SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|☒||ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the fiscal year ended December 31, 2022
|☐||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)
|(State or other jurisdiction of|
incorporation or organization)
109 Innovation Court, Suite J
Delaware, Ohio 43015
(Address of principal executive offices)
Registrant’s telephone number, including area code: (740) 363-2222
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 $0.01 per share||FRG||NASDAQ Global Market|
|7.50% Series A Cumulative Preferred Stock, par value $0.01 per share and liquidation preference of $25.00 per share||FRGAP||NASDAQ Global Market|
Securities to be registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. Yes o No ý
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||☒||Accelerated filer||☐||Non-accelerated filer ||☐||Smaller reporting company||☐|
Emerging growth company ☐
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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements.☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b).☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ý
The aggregate market value of the shares of common stock held by non-affiliates of the registrant computed based on the last reported sale price of $38.80 on June 25, 2022 was $1,097,885,557.
The number of shares of the registrant’s common stock outstanding as of February 22, 2023 was 34,925,773.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Definitive Proxy Statement for the 2023 Annual Meeting of Stockholders are incorporated by reference into Part III hereof.
Table of Contents
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K for the year ended December 31, 2022 (this “Annual Report”) contains forward-looking statements concerning our business, operations, and financial performance and condition as well as our plans, objectives, and expectations for our business operations and financial performance and condition. Any statements contained herein that are not of historical facts may be deemed to be forward-looking statements. You can identify these statements by words such as “aim,” “anticipate,” “assume,” “believe,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “potential,” “positioned,” “should,” “target,” “will,” “would,” and other similar expressions that are predictions of or indicate future events and future trends. These forward-looking statements are based on current expectations, estimates, forecasts, and projections about our business and the industry in which we operate and our management’s beliefs and assumptions. They are not guarantees of future performance or development and involve known and unknown risks, uncertainties, and other factors that are in some cases beyond our control. Additionally, other factors may cause actual results to differ materially from historical results or from any results expressed or implied by such forward-looking statements. Factors that may cause such differences include, but are not limited to, the risks described under “Item 1A-Risk Factors,” including:
•the risk that natural disasters, public health crises, political uprisings, uncertainty or unrest, or other catastrophic events could adversely affect our operations and financial results, including the impact of the COVID-19 pandemic on manufacturing operations and our supply chain, customer traffic and our operations in general;
•the possibility that any of the anticipated benefits of our acquisitions or dispositions will not be realized or will not be realized within the expected time period, our businesses and our acquisitions may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected, or revenues following our acquisitions may be lower than expected or we are unable to sell non-core assets;
•our ability to identify and consummate attractive acquisitions on favorable terms;
•additional leverage incurred in connection with acquisitions or other capital expenditure initiatives;
•our inability to grow on a sustainable basis;
•changes in operating costs, including employee compensation and benefits and increased transportation costs and delays attributed to global supply chain challenges;
•higher inflation rates, which may result in reduced customer traffic or impact discretionary consumer spending;
•the seasonality of the products and services we provide in certain of our business segments;
•departures of key executives, senior management members or directors;
•our ability to attract additional talent to our teams;
•our ability to maintain an active trading market for our common stock on The Nasdaq Global Market (“Nasdaq”);
•the effect of regulation of the products and services that we offer, including changes in laws and regulations and the costs and administrative burdens associated with complying with such laws and regulations;
•our ability to develop and maintain relationships with our third-party product and service providers;
•our ability to offer merchandise and services that our customers demand;
•our ability to successfully manage our inventory levels and implement initiatives to improve inventory management and other capabilities;
•competitive conditions in the retail industry and consumer services markets;
•the performance of our products within the prevailing industry;
•worldwide economic conditions and business uncertainty, the availability of consumer and commercial credit, higher debt capital costs, change in consumer confidence, tastes, preferences and spending, and changes in vendor relationships;
•the uncertainty of the future impact of the COVID-19 pandemic and public health measures on our business and results of operations;
•the effect of steps we take in response to the COVID-19 pandemic, the severity and duration of the pandemic, new variants of COVID-19 that have emerged, and the speed and efficacy of vaccine and treatment developments, the pace of recovery when the pandemic subsides and the heightened impact it has on many of the risks described herein and in our other filings with the SEC;
•potential regulatory actions relating to the COVID-19 pandemic and the related government mitigation efforts on our business and our financial results;
•disruption of manufacturing, warehouse or distribution facilities or information systems;
•the continued reduction of our competitors promotional pricing on new-in-box appliances, potentially adversely impacting our sales of out-of-box appliances and associated margin;
•any potential non-compliance, fraud or other misconduct by our franchisees, dealers, or employees;
•our ability and the ability of our franchisees and dealers to comply with legal and regulatory requirements;
•failures by our franchisees, the franchisees’ employees, and our dealers to comply with their contractual obligations to us and with laws and regulations, to the extent these failures affect our reputation or subject us to legal risk;
•our ability to attract and retain new franchisees and dealers and the ability of our franchisees and dealers to open new stores or territories and operate them successfully;
•the availability of suitable store locations at appropriate lease terms;
•the ability of our franchisees and dealers to generate sufficient revenue to pay us royalties and fees;
•our ability to manage Company-owned stores;
•our exposure to litigation and any governmental investigations;
•our ability and our franchisees’ and dealers’ ability to protect customers’ personal information, including from a cyber-security incident;
•the impact of identity-theft concerns on customer attitudes toward our services;
•our ability to access the credit markets and satisfy our covenants to lenders;
•our operating subsidiary’s potential repurchase of certain finance receivables if certain representations and warranties about the quality and nature of such receivables are breached, which may negatively impact our results of operations, financial condition, and liquidity;
•a decline in the credit quality of our customers, a decrease in our credit sales, or other factors outside of our control, which could lead to a decrease in our product sales and profitability;
•our reliance on technology systems and electronic communications; and
•other factors, including the risk factors discussed in this Annual Report.
Potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on the forward-looking statements. These forward-looking statements speak only as of the date of this Annual Report. Unless required by law, we do not intend to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise. A potential investor or other vendor should, however, review the factors and risks we describe in the reports we will file from time to time with the U.S. Securities and Exchange Commission (“SEC”) after the date of this Annual Report.
Item 1. Business.
We are an owner and operator of franchised and franchisable businesses that continually looks to grow our portfolio of brands while utilizing our operating and capital allocation philosophies to generate strong cash flows. We have a diversified and growing portfolio of highly recognized brands. Our asset-light business model is designed to generate consistent, recurring revenue and strong operating margins and requires limited maintenance capital expenditures. As a multi-brand operator, we continually look to diversify and grow our portfolio of brands either through acquisition or organic brand development. Our acquisition strategy typically targets businesses that are highly cash flow generative with compelling unit economics that can be scaled by adding franchise, dealer and company-owned units, or that can be restructured to enhance performance and value to Franchise Group. We strive to create value for our stockholders by generating free cash flow and capital-efficient growth across economic cycles.
Our business segments include The Vitamin Shoppe (“Vitamin Shoppe”), Pet Supplies Plus, Badcock Home Furniture & more (“Badcock”), American Freight, Buddy’s Home Furnishings (“Buddy’s”), and Sylvan Learning (“Sylvan”). As of the year ended December 31, 2022, on a combined basis, we operated 3,029 locations consisting of 1,310 franchised locations, 1,401 company-run locations and 318 dealer locations. Each of our companies has its own management team with significant experience in its respective industry. Additionally, we offer our brands a shared services platform that allows us to drive economies of scale, efficiencies and best practices. We believe our platform enables our portfolio of brands to be stronger together than they are apart.
We believe our financial performance and business model have been resilient across economic cycles and recently during the COVID-19 pandemic. In addition, our franchised business model is designed to generate consistent, recurring revenue and predictable free cash flow in order to insulate us from the operating cost variability of our franchised locations. The operating costs of our franchised locations are borne by our franchisees themselves; however, royalties paid by our franchisees to us could be dependent upon our franchisees’ ability to effectively manage these operating costs. That is why we strive to deliver to our franchisees a best-in-class franchise program through, among other things, our knowledge of the business, operational support and training.
We believe our success is driven in large part by our mutually beneficial relationships with our individual franchisees and dealers. Our franchise and dealer programs are designed to promote consistency and we are selective in granting franchises and dealerships. We are focused on partnering with franchisees and dealers who have the commitment, capability and capitalization to grow our brands. Franchisees and dealers can range in size from individuals owning just one location to publicly-traded companies.
While the specific terms of our franchise agreements vary among our brands, we utilize both store-level franchise and multi-unit development programs. Under both types of franchise programs, franchisees supply capital by purchasing or leasing the land, building, equipment, signs, inventory and supplies. Both store-level franchise and multi-unit development agreements typically require payment to us of certain upfront fees such as initial fees paid upon opening a store, fees paid to renew the term of the franchise agreement and fees paid in the event the franchise agreement is transferred to another franchisee. Franchisees also pay monthly royalties based on a percentage of their store sales and are required to spend a certain amount to advertise and promote the brand.
Additionally, our Badcock segment offers dealership agreements, whereby a dealer is granted a non-exclusive license for use at designated premises to operate the dealership devoted exclusively to the sale of merchandise and other approved activities. There are no fees that are paid by the dealer for entering into a dealership agreement. However, the dealers are able to earn and may be entitled to receive a commission, as determined by Badcock, upon the sale of merchandise consigned by Badcock to the dealer.
We seek to maintain healthy relationships with our franchisees, dealers and their representatives. We invest a significant amount of time working with the franchisee and dealer community on key aspects of the business, including products, equipment, operational improvements, standards and management techniques.
Our Vitamin Shoppe segment is an omnichannel 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, however they define it. Vitamin Shoppe offers one of the largest varieties of products among vitamin, mineral and supplement retailers. The broad product offering enables Vitamin Shoppe to provide our customers with a depth of selection of products that may not be readily available at other specialty retailers or mass merchants, such as discount stores, supermarkets, drug stores and wholesale clubs. Vitamin Shoppe continues to focus on improving the customer experience through the roll-out of initiatives including
increasing customer engagement and personalization, enhancing the omnichannel experience (including in stores, online and on mobile devices), growing private brands and improving the effectiveness of pricing and promotions.
Our Pet Supplies Plus segment is a leading omnichannel retail chain and franchisor of pet supplies and services. Pet Supplies Plus has a diversified revenue model comprised of company-owned store revenue, franchise royalties and revenue generated by the wholesale distribution of products to its franchisees. Pet Supplies Plus offers a curated selection of premium brands, proprietary private label and specialty products with retail price parity with online competitors. Additionally, Pet Supplies Plus offers grooming, pet wash and other services in most of its locations. Our Pet Supplies Plus segment’s wholly-owned subsidiary Wag N’ Wash is an emerging grooming, pet-wash and natural pet food franchise. Wag N’ Wash is primarily focused on dogs, has a store footprint that is substantially smaller than a Pet Supplies Plus location and is operated by the Pet Supplies Plus management.
Our Badcock segment is a retailer of furniture, appliances, bedding, electronics, home office equipment, accessories and seasonal items in a showroom format. Additionally, Badcock offers multiple and flexible payment solutions and credit options through third parties and its consumer financing services. We are in the process of moving its consumer financing services business to a third-party provider.
Our American Freight segment is a retail chain offering in-store and online access to furniture, mattresses, new and out-of-box home appliances and home accessories at discount prices. American Freight buys direct from manufacturers and sells direct in warehouse-style stores. By cutting out the middleman and keeping its overhead costs low, American Freight is well positioned to offer quality products at low prices. Our American Freight segment provides customers with multiple payment options, including third-party financing, providing access to high-quality products and brand name appliances that may otherwise remain aspirational to some of its customers.
American Freight also serves as a liquidation channel for major appliance vendors. American Freight operates specialty distribution centers that test out-of-box appliances before they are offered for sale to customers. Customers typically are covered by the original manufacturer’s warranty and are offered the opportunity to purchase a full suite of extended-service plans and services.
Our Buddy’s segment is a specialty retailer of high quality, name brand consumer electronic, residential furniture, appliances and household accessories through rent-to-own agreements. The rental transaction allows our customers the opportunity to benefit from the use of high-quality products under flexible rental purchase agreements without long-term obligations.
Our Sylvan Learning segment is an established and growing franchisor of supplemental education for Pre-K-12 students and families. Sylvan addresses the full range of student needs with a broad variety of academic curriculums delivered in an omnichannel format. The Sylvan platform provides franchisees with the ability to provide a range of supplemental educational services, including on premises, virtually, at a satellite location and in the home.
Each of our brands competes with many well-established companies on the basis of product choice, quality, affordability, service and location. The Vitamin Shoppe competes in the highly competitive nutritional supplements retail industry, in which competition is based primarily on quality, product assortment, price, customer service, convenience, marketing support and availability of new products. American Freight and Badcock primarily compete with discount retailers of furniture and mattresses and with big box retailers and locally-owned appliance retailers that sell new-in-box and liquidations of their out-of-box or as-is appliances. Pet Supplies Plus competes in the highly competitive pet products retail industry, in which competition is based primarily on quality, product assortment, price, customer service, convenience, marketing support and availability of new products. Buddy’s competes with other national, regional and local rent-to-own businesses, including online only competitors, as well as with rental stores that do not offer their customers a purchase option. Sylvan competes with other national, regional and local tutoring centers, including online only competitors.
