||||||||||||||||
Total other comprehensive loss | — | — | — | — | — | (768 | ) | — | (768 | ) | (175 | ) | (943 | ) | |||||||||||||||||||||||
Stock-based compensation expense, net | 3 | — | — | — | 2,449 | — | — | 2,449 | — | 2,449 | |||||||||||||||||||||||||||
Issuance of common stock | 7,462 | 75 | — | — | 123,019 | — | — | 123,094 | — | 123,094 | |||||||||||||||||||||||||||
Conversion of preferred to common stock | 3,938 | 39 | (788 | ) | (8 | ) | (279 | ) | — | — | (248 | ) | — | (248 | ) | ||||||||||||||||||||||
Dividend declared ($0.25 per share) | — | — | — | — | — | — | (6,633 | ) | (6,633 | ) | — | (6,633 | ) | ||||||||||||||||||||||||
Adjustment | — | — | — | — | — | — | 2,358 | 2,358 | (2,358 | ) | — | ||||||||||||||||||||||||||
Balance at March 28, 2020 | 29,653 | $ | 297 | 1,099 | $ | 11 | $ | 237,354 | $ | (2,306 | ) | $ | 73,652 | $ | 309,008 | $ | 20,012 | $ | 329,020 |
Three Months Ended March 31, 2019 | |||||||||||||||||||||||||||||||||||||
(In thousands) | Common stock shares | Common stock | Preferred stock shares | Preferred stock | Additional paid-in-capital | Accumulated other comprehensive loss | Retained earnings | Total Franchise Group equity | Non-controlling interest | Total equity | |||||||||||||||||||||||||||
Balance at December 31, 2018 | 14,044 | $ | 140 | — | $ | — | $ | 12,091 | $ | (2,018 | ) | $ | 52,029 | $ | 62,242 | $ | — | $ | 62,242 | ||||||||||||||||||
Net income | — | — | — | — | — | — | 38,191 | 38,191 | — | 38,191 | |||||||||||||||||||||||||||
Total other comprehensive income | — | — | — | — | — | 188 | — | 188 | — | 188 | |||||||||||||||||||||||||||
Exercise of stock options | 14 | — | — | — | 153 | — | — | 153 | — | 153 | |||||||||||||||||||||||||||
Stock-based compensation, net | — | — | — | — | 388 | — | — | 388 | — | 388 | |||||||||||||||||||||||||||
RSU Dividend accrual | — | — | — | — | — | — | 4 | 4 | — | 4 | |||||||||||||||||||||||||||
Balance at March 31, 2019 | 14,058 | $ | 140 | — | $ | — | $ | 12,632 | $ | (1,830 | ) | $ | 90,224 | $ | 101,166 | $ | — | $ | 101,166 |
See accompanying notes to condensed consolidated financial statements.
5
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended | ||||||||
(In thousands) | March 28, 2020 | March 31, 2019 | ||||||
Operating Activities | ||||||||
Net income | $ | 61,898 | $ | 38,191 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for doubtful accounts | 1,672 | 1,930 | ||||||
Depreciation, amortization and impairment charges | 15,927 | 4,073 | ||||||
Amortization of deferred financing costs | 11,744 | 100 | ||||||
Stock-based compensation expense - equity awards | 2,485 | 388 | ||||||
Loss (gain) on bargain purchases and sales of Company-owned offices | (808 | ) | 555 | |||||
Equity in (gain) loss of affiliate | 88 | (1 | ) | |||||
Deferred tax expense (benefit) | 5,010 | 1,949 | ||||||
Change in | ||||||||
Accounts, notes, and interest receivable | (10,203 | ) | (16,195 | ) | ||||
Income taxes receivable | (51,857 | ) | 13,186 | |||||
Other assets | (2,364 | ) | 270 | |||||
Accounts payable and accrued expenses | 41,921 | 7,146 | ||||||
Inventory | 40,066 | — | ||||||
Deferred revenue | 189 | (836 | ) | |||||
Net cash provided by operating activities | 115,768 | 50,756 | ||||||
Investing Activities | ||||||||
Issuance of operating loans to franchisees and ADs | (28,212 | ) | (38,402 | ) | ||||
Payments received on operating loans to franchisees and ADs | 47,800 | 63,127 | ||||||
Purchases of Company-owned offices, AD rights, and acquired customer lists | (2,251 | ) | (91 | ) | ||||
Proceeds from sale of Company-owned offices and AD rights | 950 | 22 | ||||||
Acquisition of business, net of cash acquired | (357,263 | ) | — | |||||
Purchases of property, equipment, and software | (6,184 | ) | (359 | ) | ||||
Net cash used in investing activities | (345,160 | ) | 24,297 | |||||
Financing Activities | ||||||||
Proceeds from the exercise of stock options | — | 153 | ||||||
Dividends paid | (3,943 | ) | — | |||||
Non-controlling interest distribution | (2,358 | ) | — | |||||
Repayment of other long-term obligations | (370,503 | ) | (1,801 | ) | ||||
Borrowings under revolving credit facility | 142,000 | 47,668 | ||||||
Repayments under revolving credit facility | (79,260 | ) | (114,459 | ) | ||||
Issuance of common stock | 80,682 | — | ||||||
Payment for debt issue costs | (14,408 | ) | — | |||||
Issuance of debt | 586,000 | — | ||||||
Cash paid for taxes on exercises/vesting of stock-based compensation | (36 | ) | — | |||||
Net cash provided by (used in) financing activities | 338,174 | (68,439 | ) | |||||
Effect of exchange rate changes on cash, net | (1,335 | ) | 80 | |||||
Net increase (decrease) in cash equivalents and restricted cash | 107,447 | 6,694 | ||||||
Cash and cash equivalents and restricted cash at beginning of period | 45,146 | 3,981 | ||||||
Cash and cash equivalents and restricted cash at end of period | $ | 152,593 | $ | 10,675 | ||||
Supplemental Cash Flow Disclosure | ||||||||
Cash paid for taxes, net of refunds | $ | 466 | $ | — | ||||
Cash paid for interest | $ | 15,332 | $ | 916 | ||||
Accrued capital expenditures | $ | 4,061 | $ | — | ||||
Deferred financing costs from issuance of common stock | $ | 31,013 | $ | — | ||||
Share issuance proceeds included in accounts receivable | $ | 11,385 | $ | — | ||||
Tax receivable agreement included in other long-term liabilities | $ | 7,449 | $ | — |
See accompanying notes to condensed consolidated financial statements.
6
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
March 28, 2020 and March 31, 2019
(1) Organization and Significant Accounting Policies
Description of Business
Franchise Group, Inc. (the "Company"), a Delaware corporation, is a franchisor, operator and acquirer of franchised and franchisable businesses that it believes it can scale using its operating expertise. On July 10, 2019, the Company formed Franchise Group New Holdco, LLC (“New Holdco”), which completed the acquisition of Buddy's Newco, LLC ("Buddy's") (the "Buddy's Acquisition"). On October 23, 2019, the Company completed the acquisition of the Sears Outlet ("Sears Outlet") business from Sears Hometown and Outlet Stores, Inc. (subsequently rebranded as American Freight Outlet). On December 16, 2019, the Company completed its acquisition of the Vitamin Shoppe, Inc. ("the Vitamin Shoppe"). On February 14, 2020, the Company completed its acquisition of the American Freight Group, Inc. ("American Freight") as described in “Note 2. Acquisitions”. These acquisitions have transformed us from a tax preparation business to a multi-segment operator and franchisor. New Holdco holds all of the Company’s operating subsidiaries.
Segment Information
The Company currently operates in four reportable segments: Liberty Tax, Buddy’s, Vitamin Shoppe and American Freight. Sears Outlet, which was previously a separate reportable segment, was rebranded as American Freight Outlet and is included in the American Freight segment following the acquisition of American Freight. The Liberty Tax segment provides income tax services in the United States of America (the "U.S.") and Canada. The Buddy's segment is a specialty retailer engaged in the business of leasing and selling consumer electronics, residential furniture, appliances and household accessories. The Vitamin Shoppe segment is an omni-channel specialty retailer and wellness lifestyle company with the mission of providing customers with the most trusted products, guidance and services to help them become their best selves. The Vitamin Shoppe segment offers a comprehensive assortment of nutritional solutions, including vitamins, minerals, specialty supplements, herbs, sports nutrition, homeopathic remedies, green living products, and natural beauty aids through proprietary brands. The American Freight segment operates under the American Freight and American Freight Outlet banners. American Freight is a retail chain offering brand-name furniture, mattresses and home accessories at discount prices. American Freight Outlet provides in-store and online access to purchase new, one-of-a-kind, out-of-box, discontinued, obsolete, used, reconditioned, overstocked and scratched and dented products, collectively "outlet-value products" across a broad assortment of merchandise categories, including home appliances, mattresses, furniture and lawn and garden equipment at value-oriented prices.
Principles of Consolidation
The Company consolidates any entities in which it has a controlling interest, the usual condition of which is ownership of a majority voting interest. The Company is the sole managing member of New Holdco and possesses ownership of more than 50 percent of the outstanding voting units. As a result, the Company consolidates the financial results of New Holdco and reports a non-controlling interest that represents the interests of the New Holdco units not held by the Company. The assets and liabilities of New Holdco reflect substantially all of the Company’s consolidated assets and liabilities with the exception of certain cash balances and deferred tax liabilities. As of March 28, 2020, the Company had an ownership interest of 84.2% in New Holdco and reported a non-controlling interest equal to 15.8%. Subsequent to March 28, 2020, the Company redeemed all outstanding New Holdco units for shares of common stock of the Company.
