# Grocery Outlet Holding Corp. (GO) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Grocery Outlet Holding Corp.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1771515/000177151523000009/go-20221231.htm
Accession: 0001771515-23-000009
Filing date: 2023-03-01
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/GO/
All MD&A years: /company/GO/mda/
Previous year: /company/GO/mda/a-0001771515-22-000011/ (FY 2022)
Next year: /company/GO/mda/fy2023/ (FY 2023)

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and related notes thereto included in "Item 8. Financial Statements and Supplementary Data." This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those described in "Item 1A. Risk Factors" or set forth in other sections of this report.

For discussion related to the results of operations and changes in financial condition for fiscal 2021 compared to fiscal 2020 refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II of our Annual Report on Form 10-K for the fiscal year ended January 1, 2022.

We operate on a fiscal year that ends on the Saturday closest to December 31st each year. References to fiscal 2022, fiscal 2021, and fiscal 2020 refer to the fiscal years ended December 31, 2022, January 1, 2022, and January 2, 2021, respectively. Our 2022 and 2021 fiscal years consisted of 52 weeks while our 2020 fiscal year consisted of 53 weeks.

As used in this report, references to "Grocery Outlet," "the Company," "the registrant," "we," "us" and "our," refer to Grocery Outlet Holding Corp. and its consolidated subsidiaries unless otherwise indicated or the context requires otherwise.

OVERVIEW

We are a high-growth, extreme value retailer of quality, name-brand consumables and fresh products sold through a network of independently operated stores. Our flexible buying model allows us to offer quality, name-brand opportunistic products at prices generally 40% to 70% below those of conventional grocers. Entrepreneurial independent operators ("IOs") run our stores and create a neighborhood feel through personalized customer service and a localized product offering. As of December 31, 2022, we had 441 stores in California, Washington, Oregon, Pennsylvania, Idaho, Nevada, Maryland and New Jersey.

Macroeconomic Conditions

During fiscal 2022 and continuing into fiscal 2023, our business was and continues to be impacted by current macroeconomic conditions including supply chain and labor challenges, inflation, and changes in consumer behavior, and our IOs have been impacted by staffing challenges and increased labor costs within their businesses. The extent of the continuing impact of these factors on our operational and financial performance will depend on many factors, including certain factors outside of our control.

We continue to utilize our unique buying model, our strong vendor relationships and our agile approach to inventory management to offer customers a compelling product assortment at a deep competitive value, however, like many companies in the grocery and retail sectors, we continue to experience increased product costs, which is being mitigated in part in higher retail pricing by us and IOs. These cost increases resulted in part from supply disruptions, increased shipping and transportation costs, increased commodity costs, increased labor costs in the supply chain and other disruptions. In addition to increased product costs, we have incurred greater selling, general and administrative expenses ("SG&A") related to personnel, travel, and other third party and operational costs due to the aforementioned factors. Further, planned construction and opening of new stores during fiscal 2022 was, and may continue to be, negatively impacted due to both increased lead times to acquire materials, obtain permits and licenses as well as higher construction and development related costs. In fiscal 2022 we opened 27 new stores, which was below our long-term strategic goal of 10% unit growth. Our planned new store growth in fiscal 2023 is also expected to be below our long-term strategic unit growth goal, however we expect the pace of openings to accelerate in the second half of the year to our 10% annualized new unit growth rate.

Key Factors and Measures We Use to Evaluate Our Business

We consider a variety of financial and operating measures in assessing the performance of our business. The key generally accepted accounting principles ("GAAP") financial measures we use are net sales, gross profit and gross margin, SG&A and operating income. The key operational metrics and non-GAAP financial measures we use are number of new stores, comparable store sales, EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share.

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Fiscal 2022 Overview

Key financial and operating performance results for our fiscal 2022 compared to our fiscal 2021 were as follows:

•Net sales increased 16.2% to $3.58 billion for fiscal 2022 from $3.08 billion for fiscal 2021; comparable store sales increased by 11.8% in fiscal 2022.

•We opened 27 new stores and closed one, ending fiscal 2022 with 441 stores in eight states.

•Net income increased 4.4% to $65.1 million, or $0.65 per diluted share for fiscal 2022, compared to net income of $62.3 million, or $0.63 per diluted share, for fiscal 2021.

•Adjusted EBITDA(1) increased 17.4% to $214.7 million for fiscal 2022 compared to $182.9 million for fiscal 2021.

•Adjusted net income(1) increased 19.4% to $93.9 million, or $0.94 per adjusted diluted share(1) for fiscal 2022 compared to $78.6 million, or $0.79 per adjusted diluted share, for fiscal 2021.

_______________________

(1)Adjusted EBITDA, adjusted net income and adjusted diluted earnings per share are non-GAAP financial measures, which exclude the impact of certain special items. Please note that our non-GAAP financial measures should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. Beginning with the fourth quarter of fiscal 2022, we updated our definitions of adjusted EBITDA, adjusted net income and adjusted earnings per share to no longer exclude the impact of non-cash rent expense and the provision for (write-off of) accounts receivable reserves. The presentation for adjusted EBITDA, adjusted net income and adjusted earnings per share for fiscal 2021 and 2020 has been recast to reflect these changes and a reconciliation between the current and previous definitions of adjusted EBITDA, adjusted net income and adjusted earnings per share have been provided. See the "Operating Metrics and Non-GAAP Financial Measures" section below for additional information about these items, including their definitions, how management utilizes such non-GAAP financial measures and reconciliations of the non-GAAP measures and the most directly comparable GAAP measures.