Our strategy is to focus on the operation and acquisition of franchise and franchisable businesses. We strive to assemble a mix of businesses that we believe provide us balance and overall economic resiliency, while also allowing us to benefit from the scale of a single franchising platform.
As a multi-brand operator, we continually look to diversify and grow our portfolio of brands either through acquisition or organic brand development. Our acquisition strategy typically targets businesses that are cash flow generative with unit economics that can be scaled by adding franchise and company-owned units, or that can be restructured to enhance performance and value to Franchise Group.
We have established a corporate platform that enables us to deploy capital to acquire diversified assets that may become more valuable as part of our Company. Across all businesses, we look to create operating efficiencies in order to drive incremental free cash flow while allowing the management teams of each brand to focus on growing their businesses. Furthermore, our aggregated platform of multiple brands and increased scale provides cost of capital advantages relative to financing each business alone.
We believe our portfolio of brands will allow us to offer franchisees a variety of platforms that will allow them to diversify their investment portfolio in a local area, optimize their geographic penetration and grow their businesses. We believe our investors will benefit from sustainable franchise royalties and opportunistic franchise sales. Furthermore, we expect our refranchising strategy to create cash inflows to opportunistically de-lever and acquire additional brands.
Impact of COVID-19
As of the date of this Annual Report, we have experienced some supply chain delays and disruptions, including adverse consequences to our supply chain function from decreased procurement volumes in connection with the COVID-19 pandemic. Additionally, while fiscal stimulus provided in response to the COVID-19 pandemic impacted our business positively by boosting the consumption of our products, the resulting surge in inflation from the fiscal stimulus and supply chain constraints contributed to price tension and reduced sales activity. We believe that the lingering effects of the COVID-19 pandemic could negatively impact our business and financial results by weakening demand for our products and services, further disrupting our supply chain or affecting our ability to raise capital from financial institutions. As events continue to change, we are unable to accurately predict the impact that the COVID-19 pandemic will have on our results of operations due to uncertainties including, but not limited to, the severity of the disease, the impact of new subvariants and the public’s response to the outbreak; however, we are actively managing our business to respond to the impact.
Change of Year-End
For the years ended December 25, 2021 and December 26, 2020, our fiscal year ended on the Saturday in December closest to December 31st. On February 22, 2022, our Board of Directors (“Board”) approved a change in our fiscal year-end from the last Saturday in December closest to December 31st to the Saturday in December or January, whichever is closest to December 31st. Fiscal year 2022 ended on December 31, 2022 and included 53 weeks, with the 53rd week falling in the fourth fiscal quarter and Fiscal years 2021 and 2020 included 52 weeks.
Human Capital Management
As of December 31, 2022, we employed 8,575 full-time and 5,662 part-time employees. Part-time employees work an average of fewer than 30 hours per work. The number of part-time employees fluctuates based on seasonal needs. We believe that we have developed strong relations with our employees. Our employees are a key source of our competitive advantage and their actions are expected to be guided by our values and by an underlying set of ethical principles as incorporated into our Code of Conduct. We believe these values strengthen our culture and our workforce. We strive to demonstrate to our customers, franchisees, dealers, stockholders, business partners, communities and employees that we are worthy of their trust and continually strive to enhance our brand reputation.
The success of our business relies on our ability to attract and retain talented employees. To attract and retain talent, we strive to create an inclusive, diverse and supportive workplace, with opportunities for our employees to develop and grow in their careers, supported by competitive compensation, benefits and health and wellness programs.
Our franchises and dealerships are independently owned and operated businesses. As such, employees of our franchisees and dealers are not employees of the Company.
Our Nominating and Corporate Governance Committee of our Board (our “NCG Committee”) oversees our environmental, social and governance (“ESG”) policies and activities which includes human capital management. The NCG Committee also oversees activities including the review of management’s strategies, activities, policies and goals with regard to environmental sustainability, climate change, human rights, and diversity, equity and inclusion (“DEI”) initiatives. Our NCG Committee advises the Board on significant ESG-related feedback from stakeholders and makes recommendations on how the Company can adapt to ESG trends and regulatory developments that could impact its operations, performance or reputation. Our NCG Committee also has the responsibility to update and make recommendations to our Board on the impact of our human capital management strategies as outlined in its charter, subject to NCG Committee and Board approval. In 2022, our NCG Committee recommended, and our Board approved, the implementation of the Company’s ESG, DEI and Human Rights policies.
We are focused on creating a corporate culture of integrity and respect, with the goal of working together to drive our business to be innovative and competitive. We operate in a performance-based environment where results matter and financial discipline is enforced. We strive to create a highly collaborative culture in which employees feel that their input is encouraged and valued. At the same time, we believe in holding individuals accountable and endeavor to create a culture in which employees do what they say they are going to do. We believe that our culture is a long-term competitive advantage for us, fuels our ability to execute our business strategy and is a critical component of our employee talent strategy.
Diversity, Equity and Inclusion
We believe that a diverse workforce is critical to our success. Our goal is to cultivate an inclusive environment where human differences are valued, respected and supported. We believe that maintaining a diverse leadership and employee base allows us to take advantage of the array of innovation, creativity and talent of our human capital. We have taken actions to recruit, retain, develop and advance a diverse and talented workforce. At the close of fiscal 2022, women represented 43.2% of our total workforce, with increased representation both in technical and executive roles across the enterprise, and underrepresented minorities represented 37.6% of our total workforce. At the close of fiscal 2022, the representation of women in executive management was 41.8% collectively across all segments, management and the Board. We are an equal opportunity employer. We respect diversity and do not discriminate on the basis of race, color, creed, religion, national origin, ancestry, citizenship status, age, sex, gender, gender identity or expression (including transgender status), sexual orientation, marital status, veteran status, physical or mental disability, genetic information, or any other characteristic protected by applicable federal, state or local laws. Our management is dedicated to ensuring the fulfillment of this policy with respect to hiring, placement, promotion, transfer, demotion, layoff, separation, recruitment, pay and equity, access to facilities and programs, training and general treatment during employment. We invest in attracting, developing and retaining the best talent. We do this by communicating a clear purpose and strategy, transparent goal setting, driving accountability, continuously assessing, developing, advancing talent and a leadership-driven talent strategy. We also comply with the Equal Employment Opportunity (“EEO”) Commission rules, including making our EEO reports publicly available. Our Vitamin Shoppe segment, as a government contractor, has an affirmative action plan that is updated annually.
With the support at the highest level of leadership to ensure we meet our goals for a diverse, equitable and inclusive workplace, in 2022, we established a DEI Committee comprised of senior leaders from each of our brands. Guided by our enterprise DEI Policy, the DEI Committee is charged with providing DEI-focused strategies for each Company brand, consistent with our business goals, to develop and implement DEI efforts and activities that are meaningful to our employees and the communities we serve.
Our DEI initiatives include, among other things:
•Establishing DEI as a recognized business interest, with every level of the organization taking responsibility for implementing DEI-focused strategies.
•Promoting respectful communication and cooperation between all employees regardless of title or level.
•Encouraging an environment where employees feel that their background and lifestyle do not affect perceptions of them as professionals or affect their opportunities for development and promotion.
•Fostering teamwork and employee participation, permitting the representation of all groups and employee perspectives.
•Ensuring the availability of flexible working practices where appropriate, to accommodate employees’ varying needs.
•Encouraging employer and employee contributions to the communities we serve to promote a greater understanding and respect for DEI.
Health, Safety and Wellness
We are committed to the health, safety and wellness of our employees. We provide our employees and their families with access to a variety of health and wellness programs, including programs that support their physical and mental health. We are continually focused on the safety of our associates and have a strong emphasis on identifying and addressing the safety risks and concerns of our associates. Throughout the COVID-19 pandemic, a top priority of the Company has been the health, safety and well-being of our employees and their families. Our management teams continue to monitor, identify and address emerging risks to formulate our response to actions taken by governments and public policy organizations. We base our protocols on guidance from healthcare experts and public health leaders, and regularly review and update them to reflect the best, most current information available.
Compensation, Benefits and Human Rights
We are committed to providing each of our employees a fair and equitable wage. We believe we provide competitive compensation and benefit programs for our employees. In addition to competitive salaries, these programs include, among other items, bonuses, stock awards, a 401(k) plan, health and wellness programs, health savings and flexible spending accounts, paid time off, flexible work schedules and employee assistance programs.
We recognize the importance of maintaining and promoting the fundamental human rights of employees and, in 2022, we implemented a Human Rights Policy that: promotes a workplace free of discrimination and harassment; prohibits child labor, forced labor and human trafficking; provides fair and equitable wages, benefits and other conditions of employment in accordance with all applicable labor and employment laws; provides safe working conditions in accordance with all applicable labor and employment laws; and recognizes an employee’s right to associate or not to associate.
We maintain an Ethics Hotline that is available to all employees to report (anonymously if desired) any matter of concern. Communications to the hotline are routed to Human Resources, Legal and Executive Management for investigation and resolution. In certain instances, such communications may also be escalated, pursuant to our internal policies, to the Audit Committee of our Board for review, investigation and resolution. In addition, any stockholder or other interested party may send communications to us or our Board through our website.
The products and services offered by our business segments are subject to federal laws and regulation by one or more federal agencies, including but not limited to the Food and Drug Administration (“FDA”), the Federal Trade Commission (“FTC”), the Consumer Financial Protection Bureau (“CFPB”), the United States Department of Agriculture and the Environmental Protection Agency. These activities are also regulated by various state, local and international laws and agencies of the states and localities in which our products or services are provided. Please see “Item 1A. Risk Factors—Risks Related to Our Segments” in this Annual Report.
Our Annual Report, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed with or furnished to the SEC are available, free of charge, through our website at www.franchisegrp.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Our Board’s Charter and Corporate Governance Guidelines, Board committee charters, ESG, DEI and Human Rights policies, and Code of Conduct are also available on our website. The SEC maintains a website at www.sec.gov containing reports, proxy and information statements and other information regarding issuers who file electronically with the SEC. We encourage investors to visit our website from time to time, as information is updated, and new information is posted. The content of our website is not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our website are intended to be inactive textual references only.
Item 1A. Risk Factors.
In addition to the other information contained in this Annual Report, the following risk factors should be considered carefully in evaluating our business. The Risk Factor Summary that follows should be read in conjunction with the detailed description of risk factors below. If any of the risks or uncertainties described below were to occur, our business, financial condition, and results of operations may be materially and adversely affected. Additional risks not presently known to us or that we currently deem immaterial may also impair our business and operations. When considering any investment in our securities,
investors should consider the following risk factors, as well as the information contained under the caption “Special Note Regarding Forward-Looking Statements,” in analyzing our present and future business performance.
Risks Related to Our Business, including risks related to:
•the COVID-19 pandemic;
•the integration of our recent acquisitions;
•our indebtedness and our ability to incur more indebtedness;
•additional leverage incurred in connection with acquisitions or other capital expenditure initiatives;
•our ability to generate sufficient cash to service our indebtedness;
•the terms of the agreements governing our indebtedness and their restriction of our current and future operations and operating flexibility;
•rising interest rates and interest rate risk exposure from our floating rate debt financing;
•changes in benchmark interest rates that may adversely affect interest rates on certain of our outstanding indebtedness that is currently dependent on the London Interbank Offered Rate (“LIBOR”);
•the substantial ownership stake of certain of our stockholders;
•potential difficulties associated with our rapid growth and expansion;
•the potential sale of one or more of our business segments or certain assets;
•our operation in highly competitive industries;
•our failure to maintain sound business and contractual relationships with our franchisees and dealers;
•our significant lease obligations; and
•our failure to achieve and maintain effective internal controls.
Risks Related to Our Segments, including risks related to:
•our Badcock segment’s failure to operate its dealer network in its current manner, which remains outside the purview of federal and state franchise laws, which may adversely affect its and our business, prospects, results of operations, financial condition and cash flows;
•operational and other failures by dealers may adversely impact our Badcock segment and our business, prospects, results of operations, financial condition and cash flows;
•our Badcock segment’s consumer financing business is a highly regulated industry and existing and new laws and regulations could have a material adverse effect on our Badcock segment;
•unfavorable publicity or consumer perception of our segments’ products and any similar products distributed by other companies;
•our Vitamin Shoppe and Pet Supplies Plus segments’ sale of food, dietary supplement, topical products and pet products containing cannabidiol;
•disruptions at our Pet Supplies Plus, Badcock, American Freight, and Vitamin Shoppe segments’ warehouses and distribution facilities or at our contract manufacturers’ manufacturing facilities;
•increases in the price or shortages of supply in connection with our segments’ products;
•product recalls, withdrawals or seizures;
•consumer spending factors affecting the success of our segments;
•the ability of our segments to compete effectively with the growing e-commerce sector;
•the ability of our Vitamin Shoppe, Pet Supplies Plus, Badcock, American Freight and Buddy’s segments to successfully manage their inventory levels;
•the growth and effective operations of our Company-owned locations and franchise and dealer locations;
•our franchisees’ failure to open locations in new territories and successfully operate their new locations;
•our potential to be held responsible by third parties, regulators, or courts for the action of, or failure to act, by our franchisees and dealers, and the exposure to possible fines or other liabilities, and bad publicity;
•disputes with our franchisees and dealers; and
•the effectiveness of our marketing and advertising programs and franchisee support of these programs.