The Company does not possess any ownership interests in franchisee entities; however, the Company may provide financial support to franchisee entities. Because the Company's franchise arrangements provide franchisee entities the power to direct the activities that most significantly impact their economic performance, the Company does not consider itself the primary beneficiary of any such entity that meets the definition of a variable interest entity ("VIE"). Based on the results of management's analysis of potential VIEs, the Company has not consolidated any franchisee entities. The Company's maximum exposure to loss resulting from involvement with potential VIEs is attributable to accounts and notes receivables and future lease payments due from franchisees. When the Company does not have a controlling interest in an entity but has the ability to exert significant influence over the entity, the Company applies the equity method of accounting. All intercompany balances and transactions have been eliminated in consolidation.
7
Basis of Presentation
Revenues have been classified into product, service and other and rental revenues as further discussed in "Note 5 - Revenue." Costs of sales for product includes the cost of merchandise, transportation and warehousing costs. Service and other costs of sales include the direct costs of warranties as well as, the cost of delivery and handling related to merchandise sold online. Rental cost of sales represents the amortization of inventory costs over the leased term. Other operating expenses, including employee costs, depreciation and amortization, and advertising expenses have been classified in selling, general and administrative expenses. The Company also includes occupancy costs in selling, general and administrative expenses.
Assets and liabilities of the Company's Canadian operations have been translated into U.S. dollars using the exchange rate in effect at the end of the period. Revenues and expenses have been translated using the average exchange rates in effect each month of the period. Foreign exchange transaction gains and losses are recognized when incurred.
The Company reclassifies to accounts payable checks issued in excess of funds available and reports them as cash flow from operating activities.
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information. The condensed consolidated financial statements, including these notes, are unaudited and exclude some of the disclosures required only in annual financial statements. The Company changed its fiscal year end from April 30 to the Saturday closest to December 31st of each year, resulting in an 8-month transition period from May 1, 2019 to December 28, 2019. The consolidated balance sheet data as of December 28, 2019 was derived from the Company’s Transition Report on Form 10-K/T, filed with the U.S. Securities and Exchange Commission (the "SEC") on April 24, 2020 (the "2019 Transition Report"). The Company has provided unaudited historical financial information that was not previously presented for the three months ending March 31, 2019 for comparison purposes.
In the opinion of management, all adjustments necessary for a fair presentation of such condensed consolidated financial statements in accordance with GAAP have been recorded. These adjustments consisted only of normal recurring items. The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in its 2019 Transition Report.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Merchandise Inventories
Inventory for the Buddy's segment is recorded at cost, including shipping and handling fees. All lease merchandise is available for lease or sale. Upon purchase, merchandise is not initially depreciated until it is leased or three months after the purchase date. Non-leased merchandise is depreciated on a straight-line basis over a period of 24 months. Leased merchandise is depreciated over the lease term of the rental agreement and recorded in rental cost of revenue. On a weekly basis, all damaged, lost, stolen, or unsalable merchandise identified is written off. Maintenance and repairs of lease merchandise are charged to operations as incurred.
Inventory for the American Freight segment is accounted for by banner. Inventory for the American Freight banner is comprised of finished goods and is valued at the lower of cost or market, with cost determined by the first-in, first out method. The Company writes down inventory, the impact of which is reflected in cost of sales in the Consolidated Statements of Operations, if the cost of specific inventory items on hand exceeds the amount the Company expects to be realized from the ultimate sale or disposal of the inventory. These estimates are based on management’s judgment regarding future demand and market conditions and analysis of historical experience. Inventory under the American Freight Outlet banner, previously the Sears Outlet segment, is recorded at the lower of cost or market using the weighted-average cost method. Inventory includes the purchase price of the inventory plus costs of freight for moving merchandise from vendors to distribution centers as well as from distribution centers to stores. A provision for estimated shrinkage is maintained based on the actual historical results of physical inventories. Estimates are compared to the actual results of the physical inventory counts as they are taken and adjust the shrink estimates accordingly. Inventory values are adjusted to the difference between the carrying value and the estimated
8
market value, based on assumptions about future demand or when a permanent markdown indicates that the net realizable value of the inventory is less than cost.
Inventory for the Vitamin Shoppe segment is recorded at the lower of cost or market value using the weighted-average cost method. Inventory includes costs directly incurred in bringing the product to its existing condition and location. In addition, the cost of inventory is reduced by purchase discounts and other allowances received from vendors. A markdown reserve is estimated based on a variety of factors, including, but not limited to, the amount of inventory on hand and its remaining shelf life, current and expected market conditions and product expiration dates. In addition, the Company has established a reserve for estimated inventory shrinkage based on the actual, historical shrinkage of our most recent physical inventories adjusted, if necessary, for current economic conditions and business trends. Physical inventories and cycle counts are taken on a regular basis. These adjustments are estimates, which could vary significantly from actual results if future economic conditions, customer demand or competition differ from management expectations.
Goodwill and Non-amortizing Intangible Assets
Goodwill and non-amortizing intangible assets, including the Buddy's, Vitamin Shoppe and American Freight trade names, are not amortized, but rather tested for impairment at least annually. In addition, goodwill and non-amortizing intangible assets will be tested on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred. The Company performs a qualitative and/or quantitative assessment to determine whether it is more likely than not that each reporting unit's fair value is less than its carrying value, including goodwill. If the Company determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, the Company then estimates the fair value. The Company uses a combination of a market multiple method and a discounted cash flow method to estimate the fair value of its reporting units and recognizes goodwill impairment for any excess of the carrying amount of a reporting unit’s goodwill over its estimated fair value. The Company evaluates the Buddy's, Vitamin Shoppe and American Freight trade names for impairment by comparing its fair value, based on an income approach using the relief-from-royalty method, to its carrying value. If the carrying value of the asset exceeds its estimated fair value, an impairment loss is recognized in an amount equal to that excess. The Company's reporting units are determined in accordance with the provisions of Accounting Standards Codification (“ASC”) 350, “Intangibles - Goodwill and Other (Topic 350).” The Company performs its annual impairment testing of goodwill and non-amortizing intangible assets on the last day of the first month of the Company's third quarter. Refer to “Note 4 - Goodwill and Intangible Assets” for additional information on the results of the impairment tests.
Intangible and Long-Lived Assets Impairment
Amortization of intangible assets is calculated using the straight-line method over the estimated useful lives of the assets, generally from two to ten years. Long-lived assets, such as property, equipment, and software, and other purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. Recognition and measurement of a potential impairment is performed for these assets at the lowest level where cash flows are individually identifiable. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values, and third-party independent appraisals, as considered necessary.
Revenue Recognition
The following is a description of the principal activities from which the Company generates its revenues. For more detailed information regarding reportable segments, see "Note 13 - Segments."
• | Product revenues: These include sales of merchandise at the stores and online. Revenue is measured based on the amount of fixed consideration that the Company expects to receive, reduced by estimates for variable consideration such as returns. Revenue also excludes any amounts collected from customers and remitted or payable to governmental authorities. In arrangements where the Company has multiple performance obligations, the transaction price is allocated to each performance obligation using the relative stand-alone selling price. The Company recognizes revenues from retail operations upon the transfer of control of goods to the customer. The Company satisfies its performance obligations at the point of sale for retail store transactions and upon delivery for online transactions. The Company recognizes revenue for retail store and online transactions when it transfers control of the goods to the customer. The performance obligation is generally satisfied in the following reporting |
9
period. Merchandise sales also include payments received for the exercise of the early purchase option offered through rental-purchase agreements or merchandise sold through point of sale transactions. Revenue for merchandise sales associated with rental purchase agreements is recognized when payment is received, and ownership of the merchandise passes to the customer. The remaining net value of merchandise sold is recorded to cost of sales at the time of the transaction.
• | Service and other revenues: These include royalties and advertising fees from franchisees, fees from the sales of franchises and area developer territories, financial products, interest income from loans to franchisees and ADs, tax preparation services in our Company-owned stores, electronic filing fees, commissions on merchandise sales made through www.sears.com, services and extended-service plans and financing programs. Commissions earned on services are presented net of related costs because the Company is acting as an agent in arranging the services for the customer and does not control the services being rendered. The Company recognizes revenue on the commissions on extended-service plans when it transfers control of the related goods to the customer. The Company recognizes franchise fee and AD fee revenue for the sales of individual territories on a straight-line basis over the initial contract term when the obligations of the Company to prepare the franchisee and AD for operation are substantially complete, not to exceed the estimated amount of cash to be received. Royalties and advertising fees are recognized as franchise territories generate sales. Tax return preparation fees and financial products revenue are recognized as revenue in the period the related tax return is filed for the customer. Discounts for promotional programs are recorded at the time the return is filed and are recorded as reductions to revenues. Interest income on notes receivable is recognized based on the outstanding principal note balance less unrecognized revenue unless it is put on non-accrual status. Interest income on the unrecognized revenue portion of notes receivable is recognized when received. For accounts receivable, interest income is recognized based on the outstanding receivable balance over 30 days old, net of an allowance. |
• | Rental revenues: The Company provides merchandise, consisting of consumer electronics, computers, residential furniture, appliances, and household accessories to its customers pursuant to rental-purchase agreements which provide for weekly, semi-monthly or monthly non-refundable rental payments. The average rental term is twelve to eighteen months and the Company maintains ownership of the lease merchandise until all payment obligations are satisfied under sales and lease ownership agreements. Customers have the option to purchase the leased goods at any point in the lease term. Customers can terminate the agreement at the end of any rental term without penalty. Therefore, rental transactions are accounted for as operating leases and rental revenue is recognized over the rental term. Cash received prior to the beginning of the lease term is recorded as deferred revenue. Revenue related to various payment, reinstatement or late fees are recognized when paid by the customer at the point service is provided. The Company offers additional product plans along with rental agreements that provide customers with liability protection against significant damage or loss of a product, and club membership benefits, including various discount programs, product services and replacement benefits in the event merchandise is damaged or lost. Customers renew product plans in conjunction with their rental term renewals and can cancel the plans at any time. Revenue for product plans is recognized over the term of the plan. |
Leases
The Company's lease portfolio primarily consists of leases for its retail store locations and office space. The Company also leases certain office equipment under finance leases. The finance lease right of use assets and lease liabilities are included in PP&E, current installments of long-term debt, and long-term debt, respectively. These leases are immaterial to the financial statements. The Company subleases some of its real estate and equipment leases. The Company determines if an arrangement is a lease at inception by evaluating whether the arrangement conveys the right to use an identified asset and whether the Company obtains substantially all of the economic benefits from and has the ability to direct the use of the asset. Leases with an initial term of 12 months or less are not recorded on the condensed consolidated balance sheets; the Company recognizes expense for these leases on a straight-line basis over the lease term. For leases with an initial term in excess of 12 months, lease right-of-use assets and lease liabilities are recognized based on the present value of the future lease payments over the committed lease term at the lease commencement date. The Company’s leases do not provide an implicit rate; therefore, the Company uses its incremental borrowing rate and the information available at the lease commencement date in determining the present value of future lease payments. Most leases include one or more options to renew and the exercise of renewal options is at the Company’s sole discretion. The Company does not include renewal options in its determination of the lease term unless the renewals are deemed to be reasonably certain at lease commencement. Operating lease expense for lease payments is recognized on a straight-line basis over the lease term. Lease right-of-use assets are periodically reviewed for impairment losses. The Company uses the long-lived assets impairment guidance in ASC Subtopic 360-10, “Property, Plant, and Equipment - Overall,” to determine whether a right-of-use asset is impaired, and if so, the amount of the impairment loss to recognize.