Key Components of Results of Operations

Net Sales

We recognize revenues from the sale of products at the point of sale, net of any taxes or deposits collected and remitted to governmental authorities. Discounts provided to customers by us are recognized at the time of sale as a reduction in net sales as the products are sold. Discounts that are funded solely by IOs are not recognized as a reduction in net sales as the IO bears the incidental costs arising from the discount. We do not accept manufacturer coupons. Net sales consist of net sales from comparable stores, described below under "Comparable Store Sales," and non-comparable stores. Growth of our net sales is generally driven by expansion of our store base in existing and new markets as well as comparable store sales growth. Net sales are impacted by the spending habits of our customers, product mix and supply, as well as promotional and competitive activities. Our ever-changing selection of offerings across diverse product categories supports growth in net sales by attracting new customers and encouraging repeat visits from our existing customers. The spending habits of our customers are affected by changes in macroeconomic conditions and discretionary income. Our customers' discretionary income is significantly impacted by wages, fuel and other cost-of-living increases including food-at-home inflation, as well as consumer trends and preferences, which fluctuate depending on the environment. Because we offer a broad selection of merchandise at extreme values, historically our business has benefited from periods of economic uncertainty.

Cost of Sales, Gross Profit and Gross Margin

Cost of sales includes, among other things, merchandise costs, inventory markdowns, inventory losses, transportation costs and distribution and warehousing costs, including depreciation. Gross profit is equal to our net sales less our cost of sales. Gross margin is gross profit as a percentage of our net sales. Gross margin is a measure used by management to indicate whether we are selling merchandise at an appropriate gross profit. Gross margin is impacted by product mix and availability, as some products generally provide higher gross margins, and by our merchandise costs, which can vary. Gross margin is also impacted by the costs of distributing and transporting product to our stores, which can vary. Our gross profit is variable in nature and generally follows changes in net sales. While our disciplined buying approach has produced consistent gross margins throughout economic cycles, which we believe has helped to mitigate adverse impacts on gross profit and results of operations, changes in consumer demand like we experienced and continue to experience as a result of the current macroeconomic conditions, including inflationary cost increases for goods, labor and transportation, supply chain constraints and changes in discretionary income, have resulted and could continue to result in

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unexpected changes to our gross margins. The components of our cost of sales, as well as our gross profit and gross margin, may not be comparable to the same or similar measures of our competitors and other retailers.

Selling, General and Administrative Expenses

SG&A are comprised of both store-related expenses and corporate expenses. Our store-related expenses include commissions paid to IOs, occupancy and our portion of maintenance costs and the cost of opening new IO stores. Company-operated store-related expenses also include payroll, benefits, supplies and utilities. Corporate expenses include payroll and benefits for corporate and field support, marketing and advertising, insurance and professional services and operator recruiting and training costs. We continue to closely manage our expenses and monitor SG&A as a percentage of net sales. SG&A generally increases as we grow our store base and invest in our corporate infrastructure. SG&A related to commissions paid to IOs are variable in nature and generally increase as gross profits rise and decrease as gross profits decline. We expect that our SG&A will continue to increase in future periods as we continue to grow our net sales and gross profits. The components of our SG&A may not be comparable to the components of similar measures of our competitors and other retailers.

Operating Income

Operating income is gross profit less SG&A, depreciation and amortization and share-based compensation. Operating income excludes interest expense, net, gain on insurance recoveries, loss on debt extinguishment and modification and income tax expense (benefit). We use operating income as an indicator of the productivity of our business and our ability to manage expenses.

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Results of Operations

The following tables summarize key components of our results of operations both in dollars and as a percentage of net sales (amounts in thousands, except for percentages):

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","January 2, 2021"],["Net sales","$","3,578,101","","","$","3,079,582","","","$","3,134,640"],["Cost of sales","2,486,002","","","2,130,796","","","2,161,293"],["Gross profit","1,092,099","","","948,786","","","973,347"],["Operating expenses:"],["Selling, general and administrative","889,347","","","773,718","","","772,409"],["Depreciation and amortization","75,206","","","68,358","","","55,479"],["Share-based compensation","32,556","","","17,615","","","38,084"],["Total operating expenses","997,109","","","859,691","","","865,972"],["Income from operations","94,990","","","89,095","","","107,375"],["Other expenses (income):"],["Interest expense, net","17,967","","","15,564","","","20,043"],["Gain on insurance recoveries","\u2014","","","(3,970)","","","\u2014"],["Loss on debt extinguishment and modification","1,274","","","\u2014","","","198"],["Total other expenses (income)","19,241","","","11,594","","","20,241"],["Income before income taxes","75,749","","","77,501","","","87,134"],["Income tax expense (benefit)","10,697","","","15,191","","","(19,579)"],["Net income and comprehensive income","$","65,052","","","$","62,310","","","$","106,713"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","January 2, 2021"],["Percentage of net sales (1)"],["Net sales","100.0","%","","100.0","%","","100.0","%"],["Cost of sales","69.5","%","","69.2","%","","68.9","%"],["Gross profit","30.5","%","","30.8","%","","31.1","%"],["Operating expenses:"],["Selling, general and administrative","24.9","%","","25.1","%","","24.6","%"],["Depreciation and amortization","2.1","%","","2.2","%","","1.8","%"],["Share-based compensation","0.9","%","","0.6","%","","1.2","%"],["Total operating expenses","27.9","%","","27.9","%","","27.6","%"],["Income from operations","2.7","%","","2.9","%","","3.4","%"],["Other expenses (income):"],["Interest expense, net","0.5","%","","0.5","%","","0.6","%"],["Gain on insurance recoveries","\u2014","%","","(0.1)","%","","\u2014","%"],["Loss on debt extinguishment and modification","\u2014","%","","\u2014","%","","\u2014","%"],["Total other expenses (income)","0.5","%","","0.4","%","","0.6","%"],["Income before income taxes","2.1","%","","2.5","%","","2.8","%"],["Income tax expense (benefit)","0.3","%","","0.5","%","","(0.6)","%"],["Net income and comprehensive income","1.8","%","","2.0","%","","3.4","%"]]
[[/GREPCENT_TABLE]]