Risks Related to Legal and Regulatory Matters, including risks related to:
•adverse outcomes related to litigation or regulatory actions;
•our failure to protect or failure to comply with laws and regulations related to our customers’ personal information;
•our or our franchisees’ failure to comply with marketing and advertising laws, including with regard to direct marketing;
•compliance with governmental regulations or newly enacted laws;
•product liability claims; and
•our involvement in federal securities class-action lawsuits and derivative complaints.
General Risk Factors, including risks related to:
•our failure to protect our intellectual property rights;
•our reliance on technology systems and electronic communications;
•negative publicity, costly government enforcement actions or private litigation and increased costs as a result of our inability to secure our customers’ personal and confidential information, or other private data relating to our associates, suppliers or our business;
•our failure to retain key senior management personnel or attract and retain highly skilled and other key personnel;
•our ability to attract and retain qualified employees;
•the exclusive forum provisions in our Certificate of Incorporation;
•the volatility of our stock price;
•our ability to continue to pay dividends in the future; and
•antitakeover provisions in our charter documents.
Risks Related to Our Business
Our results of operations and financial condition have been, and will likely continue to be, affected by the COVID-19 pandemic and, depending on future developments, may be materially adversely impacted by the COVID-19 pandemic.
The COVID-19 pandemic has had and will likely continue to have an impact on our operations and financial performance. The extent to which the COVID-19 pandemic impacts our business, results of operations and financial condition is uncertain and cannot be predicted. There can be no assurance that any of our efforts to address adverse impacts of the COVID-19 pandemic will be effective. Even after the COVID-19 pandemic has subsided, we may experience adverse impacts to our business as a result of any economic recession or depression that has occurred or may occur in the future. For instance, changes in the behavior of customers, businesses and their employees as a result of the COVID-19 pandemic, including social distancing practices, even after formal restrictions have been lifted, are unknown. Furthermore, the financial condition of our customers and vendors may be adversely impacted, which may result in a decrease in the demand for our products, the inability and our franchisees’ ability to operate store locations or a disruption to our supply chain. Any of these events may, in turn, have a material adverse impact our business, results of operations and financial condition.
We have incurred significant transaction and acquisition-related costs and expect to incur integration-related costs in connection with our acquisitions.
We have incurred a number of non-recurring costs associated with our acquisitions and expect to incur integration-related costs in combining areas of the companies. The substantial majority of non-recurring expenses were comprised of transaction costs related to certain of our acquisitions. We continue to assess the magnitude of these costs, and additional unanticipated costs may be incurred in connection with the integration of all of these companies’ businesses. Although we expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of these businesses, should allow us to offset integration-related costs over time, this net benefit may not be achieved in the near term, or at all.
Our indebtedness could adversely affect our financial condition, limit our ability to raise additional capital to fund our operations and prevent us from fulfilling our obligations under our debt agreements.
We have substantial indebtedness, which could adversely affect our ability to fulfill our obligations and have a negative impact on our financing options and liquidity position.
Our high level of debt could have significant consequences for us, including the following:
•limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or other general corporate purposes;
•requiring a substantial portion of our cash flows to be dedicated to debt service payments instead of other purposes, thereby reducing the amount of cash flows available for working capital, capital expenditures, acquisitions and other general corporate purposes;
•limiting our ability to refinance our indebtedness on terms acceptable to us or at all;
•increasing the cost of future borrowings and, accordingly, our cost of capital;
•imposing restrictive covenants on our operations;
•placing us at a competitive disadvantage to competitors carrying less debt; and
•making us more vulnerable to economic downturns and other conditions, changes in the markets and adverse developments in our business and limiting our ability to withstand competitive pressures.
We may not be able to generate sufficient cash to service our indebtedness and may be forced to take other actions to satisfy our indebtedness, which may not be successful.
Cash flows from operations are the principal source of funding for us. Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors beyond our control, including the impact of the COVID-19 pandemic and the availability of financing in the international banking and capital markets. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to fund our day-to-day operations or to pay the principal, premium, if any, and interest on our indebtedness, or to refinance our indebtedness on commercially reasonable terms or at all, which could materially and adversely affect our business, financial position and results of operations and our ability to satisfy our obligations.
If our cash flows and capital resources are insufficient to fund our debt service obligations and other cash requirements, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures or to sell assets or operations, seek additional debt or equity capital or restructure or refinance our indebtedness. We may not be able to effect any such alternative measures, if necessary, on commercially reasonable terms or at all and, even if successful, such alternative actions may not allow us to meet our scheduled debt service obligations. The agreements that govern our indebtedness may restrict us from accomplishing any of these alternatives on commercially reasonable terms or at all. Additionally, the agreements that govern our indebtedness may restrict (a) our ability to dispose of assets and use the proceeds from any such dispositions and (b) our ability to raise debt capital to be used to repay our indebtedness when it becomes due. We may not be able to consummate those dispositions or to obtain proceeds in an amount sufficient to meet any debt service obligations then due. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations and limit our financial flexibility. Any issuances of additional capital stock would be dilutive to existing stockholders.
In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness.
If we cannot make scheduled payments on our debt, we will be in default and, as a result, lenders under our existing and future indebtedness could declare (or some of the following could occur automatically) all outstanding principal and interest to be due and payable, the lenders under our credit facilities could terminate their commitments to loan money, our secured lenders could foreclose against the assets securing such borrowings and we could be forced into bankruptcy or liquidation, in each case, which could result in any of the holders of our indebtedness and/or our stockholders losing their investments.
Despite current and anticipated indebtedness levels, we may still be able to incur substantially more debt.
If we were to incur substantial additional indebtedness in the future, it could further exacerbate the risks described above. Although the agreements that govern our indebtedness restrict the incurrence of additional indebtedness, these restrictions are and will be subject to a number of qualifications and exceptions and any additional indebtedness incurred in compliance with these restrictions could be substantial. These restrictions also will not prevent us from incurring obligations that do not constitute indebtedness (which may include, among others, trade payables and other expenses incurred in the ordinary course of business). Further, pursuant to our credit facilities and subject to the limitations set forth therein, we may have the option to increase our commitments under our credit facilities thereunder. Such increases would be secured indebtedness. If new debt is added to our current debt levels, the related risks that we now face could intensify.
The terms of the agreements governing our indebtedness may restrict our current and future operations and operating flexibility, particularly our ability to respond to changes in the economy or our industry or to pursue our business strategies, and could adversely affect our capital resources, financial condition and liquidity.
The agreements that govern our indebtedness contain a number of restrictive covenants that impose significant operating and financial restrictions on us and limit our ability to engage in acts that may be in our long-term best interests, including, among other things, restrictions on our ability to:
•incur, assume or guarantee additional indebtedness;
•declare or pay dividends or make other distributions with respect to, or purchase or otherwise acquire or retire for value, equity interests;
•make any principal payment on, or redeem or repurchase, certain indebtedness;
•make loans, advances or other investments;
•sell or otherwise dispose of assets, including capital stock of subsidiaries;
•enter into sale and lease-back transactions;
•consolidate or merge with or into, or sell all or substantially all of our assets to, another person;
•enter into transactions with affiliates;
•materially change the nature of our business;
•enter into agreements that restrict the ability of certain subsidiaries to make dividends or other payments; and
•service our indebtedness if covenants under our credit facilities are not satisfied.
Our credit facilities also contain covenants that may limit our ability to service our other indebtedness. As a result of these restrictions, we may be limited in how we conduct our business, unable to raise additional debt or equity financing to operate during general economic or business downturns, or unable to compete effectively, take advantage of new business opportunities or grow in accordance with our plans.
The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot assure you that we will be able to maintain compliance with such covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the holders of such indebtedness and/or amend the covenants. A breach of the covenants under the agreements governing our indebtedness could result in an event of default under the applicable indebtedness, which, if not cured or waived, could result in us having to repay such indebtedness before its due date. Such an event of default may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, such an event of default may permit the lenders in our credit facilities to terminate all commitments to extend further credit thereunder. In the event the repayment of any of our indebtedness is accelerated, we cannot assure you that we will have sufficient assets to repay such indebtedness. If we are forced to refinance such indebtedness on less favorable terms or if we experience difficulty in refinancing such indebtedness, our results of operations or financial condition could be materially affected. Furthermore, if we are unable to repay the amounts due and payable under the agreements governing our secured indebtedness, the lenders or holders of such indebtedness may be able to proceed against the collateral granted to them to secure such indebtedness.
Our floating rate debt financing exposes us to interest rate risk.
We may borrow amounts under our credit facilities or otherwise that bear interest at rates that vary with prevailing market interest rates. If such market interest rates increase, our debt service obligations on the variable rate indebtedness will increase even though the amount borrowed may remain the same, and our profit and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease. In the future, we may enter into interest rate swaps that involve the exchange of floating for fixed rate interest payments in order to reduce interest rate volatility. However, it is possible that we will not maintain interest rate swaps with respect to any of our variable rate indebtedness. Alternatively, any swaps we enter into may not fully or effectively mitigate our interest rate risk.
Changes in benchmark interest rates may adversely affect interest rates on certain of our outstanding indebtedness that is currently dependent on LIBOR.
As of February 28, 2023, the indebtedness under our Second Lien Credit Agreement (the “Second Lien Credit Agreement”) bears interest at variable interest rates that use LIBOR as a reference rate, while the indebtedness under our ABL Agreement (as defined herein) and First Lien Credit Agreement (the “First Lien Credit Agreement”) (after giving effect to the Third Amendment to First Lien Credit Agreement, dated as February 2, 2023) bears interest at variable interest rates that use the Secured Overnight Financing Rate (“SOFR”) as a benchmark rate.
In March 2021, the Chief Executive of the U.K. Financial Conduct Authority (the “FCA”), which regulates LIBOR, announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of the LIBOR benchmark after June 30, 2023. The Alternative Reference Rates Committee, a group of market participants convened by the U.S. Federal Reserve Board and the Federal Reserve Bank of New York, has recommended SOFR as an alternative benchmark rate to replace LIBOR.
Our Second Lien Credit Agreement includes provisions intended to provide for the replacement of LIBOR with SOFR or another widely-accepted alternative benchmark rate upon the cessation of LIBOR. In the event that LIBOR is no longer available as a reference rate or ceases to adequately and fairly reflect the cost to our lenders of making and maintaining loans,
the Second Lien Credit Agreement permits the lenders to suspend maintaining loans that use LIBOR as a reference rate. We expect our Second Lien Credit Agreement to bear interest based on a SOFR benchmark within fiscal 2023.
SOFR is calculated based on short-term repurchase agreements, backed by U.S. treasury securities. SOFR is an observed and backward looking rate, which stands in contrast with the LIBOR benchmark rate which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Additionally, SOFR is a secured rate and does not take into account bank credit risk, as was the case with LIBOR.
While the difference between LIBOR and SOFR as of today is not significant, the difference may be larger in respect of longer interest periods. While it is impossible for us to predict the effect of switching from a LIBOR to a SOFR benchmark under our Second Lien Credit Agreement, it is possible such a switch could result in higher interest costs for us, which could in turn have an adverse effect on our operating results and liquidity.
In addition, the overall financial markets may be disrupted as a result of the phase-out or replacement of LIBOR. Disruption in the financial markets could have an adverse effect on our business, financial condition and results of operations.
Certain stockholders have a substantial ownership stake, and their interests could conflict with the interests of our other stockholders.
As of December 31, 2022, Brian Kahn and Vintage Capital Management, LLC and its affiliates (“Vintage”), in aggregate, own shares of our common stock representing approximately 40.2% of our outstanding common stock. As a result of substantial ownership of our stock, and Mr. Kahn’s participation on the Board, Vintage currently has the ability to influence certain actions requiring stockholder approval, including increasing or decreasing the authorized share capital, the election of directors, declaration of dividends, the appointment of management, and other policy decisions. The interests of Mr. Kahn and Vintage may be different from the interests of our other stockholders. While any future transaction with Mr. Kahn and Vintage or other significant stockholders could benefit us, the interests of Mr. Kahn and Vintage could at times conflict with the interests of other stockholders. Conflicts of interest may also arise between us and Mr. Kahn and Vintage, which may result in the conclusion of transactions on terms not determined by market forces. Any such conflicts of interest could adversely affect our business, financial condition and results of operations, and the trading price of our common stock. Moreover, the concentration of ownership may delay, deter or prevent acts that would be favored by other stockholders or deprive our stockholders of an opportunity to receive a premium for their shares of our common stock as part of a sale of us. Similarly, this concentration of stock ownership may adversely affect the trading price of our common stock because investors may perceive disadvantages in owning equity in a company with concentrated ownership. Refer to "Note 14: Related Party Transactions" in the Notes to the Consolidated Financial Statements.
Because of the significant changes to our business initiatives and strategies, including as a result of our acquisitions we are susceptible to the potential difficulties associated with rapid growth and expansion and we may not achieve the same level of growth in revenues and profits as we had in prior years.