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The Company has lease agreements with lease and non-lease components, which the Company elects to combine as one lease component for all classes of underlying assets. Non-lease components include variable costs based on actual costs incurred by the lessor related to the payment of real estate taxes, common area maintenance, and insurance. These variable payments are expensed as incurred as variable lease costs.
Due to the COVID-19 pandemic, the Company has been negotiating lease concessions with landlords. The lease concessions have been in the form of lease forgiveness, lease deferrals and lease deferrals with term extensions. If the total payments in the modified lease are substantially the same as or less than total payments in the original lease, the Company has elected to not evaluate whether the concession is a lease modification as defined in ASC 842 - "Leases".
Deferred Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities, which are shown on our condensed consolidated balance sheets, are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has elected to classify interest charged on a tax settlement in interest expense, and accrued penalties, if any, in selling, general, and administrative expenses.
The determination of the Company's provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment is required in assessing the timing and amounts of deductible and taxable items. The Company records unrecognized tax benefit liabilities for known or anticipated tax issues based on an analysis of whether, and the extent to which, additional taxes will be due.
Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-13, "Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which changes how companies will measure credit losses for most financial assets and certain other instruments that aren't measured at fair value through net income. The standard replaces the "incurred loss" approach with an "expected loss" model for instruments measured at amortized cost (which generally will result in the earlier recognition of allowances for losses) and requires companies to record allowances for available-for-sale debt securities, rather than reduce the carrying amount. In addition, companies will have to disclose significantly more information, including information used to track credit quality by year of origination, for most financing receivables. The ASU should be applied as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the standard is effective. The ASU is effective for SEC filers that are smaller reporting companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. The ASU is effective for the Company for the fiscal year beginning January 1, 2023. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This standard eliminates Step 2 from the goodwill impairment test. Instead, an entity should compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The ASU is effective for SEC filers that are not smaller reporting companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 and for smaller reporting companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. The ASU is effective for the Company for the fiscal year beginning January 1, 2023. The Company is currently evaluating the impact of the adoption of this standard to its consolidated financial statements.
11
(2) Acquisitions
American Freight Acquisition
On February 14, 2020, the Company, pursuant to the terms of the Agreement and Plan of Merger with American Freight, the Company completed its acquisition of American Freight (the "American Freight Acquisition"). The Company accounted for the transaction as a business combination using the acquisition method of accounting. The preliminary fair value of the consideration transferred at the acquisition date was $357.3 million.
The table below summarizes the unaudited preliminary estimates of the fair values of the identifiable assets acquired and liabilities assumed in the American Freight Acquisition as of February 14, 2020. The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in an adjustment to the preliminary values presented below. The Company expects to complete the purchase price allocation as soon as reasonably possible but not to exceed one year from the American Freight Acquisition date.
(In thousands) | Preliminary 2/14/2020 | |||
Cash and cash equivalents | $ | 3,840 | ||
Prepaid expenses and other current assets | 3,284 | |||
Inventories, net | 99,200 | |||
Property, equipment and software, net | 11,032 | |||
Goodwill | 335,474 | |||
Operating lease right-of-use assets | 91,101 | |||
Other intangible assets, net | 70,200 | |||
Other non-current assets | 1,607 | |||
Total assets | 615,738 | |||
Current operating lease liabilities | 17,242 | |||
Accounts payable | 44,696 | |||
Accrued expenses and other current liabilities | 26,451 | |||
Current installments of long-term obligations | 3,210 | |||
Long-term obligations, excluding current installments | 93,975 | |||
Deferred tax liabilities | 11,451 | |||
Non-current operating lease liabilities | 61,450 | |||
Total liabilities | 258,475 | |||
Consideration transferred | $ | 357,263 |
Goodwill is calculated as the excess of the purchase price over the fair value of the net assets acquired. The goodwill recognized is attributable to operational synergies in the expected franchise models and growth opportunities.
The Company identified the American Freight trade name as an indefinite-lived intangible asset with a fair value of $70.2 million. The trade name is not subject to amortization but will be evaluated annually for impairment.
Lease right-of-use assets and lease liabilities consists of leases for retail store locations, vehicles and office equipment. The lease right of use assets incorporates an adjustment of $11.5 million, net for favorable and unfavorable American Freight leases (as compared to prevailing market rates) which will be amortized over the remaining lease terms.
The acquired property and equipment consists of leasehold improvements of $7.6 million, office furniture, fixtures and equipment of $2.2 million, computer hardware and software of $1.1 million and construction in progress of $0.2 million.
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Sears Outlet Acquisition
On October 23, 2019, the Company completed the acquisition of the Sears Outlet business from Sears Hometown and Outlet Stores, Inc. (the "Sears Outlet Acquisition") pursuant to the terms of the Equity and Asset Purchase Agreement, dated as of August 27, 2019, for an aggregate purchase price of $128.8 million. The Company accounted for the transaction as a business combination using the acquisition method of accounting. In the three months ended March 28, 2020 the preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed were adjusted which resulted in an increase in goodwill of $0.3 million.
Pro forma financial information
The following unaudited consolidated pro forma summary has been prepared by adjusting the Company's historical data to give effect to the acquisitions of American Freight, Vitamin Shoppe, Sears Outlet, Buddy's, A Team Leasing LLC and Buddy's Partners as if they had occurred on May 1, 2018.
Pro Forma -Unaudited | ||||||||
Three Months Ended | ||||||||
(In thousands) | March 28, 2020 | March 31, 2019 | ||||||
Revenue | $ | 641,196 | $ | 678,394 | ||||
Net income | $ | 70,832 | $ | 50,964 |
The unaudited consolidated pro forma financial information was prepared in accordance with accounting standards and is not necessarily indicative of the results of operations that would have occurred if the acquisition of American Freight, Vitamin Shoppe, the Sears Outlet, the Buddy's, the A-Team Leasing or the Buddy's Partners had been completed on the date indicated, nor is it indicative of the future operating results of the Company.
The unaudited pro forma results do not reflect events that either have occurred or may occur after the acquisition, including, but not limited to, the anticipated realization of operating synergies in subsequent periods. They also do not give effect to certain charges that the Company expects to incur in connection with the acquisition, including, but not limited to, additional professional fees and employee integration.
(3) Accounts and Notes Receivable
Current and non-current receivables, as of March 28, 2020 and December 28, 2019 are presented in the condensed consolidated balance sheets as follows:
3/28/2020 | 12/28/2019 | |||||||
(In thousands) | ||||||||
Accounts receivable, net | $ | 67,801 | $ | 44,333 | ||||
Notes receivable | 18,302 | 37,994 | ||||||
Interest receivable, net | 2,328 | 3,132 | ||||||
Income tax receivable | 56,409 | 3,356 | ||||||
Allowance for doubtful accounts | (8,586 | ) | (9,122 | ) | ||||
Current receivables, net | 136,254 | 79,693 | ||||||
Notes receivable - non-current | 16,165 | 19,501 | ||||||
Allowance for doubtful accounts - non-current | (584 | ) | (863 | ) | ||||
Non-current receivables, net | 15,581 | 18,638 | ||||||
Total receivables | $ | 151,835 | $ | 98,331 |
The Company provides select financing to area developers ("ADs") and franchisees for the purchase of franchises, areas, Company-owned offices, and operating loans for working capital and equipment needs. The franchise-related notes generally are payable over five years and the operating loans generally are due within one year. Most notes bear interest at 12%.
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Most of the notes receivable are due from the Company's ADs and franchisees and are collateralized by the underlying franchise and when the AD or franchise is an entity, are guaranteed by the owners of the respective entity. The debtors' ability to repay the notes is dependent upon both the performance of the franchisee's industry as a whole and the individual franchise or AD areas.