_______________________

(1)Components may not sum to totals due to rounding.

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Operating Metrics and Non-GAAP Financial Measures

Number of New Stores

The number of new stores reflects the number of stores opened during a particular reporting period. New stores require an initial capital investment from us for store build-outs, fixtures and equipment that we amortize over time as well as cash required for inventory and pre-opening expenses.

We expect new store growth to be the primary driver of our net sales growth over the long term. We lease substantially all of our store locations. Our initial lease terms on stores are typically ten years with options to renew for two or three successive five-year periods.

Comparable Store Sales

We use comparable store sales as an operating metric to measure performance of a store during the current reporting period against the performance of the same store in the corresponding period of the previous year. Comparable store sales are impacted by the same factors that impact net sales.

Comparable store sales consists of net sales from our stores beginning on the first day of the fourteenth full fiscal month following the store's opening, which is when we believe comparability is achieved. Included in our comparable store definition are those stores that have been remodeled, expanded, or relocated in their existing location or respective trade areas. Excluded from our comparable store definition are those stores that have been closed for an extended period as well as any planned store closures or dispositions. When applicable, as was the case with fiscal 2020 and will be the case with fiscal 2025, we exclude the net sales in the non-comparable week of a 53-week year from the same store sales calculation after comparing the current and prior year weekly periods that are most closely aligned.

Opening new stores is a primary component of our growth strategy and, as we continue to execute on our growth strategy, we expect that a significant portion of our net sales growth will be attributable to non-comparable store net sales. Accordingly, comparable store sales is only one of many measures we use to assess the success of our growth strategy.

EBITDA, Adjusted EBITDA, Adjusted Net Income and Adjusted Earnings Per Share

EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share are supplemental key metrics used by management and our Board of Directors to assess our financial performance. EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share are also frequently used by analysts, investors and other interested parties to evaluate us and other companies in our industry. We use EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions and to compare our performance against that of other peer companies using similar measures. In addition, we use adjusted EBITDA to supplement GAAP measures of performance to evaluate our performance in connection with compensation decisions. Management believes it is useful to investors and analysts to evaluate these non-GAAP measures on the same basis as management uses to evaluate our operating results. We believe that excluding items from operating income, net income and net income per diluted share that may not be indicative of, or are unrelated to, our core operating results, and that may vary in frequency or magnitude, enhances the comparability of our results and provides additional information for analyzing trends in our business.

We define EBITDA as net income before net interest expense, income taxes and depreciation and amortization expenses. Adjusted EBITDA represents EBITDA adjusted to exclude share-based compensation expense, asset impairment and gain or loss on disposition and certain other expenses that may not be indicative of, or are unrelated to, our core operating results, and that may vary in frequency or magnitude. Adjusted net income represents net income adjusted for the previously mentioned adjusted EBITDA adjustments, further adjusted for costs related to amortization of purchase accounting assets and deferred financing costs, tax adjustment to normalize the effective tax rate, and tax effect of total adjustments. Basic adjusted earnings per share is calculated using adjusted net income, as defined above, and basic weighted average shares outstanding. Diluted adjusted earnings per share is calculated using adjusted net income, as defined above, and diluted weighted average shares outstanding. EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share are non-GAAP measures and may not be comparable to similar measures reported by other companies. EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. We address the limitations of the non-GAAP measures through the use of various GAAP measures. In the future, we will incur expenses or charges such as those added back to calculate adjusted EBITDA or adjusted net income. Our presentation of EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share should not be construed as an inference that our future results will be unaffected by the adjustments we have used to derive our non-GAAP measures.

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Beginning with the fourth quarter of fiscal 2022, we updated our definitions of adjusted EBITDA, adjusted net income and adjusted earnings per share to no longer exclude the impact of non-cash rent expense and the provision for (write-off of) accounts receivable reserves. The presentation for adjusted EBITDA, adjusted net income and adjusted earnings per share for fiscal 2021 and 2020 has been recast to reflect these changes and a reconciliation between the current and previous definitions of adjusted EBITDA, adjusted net income and adjusted earnings per share have been provided within the “—GAAP to Non-GAAP Reconciliations” section below.