Our future viability, profitability, and growth will depend upon our ability to successfully operate and continue to expand our operations. We have grown rapidly since we began making the acquisitions in July 2019. Our management believes that our future success depends in part on our ability to manage the rapid growth and integration that we have experienced from current and future acquisitions, and the demands from increased responsibility on management personnel within the businesses we acquired and at the corporate level. Our ability to continue to grow our business will be subject to a number of risks and uncertainties and will depend in large part on:
•our ability to manage increased responsibilities for our executive level personnel and administrative burdens;
•our risk of litigation and other unanticipated liabilities;
•adding new customers and retaining existing customers, franchisees and dealers;
•innovating new products and services to meet the needs of our customers;
•finding new opportunities in our existing and new markets;
•remaining competitive in the specialty retailing, consumable durable goods and retail industries;
•attracting and retaining capable franchisees and dealers;
•delivering on our products and services in sufficient volumes and in a timely manner;
•hiring, training, and retaining skilled managers and employees; and
•expanding and improving the efficiency of our operations and systems and managing related organizational challenges.
There can be no assurance that any of our efforts will prove successful or that we will continue to achieve growth in revenues and profits. Our operating results could be adversely affected if we do not successfully manage our ability to grow and these potential risks and uncertainties. Our historical and pro forma financial information is not necessarily indicative of the results that may be realized in the future. In addition, due to the timing of the acquisitions, there is very limited comparative information on our combined business.
We may seek to continue to expand through acquisitions of and investments in other businesses. These acquisition activities may be unsuccessful or divert management’s attention.
We may consider strategic and complementary acquisitions of and investments in other franchise-centric businesses. In pursuing these opportunities, we will likely be competing with third parties that may have substantially greater financial resources than us. Acquisitions or investments in brands, businesses, properties or assets, as well as third-party alliances are subject to risks that could affect our business, including risks related to: (i) issuing shares of stock that could dilute the interests of our existing stockholders, (ii) spending cash and incurring debt, (iii) assuming contingent liabilities, or (iv) creating additional expenses.
We may not be able to identify opportunities or complete transactions on commercially reasonable terms or at all or we may not actually realize any anticipated benefits from such acquisitions or investments. Similarly, we may not be able to obtain financing for acquisitions or investments on attractive terms or at all, or the ability to obtain financing may be restricted by the terms of our indebtedness. In addition, the success of any acquisition or investment also will depend, in part, on our ability to integrate the acquisition or investment with our existing operations. Finally, any potential acquisitions or investments could demand significant attention from management that would otherwise be available for business operations, which could harm our business.
We may seek to sell one of our business segments which may adversely affect our results of operations, personnel, reputation and financial position.
As a company that manages a portfolio of retail and franchised brands, we continue to evaluate opportunities to restructure our business in an effort to optimize shareholder value, which could potentially include the divestiture of certain business segments. Divestitures involve numerous risks, such as: (i) the acceptance of a less than favorable sales price, (ii) the potential loss of key employees, (iii) adverse reactions by customers, suppliers, or parties transacting business with the divested business segment or us, (iv) potential litigation or any administrative proceedings arising from the divestiture, (v) negative impacts on stock analyst ratings, and (vi) our inability to retain certain intellectual property rights. Such divestitures could result in significant costs to us which could adversely affect our financial condition and results of operations. We cannot provide assurance that such a sale of a business segment will be successful or will not harm our business, results of operations, financial condition, or stock price.
We operate in highly competitive industries and our revenues or profits could be harmed if we are unable to compete effectively.
The retail, consumer services, tutoring, and rent-to-own industries in which we operate are subject to intense competition. Our principal competitors are other similar operators with well-established and recognized brands. We also compete against smaller retailers and “mom and pop” operations. If we are unable to compete successfully, our revenues or profits may decline. Certain of our competitors may have significantly greater financial, technical and marketing resources than we do, and may be able to adapt to changes in consumer preferences more quickly, devote greater resources to the marketing and sale of their products or services, or generate greater brand recognition. In addition, our competitors may be more effective and efficient in introducing new products and services. Furthermore, if we fail to meet supply and demand or fail to provide our customers with an attractive omnichannel experience, our business and results of operations could be materially and adversely affected.
Failure to maintain sound business and contractual relationships with our franchisees and dealers may have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
Our financial success depends in significant part on our ability to maintain sound business relationships with our franchisees and dealers. The support of our franchisees and dealers is also critical for the success of our marketing programs and any new strategic initiatives we seek to undertake. Deterioration in our relationships with our franchisees and dealers or the failure of our franchisees and dealers to support our marketing programs and strategic initiatives could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows. In addition, the failure of
our franchisees and dealers to timely renew their franchise agreements could have a material adverse effect on our business and our ability to enforce the franchisees’ and dealers’ contractual obligations.
We have significant lease obligations, which may require us to continue paying rent for store locations that we no longer operate.
We have company-owned operations of which the majority are operated in leased locations, specifically in our Vitamin Shoppe and American Freight segments. We are subject to risks associated with our current and future real estate leases. Our costs could increase because of changes in the real estate markets and supply or demand for real estate sites. We generally cannot cancel our leases, so if we decide to close or relocate a location, we may nonetheless be committed to perform our obligations under the applicable lease including paying the base rent for the remaining lease term. As each lease expires, we may fail to negotiate renewals, either on commercially acceptable terms or any terms at all and may not be able to find replacement locations that will provide for the same success as current store locations.
Our failure to achieve and maintain effective internal controls could have a material adverse effect on our business and stock price.
Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our brands and operating results could be harmed. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. While we continue to evaluate and improve our internal controls, we cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could cause investors to lose confidence in our reported financial information, which could have a material adverse effect on our stock price.
As we have grown our business through our acquisitions, our disclosure controls and internal controls have become more complex and may require significantly more resources to ensure the effectiveness of these controls. If we are unable to continue upgrading our financial and management controls, reporting segments, information technology and procedures in a timely and effective fashion, additional management and other resources may need to be devoted to assist in compliance with the disclosure and financial reporting requirements which would adversely affect our business, financial position and results of operations.
Risks Related to Our Segments
Our Badcock segment’s failure to operate its dealer network in a manner which remains outside the purview of federal and state franchise laws may adversely affect its and our business, prospects, results of operations, financial condition and cash flows.
As operated now, our Badcock segment’s dealer program is not a franchise subject to franchise laws and regulations enacted by a number of states and rules promulgated by the U.S. Federal Trade Commission (collectively, the “Franchise Laws”). However, if the relationship between our Badcock segment and its dealers should be deemed to constitute a franchise under the Franchise Laws or otherwise violate one or more of the Franchise Laws, our Badcock segment’s and our operations could be negatively affected including requiring our Badcock segment to incur substantial additional costs which could adversely affect its and our business, prospects, results of operations, financial condition and cash flows. Additionally, our Badcock segment could face the prospect that discontented dealers could use such violations as the basis for seeking to terminate its dealership agreement or to initiate claims against our Badcock segment for alleged prior failure to comply with the Franchise Laws. Our Badcock segment may also face enforcement actions by the U.S. Federal Trade Commission and state governmental agencies, which may seek fines and other remedies available to these agencies under such Franchise Laws. If our Badcock segment’s dealer program were determined to be a franchise subject to the Franchise Laws, as a franchisor, our Badcock segment would be more susceptible to the risk of adverse legislation or regulations being enacted in the future and we cannot predict how existing or future laws or regulations will be administered or interpreted. Additionally, we cannot predict the amount of future expenditures that may be required in order to comply with any such laws or regulations. Companies that operate franchise systems may be subject to claims arising out of violations of laws and regulations at their franchised locations, including, without limitation, for allegedly being a joint employer with a franchisee. Litigation may lead to a decline in the sales
and operating results of our Badcock segment’s stores and divert management resources regardless of whether the allegations in such litigation are valid or whether our Badcock segment is liable.
Our Badcock segment’s consumer financing business is in an industry that is highly regulated. Existing and new laws and regulations could have a material adverse effect on Badcock and adversely affect the Badcock segment’s and our business, prospects, results of operations, financial condition and cash flows and failure to comply with these laws and regulations could subject our Badcock segment and us to various fines, civil penalties and other relief.
Our Badcock segment’s consumer financing business is subject to extensive regulation, supervision and licensing under various federal, state, and local statutes, ordinances, regulations, rules and guidance. We must comply with federal laws, such as The Truth In Lending Act and Regulation Z, the Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, The Gramm-Leach-Bliley Act and Regulation P, and Title X of the Dodd-Frank Act, among others. In addition, the CFPB has regulatory and enforcement powers over providers of consumer financial products and services under many federal consumer protection laws and regulations. Included in the CFPB’s authority is the power to prohibit unfair, deceptive or abusive acts or practices (“UDAAP”) and to investigate and penalize financial institutions. In addition to assessing financial penalties, the CFPB can require remediation of practices, pursue administrative proceedings or litigation and obtain cease and desist orders (which can include orders for restitution or rescission or reformation of contracts). Also, if a company has violated Title X of the Dodd-Frank Act or related CFPB regulations, the Dodd-Frank Act empowers state attorney general and state regulators to bring civil actions to remedy violations. In addition, state attorneys generals and/or other state regulators have the authority to prohibit unfair and deceptive acts and practices under state law (“UDAP”), as well as a wide variety of state consumer protection laws and regulations. If the CFPB or state attorneys general or state regulators believe that our Badcock segment has violated any laws or regulations, they could exercise their enforcement powers which could adversely affect our Badcock segment’s and our business, prospects, results of operations, financial condition and cash flows.
Accordingly, regulatory requirements, and the actions our Badcock segment must take to comply with regulations, vary considerably by jurisdiction. Managing this complex regulatory environment requires considerable compliance efforts. It is costly to operate in this environment, and it is possible that those costs will increase materially over time. This complexity also increases the risks that our Badcock segment will fail to comply with regulations which could adversely affect our Badcock segment’s and our business, prospects, results of operations, financial condition and cash flows. These regulations affect our Badcock segment’s business in many ways, and include regulations relating to:
•the terms of consumer loans (such as interest rates, finance and other charges, fees, durations, repayment terms, maximum loan amounts, renewals and extensions and repayment plans), the number and frequency of loans and reporting and use of state-wide databases;
•collection and servicing activity, including initiation of payments from consumer accounts;
•licensing, reporting and document retention;
•unfair, deceptive and abusive acts and practices and discrimination;
•disclosures, notices, advertising and marketing;
•requirements governing electronic payments, transactions, signatures and disclosures;
•privacy and use of personally identifiable information and consumer data, including credit reports; and
•posting of fees and charges.
There are a range of penalties that governmental entities could impose if our Badcock segment fails to comply with the various laws and regulations that apply to its business, including:
•ordering corrective actions, including changes to compliance systems, product terms and other business operations;
•imposing fines or other monetary penalties, which could be substantial;
•ordering restitution, damages or other amounts to customers, including multiples of the amounts charged;
•requiring disgorgement of revenues or profits from certain activities;
•imposing cease and desist orders, including orders requiring affirmative relief, targeting specific business activities;
•subjecting Badcock’s operations to monitoring or additional regulatory examinations during a remediation period;
•revoking licenses required to operate in particular jurisdictions; and/or
•ordering the closure of one or more stores.
Accordingly, if our Badcock segment fails to comply with applicable laws and regulations, it could adversely affect our Badcock segment’s and our business, prospects, results of operations, financial condition and cash flows.
Unfavorable publicity or consumer perception of our services, products and any similar products distributed by other companies could have a material adverse effect on our reputation, which could result in decreased sales and significant fluctuations in our business, financial condition and results of operations.
We depend significantly on consumer perception regarding the safety and quality of our products, as well as similar products distributed by other companies. Consumer perception of products can be significantly influenced by adverse publicity in the form of published scientific research, national media attention or other publicity, whether or not accurate, that associates consumption of our Vitamin Shoppe segment’s products or any other similar products with illness or other adverse effects, or questions the benefits of our or similar products or that claims that any such products are ineffective. A new product may initially be received favorably, resulting in high sales of that product, but that sales level may not be sustainable as consumer preferences change. Future scientific research or publicity could be unfavorable to our Vitamin Shoppe segment’s industry or any of its particular products and may not be consistent with earlier favorable research or publicity. Unfavorable research or publicity could have a material adverse effect on our ability to generate sales within our Vitamin Shoppe segment.
Our Vitamin Shoppe and Pet Supplies Plus segments sell food, dietary supplement, topical products and/or pet products containing cannabidiol (“CBD”), which is a cannabinoid derived from the cannabis plant. There is significant uncertainty regarding the legal status of CBD and other hemp-based products in the U.S. In addition, the FDA currently prohibits the sale of foods and dietary supplements containing certain CBD, which could subject our Vitamin Shoppe and Pet Supplies Plus segments to regulatory enforcement action.
Products that contain CBD are subject to various state and federal laws regarding the production and sale of hemp-based products. Historically, the Drug Enforcement Administration (“DEA”) considered CBD to be a Schedule I controlled substance subject to the Controlled Substances Act (“CSA”) under the definition for “marijuana.” However, the Agriculture Improvement Act of 2018 (the “2018 Farm Bill”) removed “hemp” from the definition of “marijuana.” “Hemp” is defined as the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol (“THC”) concentration of not more than 0.3 percent on a dry weight basis. As a result of the enactment of the 2018 Farm Bill, we believe that our Vitamin Shoppe segment’s CBD products and the hemp from which they are derived are not Schedule I controlled substances under the CSA. However, there is a risk that we could be subject to DEA enforcement action, including prosecution, if any of our Vitamin Shoppe segment’s products are determined to not meet the definition of “hemp” and to constitute “marijuana” based on THC levels or other violations.