Analysis of Past Due Receivables
The breakdown of accounts and notes receivable past due at March 28, 2020 was as follows:
Past due | Current | Interest receivable, net | Total receivables | |||||||||||||
(In thousands) | ||||||||||||||||
Accounts receivable | $ | 18,230 | $ | 49,571 | $ | — | $ | 67,801 | ||||||||
Notes and interest receivable, net (1) | 12,154 | 22,313 | 2,328 | 36,795 | ||||||||||||
Total accounts, notes and interest receivable | $ | 30,384 | $ | 71,884 | $ | 2,328 | $ | 104,596 |
(1) Interest receivable is shown net of an allowance for uncollectible interest of $2.3 million.
Accounts receivable are considered to be past due if unpaid 30 days after billing, and notes receivable are considered past due if unpaid 90 days after the due date. If it is determined the likelihood of collecting substantially all of the notes and accrued interest is not probable, the notes are put on non-accrual status. The Company’s investment in notes receivable on non-accrual status was $12.2 million and $8.5 million at March 28, 2020 and December 28, 2019, respectively. Payments received on notes in non-accrual status are applied to the principal until the note is current and then to interest income. Non-accrual notes that are paid current and expected to remain current are moved back into accrual status during the next annual review.
Allowance for Doubtful Accounts
The adequacy of the allowance for doubtful accounts is assessed on a quarterly basis and adjusted as deemed necessary. Management believes the recorded allowance is adequate based upon its consideration of the estimated fair value of the franchises and AD areas collateralizing the receivables. Any adverse change in the individual franchise or AD areas could affect the Company's estimate of the allowance.
Activity in the allowance for doubtful accounts for the three months ended March 28, 2020 and March 31, 2019 was as follows:
Three Months Ended | ||||||||
March 28, 2020 | March 31, 2019 | |||||||
(In thousands) | ||||||||
Balance at beginning of period | $ | 9,985 | $ | 12,353 | ||||
Provision for doubtful accounts | 1,672 | 1,930 | ||||||
Write-offs and reduction from repurchases of franchises | (2,351 | ) | (3,708 | ) | ||||
Foreign currency adjustment | (136 | ) | 6 | |||||
Balance at end of period | $ | 9,170 | $ | 10,581 |
Management considers specific accounts and notes receivable to be impaired if the net amounts due exceed the fair value of the underlying franchise at the time of the annual valuation and estimates an allowance for doubtful accounts based on that excess. At the end of each fiscal quarter, the Company considers the activity during the period for accounts and notes receivable impaired from the prior annual valuation and adjusts the allowance for doubtful accounts accordingly. While not specifically identifiable as of the balance sheet date, the Company's analysis of its experience also indicates that a portion of other accounts and notes receivable may not be collectible. Net amounts due include contractually obligated accounts and notes receivable plus accrued interest, reduced by unrecognized revenue, the allowance for uncollected interest, amounts due ADs, and amounts owed to the franchisee by the Company. When a franchise is repurchased, intangible assets are recorded if the franchise will be run as a Company-owned store.
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(4) Goodwill and Intangible Assets
Changes in the carrying amount of goodwill for the three months ended March 28, 2020 were as follows:
March 28, 2020 | ||||
(In thousands) | ||||
Balance at beginning of period | $ | 134,301 | ||
Acquisitions of assets from franchisees and third parties | 269 | |||
American Freight Acquisition | 335,474 | |||
Disposals and foreign currency changes, net | (660 | ) | ||
Impairments | (235 | ) | ||
Purchase price reallocation | 310 | |||
Balance at end of period | $ | 469,459 |
Components of intangible assets as of March 28, 2020 and December 28, 2019 were as follows:
March 28, 2020 | ||||||||||||
Gross carrying amount | Accumulated amortization | Net carrying amount | ||||||||||
(In thousands) | ||||||||||||
Trade names (1) | $ | 107,867 | $ | (14,140 | ) | $ | 93,727 | |||||
Franchise agreements and non-compete agreements | 10,609 | (775 | ) | 9,834 | ||||||||
Customer contracts | 12,736 | (1,466 | ) | 11,270 | ||||||||
Assets acquired from franchisees: | ||||||||||||
Customer lists | 3,116 | (1,488 | ) | 1,628 | ||||||||
Reacquired rights | 11,423 | (2,469 | ) | 8,954 | ||||||||
AD rights | 40,948 | (17,582 | ) | 23,366 | ||||||||
Total intangible assets | $ | 186,699 | $ | (37,920 | ) | $ | 148,779 |
(1) Trade names include those acquired in the Buddy's Acquisition, Vitamin Shoppe Acquisition and American Freight Acquisition which have an indefinite life. They are tested for impairment on an annual basis.
During the three months ended March 28, 2020, $70.2 million of the assets acquired pertained to the American Freight Acquisition and the remaining intangible assets were acquired from franchisees and other third parties.
December 28, 2019 | ||||||||||||
Gross carrying amount | Accumulated amortization | Net carrying amount | ||||||||||
(In thousands) | ||||||||||||
Customer lists acquired from unrelated third parties | $ | 1,027 | $ | (1,027 | ) | $ | — | |||||
Trade names | 23,534 | (72 | ) | 23,462 | ||||||||
Customer contracts | 12,736 | (886 | ) | 11,850 | ||||||||
Franchise agreements | 10,609 | (486 | ) | 10,123 | ||||||||
Assets acquired from franchisees: | ||||||||||||
Customer lists | 3,311 | (1,532 | ) | 1,779 | ||||||||
Reacquired rights | 11,577 | (2,053 | ) | 9,524 | ||||||||
AD rights | 37,263 | (16,411 | ) | 20,852 | ||||||||
Total intangible assets | $ | 100,057 | $ | (22,467 | ) | $ | 77,590 |
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(5) Revenue
For details regarding the principal activities from which the Company generates its revenue, see "Note 1. Organization and Significant Accounting Policies" in the Company’s 2019 Transition Report. For more detailed information regarding reportable segments, see "Note 13. Segments."
The following represents the disaggregated revenue by reportable segments for the three months ended March 28, 2020:
March 28, 2020 | ||||||||||||||||
(In thousands) | Vitamin Shoppe | American Freight | Liberty Tax | Buddy's | ||||||||||||
Retail sales | $ | 275,888 | $ | 196,099 | $ | — | $ | 1,518 | ||||||||
Total product revenue | 275,888 | 196,099 | — | 1,518 | ||||||||||||
Franchise fees | — | — | 506 | — | ||||||||||||
Area developer fees | — | — | 1,021 | — | ||||||||||||
Royalties and advertising fees | — | — | 41,448 | 2,422 | ||||||||||||
Financial products | — | — | 27,439 | — | ||||||||||||
Interest income | — | 339 | 1,956 | — | ||||||||||||
Assisted tax preparation fees, net of discounts | — | — | 12,250 | — | ||||||||||||
Electronic filing fees | — | — | 2,028 | — | ||||||||||||
Agreement, club and damage waiver fees | — | — | — | 3,320 | ||||||||||||
Other revenues | — | 6,309 | 2,970 | 632 | ||||||||||||
Total service revenue | — | 6,648 | 89,618 | 6,374 | ||||||||||||
Lease revenue, net | — | — | — | 16,420 | ||||||||||||
Total leasing revenue | — | — | — | 16,420 | ||||||||||||
Total revenue | $ | 275,888 | $ | 202,747 | $ | 89,618 | $ | 24,312 |
The following represents the disaggregated revenue by reportable segments for the three months ended March 31, 2019:
March 31, 2019 | ||||||||||||||||
(In thousands) | Vitamin Shoppe | American Freight | Liberty Tax | Buddy's | ||||||||||||
Retail sales | $ | — | $ | — | $ | — | $ | — | ||||||||
Total product revenue | — | — | — | — | ||||||||||||
Franchise fees | — | — | 341 | — | ||||||||||||
Area developer fees | — | — | 912 | — | ||||||||||||
Royalties and advertising fees | — | — | 49,221 | — | ||||||||||||
Financial products | — | — | 28,850 | — | ||||||||||||
Interest income | — | — | 3,235 | — | ||||||||||||
Assisted tax preparation fees, net of discounts | — | — | 9,176 | — | ||||||||||||
Electronic filing fees | — | — | 2,378 | — | ||||||||||||
Other revenues | — | — | 1,725 | — | ||||||||||||
Total service revenue | — | — | 95,838 | — | ||||||||||||
Lease revenue, net | — | — | — | — | ||||||||||||
Total leasing revenue | — | — | — | — | ||||||||||||
Total revenue | $ | — | $ | — | $ | 95,838 | $ | — |
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Contract Balances
The following table provides information about receivables and contract liabilities (deferred revenue) from contracts with customers:
March 28, 2020 | December 28, 2019 | |||||||
(In thousands) | ||||||||
Notes receivable | $ | 34,467 | $ | 57,495 | ||||
Deferred revenue | 23,838 | 10,519 |
Significant changes in deferred revenue are as follows:
Three Months Ended | ||||
March 28, 2020 | ||||
(In thousands) | ||||
Deferred revenue at beginning of period | $ | 10,519 | ||
Revenue recognized during the period | (7,401 | ) | ||
Deferred revenue assumed from the American Freight Acquisition | 12,619 | |||
New deferred revenue during the period | 8,101 | |||
Deferred revenue at end of period | $ | 23,838 |
Anticipated Future Recognition of Deferred Revenue
The following table reflects when deferred revenue is expected to be recognized in the future related to performance obligations that are unsatisfied at the end of the period:
Estimate for Fiscal Year | ||||
(In thousands) | ||||
2020 (1) | $ | 19,719 | ||
2021 | 1,607 | |||
2022 | 1,010 | |||
2023 | 446 | |||
2024 | 188 | |||
Thereafter | 868 | |||
Total | $ | 23,838 |
(1) Represents deferred revenue expected to be recognized for the remainder of fiscal 2020. The amount does not include deferred revenues recognized for the three months ended March 28, 2020.