The following table summarizes key operating metrics and non-GAAP financial measures for the periods presented (amounts in thousands, except for percentages and store counts):

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","January 2, 2021"],["Other Financial and Operations Data"],["Number of new stores","27","","","36","","","35"],["Number of stores open at end of period","441","","","415","","","380"],["Comparable store sales increase (decrease) (1)","11.8","%","","(6.0)","%","","12.7","%"],["EBITDA (2)","$","171,967","","","$","164,189","","","$","165,228"],["Adjusted EBITDA (2)","$","214,682","","","$","182,892","","","$","212,705"],["Adjusted net income (2)","$","93,858","","","$","78,588","","","$","105,309"]]
[[/GREPCENT_TABLE]]

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(1)Comparable store sales consist of net sales from our stores beginning on the first day of the fourteenth full fiscal month following the store's opening, which is when we believe comparability is achieved. For fiscal 2020, which is a 53-week year, we excluded the sales in the non-comparable week from the comparable store sales calculation after comparing the current and prior year weekly periods that are most closely aligned.

(2)See "—GAAP to Non-GAAP Reconciliations" section below for the applicable reconciliations. Beginning with the fourth quarter of fiscal 2022, we updated our definitions of adjusted EBITDA and adjusted net income to no longer exclude the impact of non-cash rent expense and the provision for (write-off of) accounts receivable reserves.

GAAP to Non-GAAP Reconciliations

The following tables provide a reconciliation from our GAAP net income to EBITDA and adjusted EBITDA, GAAP net income to adjusted net income, and our GAAP earnings per share to adjusted earnings per share for the periods presented (amounts in thousands, except per share data):

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","January 2, 2021"],["Net income","$","65,052","","","$","62,310","","","$","106,713"],["Interest expense, net","17,967","","","15,564","","","20,043"],["Income tax expense (benefit)","10,697","","","15,191","","","(19,579)"],["Depreciation and amortization expenses (1)","78,251","","","71,124","","","58,051"],["EBITDA","171,967","","","164,189","","","165,228"],["Share-based compensation expenses (2)","32,556","","","17,615","","","38,084"],["Asset impairment and gain or loss on disposition (3)","1,176","","","1,241","","","1,727"],["Other (4)","8,983","","","(153)","","","7,666"],["Adjusted EBITDA, revised definition","$","214,682","","","$","182,892","","","$","212,705"],["Revised definition no longer adjusts for:"],["Non-cash rent (5)","6,932","","","10,753","","","10,673"],["Provision for (write-off of) accounts receivable reserves (6)","4,318","","","4,813","","","(456)"],["Adjusted EBITDA, previous definition","$","225,932","","","$","198,458","","","$","222,922"]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","January 2, 2021"],["Net income","$","65,052","","","$","62,310","","","$","106,713"],["Share-based compensation expenses (2)","32,556","","","17,615","","","38,084"],["Asset impairment and gain or loss on disposition (3)","1,176","","","1,241","","","1,727"],["Other (4)","8,983","","","(153)","","","7,666"],["Amortization of purchase accounting assets and deferred financing costs (7)","10,877","","","11,821","","","11,808"],["Tax adjustment to normalize effective tax rate (8)","(10,084)","","","(5,928)","","","(44,089)"],["Tax effect of total adjustments (9)","(14,702)","","","(8,318)","","","(16,600)"],["Adjusted net income, revised definition","$","93,858","","","$","78,588","","","$","105,309"],["GAAP earnings per share"],["Basic","$","0.67","","","$","0.65","","","$","1.16"],["Diluted","$","0.65","","","$","0.63","","","$","1.08"],["Adjusted earnings per share, revised definition"],["Basic","$","0.97","","","$","0.82","","","$","1.15"],["Diluted","$","0.94","","","$","0.79","","","$","1.07"],["Revised definition no longer adjusts for:"],["Non-cash rent (5)","6,932","","","10,753","","","10,673"],["Provision for (write-off of) accounts receivable reserves (6)","4,318","","","4,813","","","(456)"],["Change in tax effect of total adjustments (9)","(3,087)","","","(4,241)","","","(2,861)"],["Adjusted net income, previous definition","$","102,021","","","$","89,913","","","$","112,665"],["Adjusted earnings per share, previous definition"],["Basic","$","1.05","","","$","0.94","","","$","1.23"],["Diluted","$","1.02","","","$","0.90","","","$","1.14"],["Weighted average shares outstanding"],["Basic","96,812","","","95,725","","","91,818"],["Diluted","100,162","","","99,418","","","98,452"]]
[[/GREPCENT_TABLE]]

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(1)Includes depreciation related to our distribution centers, which is included within the cost of sales line item in our consolidated statements of operations and comprehensive income. See NOTE 1—Organization and Summary of Significant Accounting Policies to our Consolidated Financial Statements for additional information about the components of cost of sales.

(2)Includes non-cash share-based compensation expense and $0.1 million, $0.2 million, and $0.4 million of cash dividends paid in fiscal 2022, 2021, and 2020 respectively, on vested share-based awards as a result of dividends declared in connection with recapitalizations that occurred in fiscal 2018 and 2016.

(3)Represents asset impairment charges and gains or losses on dispositions of assets.

(4)Represents other non-recurring, non-cash or non-operational items, such as store closing costs, technology upgrade implementation costs, legal settlements and other legal expenses, loss on debt extinguishment, costs related to employer payroll

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taxes associated with equity awards, certain personnel-related costs, strategic project costs, gain on insurance recoveries, and miscellaneous costs.