In addition, although hemp and hemp-derived CBD are no longer controlled substances subject to regulation under the CSA, the FDA has stated publicly that it is nonetheless unlawful under the Federal Food, Drug, and Cosmetic Act (“FDCA”) to market foods or dietary supplements containing CBD, even if lawful under the 2018 Farm Bill. Specifically, the FDCA prohibits the introduction or delivery for introduction into interstate commerce of any food or dietary supplement that contains an approved drug or a drug for which substantial clinical investigations have been instituted and made public, unless a statutory exemption applies. The FDA has stated its conclusion that this statutory prohibition applies and none of the exceptions has been met for CBD.
The FDA has held public meetings and formed an internal working group to evaluate the potential pathways to market for CBD products, which could include seeking statutory changes from Congress or promulgating new regulations. If legislative action is necessary, such legislative changes could take years to finalize and may not include provisions that would enable our Vitamin Shoppe and Pet Supplies Plus segments to produce, market and/or sell CBD products, and FDA could similarly take years to promulgate new regulations. Additionally, while the agency’s enforcement focus to date has primarily been on CBD products that are associated with therapeutic claims, the agency has recently issued warning letters to companies marketing CBD products without such claims, and there is a risk that FDA could take enforcement action against our Vitamin Shoppe and Pet Supplies Plus segments, their third-party contract manufacturers or suppliers, or those marketing similar products, which could limit or prevent these segments from marketing CBD products. While the FDA announced on March 5, 2020 that it is currently evaluating a risk-based enforcement policy for CBD to provide more clarity to industry and the public while the agency takes potential steps to establish a clear regulatory pathway, it remains unclear whether or when FDA will ultimately issue such an enforcement policy.
Moreover, local, state, federal, and international CBD, hemp and cannabis laws and regulations are rapidly changing and subject to evolving interpretations, which could require our Vitamin Shoppe and Pet Supplies Plus segments to incur substantial costs associated with compliance requirements or alteration of certain aspects of their business plan in the event that its CBD products become subject to new restrictions. In addition, violations of these laws, or allegations of such violations, could disrupt the businesses and result in a material adverse effect on their operations. We cannot predict the nature of any future laws,
regulations, interpretations, or applications, nor can we determine what effect additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our Vitamin Shoppe and Pet Supplies Plus segments’ activities in the hemp and CBD industry. The constant evolution of laws and regulations may require these segments to incur substantial costs associated with legal and compliance fees and ultimately require them to alter their current business plans.
Disruptions at our American Freight, Pet Supplies Plus, Badcock, and Vitamin Shoppe segments’ warehouses and distribution facilities or at our contract manufacturers’ manufacturing facilities could materially and adversely affect our business, financial condition, results of operations and customer relationships.
Any significant disruption in our segments’ warehouse and distribution facilities or at any contract manufacturers’ manufacturing facilities for any reason, including regulatory requirements, and FDA determination that the contract manufacturers’ facility is not in compliance with the cGMP regulations, the loss of certifications, power interruptions, destruction of or damage to facilities, unexpected delays in delivery or increases in transportation costs (including through increased fuel costs), terrorist attacks, civil unrest, war or the perceived threat thereof, natural disasters could disrupt our contract manufacturer’s ability to manufacture products for our segments and our ability to deliver products to our customers. Any such disruption could have a material adverse effect on our business.
Increases in the price or shortages of supply in connection with products sold by our segments and increased inflation could have a material adverse effect on our business.
Certain products sold by our segments are composed of certain key raw materials. If the prices of these raw materials were to increase significantly, including but not limited to the impact of higher interest rates or inbound freight costs, it could result in a significant increase to us in the prices charged to us for our segments’ own branded products and third-party products. Raw material prices may increase in the future and we may not be able to pass on those increases to customers who purchase our products. A significant increase in the price of raw materials that cannot be passed on to customers could have a material adverse effect on our business.
Additionally, inflation rates have increased and may continue to rise. Our suppliers have raised their prices and may continue to raise prices that we may not be able to pass on to our customers. This may adversely affect our business, including our competitive position, market share, revenues, and profit.
We may experience product recalls, withdrawals or seizures, which could materially and adversely affect our business.
We may be subject to product recalls, withdrawals or seizures if any of the products we sell are believed to cause injury or illness or if we are alleged to have violated governmental regulations in the manufacturing, labeling, promotion, sale or distribution of those products. A significant recall, withdrawal or seizure of any of the products we manufacture or sell may require significant management attention, which would likely result in substantial and unexpected costs and may materially and adversely affect our business. Furthermore, a recall, withdrawal or seizure of any of our products may adversely affect consumer confidence in our brands and thus decrease consumer demand for our products. In some cases, we rely on our contract manufacturers and suppliers to ensure that the products they manufacture and sell to us comply with all applicable regulatory and legislative requirements. In general, we seek representations and warranties, indemnification and/or insurance from our contract manufacturers and suppliers. However, even with adequate insurance and indemnification, any claims of non-compliance could significantly damage our reputation and consumer confidence in our products. In addition, the failure of those products to comply with applicable regulatory and legislative requirements could prevent us from marketing the products or require us to recall or remove such products from the market, which in certain cases could materially and adversely affect our business, financial condition and results of operations.
The success of our segments is dependent on factors affecting consumer spending that are not under our control.
Consumer spending is affected by general economic conditions and other factors including levels of employment, disposable consumer income, prevailing interest rates, consumer debt and availability of credit, costs of fuel, inflation, recession and fears of recession, war and fears of war, pandemics (such as the COVID-19 pandemic), inclement weather, tariff policies, tax rates and rate increases, timing of receipt of tax refunds, consumer confidence in future economic conditions and political conditions, and consumer perceptions of personal well-being and security. Unfavorable changes in factors affecting discretionary spending could reduce demand for our products and services resulting in lower revenue and negatively impacting our business and financial results.
If our segments are unable to compete effectively with the growing e-commerce sector, our business and results of operations may be materially adversely affected.
With the continued expansion of Internet use, as well as mobile computing devices and smartphones, competition from the e-commerce sector continues to grow. There can be no assurance we will be able to compete effectively on our existing e-commerce platform or grow our e-commerce operations in a profitable manner. Certain of our competitors, and a number of e-commerce retailers, have established e-commerce operations against which we compete for customers. It is possible that the increasing competition from the e-commerce sector may reduce our market share, gross and operating margins, and may materially adversely affect our business and results of operations in other ways.
If our segments do not successfully manage their inventory levels, our operating results will be adversely affected.
We must maintain sufficient inventory levels to operate our business successfully. However, we also must avoid accumulating excess inventory as we seek to minimize out-of-stock levels across all product categories and to maintain in-stock levels. We continue to rely on and obtain significant portions of our inventory from vendors located outside the United States. Some of these vendors often require us to provide lengthy advance notice of our requirements in order to be able to supply products in the quantities we request. This usually requires us to order merchandise and enter into purchase order contracts for the purchase and manufacture of such merchandise, well in advance of the time these products will be offered for sale. As a result, we may experience difficulty in responding to a changing retail environment, which makes us vulnerable to changes in price and consumer preferences. If we do not accurately anticipate the future demand for a particular product or the time it will take to obtain new inventory, our inventory levels will not be appropriate, and our results of operations may be negatively impacted.
Our success is tied to the growth and effective operations of our Company-owned locations, franchises and dealers, and the franchise and dealer operations could adversely affect our business.
Our financial success depends on how effectively we operate our Company-owned locations and how our franchisees and dealers operate and develop their businesses. We do not exercise direct control over the day-to-day operations of our franchises and dealers, and our franchisees and dealers may not operate their businesses in a manner consistent with our philosophy and standards and may not increase the level of revenues generated compared to prior years. Our growth and revenues may, therefore, be adversely affected. There can be no assurance that the training programs and quality control procedures we have established will be effective in enabling franchisees and dealers to run profitable businesses or that we will be able to identify problems or take corrective action quickly enough. In addition, failure by a franchisee or dealer to provide service at acceptable levels may result in adverse publicity that can materially adversely affect our reputation and ability to compete in the market in which the franchisee or dealer is located.
If our franchisees or dealers fail to open locations in new territories or if they are not successful in operating their new locations, our franchise-related revenue and results of operation will be adversely affected.
Each year, we anticipate adding locations to our franchise and dealer system, but the opening of these locations depends on the purchase of additional territories by our franchisees and the opening of offices in territories previously purchased and newly purchased. Many factors go into opening a new location, including obtaining a suitable location, the availability of sufficient start-up capital, and the ability to recruit qualified personnel to work in new locations. If a significant number of locations that we expect to be open, fail to open, are delayed, or open in unsuitable locations or with insufficient personnel, the revenue we expect to receive from royalty payments and the repayment of indebtedness to us by our franchisees and dealers will be adversely affected.
We may be held responsible by third parties, regulators, or courts for the action of, or failure to act, by our franchisees and dealers and their employees which could expose us to possible fines, other liabilities, bad publicity or damage to our brands.
We grant our franchisees and dealers a limited license to use our registered service marks and, accordingly, there is risk that one or more of the franchisees or dealers may be identified as being controlled by us. Third parties, regulators, or courts may seek to hold us responsible for the actions or failures to act by our franchisees and dealers. In recent years, some government agencies have taken the position that the extent to which a franchise system establishes requirements for franchisees may justify treating the franchisor or dealer as if it “controls” the franchisee’s or dealer’s behavior. Thus, the failure of our franchisees and dealers to comply with laws and regulations may expose us to liability and damages that may have an adverse effect on our business.
Our franchisees and dealers operate their businesses under our brands. Because our franchisees and dealers are independent third parties with their own financial objectives, actions taken by them, including breaches of their contractual obligations, and negative publicity associated with these actions, could adversely affect our reputation and brands more broadly. Any actions as a result of conduct by our franchisees and dealers, their employees or otherwise which negatively impacts our reputation and brands may result in fewer customers and lower revenues and profits for us.
Disputes with our franchisees or dealers may have a material adverse effect on our business.
From time to time, we engage in disputes with some of our franchisees and dealers, and some of these disputes result in litigation or arbitration proceedings. Disputes with our franchisees and dealers may require us to incur significant legal fees, subject us to damages, and occupy a disproportionate amount of management’s time. A material increase in the number of these disputes, or unfavorable outcomes in these disputes, may have a material adverse effect on our business. To the extent we have disputes with our franchisees and dealers, our relationships with our franchisees and dealers could be negatively impacted, which could hurt our growth prospects or negatively impact our financial performance.
Additionally, to attempt to limit costly and lengthy consumer and other litigation, including class actions, and to provide a streamlined, faster and less expensive method of dispute resolution, some of our segments require customers and employees to sign arbitration agreements and class action waivers, many of which offer opt-out provisions. Recent judicial and regulatory actions have attempted to restrict or eliminate the enforceability of such agreements and waivers. If we are not permitted to use arbitration agreements and/or class action waivers, or if the enforceability of such agreements and waivers is restricted or eliminated, we could incur increased costs to resolve legal actions brought by customers, employees and others as we would be forced to participate in more expensive and lengthy dispute resolution processes, including class actions.
Our operating results depend on the effectiveness of our marketing and advertising programs and franchisee or dealer support of these programs.
Our revenues are heavily influenced by brand marketing and advertising. If our marketing and advertising programs are unsuccessful, we may fail to retain existing customers and attract new customers, which could limit the growth of our revenues or profitability or result in a decline in our revenues or profitability. Moreover, because franchisees and dealers are required to pay us marketing and advertising fees based on a percentage of their revenues, our marketing fund expenditures are dependent upon sales volumes of our franchisees and dealers.
The support of our franchisees and dealers is critical for the success of our marketing programs and any new strategic initiatives we seek to undertake. While we can mandate certain strategic initiatives through enforcement of our franchise agreements, we need the active support of our franchisees and dealers if the implementation of our marketing programs and strategic initiatives is to be successful. Although certain actions are required of our franchisees and dealers under the franchise agreements, there can be no assurance that our franchisees or dealers will continue to support our marketing programs and strategic initiatives. The failure of our franchisees and dealers to support our marketing programs and strategic initiatives would adversely affect our ability to implement our business strategy and could have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to Legal and Regulatory Matters
The lines of business in which we operate involve substantial litigation, and such litigation may damage our reputation or result in material liabilities and losses.
We have been named, from time to time, as a defendant in various legal actions, including arbitration, class-actions, and other litigation arising in connection with our various business activities. We are currently involved in a class-action lawsuit, in which we are vigorously defending ourselves. There can be no assurance, however, that we will not have to pay significant damages or amounts in settlement above insurance coverage. Adverse outcomes related to litigation could result in substantial damages and could materially affect our liquidity and capital resources and cause our net income to decline or may require us to alter our business operations. Failure to pay any material judgment would be a default under our credit facilities. Negative public opinion can also result from our actual or alleged conduct in such claims, possibly damaging our reputation, which could negatively impact our financial performance and could cause the value of our stock to decline. Refer to “Note 15 – Commitments and Contingencies” in the Notes to the Consolidated Financial Statements.
If we fail to protect or fail to comply with laws and regulations related to our customers’ personal information, we may face significant fines, penalties, or damages and our brands and reputation may be harmed.