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(6) Long-Term Obligations
Debt at March 28, 2020 and December 28, 2019, and was as follows:
March 28, 2020 | December 28, 2019 | |||||||
(In thousands) | ||||||||
Revolving credit facilities | $ | 192,000 | $ | 129,260 | ||||
Term loan, net of debt issuance costs | 604,715 | 268,660 | ||||||
Convertible senior notes | — | 60,439 | ||||||
Amounts due to former ADs, franchisees and third parties | 13,020 | 1,661 | ||||||
Mortgages | 1,928 | 1,825 | ||||||
Finance lease liability | 1,600 | 1,775 | ||||||
Total long-term obligations | 811,470 | 463,620 | ||||||
Less current installments | 257,466 | 218,384 | ||||||
Total long-term obligations, excluding current installments, net | $ | 554,004 | $ | 245,236 |
Franchise Group New Holdco Credit Agreement and Term Loan
On February 14, 2020, the Company, through an indirect subsidiary, executed a term loan agreement with GACP Finance Co., LLC for an amount of $575.0 million (the “FGNH Credit Agreement”), which consists of a $375.0 million first out Tranche (the “FGNH Tranche A-1 Term Loan”) and a $200.0 million last out Tranche (the “FGNH Tranche A-2 Term Loan”). The term loan will mature on May 14, 2025, unless the maturity is accelerated subject to the terms set forth in the term loan agreement.
The FGNH Credit Agreement will, at the option of the Company, bear interest at either (i) a rate per annum based on London Interbank Offered Rate ("LIBOR") for an interest period of one, two, three or six months, plus an interest rate margin of 8.0% for the FGNH Tranche A-1 Term Loan and 12.5% for the FGNH Tranche A-2 Term Loan with a 1.50% LIBOR floor, or (ii) an alternate base rate determined as provided in the FGNH Credit Agreement, plus an interest rate margin of 7.0% for the FGNH Tranche A-1 Term Loan and 11.5% for the FGNH Tranche A-2 Term Loan with a 2.50% alternate base rate floor. Interest is payable in arrears at the end of each fiscal quarter. The Company is required to repay the FGNH Credit Agreement in equal fiscal quarterly installments of $6.25 million on the last day of each fiscal quarter, commencing with the fiscal quarter ending June 30, 2020. Further, the Company is required to prepay the FGNH Credit Agreement with 50% of consolidated excess cash flow on a quarterly basis with the net cash proceeds of certain other customary events. All repayments or prepayments (whether voluntary or mandatory) of the FGNH Credit Agreement, other than the fixed quarterly installments and excess cash flow prepayments are subject to early repayment fees.
The FGNH Credit Agreement includes customary affirmative, negative, and financial covenants binding on the Company and its subsidiaries, including delivery of financial statements and other reports. The negative covenants limit the ability of the Company and its subsidiaries, among other things, to incur debt, incur liens, make investments, sell assets, pay dividends on its capital stock and enter into transactions with affiliates. The financial covenants set forth in the FGNH Credit Agreement include a maximum total leverage ratio (net of certain cash) and a minimum fixed charge coverage ratio, to be tested at the end of each fiscal quarter, in each case with respect to the Company and its subsidiaries. In addition, the FGNH Credit Agreement includes customary events of default, the occurrence of which may require that the Company pay an additional 2.0% interest.
In addition to financing the American Freight acquisition and its related acquisition costs, a portion of the proceeds from the FGNH Credit Agreement and the FGNH ABL Term Loan (as defined below) were used to repay the Buddy’s and Sears Outlet’s term loan for an outstanding amount of $101.6 million and $106.7 million including accrued interest, respectively.
18
Franchise Group New Holdco ABL Credit Agreement and ABL Term Loan
On February 14, 2020, the Company, through direct and indirect subsidiaries, entered into an ABL credit agreement (the "FGNH ABL Credit Agreement") with various lenders which provided the Company with a $100.0 million credit facility (the “FGNH ABL Term Loan”). On February 14, 2020, the Company borrowed $100.0 million on the FGNH ABL Term Loan to finance the acquisition of American Freight. The FGNH ABL Term Loan will mature on September 30, 2020.
Borrowings under the FGNH ABL Term Loan will, at the Company's option, bear interest at either (i) a rate per annum based on LIBOR for an interest period of one, two, three or six months, plus an interest rate margin of 6.50% with a 1.50% LIBOR floor, or (ii) an alternate base rate plus an interest rate margin of 5.50% with a 2.50% alternate base rate floor. Interest is payable in arrears on the first day of each fiscal quarter. If the borrowing base exceeds the outstanding principal amount of the FGNH ABL Term Loan, the Company must prepay the FGNH ABL Term Loan in the amount of any such excess. The Company is also required to prepay the FGNH ABL Term Loan, with the net cash proceeds of certain other customary events. All repayments or prepayments (whether voluntary or mandatory) of the VGNH ABL Term Loan which are made on or after September 30, 2020 are subject to an exit fee of 2.0%.
The FGNH ABL Credit Agreement includes customary affirmative, negative, and financial covenants binding on the Company and its subsidiaries, including delivery of financial statements and other reports. The negative covenants limit the ability of the Company and its subsidiaries, among other things, to incur debt, incur liens, make investments, sell assets, pay dividends on its capital stock and enter into transactions with affiliates. The financial covenants set forth in the FGNH ABL Credit Agreement include a minimum consolidated liquidity of the Loan Parties and their subsidiaries (other than certain excluded subsidiaries), to be tested at all times, and a minimum borrowing base ratio of the Loan Parties, to be tested at the end of each month. In addition, the FGNH ABL Credit Agreement includes customary events of default, the occurrence of which may require that the Company to pay an additional 2.0% interest on the borrowings under the FGNH ABL Term Loan.
The proceeds of the FGNH Credit Agreement and the FGNH ABL Credit Agreement were used to repay the debt used to finance the acquisitions of Sears Outlet and Buddy's Home Furnishings. The early repayment of the term loans resulted in additional interest expense of $4.6 million for the write-off of deferred financing costs and $4.0 million for a prepayment penalty.
Vitamin Shoppe Term Loan
On December 16, 2019 as part of the Vitamin Shoppe Acquisition, the Company, through direct and indirect subsidiaries, entered into a Loan and Security Agreement (the “Vitamin Shoppe Term Loan Agreement”) that provides for a $70.0 million senior secured term loan (the "Vitamin Shoppe Term Loan") which matures on December 16, 2022. The obligations under the Vitamin Shoppe Term Loan are secured by substantially all of the assets of the Company's Vitamin Shoppe segment.
An Intercreditor Agreement (the “Intercreditor Agreement”) sets forth the relative priorities of the security interests granted with respect to the Vitamin Shoppe Term Loan and those granted with respect to the Vitamin Shoppe ABL Revolver (as defined below). The security interest granted to the Vitamin Shoppe Term Loan lenders is senior to that granted to the Vitamin Shoppe ABL Revolver lenders.
The Vitamin Shoppe Term Loan bears interest at a rate per annum based on LIBOR for an interest period of one month (or, during the continuance of an event of default, an alternate base rate determined as provided in the Vitamin Shoppe Term Loan Agreement), plus an interest rate margin of 9.0%, with a 2.0% LIBOR (or alternate base rate) floor. Interest is payable in arrears on the first business day of each calendar month. The Company is required to repay the Vitamin Shoppe Term Loan in equal fiscal quarterly installments of $4.25 million on the last business day of each fiscal quarter, commencing with the fiscal quarter ending March 28, 2020. Further, the Company is required to prepay the Vitamin Shoppe Term Loan (i) with 60% of consolidated excess cash flow on a fiscal quarterly basis (less voluntary prepayments already made), up to a maximum of $12.5 million in any fiscal year, and (ii) subject to the Intercreditor Agreement, with the net cash proceeds of certain other customary prepayment events (subject to certain customary reinvestment rights). Such fixed quarterly installments and excess cash flow prepayments cease to be required (subject to certain exceptions) if the then outstanding aggregate principal amount of the Vitamin Shoppe Term Loan is less than or equal to the lesser of $25 million and a specified borrowing base based on the Company's eligible credit card receivables, accounts, inventory and equipment, less certain reserves. All repayments or prepayments (whether voluntary or mandatory) of the Vitamin Shoppe Term Loan, other than the fixed quarterly installments and excess cash flow prepayments, are subject to early repayment fees. If the outstanding aggregate principal amount of the Term Loan at any time exceeds a specified borrowing base, set at $70.0 million until January 10, 2020, and thereafter based on the eligible credit card receivables, accounts receivable, inventory, equipment and intellectual property, less certain reserves, the Agent must instruct the agent of the Vitamin Shoppe ABL Revolver to implement a reserve against the borrowing base under
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the Vitamin Shoppe ABL Agreement (as defined below) in the amount of such excess, and if such reserve is not implemented, the Company is required to repay the amount of such excess.
The Vitamin Shoppe Term Loan Agreement includes customary affirmative, negative, and financial covenants binding on the Company and its subsidiaries, including the delivery of financial statements, borrowing base certificates and other reports. The negative covenants limit the ability of the Company and its subsidiaries, among other things, to incur debt, incur liens, make investments, sell assets, pay dividends on its capital stock and enter into transactions with affiliates. The financial covenants set forth in the Vitamin Shoppe Term Loan Agreement include a limit on capital expenditures in each fiscal year, a minimum consolidated liquidity requirement to be tested weekly and a minimum consolidated EBITDA requirement to be tested at the end of each fiscal quarter, in each case with respect to the Company and its subsidiaries. In addition, the Vitamin Shoppe Term Loan Agreement includes customary events of default, the occurrence of which may require that the Company pay an additional 3.0% interest on the Vitamin Shoppe Term Loan.