(5)Consists of the non-cash portion of rent expense, which represents the difference between our straight-line rent expense recognized under GAAP and cash rent payments. The adjustment can vary depending on the average age of our lease portfolio, which has been impacted by our significant store growth in recent years.

(6)Represents non-cash changes in reserves related to our IO notes and accounts receivable.

(7)Represents the amortization of debt issuance costs and incremental amortization of an asset step-up resulting from purchase price accounting related to our acquisition in 2014 by an investment fund affiliated with Hellman & Friedman LLC, which included trademarks, customer lists, and below-market leases.

(8)Represents adjustments to normalize the effective tax rate for the impact of unusual or infrequent tax items that we do not consider in our evaluation of ongoing performance, including excess tax benefits related to stock option exercises and vesting of restricted stock units ("RSUs") that are recorded in earnings as discrete items in the reporting period in which they occur.

(9)Represents the tax effect of the total adjustments. We calculate the tax effect of the total adjustments on a discrete basis excluding any non-recurring and unusual tax items.

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Comparison of fiscal 2022 to fiscal 2021 (amounts in thousands, except percentages)

Net Sales

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Net sales","$","3,578,101","","","$","3,079,582","","","$","498,519","","","16.2","%"]]
[[/GREPCENT_TABLE]]

The increase in net sales for fiscal 2022 compared to fiscal 2021 was primarily attributable to an increase in comparable store sales as well as non-comparable store net sales growth primarily from the 26 net new stores opened during fiscal 2022.

Comparable store sales increased 11.8% for fiscal 2022 compared to fiscal 2021. The increase was driven by a 5.9% increase in the number of transactions combined with a 5.6% increase in average transaction size.

Cost of Sales

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Cost of sales","$","2,486,002","","","$","2,130,796","","","$","355,206","","","16.7","%"],["% of net sales","69.5","%","","69.2","%"]]
[[/GREPCENT_TABLE]]

The increase in cost of sales for fiscal 2022 compared to fiscal 2021 was primarily the result of an increase in comparable store sales combined with non-comparable sales from 26 net new stores opened during fiscal 2022 (as discussed above).

Costs as a percentage of net sales increased for fiscal 2022 compared to fiscal 2021 due to the impact of inflationary product and supply chain cost pressures, partially offset by increases in retail pricing. Due to the interdependencies of the above-mentioned inflationary and supply chain factors as well as our dynamic ever-changing assortment, we are unable to quantify the impact that they individually had on costs as a percentage of net sales.

Gross Profit and Gross Margin

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Gross profit","$","1,092,099","","","$","948,786","","","$","143,313","","","15.1","%"],["Gross margin","30.5","%","","30.8","%"]]
[[/GREPCENT_TABLE]]

The increase in gross profit for fiscal 2022 compared to fiscal 2021 was primarily the result of an increase in comparable store sales combined with non-comparable sales from 26 net new stores opened during fiscal 2022 (as discussed above).

Gross margin decreased for fiscal 2022 compared to fiscal 2021 due to the impact of inflationary product and supply chain cost pressures, partially offset by increases in retail pricing (as discussed above).

Selling, General and Administrative Expenses

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["SG&A","$","889,347","","","$","773,718","","","$","115,629","","","14.9","%"],["% of net sales","24.9","%","","25.1","%"]]
[[/GREPCENT_TABLE]]

The increase in SG&A for fiscal 2022 compared to fiscal 2021 was driven by $80.0 million in higher store-related expenses and $35.7 million in higher corporate-related expenses. Store-related expenses primarily increased as a result of

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higher commission payments to IOs, reflecting gross profit growth, as well as higher store occupancy costs due to 26 net new stores opened during 2022. Corporate-related expenses increased largely due to higher incentive compensation, reflecting stronger financial performance versus the prior year.

As a percentage of net sales, SG&A decreased slightly for fiscal 2022 compared to fiscal 2021 as leverage on store-related expenses was largely offset by higher incentive compensation expense.

Depreciation and Amortization Expense

[[GREPCENT_TABLE]]
[["","Fiscal Year End"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Depreciation and amortization","$","75,206","","","$","68,358","","","$","6,848","","","10.0","%"],["% of net sales","2.1","%","","2.2","%"]]
[[/GREPCENT_TABLE]]

The increase in depreciation and amortization expenses for fiscal 2022 compared to fiscal 2021 was primarily driven by new store growth and existing store investments.

Share-based Compensation Expense

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Share-based compensation","$","32,556","","","$","17,615","","","$","14,941","","","84.8","%"],["% of net sales","0.9","%","","0.6","%"]]
[[/GREPCENT_TABLE]]

The increase in share-based compensation expenses for fiscal 2022 compared to fiscal 2021 was primarily due to the impact of share-based awards granted in October of fiscal 2021 and March of fiscal 2022 as well as an increase in the number of performance-based restricted stock units ("PSUs") expected to be earned based on revised performance expectations during fiscal 2022.

See NOTE 8—Share-based Awards to our Consolidated Financial Statements for additional information.