We are subject to various federal and state laws related to the use of and protection of customer personal information, including but not limited, California Consumer Privacy Act (“CCPA”), which became effective January 1, 2020, as amended by the California Privacy Rights Act (“CPRA”), which became effective as of January 1, 2023, the Gramm-Leach-Bliley Act and other laws and regulations enacted by the Federal Trade Commission (“FTC”). We rely on technology in virtually all aspects of our business. Like those of many large businesses, certain of our information systems have been subject to computer viruses, malicious code, unauthorized access, phishing efforts, denial-of-service attacks and other cyber-attacks and we expect to be subject to similar attacks in the future as such attacks become more sophisticated and frequent. A significant disruption or failure of our technology systems could result in service interruptions, safety failures, security events, regulatory compliance failures, an inability to protect information and assets against unauthorized users, and other operational difficulties. Attacks perpetrated against our systems could result in loss of assets and critical information and expose us to remediation costs and reputational damage.
We and our franchisees manage highly sensitive client information in our operations, and although we have established security procedures to protect against identity theft and require our franchisees to do the same, a security incident resulting in breaches of our customers’ privacy may occur. Our computer systems are subject to penetration and our data protection measures may not prevent unauthorized access to sensitive client information. Threats to our systems, our franchisees systems, or associated third parties’ systems can derive from human error, fraud, or malice on the part of employees or third parties, or may result from accidental technological failure. If the measures we have taken prove to be insufficient or inadequate or if our franchisees fail to meet their obligations in this area, we and our franchisees may become subject to litigation or administrative sanctions, which could result in significant fines, penalties, or damages and harm to our brands and reputation, which in turn could negatively impact our ability to retain our customers. Moreover, although we have some insurance that may defray the cost, the cost of remediating any breach resulting from a cybersecurity incident or other breach of the privacy of customer information would likely be substantial. Furthermore, we may be required to invest additional resources to protect us against damages caused by these actual or perceived disruptions or security breaches in the future. We could also suffer harm to our reputation from a security breach or inappropriate disclosure of customer information. Changes in these federal and state regulatory requirements could result in more stringent requirements and could result in a need to change business practices, including how information is disclosed. These changes could have a material adverse effect on our business, financial condition, and results of operations. Moreover, a significant security breach or disclosure of customer information could so damage our brands and reputation that demand for the services that are provided by us and our franchisees may be reduced.
Although we have taken steps intended to mitigate these risks, a significant disruption or cyber intrusion could adversely affect our results of operations, financial condition and liquidity. If we become victim to a security breach resulting in third-party access to customer’s personal information which we host, collect, use and retain, this could have a material adverse effect on the demand for our services and products, our reputation, and cause material losses. These risks apply to all of our business segments.
If we or our franchisees or dealers fail to comply with marketing and advertising laws, including with regard to direct marketing we may face significant damages.
We rely on a variety of marketing techniques, including telemarketing, email and social media marketing and postal mailings, and we are subject to various laws and regulations in the U.S. and internationally that govern marketing and advertising practices. The retention of customers by our business and franchisees and dealers, and our ability to attract additional franchisees and dealers, depends on the use of these marketing techniques to contact customers and potential franchisees and dealers. However, the Telephone Consumer Protection Act (“TCPA”) imposes significant restrictions on the ability to utilize telephone calls and text messages to mobile telephone numbers as a means of communication, when the prior consent of the person being contacted has not been obtained. Violations of the TCPA may be enforced by individual customers through class-actions, and statutory penalties for TCPA violations range from $500 to $1,500 per violation. If we fail to ensure that our own telemarketing and telemarketing efforts are TCPA compliant, or if our franchisees or dealers fail to do so and we are held responsible for their behavior, we may incur significant damages.
Compliance with governmental regulations or newly enacted laws could increase our costs significantly and adversely affect our operating income and financial results.
The products and services offered by our business segments are subject to federal laws and regulation by one or more federal agencies, including but not limited to the FDA, the FTC, the CFPB, the United States Department of Agriculture and the Environmental Protection Agency. These activities are also regulated by various state, local and international laws and agencies of the states and localities in which our products or services are provided. Regulations may prevent or delay the introduction, or require the reformulation, of our products or services, which could result in lost sales and
increased costs to us.
For example, the FDA may not accept the evidence of safety for any new ingredients that our Vitamin Shoppe segment may want to market, may determine that a particular ingredient is not a legal dietary ingredient under the FDCA, may determine that a particular product or product ingredient presents an unacceptable health risk, may determine that a particular statement of nutritional support on our products, or that we want to use on our products, is an unacceptable drug claim or an unauthorized version of a food “health claim.” The FDA or FTC may determine that particular claims are not adequately supported by available scientific evidence. The FDA may also determine that our Vitamin Shoppe segment’s CBD-containing food and dietary supplement products are unlawful and may issue an enforcement action against us. Any such regulatory determination would prevent us from marketing particular products or using certain statements on those products or force us to recall a particular product and be subject to additional enforcement or penalties, which could adversely affect our sales of those products.
Additionally, our rental business unit is subject to various federal and state including consumer protection statutes, such as a grace period for late fees and certain contract reinstatement rights. Moreover, many states have passed laws that regulate rental purchase transactions as separate and distinct from credit sales. Specific rental purchase laws generally require certain contractual and advertising disclosures. Any failure of our Buddy’s segment to comply with such laws could have a material adverse effect on our business.
The CCPA requires covered companies to provide new disclosures to California consumers, and afford such consumers new abilities to opt-out of certain sales of personal information. We collect internal and customer data, including personally identifiable information for a variety of important business purposes, including managing our workforce and providing requested products and services. The CCPA required us to modify our data processing practices and policies at our Pet Supplies Plus, Vitamin Shoppe, Sylvan and American Freight segments, as a result of which we may incur substantial costs and expenses in an effort to comply. Further, the CPRA, which became effective on January 1, 2023 (with certain provisions having retroactive effect to January 1, 2022), created additional obligations with respect to processing and storing personal information of California consumers. The effects of the CCPA and CPRA are potentially significant and require us to modify our data processing practices and policies which as a result, we may incur substantial costs and expenses in an effort to comply. Additionally, Colorado, Connecticut, Utah, and Virginia have adopted comprehensive privacy laws, and other jurisdictions have adopted or may in the future adopt their own, different privacy laws. We may also from time to time be subject to, or face assertions that we are subject to, additional obligations relating to personal data by contract or due to assertions that self-regulatory obligations or industry standards apply to our practices. There may be additional regulatory actions or enforcement priorities, or new interpretations of existing requirements that differ from ours, which could impose unanticipated limitations or require changes to our business. Any developments of this nature could increase our costs significantly and could have a material adverse effect on our business, financial condition and results of operations.
We may be subject to product liability claims if people or properties are harmed by the products we sell or the services we offer.
Some of the products we sell may expose us to product liability claims relating to personal injury, death, or property damage caused by such products, and may require us to take actions such as product recalls. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on commercially reasonable terms, or at all. Our Vitamin Shoppe segment, in particular, as a retailer and direct marketer of products designed for human consumption, is subject to product liability claims if the use of its products is alleged to have resulted in injury or to include inadequate instructions for use or inadequate warnings concerning possible side effects and interactions with other substances. In addition, third-party manufacturers produce many of the products we sell which may expose us to product liability claims for products we do not manufacture. While we attempt to manage these risks by obtaining insurance and indemnification agreements from the manufacturers of products that we sell, third parties may not satisfy their indemnification obligations to us and/or our insurance policies may not be sufficient or available. A product liability claim against us, whether with respect to products of a third-party that we sell or our branded products, could result in increased costs and could adversely affect our reputation with our customers, which in turn could materially adversely affect our business, financial condition and results of operations.
General Risk Factors
Our failure to protect our intellectual property rights may harm our competitive position, and litigation to protect our intellectual property rights or defend against third-party allegations of infringement may be costly.
We regard our intellectual property as critical to the success of our business. Third parties may infringe or misappropriate our brand names, trademarks or other intellectual property rights, which could have a material adverse effect on our business, financial condition, or operating results. The actions we take to protect our trademarks and other proprietary rights may not be adequate. Litigation may be necessary to enforce our intellectual property rights, protect our trade secrets, or determine the validity and scope of the proprietary rights of others. There are no assurances that we will be able to prevent infringement of our intellectual property rights or misappropriation of our proprietary information. Any infringement or misappropriation could harm any competitive advantage we currently derive or may derive from our proprietary rights. In addition, third parties may assert infringement claims against us. Any claims and any resulting litigation could subject us to significant liability for damages. An adverse determination in any litigation of this type could require us to design around a third-party’s patent or to license alternative technology from another party. Litigation is time-consuming and expensive to defend and could result in the diversion of our time and resources. Any claims from third parties may also result in limitations on our ability to use the intellectual property subject to these claims.
Our business relies on technology systems and electronic communications, which, if disrupted, could materially affect our business.
We depend heavily upon our information technology systems in the conduct of our business. We develop, own and license or otherwise contract for sophisticated technology systems and services. If we experience significant disruptions to our systems, we could experience a loss of business, which could have a material adverse effect on our business, financial condition, and results of operations. Any data breach or severe disruption of our network or electronic communications could have a material adverse effect on our business, financial condition, and results of operations.
We rely on certain software vendors to maintain and periodically upgrade many of these systems so that they can continue to support our business. The software programs supporting many of our systems were licensed to us by independent software developers. The inability of these developers or us to continue to maintain and upgrade these information systems and software programs would disrupt or reduce the efficiency of our operations if we were unable to convert to alternate systems in an efficient and timely manner.
If we are unable to secure our customers’ personal and confidential information, or other private data relating to our associates, suppliers or our business, we could be subject to negative publicity, costly government enforcement actions or private litigation and increased costs, which could damage our business reputation and adversely affect our results of operations or business.
Many of our information technology systems, such as those we use for our point-of-sale, web and mobile platforms, including online and mobile payment systems, and for administrative functions, including human resources, payroll, accounting, and internal and external communications, contain personal, financial or other information that is entrusted to us by our customers and associates. Many of our information technology systems also contain proprietary and other confidential information related to our business and suppliers. Although we have developed procedures, employee training and technology in place to safeguard our customers’ personal information, our associates’ private data, suppliers’ data, and our business records and intellectual property and other sensitive information, we may nevertheless, be vulnerable to, and unable to anticipate, detect and appropriately respond to, data security breaches and data loss, including cyber-security attacks. To date, we have not experienced a material information security data breach, however, if we or any third-party systems we use experience a data security breach, we could be exposed to negative publicity, reputational risk with our customers, government enforcement actions and private litigation, in addition to the potential of significant capital investments and other expenditures to remedy cybersecurity problems and prevent future security breaches. These costs, which could be material, could adversely impact our results of operations in the period in which they are incurred and may not meaningfully limit the success of future attempts to breach our information technology systems.
If we fail to retain our key senior management personnel or are unable to attract and retain highly skilled and other key personnel, our financial performance could be materially adversely affected.
We depend on our senior management and other key or highly skilled personnel. The loss of any of our executive officers or other key employees or the inability to hire, train, retain, and manage qualified personnel, could harm our business.
If we and our franchisees and dealers are unable to attract and retain qualified employees, our financial performance could be materially adversely affected.
Both we and our franchisees and dealers depend on the ability to find, hire and retain qualified employees to manage day-to-day business activities. Our operating subsidiaries also need qualified and competent personnel in executing their business plans and serving their customers. Our inability to recruit and retain qualified and competent managers and personnel could have a material adverse effect on our business, financial condition and results of operations.
Our Certificate of Incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for certain disputes between us and our stockholders, which may limit a stockholder’s ability to bring a claim in a judicial forum that it finds preferable for disputes with us and our directors, officers or other employees.
Our Certificate of Incorporation provides that, unless we otherwise determine, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, any action asserting a claim against us arising pursuant to any provision of the Delaware General Corporation Law, our Certificate of Incorporation or Bylaws, or any action asserting a claim governed by the internal affairs doctrine. This forum selection provision does not apply to suits brought to enforce a duty or liability created by the Securities Act of 1933, as amended (the “Securities Act”), or the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or any claim for which the federal courts have exclusive jurisdiction. This forum selection provision may limit a stockholder’s ability to bring a claim that is not arising under the Securities Act or the Exchange Act, in a judicial forum (other than in a Delaware court) that it finds preferable for disputes with us or any of our directors, officers or other employees, which may discourage lawsuits with respect to such claims and result in increased costs for stockholders to bring a claim. If a court were to find this forum selection provision to be inapplicable or unenforceable in an action, we may incur additional costs or business interruption associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.
Our stock price has been extremely volatile, and investors may be unable to resell their shares at or above their acquisition price or at all.
Our stock price has been, and may continue to be, subject to wide fluctuations in response to many risk factors listed in this section, and others beyond our control, including, but not limited to:
•actual or anticipated variations in our operating results from quarter to quarter;
•actual or anticipated variations in our operating results and financial performance from the expectations of securities analysts and investors;
•if analysts do not publish research or reports about our business or if they publish misleading or unfavorable research or reports about our business;
•actual or anticipated variations in our operating results from our competitors;
•fluctuations in the valuation of companies perceived by investors to be comparable to us;
•sales of common stock or other securities by us or our stockholders in the future;
•certain non-compliance, fraud and other misconduct by our franchisees, dealers, and/or employees;
•departures of key executives or directors;
•announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, financing efforts or capital commitments;
•delays or other changes in our expansion plans;
•failure to maintain adequate internal controls;
•involvement in litigation (including securities class action litigation) or governmental investigations or enforcement activity;
•stock price and volume fluctuations attributable to inconsistent trading volume levels of our shares;
•general economic, stock market and market conditions in our industry and the industries of our customers;
•regulatory or political developments;
•global pandemics (such as the ongoing COVID-19 pandemic); and
•capital markets and trading markets fluctuations.