Vitamin Shoppe ABL Revolver
On December 16, 2019, the Company, through direct and indirect subsidiaries, entered into a Second Amended and Restated Loan and Security Agreement (the “ Vitamin Shoppe ABL Agreement”) providing for a senior secured revolving loan facility (the “Vitamin Shoppe ABL Revolver”) with commitments available to the Company of the lesser of (i) $100.0 million and (ii) a specified borrowing base based on our eligible credit card receivables, accounts receivable and inventory, less certain reserves, and as to each of clauses (i) and (ii), less a $10.0 million availability block. The Vitamin Shoppe ABL Revolver will mature on December 16, 2022, unless the maturity is accelerated subject to the terms set forth in the Vitamin Shoppe ABL Agreement. The Company borrowed $70.0 million on December 16, 2019, the proceeds of which were used to consummate the Vitamin Shoppe Acquisition. The ABL Agreement amended and restated the existing Amended and Restated Loan and Security Agreement (the “Existing Vitamin Shoppe ABL Agreement”), dated as of January 20, 2011.
The Company's obligations under the ABL Agreement are secured by substantially all of the assets of the Vitamin Shoppe segment. The Intercreditor Agreement sets forth the relative priorities of the security interests granted with respect to the Vitamin Shoppe ABL Revolver and those granted with respect to the Vitamin Shoppe Term Loan. The security interest granted to the Vitamin Shoppe ABL Revolver lenders is senior to that granted to the Vitamin Shoppe Term Loan lenders with respect to, among other assets, accounts receivable, inventory and deposit accounts.
Borrowings under the Vitamin Shoppe ABL Revolver will, at the Company's option, bear interest at either (i) a rate per annum based on LIBOR for an interest period of one, two, three or six months, plus an interest rate margin that ranges from 1.25% to 1.75%, depending on excess availability (a “LIBOR Loan”), with a 0.0% LIBOR floor, or (ii) an alternate base rate determined as provided in the Vitamin Shoppe ABL Agreement, plus an interest rate margin that ranges from 0.25% to 0.75%, depending on excess availability (an “ABR Loan”), with a 1.0% alternate base rate floor. Interest on LIBOR Loans is payable in arrears at the end of each applicable interest period (and, with respect to a six-month interest period, three months after commencement of the interest period), and interest on ABR Loans is payable in arrears on the first business day of each calendar quarter.
Subject to the Intercreditor Agreement, the Company is required to repay borrowings under the Vitamin Shoppe ABL Revolver with the net cash proceeds of certain customary events (subject to certain customary reinvestment rights). Further, if the outstanding principal amount of the borrowings under the Vitamin Shoppe ABL Revolver at any time exceeds the lesser of $100.0 million and the borrowing base, less, in each case, a $10.0 million availability block, the Company must prepay any such excess.
The Vitamin Shoppe ABL Agreement includes customary affirmative and negative covenants binding on the Company and its subsidiaries, including the delivery of financial statements, borrowing base certificates and other reports. The negative covenants limit the ability of the Company and its subsidiaries, among other things, to incur debt, incur liens, make investments, sell assets, pay dividends on its capital stock and enter into transactions with affiliates. In addition, the Vitamin Shoppe ABL Agreement includes customary events of default, the occurrence of which may require the Company to pay an additional 2.0% interest on the borrowings under the Vitamin Shoppe ABL Revolver.
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Liberty Tax Credit Agreement
On May 16, 2019, the Company entered into the Liberty Tax Credit Agreement that provides for a $135.0 million senior revolving credit facility (the "Revolving Credit Facility"), with a $10.0 million sub-facility for the issuance of letters of credit, and a $20.0 million swingline loan sub-facility. The Company’s obligations under the Liberty Tax Credit Agreement are secured by substantially all of the assets (other than existing real property) of the Liberty Tax segment and each guarantor (including all or a portion of the equity interests in certain of the Company’s domestic and foreign subsidiaries). The Liberty Tax Credit Agreement expired on April 30, 2020.
The Liberty Tax Credit Agreement includes customary affirmative, negative, and financial covenants binding on the Company, including the delivery of financial statements and other reports and maintenance of existence. The financial covenants set forth in the Liberty Tax Credit Agreement include a maximum consolidated leverage ratio and a minimum consolidated fixed charge coverage ratio, each of which will be tested at the end of each fiscal quarter of the Company, and a minimum consolidated net worth ratio tested at the end of each fiscal year of the Company. The Liberty Tax Credit Agreement provides that, for a period of 30 consecutive days after May 16, 2019, our outstanding obligations under the Liberty Tax Credit Agreement will not exceed $12.5 million. In addition, the Liberty Tax Credit Agreement includes customary events of default. The Company was in compliance with all covenants of the Liberty Tax Credit Agreement as of March 28, 2020.
On October 2, 2019, the Company amended the Liberty Tax Credit Agreement to extend the maturity date to October 2, 2022, from the original maturity date of May 31, 2020, and decrease the aggregate amount of commitments from $135.0 million to $125.0 million as of October 2, 2019. The amendment reduced the applicable interest rate margin used to calculate interest for LIBOR Loans and ABR Loans. The amended LIBOR Loans interest rate margin is 2.75% per annum to 3.50% per annum compared to a range of 3.00% per annum to 4.00% per annum prior to the amendment. The amended ABR Loans applicable interest rate margin range is 1.75% per annum to 2.50% per annum compared to a range of 2.00% per annum to 3.00% per annum before the amendment. The range is dependent on the Company’s consolidated leverage ratio and is determined in accordance with a pricing grid set forth in the amendment. The amendment also eliminated a negative covenant in the Liberty Tax Credit Agreement that prohibited the Company from incurring certain types of indebtedness and liens.
On February 14, 2020, the Company amended the Liberty Tax Credit Agreement to, among other things, terminate the agreement on April 30, 2020.
Other Indebtedness
In December 2016, the Company obtained a mortgage payable to a bank in monthly installments of principal payments plus interest at the one-month LIBOR plus 1.85% through December 2026 with a balloon payment of $0.8 million due at maturity. The mortgage is collateralized by land and buildings.
On May 1, 2020, in connection with our acquisition of American Freight and the ABL Credit Agreement, the Company entered into an Amended and Restated ABL Commitment Letter with B. Riley pursuant to which B. Riley agreed to provide, subject to the terms and conditions set forth therein, a backstop commitment for a $100 million asset-based lending facility.
(7) Income Taxes
The CARES Act (the “Act”) was enacted on March 27, 2020. The Act retroactively changed the eligibility of certain assets for expense treatment in the year placed in service, back to 2018, and permitted any net operating loss for the tax years 2018, 2019 and 2020 to be carried back for five years. The Company recorded an income tax benefit of $46.8 million in the first quarter associated with the income tax components contained in the Act. As of March 28, 2020, the Company has completed an initial analysis of the tax effects of the Act but continues to monitor developments by federal and state rulemaking authorities regarding implementation of the Act. The Company has made reasonable estimates of the effects of the Act and will adjust, if needed, as new laws or guidance becomes available.
For the three months ended March 28, 2020, the Company recognized an income tax benefit of $45.9 million, which represented an effective tax rate of (286.2)%. For the three months ended March 31, 2019, the Company recognized income tax expense of $15.6 million, which represented an effective tax rate of 29.0%. The income tax benefit for the three months ended March 28, 2020 included the impact of the enactment of the Act, as discussed above which is the primary driver of the difference in effective rate.
In addition, the impact of the American Freight Acquisition has been considered for the three months ended March 28, 2020. The Company recorded an additional $11.4 million deferred tax liability to account for cumulative temporary differences resulting from the American Freight Acquisition. These initial amounts recorded in connection with purchase accounting will be adjusted during the measurement periods as the Company gathers information regarding facts and circumstances that existed as of the acquisition date. American Freight is treated as a corporation for income tax purposes.
The Company has a full valuation allowance recorded against its net deferred tax assets of $11.6 million. The Company intends to maintain a valuation allowance on its deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. A reduction in the valuation allowance could result in a significant decrease in income tax expense in the period that the release is recorded. However, the exact timing and amount of any reduction in the Company’s valuation allowance are unknown at this time and will be subject to the earnings level it achieves in future periods.
During the three months ended March 28, 2020, we also recognized $18.8 million of deferred tax assets related to additional tax basis increases generated from expected future payments under the Tax Receivable Agreement and related deductions for imputed interest on such payments. See "-Tax Receivable Agreement" for more information.
Tax Receivable Agreement
Pursuant to an election under Section 754 of the Internal Revenue Code (the "Code"), the Company expects to obtain an increase in our share of the tax basis in the net assets of New Holdco when New Holdco units are redeemed or exchanged by the Buddy's Members and other qualifying transactions. The Company plans to make an election under Section 754 of Code for each taxable year in which a redemption of partnership interests occurs. The Company intends to treat any redemptions and exchanges of New Holdco units by the non-controlling interest holders as direct purchases of partnership interests for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that the Company would otherwise pay in the future to various tax authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.
On July 10, 2019, the Company entered into a tax receivable agreement with the then-existing non-controlling interest holders (the "TRA") that provides for the payment by the Company to the non-controlling interest holders of 40% of the cash savings, if any, in federal, state and local taxes that the Company realizes or is deemed to realize as a result of any increases in tax basis of the assets of New Holdco resulting from future redemptions or exchanges of New Holdco units.