Interest Expense, net

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Interest expense, net","$","17,967","","","$","15,564","","","$","2,403","","","15.4","%"],["% of net sales","0.5","%","","0.5","%"]]
[[/GREPCENT_TABLE]]

The increase in net interest expense for fiscal 2022 compared to fiscal 2021 was primarily driven by increases in the effective borrowing rate, partially offset by both the April 2022 prepayment of $75.0 million of principal on the senior term loan outstanding under our prior first lien credit agreement, dated as of October 22, 2018, as well as increased interest income from cash and cash equivalents.

See NOTE 6—Long-term Debt to our Consolidated Financial Statements for additional information.

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Gain on Insurance Recoveries

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Gain on insurance recoveries","$","\u2014","","","$","(3,970)","","","$","3,970","","","(100.0)","%"],["% of net sales","\u2014","%","","(0.1)","%"]]
[[/GREPCENT_TABLE]]

During fiscal 2021, we recorded a $4.0 million gain on insurance due to proceeds received related to the loss of our Paradise, California store due to a wildfire in 2018.

Loss on Debt Extinguishment and Modification

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Loss on debt extinguishment and modification","$","1,274","","","$","\u2014","","","$","1,274","","","N/A"],["% of net sales","\u2014","%","","\u2014","%"]]
[[/GREPCENT_TABLE]]

During fiscal 2022, we recorded a $1.3 million loss on debt extinguishment related to the prepayment of $75.0 million of principal on the senior term loan outstanding under our prior first lien credit agreement, dated as of October 22, 2018.

See NOTE 6—Long-term Debt to our Consolidated Financial Statements for additional information.

Income Tax Expense (Benefit)

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Income tax expense (benefit)","$","10,697","","","$","15,191","","","$","(4,494)","","","(29.6)","%"],["% of net sales","0.3","%","","0.5","%"],["Effective tax rate","14.1","%","","19.6","%"]]
[[/GREPCENT_TABLE]]

The decrease in income tax expense for fiscal 2022 compared to fiscal 2021 was primarily driven by benefits associated with accelerated tax depreciation on fixtures and equipment as well as leasehold assets.

See NOTE 10—Income Taxes to our Consolidated Financial Statements for additional information.

Net Income

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Net income","$","65,052","","","$","62,310","","","$","2,742","","","4.4","%"],["% of net sales","1.8","%","","2.0","%"]]
[[/GREPCENT_TABLE]]

As a result of the foregoing factors, net income increased in fiscal 2022 compared to fiscal 2021.

Adjusted EBITDA

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Adjusted EBITDA","$","214,682","","","$","182,892","","","$","31,790","","","17.4","%"]]
[[/GREPCENT_TABLE]]

The increase in adjusted EBITDA for fiscal 2022 compared to fiscal 2021 was primarily attributable to net sales growth, as discussed above, partially offset by decreases in gross margin and increases in SG&A.

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Adjusted Net Income

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","$ Change","","% Change"],["Adjusted net income","$","93,858","","","$","78,588","","","$","15,270","","","19.4","%"]]
[[/GREPCENT_TABLE]]

The increase in adjusted net income for fiscal 2022 compared to fiscal 2021 was primarily a result of net sales growth, as discussed above, partially offset by decreases in gross margin and increases in SG&A.

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Liquidity and Capital Resources

Sources of Liquidity

Based on our current operations and new store growth plans, we expect to satisfy our short-term and long-term cash requirements through a combination of our existing cash and cash equivalents position, funds generated from operating activities, and the borrowing capacity available in the revolving credit facility under our credit agreement, dated as of February 21, 2023 (the "Credit Agreement"). If cash generated from our operations and borrowings under our revolving credit facility are not sufficient or available to meet our liquidity requirements, then we will be required to obtain additional equity or debt financing in the future. There can be no assurance equity or debt financing will be available to us when we need it or, if available, the terms will be satisfactory to us and not dilutive to our then-current stockholders. Additionally, we may seek to take advantage of market opportunities to refinance our existing debt instruments with new debt instruments at interest rates, maturities and terms we deem attractive.

As of December 31, 2022, we had cash and cash equivalents of $102.7 million, which consisted primarily of cash held in checking and money market accounts with financial institutions. In addition, on such date we had a revolving credit facility with $100.0 million in borrowing capacity under a first lien credit agreement, dated as of October 22, 2018, with GOBP Holdings, Inc., as borrower (the "Prior First Lien Credit Agreement"). As of December 31, 2022, we had $3.5 million of outstanding standby letters of credit and $96.5 million of remaining borrowing capacity available under this revolving credit facility. We did not borrow under this revolving credit facility during fiscal 2022 and had no borrowings outstanding thereunder as of December 31, 2022.

On February 21, 2023, we entered into the Credit Agreement, which provides for senior secured credit facilities consisting of (i) a senior secured term loan facility in an aggregate principal amount of $300.0 million and (ii) a senior secured revolving credit facility in an aggregate principal amount of $400.0 million. The term loan facility was borrowed in full on such date, and $25.0 million of the revolving credit facility was borrowed on such date, resulting in a remaining borrowing capacity of $375.0 million under the revolving credit facility.