Although we may desire to continue to pay dividends in the future, our financial condition, debt covenants, or Delaware law may prohibit us from doing so.
The payment of dividends will be at the discretion of our Board and will depend, among other things, on our earnings, capital requirements, and financial condition. Our ability to pay dividends will also be subject to compliance with financial covenants that are contained in our credit facility and may be restricted by any future indebtedness that we incur or issuances of preferred stock. In addition, applicable law requires our Board to determine that we have adequate surplus prior to the declaration of dividends. Although we expect to pay a quarterly cash dividend to holders of our common stock, we have no obligation to do so, and our dividend policy may change at any time without notice to our stockholders. We cannot provide an assurance that we will continue to pay dividends at any specific level or at all.
Anti-takeover provisions in our charter documents, Delaware law, and our credit facility could make an acquisition of us more difficult, limit attempts by our stockholders to replace or remove our current management, and adversely affect the value of our common stock.
Provisions in our second amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. In addition, our credit facility contains covenants that may impede, discourage, or prevent a takeover of us. For instance, upon a change of control, we would default on our credit facility. As a result, a potential takeover may not occur unless sufficient funds are available to repay our outstanding debt. Provisions in our bylaws and credit facility may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our Board, which is responsible for appointing the members of our management. Any provision of our amended and restated certificate of incorporation and bylaws or our debt documents that has the effect of delaying or deterring a change of control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect our stock value if they are viewed as discouraging takeover attempts in the future.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
As of December 31, 2022, we operated 1,401 Company-owned stores, operated 318 dealer-owned stores, and franchised 1,310 stores. See breakout of Company-owned stores, dealer-owned stores, franchised stores, and distribution centers by segment as detailed below:
|Vitamin Shoppe||702 ||— ||2 ||704 ||2 |
|Pet Supplies Plus||232 ||— ||443 ||675 ||3 |
|Badcock||64 ||318 ||— ||382 ||3 |
|American Freight||362 ||— ||9 ||371 ||8 |
|Buddy’s||36 ||— ||302 ||338 ||— |
|Sylvan||5 ||— ||554 ||559 ||— |
|Total Franchise Group||1,401 ||318 ||1,310 ||3,029 ||16 |
We lease the vast majority of our Company-owned stores and our distribution centers. Our leases typically provide an initial term with options to extend. As current leases expire, we believe that we will be able to obtain lease renewals, if desired, for present store locations, or to obtain leases for equivalent or better locations in the same general area.
We lease our corporate headquarters, which is shared with American Freight. Our principal executive office is located at 109 Innovation Court, Suite J, Delaware, Ohio 43015.
Item 3. Legal Proceedings.
For information regarding legal proceedings, refer to “Note 15 - Commitments and Contingencies” in the Notes to the Consolidated Financial Statements, which information is incorporated herein by reference.
Item 4. Mine Safety Disclosures.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.
Market and Stock Information
Our common stock and Series A Preferred Stock is traded on NASDAQ under the symbols “FRG” and “FRGAP,” respectively. As of February 22, 2023, we had approximately 116 registered record holders of our common stock and 1 registered record holder of our Series A Preferred Stock. An aggregate maximum of 5,000,000 shares of common stock are reserved for stock compensation award issuance.
Future decisions to pay cash dividends continue to be at the discretion of our Board and will be dependent on our earnings, capital requirements and financial condition. Our ability to pay dividends is also subject to compliance with financial covenants that are contained in our credit facility and may be restricted by any future indebtedness that we incur. In addition, applicable law requires our Board to determine that we have adequate surplus prior to the declaration of dividends. We cannot provide an assurance that we will pay dividends at any specific level or at all.
Recent Sales of Unregistered Securities
Other than those sales of unregistered securities that we have disclosed in quarterly reports on Form 10-Q or current reports on Form 8-K, we have not recently sold any unregistered securities.
On May 18, 2022, our Board of Directors approved a stock repurchase program under which we may repurchase up to $500.0 million of our outstanding shares of common stock over the next three years. The repurchase program authorizes shares to be repurchased from time to time in open market or private transactions, through block trades and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The actual timing, number and value of shares, if any, repurchased under the program will be determined by management in its discretion and will depend on a number of factors, including, among others, the availability of stock, general market and business conditions, the trading price of our common stock and applicable legal requirements. This plan supersedes our previous stock repurchase programs. The following table represents our share repurchase activity during the three months ended December 31, 2022:
|Fiscal Period||Total number|
of shares purchased
|Average price paid per share||Total number of shares purchased as part of public stock repurchase programs||Approximate dollar value of shares that may yet be purchased under the program (in millions)|
|September 25, 2022 - October 22, 2022||— ||— ||— ||$||422.1 |
|October 23, 2022 - November 19, 2022||733,951 ||24.75 ||733,951 ||403.9 |
|November 20, 2022 - December 31, 2022||2,959,593 ||25.81 ||2,209,593 ||327.5 |
|Total||3,693,544 ||$||25.61 ||2,943,544 ||$||327.5 |
During the fiscal year ended December 31, 2022, we purchased a total of 5,920,744 shares for a total of $172.5 million. As of February 22, 2023, we had approximately $327.5 million remaining under the stock repurchase program approved by our Board.
Stock Performance Graph
The following graph sets forth the yearly percentage change in the cumulative total shareholder return on our common stock during the five fiscal years ended December 31, 2022, compared with the cumulative total returns of the S&P 500 Index and the S&P Retailing Index. The comparison assumes that $100 was invested in our common stock on May 1, 2017, and, in each of the foregoing indices on May 1, 2017, that dividends were reinvested. The stock price performance shown in the graph is not necessarily indicative of future price performance.
|Year or Period Ended|
|April 30, 2017||April 30, 2018||April 30, 2019||December 28, 2019||December 26, 2020||December 25, 2021||December 31, 2022|
|Franchise Group, Inc.||$||100.00 ||77.86 ||57.97 ||137.21 ||169.25 ||323.62 ||160.68 |
|S&P 500 Index||$||100.00 ||123.56 ||152.66 ||167.91 ||191.23 ||244.90 ||198.97 |
|S&P Retailing Index||$||100.00 ||101.11 ||102.23 ||103.48 ||144.92 ||198.68 ||135.28 |
Item 6. [Reserved]
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The discussion of our financial condition and results of operations for the years ended December 25, 2021 and December 26, 2020, included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) can be found in the Annual Report on Form 10-K for the fiscal year ended December 25, 2021 that was previously filed with the Securities and Exchange Commission (“SEC”) on February 23, 2022 (the “Form 10-K”).
We are an owner and operator of franchised and franchisable businesses that continually looks to grow our portfolio of brands while utilizing our operating and capital allocation philosophy to generate strong cash flows. We currently operate six reportable segments: Vitamin Shoppe, Pet Supplies Plus, Badcock, American Freight, Buddy’s and Sylvan.
Our Vitamin Shoppe segment is an omnichannel specialty retailer of vitamins, minerals, herbs, specialty supplements, sports nutrition and other health and wellness products. Our Pet Supplies Plus segment is a leading franchisor and retailer of pet supplies and services. Our Badcock segment carries a complete line of furniture, appliances, bedding, electronics, home office equipment, accessories and seasonal items in a showroom format. Our American Freight segment is a retail chain offering in-store and online access to furniture, mattresses, new and out-of-box appliances and home accessories at discount prices. Our Buddy’s segment is a specialty retailer of high quality, name brand consumer electronic, residential furniture, appliances and
household accessories through rent-to-own agreements. Our Sylvan segment is an established and growing franchisor of supplemental education for Pre-K-12 students and families.
Our revenue is primarily derived from merchandise sales, rental revenue, and service revenues comprised of royalties and other required fees from our franchisees, dealers and financing programs.
In evaluating our performance, management focuses on several metrics that we believe are key to our success:
•Net change in retail and franchise locations. The change in retail and franchise locations from year to year is a function of the opening of new locations, offset by locations that we or our franchisees close. Please see “Item 2. Properties” in this Annual Report for the number of locations as of December 31, 2022.
•Same-store or comparable store sales. The difference in revenue generated by the segment’s existing store locations over a certain period (often a fiscal week, month or quarter), compared to an identical period in the past, usually in the previous year. A segment’s store becomes a comparable store at the beginning of the fiscal period following the one-year anniversary of the store open date (or the beginning of the 13th fiscal period after the store opens). If a store relocates outside of the current trade area or defined territory, it is removed from the comparable store base and is treated as a new store. Online revenue is included in the overall segment comparable store sales calculation.
•Adjusted EBITDA. Management focuses on adjusted EBITDA as a measure of the cash flow from recurring operations from the businesses. Adjusted EBITDA represents net income (loss), before income taxes, interest expense, depreciation, amortization and certain other items.
Results of Operations
For the Year Ended December 31, 2022 as compared to the Year Ended December 25, 2021
The following table sets forth the results of our operations for the years ended December 31, 2022, and December 25, 2021:
|Fiscal Years Ended||Change|
|Total revenues||$||4,397,832 ||$||3,255,204 ||$||1,142,628 ||35.1 ||%|
|Total operating expenses||4,176,625 ||3,028,853 ||1,147,772 ||37.9 ||%|
|Income (loss) from operations||221,207 ||226,351 ||(5,144)||(2.3)||%|
|Net income (loss) from continuing operations||(68,573)||191,966 ||(260,539)||(135.7)||%|
|Net income (loss) from discontinued operations, net of tax||— ||171,822 ||(171,822)||(100.0)||%|
|Net income (loss) attributable to Franchise Group, Inc.||$||(68,573)||$||363,788 ||$||(432,361)||(118.8)||%|Revenues. The table below sets forth the components and changes in our revenue for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Product||$||3,832,291 ||$||3,012,471 ||$||819,820 ||27.2 ||%|
|Service and other||535,961 ||209,103 ||326,858 ||156.3 ||%|
|Rental||29,580 ||33,630 ||(4,050)||(12.0)||%|
|Total revenue||$||4,397,832 ||$||3,255,204 ||$||1,142,628 ||35.1 ||%|
Our total revenue increased by $1.1 billion, or 35%, in the year ended December 31, 2022 compared to the year ended December 25, 2021. This increase was primarily due to:
•A full year of revenue from the Badcock Acquisition, which increased revenue by $817.0 million;
•a $371.3 million revenue increase at our Pet Supplies Plus segment due to a full period of activity reported in the current period compared to the prior period, which began on the acquisition date of March 10, 2021, an increase in comparable store sales, and 81 additional franchisee stores;
•a $34.1 million increase in revenue at our Vitamin Shoppe segment primarily attributable to the additional week in fiscal 2022 and higher average transaction value; and
•a full year of revenue from the Sylvan Acquisition, which increased revenue by $32.7 million.
Of the increases noted above, $73.1 million was attributable to the additional week in fiscal 2022 compared with fiscal 2021. These increases were offset by a $105.4 million decrease in revenue at our American Freight segment and a $7.0 million decrease at our Buddy’s segment.
Operating expenses. The following table details the amounts and changes in our operating expenses for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Cost of revenue:|
|Product||$||2,485,934 ||$||1,892,741 ||$||593,193 ||31.3 ||%|
|Service and other||36,340 ||16,506 ||19,834 ||120.2 ||%|
|Rental||11,070 ||11,552 ||(482)||(4.2)||%|
|Total cost of revenue||2,533,344 ||1,920,799 ||612,545 ||31.9 ||%|
|Selling, general and administrative expenses||1,573,281 ||1,108,054 ||465,227 ||42.0 ||%|
|Goodwill impairment||70,000 ||— ||70,000 ||100.0 ||%|
|Total operating expenses||$||4,176,625 ||$||3,028,853 ||$||1,147,772 ||37.9 ||%|
Total operating expenses increased $1.1 billion, or 38%, in the year ended December 31, 2022 compared to the year ended December 25, 2021. This increase was primarily due to:
•the Badcock Acquisition, which increased operating expenses by $710.6 million;
•the corresponding increased sales and inclusion of full period results from Pet Supplies Plus in the current period, which increased operating expenses by $331.7 million;
•Vitamin Shoppe segment’s increase in operating expenses of $31.3 million primarily due to a corresponding increase in sales for the period; and
•operating expenses at our American Freight segment increased $40.7 million primarily due to a $70.0 million non-cash goodwill impairment charge partially offset by a $28.5 million decrease in selling, general, and administrative expenses.