During the three months ended March 28, 2020, the Company redeemed 3,937,726 New Holdco units, which resulted in an increase in the tax basis of our investment in New Holdco subject to the provisions of the TRA. We recognized an additional liability in the amount of $7.4 million, which is recorded in "Other non-current liabilities" in the accompanying condensed consolidated balance sheets, for the TRA payments due to the redeeming members, representing 40% of the cash savings the Company expects to realize from the tax basis increases related to the redemption of New Holdco units, after concluding it was probable that such TRA payments would be paid based on our estimates of future taxable income. No payments were made to members of New Holdco pursuant to the TRA during the quarter ended March 28, 2020.
(8) Stockholders’ Equity
Stockholders' Equity Activity
On January 3, 2020, the Company entered into a Subscription Agreement with an affiliate of Vintage Capital Management, LLC ("Vintage"), pursuant to which the affiliate of Vintage purchased from the Company 2,354,000 shares of common stock of the Company, par value $0.01 per share, at a purchase price of $12.00 per share for an aggregate purchase price of $28.2 million in cash. The common stock was purchased pursuant to an amendment to an equity commitment letter, dated August 7, 2019, between the Company and Tributum, L.P. (as amended, the "ECL"), pursuant to which Vintage agreed to provide $70.0 million of equity financing for the Vitamin Shoppe Acquisition.
On February 7, 2020, investors purchased approximately 3,877,965 shares of the Company's common stock for $65.9 million. As of March 28, 2020, $11.4 million of the proceeds were not received and are recorded in "Current receivables, net" in the accompanying condensed consolidated balance sheets. These proceeds were received in April 2020. The equity financing was done through purchases of shares of common stock of the Company at $12.00 per share under the Vintage ECL, and $23.00 per share in connection with a separate private placement of shares of common stock (collectively, the "Equity Financing") pursuant to certain subscription agreements entered into by each investor with the Company. Pursuant to the ECL, Tributum, L.P. assigned certain of its obligations thereunder to provide a portion of such Equity Financing to certain of the investors. The proceeds of the of Equity Financing were used by the Company to fund the repurchase or redemption of the Company's outstanding 2.25% Convertible Notes (the "Convertible Notes"), to make interest payments on the Convertible Notes that are not repurchased or redeemed until their maturity and to also fund general, working capital and cash needs of the
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Company. On February 7, 2020, the Company completed the repurchase of $60.4 million in aggregate principal amount of outstanding Convertible Notes for a purchase price of $60.6 million, which includes accrued interest.
On February 14, 2020, the Company issued 1,250,000 shares of the Company's common stock with a value of $31.0 million, which was recorded as deferred financing costs, to Kayne FRG Holdings L.P. for services provided in the financing of the American Freight Acquisition.
During the quarter ended March 28, 2020, the Company corrected an immaterial misclassification between retained earnings and non-controlling interest related to distributions declared to the non-controlling interest in the prior year.
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss at March 28, 2020 and December 28, 2019 are as follows:
March 28, 2020 | December 28, 2019 | ||||||||
(In thousands) | |||||||||
Foreign currency adjustment | $ | (2,191 | ) | $ | (1,496 | ) | |||
Interest rate swap agreements, net of tax | (115 | ) | (42 | ) | |||||
Total accumulated other comprehensive loss | $ | (2,306 | ) | $ | (1,538 | ) |
Non-controlling interest
The Company is the sole managing member of New Holdco and, as a result, consolidates the financial results of New Holdco. The Company reports a non-controlling interest representing the economic interest in New Holdco held by the Buddy’s Members. The New Holdco LLC Agreement provides that the Buddy’s Members may, from time to time, require the Company to redeem all or a portion of their New Holdco units for newly-issued shares of common stock on a basis of one New Holdco unit and one-fifth of a share of Preferred Stock of the Company for one share of common stock of the Company. In connection with any redemption or exchange, the Company will receive a corresponding number of New Holdco units, increasing its total ownership interest in New Holdco. Changes in the Company's ownership interest in New Holdco while it retains their controlling interest in New Holdco will be accounted for as equity transactions. As such, future redemptions or direct exchanges of New Holdco units by the Buddy’s Members will result in a change in ownership and reduce the amount recorded as non-controlling interest and increase additional paid-in capital. On March 26, 2020, the Company redeemed 3,937,726 New Holdco units and 787,545 shares of preferred stock for common stock. As of March 28, 2020, the Company had an ownership interest of 84.2% in New Holdco and reported a non-controlling interest equal to 15.8%. On April 1, 2020, the Company redeemed the remaining 5,495,606 New Holdco units and 1,099,121 shares of preferred stock for common stock and the Company has 100% ownership interest in New Holdco.
The exchange of New Holdco units for common stock resulted in an increase in the tax basis of the net assets of New Holdco and a liability to be recognized pursuant to the TRA. The difference of $0.3 million in the adjustment of the deferred tax balances and the tax receivable agreement liability was recorded as an adjustment to additional paid-in-capital. Refer to "Note 7. Income Taxes" for further discussion of the TRA.
Net Income (Loss) per Share
Diluted net income (loss) per share is computed using the weighted-average number of common stock and, if dilutive, the potential common stock outstanding during the period. Potential common stock consists of the incremental common stock issuable upon the exercise of stock options and vesting of restricted stock units. The dilutive effect of outstanding stock options and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method. Additionally, the computation of the diluted net income (loss) per share of common stock assumed the conversion of exchangeable shares, and Preferred Stock, if dilutive.
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The computation of basic and diluted net income per share for the three months ended March 28, 2020 and March 31, 2019 is as follows:
Three Months Ended March 28, 2020 | Three Months Ended March 31, 2019 | ||||||||||
Common Stock | Common Stock | ||||||||||
(In thousands, except for share and per share amounts) | |||||||||||
Basic and diluted net income per share: | |||||||||||
Numerator | |||||||||||
Allocation of undistributed income attributable to Franchise Group | $ | 59,539 | $ | 38,191 | |||||||
Denominator | |||||||||||
Weighted-average common stock outstanding | 23,373,980 | 14,055,752 | |||||||||
Basic and diluted net income per share | $ | 2.55 | $ | 2.72 | |||||||
Diluted net income per share: | |||||||||||
Numerator | |||||||||||
Allocation of undistributed earnings for basic computation | $ | 59,539 | $ | 38,191 | |||||||
Denominator | |||||||||||
Number of shares used in basic computation | 23,373,980 | 14,055,752 | |||||||||
Weighted-average effect of dilutive securities | |||||||||||
Employee stock options and restricted stock units | 319,055 | 56,907 | |||||||||
Weighted-average diluted shares outstanding | 23,693,035 | 14,112,659 | |||||||||
Diluted net income per share | $ | 2.51 | $ | 2.71 |
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(9) Stock Compensation Plans
2019 Omnibus Incentive Plan
In December 2019, the Company's stockholders approved the Company's 2019 Omnibus Incentive Plan (the "2019 Plan"). The 2019 Plan provides for a variety of awards, including stock options, stock appreciation rights, performance units, performance shares, shares of the Company’s common stock, par value $0.01 per share, restricted stock, restricted stock units, incentive awards, dividend equivalent units and other stock-based awards. Awards under the 2019 Plan may be granted to the Company’s eligible employees, directors, or consultants or advisors. The 2019 Plan provides that an aggregate maximum of 5,000,000 shares of common stock are reserved for issuance under the 2019 Plan, subject to adjustment for certain corporate events. At March 28, 2020, 4,118,495 shares of common stock remained available for grant.
Stock Options
Stock option activity during the three months ended March 28, 2020 was as follows:
Number of options | Weighted average exercise price | ||||||
Outstanding at December 28, 2019 | 460,285 | $ | 10.28 | ||||
Granted | — | — | |||||
Exercised | — | — | |||||
Expired or forfeited | — | — | |||||
Outstanding at March 31, 2020 | 460,285 | $ | 10.28 |
Intrinsic value is defined as the fair value of the stock less the cost to exercise. No options were exercised during the three months ended March 28, 2020. The total intrinsic value of stock options outstanding at March 28, 2020 was $0.4 million. Stock options vest from the date of grant to five years after the date of grant and expire from four to seven years after the vesting date.
Nonvested stock options activity during the three months ended March 28, 2020 was as follows:
Nonvested options | Weighted average exercise price | ||||||
Outstanding at December 28, 2019 | 215,007 | $ | 10.11 | ||||
Granted | — | — | |||||
Vested | — | — | |||||
Forfeited | — | — | |||||
Outstanding at March 28, 2020 | 215,007 | $ | 10.11 |
At March 28, 2020, unrecognized compensation costs related to nonvested stock options were $0.3 million. These costs are expected to be expensed through fiscal 2021.
The following table summarizes information about stock options outstanding and exercisable at March 28, 2020:
Options Outstanding | Options Exercisable | |||||||||||||||
Range of exercise prices | Number | Weighted average exercise price | Weighted average remaining contractual life (in years) | Number | Weighted average exercise price | |||||||||||
$0.00 - $10.89 | 240,000 | $ | 8.72 | 4.8 | 113,333 | $ | 8.60 | |||||||||
$10.90 - $16.38 | 220,285 | 11.98 | 4.0 | 131,945 | 12.01 | |||||||||||
460,285 | $ | 10.28 | 245,278 | $ | 10.43 |
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Restricted Stock Units
The Company has awarded restricted stock units to its non-employee directors and certain employees. Restricted stock units are valued at the closing stock price the day preceding the grant date. Compensation costs associated with these restricted shares are amortized on a straight-line basis over the vesting period and recognized as an increase in additional paid-in capital. At March 28, 2020, unrecognized compensation cost related to restricted stock units was $17.7 million. These costs are expected to be recognized through fiscal 2023.