The new senior secured credit facilities of the Credit Agreement permit us to add incremental term loan facilities, increase any existing term loan facility, increase revolving commitments, and/or add incremental replacement revolving credit facility tranches. The aggregate principal amount of such incremental facilities are limited to (a) an amount not in excess of the sum of the greater of $200.0 million and 100% of Consolidated EBITDA (as defined in the Credit Agreement), subject to certain limitations, plus (b) voluntary prepayments of the term loan facility, voluntary permanent reductions of the commitments for the revolving credit facility and voluntary prepayments of indebtedness secured by liens on the collateral securing the credit facilities, subject to certain exceptions, plus (c) an amount such that (assuming that the full amount of any such incremental revolving increase and/or incremental replacement revolving credit facility was drawn, and after giving effect to any appropriate pro forma adjustment events) we would be in compliance, on a pro forma basis (but excluding the cash proceeds of such incurrence), with a total net leverage ratio of 3.00 to 1.00.

We used the net proceeds from the Credit Agreement, together with cash on hand, to repay all of the outstanding balance on the credit facilities under our Prior First Lien Credit Agreement of $387.2 million, and pay fees and expenses in connection therewith. All of our subsidiaries’ obligations under the Prior First Lien Credit Agreement were discharged at such time.

We may, from time to time, at our sole discretion, prepay or retire all or a portion of our outstanding debt. In April 2022, for example, we prepaid $75.0 million of principal on the senior term loan outstanding under our Prior First Lien Credit Agreement.

Material Cash Requirements

Leases

We have operating and finance lease arrangements for substantially all store locations, distribution centers, and certain office space and equipment. As of December 31, 2022, total lease assets and lease liabilities were $907.9 million and $1.0 billion, respectively, and we had executed leases for 43 store locations that we had not yet taken possession of with total undiscounted future lease payments of $224.7 million and lease terms through 2041. See NOTE 4—Leases to our Consolidated Financial Statements for further detail of our lease obligations and the timing of lease liability maturities.

Debt Obligations and Interest Payments

See NOTE 6—Long-term Debt to our Consolidated Financial Statements for further detail of our Prior First Lien Credit Agreement, which consisted of a $385.0 million senior term loan and a revolving credit facility for an amount up to $100.0 million, and the timing of principal maturities. As of December 31, 2022, based on the then-current interest rate of

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7.13%, expected future interest payments associated with our debt totaled $78.2 million, with $27.8 million payable during fiscal 2023.

In February 2023, we repaid this indebtedness with the net proceeds from borrowings under our Credit Agreement as discussed above. Our borrowings under the Credit Agreement bear interest at variable interest rates. In addition, the Credit Agreement requires the Company to make scheduled quarterly amortization payments of the outstanding term loans starting in June 2023. Such payments total $56.3 million over the term of the term loan facility, with $3.8 million payable during Fiscal 2023. The remaining term loan facility principal balance will become due in February 2028 at maturity. See NOTE 14—Subsequent Event to our Consolidated Financial Statements for further detail of our Credit Agreement.

Capital Expenditures

Our capital expenditures are primarily related to new store openings, ongoing store maintenance and improvements, expenditures related to our distribution centers and infrastructure-related investments, including investments related to upgrading and maintaining our information technology systems and corporate offices. We expect to fund capital expenditures through cash generated from our operations. As compared to capital expenditures of $129.2 million, net of tenant improvement allowances, in fiscal 2022, we expect to incur capital expenditures of approximately $155.0 million, net of tenant improvement allowances, in fiscal 2023, primarily related to new store openings, ongoing store maintenance and improvements and systems and infrastructure investments.

Working Capital and Purchase Commitments

Our primary working capital requirements are for the purchase of inventory, payroll, rent, issuance of IO notes, other store facilities costs, distribution costs and general and administrative costs. Our working capital requirements fluctuate during the year, driven primarily by the timing of inventory fluctuations, new store openings and capital spending.

Our purchase commitments consist of non-cancelable obligations under service and supply contracts. As of December 31, 2022, we had total purchase obligations of $2.5 million, with $0.6 million payable during fiscal 2023.

Share Repurchases and Dividends

We may repurchase our common stock pursuant to programs approved by our Board of Directors. As of December 31, 2022, we had $96.6 million of repurchase authority remaining under the current share repurchase program. See "Item 5. Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Issuer Purchases of Equity Securities" for discussion about our Board-authorized share repurchase program.

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As of December 31, 2022, we expect to pay less than $0.1 million related to dividends declared in our recapitalization in 2018 for stock options that will vest during fiscal 2023. Pursuant to The Globe Holding Corp. 2014 Plan, if we are unable to make those payments, we may instead elect to reduce the per share exercise price of each such option by an amount equal to the dividend amount in lieu of making the applicable dividend payment.

Debt Covenants

The Credit Agreement contains certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants. The Credit Agreement contains certain covenants that, among other things, limit the our ability and the ability of our restricted subsidiaries to: pay dividends or distributions, repurchase equity, prepay junior debt and make certain investments; incur additional debt or issue certain disqualified stock and preferred stock; incur liens on assets; merge or consolidate with another company or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets; enter into transactions with affiliates; and allow to exist certain restrictions on the ability of subsidiaries to pay dividends or make other payments to the borrower. The Credit Agreement also contains financial performance covenants requiring us to satisfy a maximum total net leverage ratio test and a minimum interest coverage ratio test as of the last day of each fiscal quarter ending on or after April 1, 2023, as specified therein.

Our Prior First Lien Credit Agreement also contained certain customary representations and warranties, subject to limitations and exceptions, and affirmative and customary covenants and restricted us from entering into certain types of transactions. Additionally, borrowing under the revolving credit facility under our Prior First Lien Credit Agreement was subject to compliance with a first lien secured leverage ratio of 7.00 to 1.00 (as specified in the Prior First Lien Credit Agreement), tested quarterly if, and only if, the aggregate principal amount outstanding and/or issued, as applicable, from the revolving facility, letters of credit (to the extent not cash collateralized or backstopped or, in the aggregate, not in excess of the greater of $10.0 million and the stated face amount of letters of credit outstanding on the closing date) and swingline loans exceeded 35% of the total amount of the revolving credit facility commitments.

As of December 31, 2022, we were in compliance with all applicable financial covenant requirements for our Prior First Lien Credit Agreement.

Cash Flows

The following table summarizes our cash flows for the periods presented (amounts in thousands):

[[GREPCENT_TABLE]]
[["","Fiscal Year Ended"],["","December 31, 2022","","January 1, 2022","","January 2, 2021"],["Net cash provided by operating activities","$","185,511","","","$","165,587","","","$","181,237"],["Net cash used in investing activities","(149,931)","","","(136,713)","","","(133,786)"],["Net cash provided by (used in) financing activities","(72,937)","","","5,885","","","29,774"],["Net increase (decrease) in cash and cash equivalents","$","(37,357)","","","$","34,759","","","$","77,225"]]
[[/GREPCENT_TABLE]]

Cash Provided by Operating Activities

Net cash provided by operating activities was $185.5 million for fiscal 2022 compared to $165.6 million for fiscal 2021. The $19.9 million increase was primarily due to higher net sales driven by an increase in comparable store sales combined with changes to our working capital balances. Changes to trade accounts payable and accrued compensation increased net cash flow provided by operating activities, which were partially offset by changes to merchandise inventory levels.

Cash Used in Investing Activities

Net cash used in investing activities for fiscal 2022, fiscal 2021, and fiscal 2020 was primarily for capital expenditures and loans to IOs.

Net cash used in investing activities was $149.9 million for fiscal 2022 compared to $136.7 million for fiscal 2021. The $13.2 million increase was primarily related to an increase in expenditures related to construction of newly opened stores and stores under development and existing store capital investments, combined with an increase of investments in computer software intangible assets. Of the $149.9 million net cash used in investing activities during fiscal 2022, $130.5 million represented purchases of property and equipment prior to the application of tenant improvement allowances.

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Cash Provided by (Used in) Financing Activities

Net cash used in financing activities of $72.9 million for fiscal 2022 was primarily due to the prepayment of $75.0 million of principal on the senior term loan outstanding under our First Lien Credit Agreement as well as the repurchase of $3.5 million worth of common stock, partially offset by $6.9 million in proceeds from the exercise of stock options. Net cash provided by financing activities of $5.9 million for fiscal 2021 was primarily due to $7.2 million in proceeds from the exercise of stock options, partially offset by $1.2 million in principal payments on finance leases.

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Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with GAAP. A summary of our significant accounting policies can be found in NOTE 1—Organization and Summary of Significant Accounting Policies to our Consolidated Financial Statements. The preparation of our consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. These judgments and estimates are based on historical experience and other factors believed to be reasonable under the circumstances.

Management evaluated the development and selection of our critical accounting policies and estimates and believes that the following involves a higher degree of judgment or complexity and is most significant to reporting our results of operations and financial position, and is therefore discussed as critical. The following critical accounting policy reflects a significant estimate and judgment used in the preparation of our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected results can potentially have a materially favorable or unfavorable impact on subsequent results of operations.

Long-lived asset impairment

We evaluate long-lived assets, including property and equipment and lease right-of-use assets, for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. For purposes of this evaluation, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets. Our retail stores are evaluated for impairment at the store level. A long-lived asset or asset group may be impaired if its carrying value exceeds its estimated undiscounted future cash flows over its remaining useful life. The total amount of property and equipment, including store assets, and operating lease right-of-use assets as of December 31, 2022 were $560.7 million and $902.2 million, respectively.

Our impairment calculations contain uncertainties because they require us to make assumptions and to apply judgment to estimate future cash flows. Key assumptions used in estimating future cash flows include projected sales growth and operating expenses. Estimates of sales growth and operating expenses are based on internal projections and consider the store’s historical performance, length of time the store has been open, the local market economics and the business environment impacting the store’s performance. These estimates are subjective and our ability to realize future cash flows is affected by factors such as ongoing maintenance and improvement of the assets, changes in economic conditions and changes in operating performance. We have not made any material changes in the accounting methodology used to evaluate the impairment of long-lived assets during fiscal 2022. If actual results are not consistent with our estimates and assumptions used to calculate estimated future cash flows, we may be exposed to impairment losses that could be material.

If a long-lived asset or asset group is determined to be impaired, we record an impairment loss for the amount by which the carrying value of the asset or asset group exceeds its fair value. The estimated fair value of the asset or asset group is based on the estimated discounted future cash flows of the asset or asset group using a discount rate commensurate with the related risk.

There were no adjustments to the carrying value of long-lived assets due to impairment charges during fiscal 2022, 2021 and 2020.

Recent Accounting Pronouncements

Refer to NOTE 1—Organization and Summary of Significant Accounting Policies to our Consolidated Financial Statements.

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