In the three months ended March 28, 2020, the Company awarded performance restricted stock units with an estimated fair value of $3.0 million to certain officers and employees. Each employee has the opportunity to earn an amount between 0% and 150% of the individual target award contingent on the Company meeting certain performance targets for the period beginning December 28, 2019 and ending on December 31, 2022. Provided the vesting conditions are satisfied, the awards will vest at the end of the performance period. The estimated value is to be expensed over the performance period. The Company recognized $0.1 million of expense related to these performance restricted stock units in the three months ended March 28, 2020. The estimated fair value of these performance restricted stock units was determined using the Company's closing price on the grant date.
In the three months ended March 28, 2020, the Company also awarded restricted stock units with a fair value of $3.9 million to certain officers and employees. One-third of the awards will vest each year on the anniversary date of the grant. The Company recognized $0.1 million of expense related to these restricted stock units in the three months ended March 28, 2020. The Company also awarded restricted stock units with a fair value of $0.9 million to directors of the Company. The awards will vest on the anniversary date of the grant. The Company recognized $0.2 million of expense related to these restricted stock units in the three months ended March 28, 2020. The fair value of restricted stock units was determined using the Company's closing price on the grant date.
Restricted stock activity during the three months ended March 28, 2020 was as follows:
Number of restricted stock units | Weighted average fair value at grant date | ||||||
Balance at December 28, 2019 | 671,039 | $ | 14.00 | ||||
Granted | 279,839 | 24.80 | |||||
Vested | (4,657 | ) | 12.22 | ||||
Canceled | (1,453 | ) | 11.48 | ||||
Balance at March 28, 2020 | 944,768 | $ | 17.21 |
Stock Compensation Expense
The Company recorded $2.5 million of expense related to stock awards for the three months ended March 28, 2020.
(10) Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets and liabilities subject to fair value measurements are classified according to a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. Valuation methodologies for the fair value hierarchy are as follows:
• | Level 1 — Quoted prices for identical assets and liabilities in active markets. |
• | Level 2 — Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-based valuations in which all significant inputs are observable in the market. |
• | Level 3 — Unobservable inputs in which little or no market data exists, therefore, requiring an entity to develop its own assumptions. |
The Company measures or monitors certain of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for those assets and liabilities for which fair value is the primary basis of accounting. Other assets and liabilities are measured at fair value on a nonrecurring basis; that is, they are subject to fair value adjustment in certain circumstances, such as when there is evidence of impairment.
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The following tables present, for each of the fair value hierarchy levels, the assets and liabilities that are measured at fair value on a recurring and nonrecurring basis at March 28, 2020 and December 28, 2019.
March 28, 2020 | ||||||||||||||||
Fair value measurements using | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets: | ||||||||||||||||
Recurring assets: | ||||||||||||||||
Cash equivalents | $ | 573 | $ | 573 | $ | — | $ | — | ||||||||
Forward contract related to foreign currency exchange rates | 1,429 | — | — | 1,429 | ||||||||||||
Total recurring assets | 573 | 573 | — | — | ||||||||||||
Nonrecurring assets: | ||||||||||||||||
Impaired accounts and notes receivable, net of unrecognized revenue and allowance | 10,518 | — | — | 10,518 | ||||||||||||
Total nonrecurring assets | 10,518 | — | — | 10,518 | ||||||||||||
Total recurring and nonrecurring assets | $ | 11,091 | $ | 573 | $ | — | $ | 10,518 | ||||||||
Liabilities: | ||||||||||||||||
Recurring liabilities: | ||||||||||||||||
Contingent consideration included in obligations due former ADs, franchisees and others | $ | 863 | $ | — | $ | — | $ | 863 | ||||||||
Interest rate swap agreement | 160 | — | 160 | — | ||||||||||||
Total recurring liabilities | $ | 1,023 | $ | — | $ | 160 | $ | 863 |
December 28, 2019 | ||||||||||||||||
Fair value measurements using | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets: | ||||||||||||||||
Recurring assets: | ||||||||||||||||
Cash equivalents | $ | 4,253 | $ | 4,253 | $ | — | $ | — | ||||||||
Total recurring assets | 4,253 | 4,253 | — | — | ||||||||||||
Nonrecurring assets: | ||||||||||||||||
Impaired accounts and notes receivable, net of unrecognized revenue | 7,310 | — | — | 7,310 | ||||||||||||
Total nonrecurring assets | 7,310 | — | — | 7,310 | ||||||||||||
Total recurring and nonrecurring assets | $ | 11,563 | $ | 4,253 | $ | — | $ | 7,310 | ||||||||
Liabilities: | ||||||||||||||||
Recurring liabilities: | ||||||||||||||||
Contingent consideration included in obligations due to former ADs, franchisees and others | $ | 916 | $ | — | $ | — | $ | 916 | ||||||||
Interest rate swap agreement | 58 | — | 58 | — | ||||||||||||
Total recurring liabilities | $ | 974 | $ | — | $ | 58 | $ | 916 |
The Company's policy is to recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers into or out of Level 1 or 2 recurring fair value measurements for the three months ended March 28, 2020, as well as the year ended December 28, 2019.
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The following methods and assumptions are used to estimate the fair value of our financial instruments.
Cash equivalents: The carrying amounts approximate fair value because of the short maturity of these instruments. Cash equivalent financial instruments consist of money market accounts.
Impaired accounts and notes receivable: Accounts and notes receivable are considered to be impaired if the net amounts due exceed the fair value of the underlying franchise or if management considers it probable that all principal and interest will not be collected when contractually due. In establishing the estimated fair value of the underlying franchise, consideration is given to a variety of factors, including, recent comparable sales of Company-owned stores, sales between franchisees, the net fees of open offices, and the number of unopened offices.
Contingent consideration included in long-term obligations: Contingent consideration is carried at fair value. The fair value of these obligations was determined based upon the estimated future net revenues of the acquired businesses.
Interest rate swap agreement: Value of interest rate swap on variable rate mortgage debt. The fair value of this instrument was determined based on third-party market research.
Other Fair Value Measurements
Accounting standards require the disclosure of the estimated fair value of financial instruments that are not recorded at fair value. For the financial instruments not recorded at fair value, estimates of fair value are made at a point in time based on relevant market data and information about the financial instrument. No readily available market exists for a significant portion of the Company's financial instruments. Fair value estimates for these instruments are based on current economic conditions, interest rate risk characteristics, and other factors. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision. Therefore, the calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. In addition, changes in assumptions could significantly affect these fair value estimates. The following methods and assumptions were used by the Company in estimating the fair value of these financial instruments.
Receivables other than notes, other current assets, accounts payable and accrued expenses, and due to ADs: The carrying amounts approximate fair value because of the short maturity of these instruments (Level 1).
Notes receivable: The carrying amount approximates fair value because the interest rate charged by the Company on these notes approximates rates currently offered by local lending institutions for loans of similar terms to individuals/entities with comparable credit risk (Level 3).
Long-term debt: The carrying amount approximates fair value because the interest rate paid has a variable component (Level 2).
(11) Related Party Transactions
The Company considers directors and their affiliated companies, as well as named executive officers and members of their immediate families, to be related parties.
Messrs. Kahn and Laurence
Vintage and its affiliates held approximately 45% of the aggregate voting power of the Company through their ownership of common stock and Preferred Stock as of March 28, 2020. Brian Kahn and Andrew Laurence, principals of Vintage, are members of the Company's Board of Directors with Mr. Laurence serving as the Company's Chairman of the Board until March 31, 2020. Mr. Kahn is the President and Chief Executive Officer of the Company and Mr. Laurence is an Executive Vice President of the Company.
Stock Subscription Agreement. On January 6, 2020, Vintage affiliates purchased 2,354,000 shares of the Company's common stock for $28.2 million under a subscription agreement dated August 7, 2019 with the Company.
Buddy's Franchises. Mr. Kahn has an equity interest in an entity that owns three Buddy's franchisees. All transactions between the Company's Buddy's segment and Mr. Kahn's entity are conducted on a basis consistent with other franchisees. Mr. Kahn's brother-in-law owns seven Buddy's franchisees. All transactions between the Company's Buddy's segment and Mr. Kahn's brother-in-law are conducted on a basis consistent with other franchisees.
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Bryant Riley (former director)
Mr. Riley, through controlled entities or affiliates held approximately 13% of the aggregate ownership of the Company's common stock as of March 28, 2020. Mr. Riley was also a member of the Company's Board of Directors from September 2018 through March 2020.
Credit Agreements. On December 16, 2019, the Company entered into the Vitamin Shoppe Term Loan with an entity controlled by Mr. Riley. On February 14, 2020, the Company entered into a $675.0 million credit facility, which included a $575.0 million AF Term Loan and a $100.0 million ABL Term Loan with an entity controlled by Mr. Riley acting as the administrative agent.
Stock Subscription Agreements. On February 7, 2020, Mr. Riley, and entities or affiliates of Mr. Riley purchased 669,678 shares for $11.4 million under the Equity Financing as defined above in "Note 8. Stockholder's Equity".
Fee Letter. On February 19, 2020, the Company entered into a fee letter with B. Riley pursuant to which B. Riley received an equity fee equal to 6% of the $36.0 million of equity raised by B. Riley for the Company.
Backstop ABL Commitment Letter. On May 1, 2020, in connection with our acquisition of American Freight and the ABL Credit Agreement, the Company entered into an Amended and Restated ABL Commitment Letter with B. Riley pursuant to which B. Riley agreed to provide, subject to the terms and conditions set forth therein, a backstop commitment for a