Non-operating expense. The following table sets forth certain information regarding our non-operating income (expense) for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change (Fiscal 2022 vs. Fiscal 2021)|
|Bargain purchase gain||$||3,514 ||$||132,559 ||$||(129,045)||(97.3)||%|
|Gain on sale-leaseback transactions||59,772 ||— ||59,772 ||100.0 ||%|
|Interest expense, net||(339,982)||(133,114)||(206,868)||155.4 ||%|
|Non-operating (expense)||$||(298,625)||$||(67,923)||$||(230,702)||339.7 ||%|
Non-operating expense increased $230.7 million due to the following:
•In the prior year, a $132.0 million bargain purchase gain was recorded from the Badcock Acquisition. During the year ended December 31, 2022, preliminary estimates were finalized, resulting in $3.5 million of bargain purchase gain in the current year;
•Gain on sale-leaseback transactions of $59.8 million in the current year as the Company’s Badcock segment entered into sale-leaseback transactions for a number of its retail locations, distribution centers and corporate headquarters, resulting in a net gain of $59.8 million.
•Other expenses decreased $45.4 million for the year ended December 31, 2022, primarily due to a prepayment penalty in the prior period of $36.7 million from the repayment of the Franchise Group New Holdco Term Loan and ABL Term Loan and a $8.1 million increase in the loss related to our investment in NextPoint (as defined herein) compared to the prior period; and
•Interest expense, net increased by $206.9 million due to an increase of $220.5 million of interest expense related to the Badcock securitized receivables portfolio and $14.1 million in additional interest expense on the First and Second Lien Term Loans and revolving credit facility (the “ABL Revolver”), offset by a decrease of $31.2 million of amortized deferred financing costs for the year ended December 31, 2022 compared to the prior year period.
Income Taxes. The following table sets forth certain information regarding our income taxes for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Gain (loss) before income taxes||$||(77,418)||$||158,428 ||$||(235,846)||(149)||%|
|Income tax expense (benefit)||(8,845)||(33,538)||24,693 ||(74)||%|
|Effective tax rate||11.4 ||%||(21.2)||%|
The increase in the effective tax rate from (21.2)% to 11.4% for the year ended December 31, 2022 compared to the year ended December 25, 2021 is primarily due to a $14.7 million impairment of goodwill that is permanently disallowed for tax purposes. In addition, the Company released $6.8 million of a valuation allowance in the current year compared to release of $45.2 million in the prior year, on the basis of management’s reassessment of the amount of its deferred tax assets that are more likely than not to be realized. The bargain purchase gain recorded in the Badcock Acquisition in the prior year was disregarded for tax purposes, which resulted in a permanent benefit.
Net Income. In the year ended December 31, 2022, we had net loss from continuing operations of $(68.6) million compared to net income of $192.0 million in the year ended December 25, 2021 due to the fluctuations noted above.
Our operations are conducted in six reporting business segments: Vitamin Shoppe, Pet Supplies Plus, Badcock, American Freight, Buddy’s, and Sylvan. We define our segments as those operations whose results our Chief Operating Decision Maker regularly reviews to analyze performance and allocate resources. Because the Sylvan Acquisition and Badcock Acquisition occurred in the fourth quarter of the year ended December 25, 2021, comparable information is not available; therefore, Sylvan and Badcock segment information is not provided.
The following table summarizes the operating results of our Vitamin Shoppe segment for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Total revenues||$||1,206,824 ||$||1,172,725 ||$||34,099 ||2.9 ||%|
|Operating expenses||1,100,035 ||1,068,721 ||31,314 ||2.9 ||%|
|Operating income (loss)||$||106,789 ||$||104,004 ||$||2,785 ||2.7 ||%|
Total revenue for our Vitamin Shoppe segment increased $34.1 million, or 2.9%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The increase was attributable to higher average transaction values and $19.5 million from the additional week in fiscal 2022.
Operating expenses for the Vitamin Shoppe segment increased $31.3 million, or 2.9%, for the year ended December 31, 2022 as compared to the year ended December 25, 2021. The increase in operating expenses was primarily driven by:
•a $28.9 million increase in cost of revenue correlated to the revenue growth noted above;
•Gross profit decreased approximately eighty-five basis points to 44.4% compared to 45.2% in the prior year due to increased transportation and fuel costs and higher sales for sports nutrition products, which have lower merchandise margins; and
•a $6.4 million increase in rent and utility expenses offset by a $4.1 million decrease in depreciation expense primarily due to accelerated depreciation related to vacant office space in fiscal year 2021.
Pet Supplies Plus
The following table summarizes the operating results of our Pet Supplies Plus segment for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Total revenues||$||1,288,724 ||$||917,439 ||$||371,285 ||40.5 ||%|
|Operating expenses||1,207,496 ||875,785 ||331,711 ||37.9 ||%|
|Operating income (loss)||$||81,228 ||$||41,654 ||$||39,574 ||95.0 ||%|
Total revenue for our Pet Supplies Plus segment increased $371.3 million, or 40.5%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The increase in revenue was driven by:
•The Pet Supplies Plus Acquisition occurring on March 10, 2021, resulting in a $203.1 million increase as the prior period did not include a full year's results;
•a $23.3 million increase due to the additional week in fiscal 2022 compared with fiscal 2021;
•a $10.5 million increase in grooming and dog wash revenue compared to the prior year;
•an increase in product revenue due to positive comparable store sales; and
•an increase in wholesale and royalty revenue attributable to a net increase of 81 franchisee stores during fiscal year 2022.
Operating expenses for the Pet Supplies Plus segment increased $331.7 million, or 37.9%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The increase in operating expenses was primarily due to the Pet Supplies Plus Acquisition occurring on March 10, 2021, resulting in the prior period not including a full year’s results. Additionally, $20.0 million of the increase was attributable to the additional week in fiscal 2022 compared with fiscal 2021.
The following table summarizes the operating results of our American Freight segment for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Total revenues||$||883,484 ||$||988,892 ||$||(105,408)||(10.7)||%|
|Operating expenses||963,008 ||922,351 ||40,657 ||4.4 ||%|
|Operating income (loss)||$||(79,524)||$||66,541 ||$||(146,065)||(219.5)||%|
Total revenue for our American Freight segment decreased $105.4 million, or (10.7)%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The decrease in revenue was attributable to lower demand for large discretionary spending due to high inflation and reduced government stimulus programs which was nominally offset by a revenue increase of $15.3 million from the additional week in fiscal 2022.
Operating expenses for the American Freight segment increased $40.7 million, or 4.4%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The increase in operating expenses was primarily due to a $70.0 million non-cash goodwill impairment charge partially offset by lower cost of revenue, variable compensation and reduced advertising expenditures.
The following table summarizes the operating results of our Buddy’s segment for the years ended December 31, 2022 and December 25, 2021:
|Fiscal Years Ended||Change|
|Total revenues||$||57,407 ||$||64,409 ||$||(7,002)||(10.9)||%|
|Operating expenses||44,887 ||47,724 ||(2,837)||(5.9)||%|
|Operating income (loss)||$||12,520 ||$||16,685 ||$||(4,165)||(25.0)||%|
Total revenue for our Buddy’s segment decreased $7.0 million, or (10.9)%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The decrease in revenue was primarily attributable to the refranchising of eight Company-owned stores on August 25, 2021 partially offset by $1.0 million in revenue from the additional week in fiscal 2022.
Operating expenses for the Buddy’s segment decreased $2.8 million, or (5.9)%, for the year ended December 31, 2022 compared to the year ended December 25, 2021. The decrease in operating expenses was primarily due to the refranchising of eight Company-owned stores on August 25, 2021.
To provide additional information regarding our financial results, we have disclosed Adjusted EBITDA in the table below and within this Annual Report. Adjusted EBITDA represents net income (loss), before income taxes, interest expense, depreciation and amortization, and certain other items specified below. We have provided a reconciliation below of Adjusted EBITDA to net income (loss) from continuing operations, the most directly comparable GAAP financial measure.
We have included Adjusted EBITDA in this Annual Report because we believe the presentation of these measures is useful to investors as supplemental measures in evaluating the aggregate performance of our operating businesses and in comparing our results from period to period because they exclude items that we do not believe are reflective of our core or ongoing operating results. These measures are used by our management to evaluate performance and make resource allocation decisions each period. Adjusted EBITDA is also the primary operating metric used in the determination of executive management’s compensation. In addition, a measure similar to Adjusted EBITDA is used in our credit facilities. Adjusted EBITDA is not a recognized financial measure under GAAP and may not be comparable to similarly-titled measures used by
other companies in our industry. Adjusted EBITDA should not be considered in isolation from or as an alternative to net income (loss), operating income (loss), or any other performance measures derived in accordance with GAAP.
The following table presents a reconciliation of Adjusted EBITDA for the fiscal years ended December 31, 2022 and December 25, 2021.
|Fiscal Years Ended|
|Net income (loss) from continuing operations||$||(68,573)||$||191,966 |
|Interest expense||339,982 ||133,114 |
|Income tax benefit||(8,845)||(33,538)|
|Depreciation and amortization charges||81,942 ||69,086 |
|Total Adjustments||413,079 ||168,662 |
|EBITDA||344,506 ||360,628 |
|Adjustments to EBITDA|
|Executive severance and related costs||1,890 ||302 |
|Stock-based and long term executive compensation||21,422 ||14,956 |
|Litigation costs and settlements||526 ||(1,130)|
|Corporate compliance costs||608 ||2,172 |
|Store closures||1,342 ||2,429 |
|Securitized accounts receivable interest income||(192,920)||— |
|Securitized accounts receivable bad debt reserve||144,402 ||— |
|W.S. Badcock financing operations||(7,841)||(19,919)|
|Prepayment penalty on early debt repayment||— ||36,726 |
|Right-of-use asset and long-term asset impairment||3,422 ||2,948 |
|Goodwill impairment||70,000 ||— |
|Integration costs||(2,274)||16,655 |
|Gain on sale-leaseback and owned properties, net||(61,548)||— |
|Divestiture costs||4,079 ||515 |
|Acquisition costs||6,267 ||22,878 |
|Loss on investment in equity securities||23,671 ||31,773 |
|Acquisition bargain purchase gain||(3,514)||(132,559)|
|Total Adjustments to EBITDA||9,532 ||(22,254)|
|Adjusted EBITDA||$||354,038 ||$||338,374 |
We believe that we have sufficient liquidity to support our ongoing operations and maintain a sufficient liquidity position to meet our obligations and commitments. Our liquidity plans are established as part of our financial and strategic planning processes and consider the liquidity necessary to fund our operating, capital expenditure and debt service needs.
We primarily fund our operations and acquisitions through operating cash flows and, as needed, a combination of borrowings under various credit agreements, availability under our revolving credit facilities and the issuance of equity securities. Cash generation can be subject to variability based on many factors, including seasonality, receipt of prepaid payments from area developers, timing of repayment of loans to franchisees and the effects of changes in end markets.
Subsequent to December 31, 2022, several transactions and events occurred that will or have the potential to affect our liquidity and capital resources in future periods. For more information, refer to “Note 17 - Subsequent Events”, to the Consolidated Financial Statements in Item 8.
Sources and uses of cash
Net cash provided by operating activities decreased $143.4 million in fiscal 2022 compared to fiscal 2021 due to a net $90.6 million decrease in accounts receivable and securitized accounts receivable and a $17.0 million decrease in accounts payable and accrued expenses due to the timing of payments. These were partially offset by a $73.8 million increase in interest payable, a $13.9 million increase in cash net income and a $56.7 million decrease in cash used for inventory in the current year. Cash net income represents net income adjusted for non-cash or non-operating activities such as gain on bargain purchases, gains on the sale of Company assets, depreciation and amortization, deferred financing cost amortization and the change in fair value of investments.
Net cash provided by (used in) investing activities increased $1,129.9 million in fiscal 2022 compared to fiscal 2021. This increase was primarily driven by a $1,060.0 million reduction of cash used for acquisitions and an increase of $260.7 million of proceeds from the sale of property, plant, and equipment. These increases for fiscal year 2022 were partially offset by $179.5 million in cash received from divestitures in the prior year.
Net cash provided by financing activities decreased $1,339.9 million in fiscal 2022 compared to fiscal 2021. The decrease was due to a $1,462.7 million decrease in proceeds from the issuance of debt, a $392.6 million net increase in repayments of and proceeds from secured debt obligations, a $172.5 million increase in payments for share repurchases, a $79.5 million decrease in proceeds from the issuance of preferred stock, and an increase of $44.5 million for dividends paid. The decreases in cash provided by financing activities were partially offset by a $720.0 million reduction in repayments of long-term obligations and a $101.3 million reduction of payments for debt issuance costs and penalty prepayment.
The following tables summarize our contractual obligations as of December 31, 2022:
|Finance lease liabilities||$||11,055 ||$||926 ||$||3,300 ||$||2,827 ||$||2,602 ||$||1,997 ||$||1,255 ||$||— |
|Operating lease liabilities||899,993 ||151,806 ||227,700 ||197,095 ||154,809 ||123,037 ||91,038 ||258,120 |
|Debt secured by accounts receivable||447,469 ||— ||340,021 ||107,448 ||— ||— ||— ||— |
|Term Loans and other debt||1,105,262 ||— ||1,145 ||4,660 ||337 ||1,099,120 ||— ||— |
|ABL Revolver||295,000 ||— ||— ||— ||295,000 ||— ||— ||— |
|Total Obligations||$||1,847,731 ||$||— ||$||341,166 ||$||112,108 ||$||295,337 ||$||1,099,120 ||$||— ||$||— |
|(in thousands)||Total||Expiring in 2023||Expiring in 2024||Expiring in 2025||Expiring in 2026||Expiring in 2027||Thereafter|
|Guarantees||$||30,242 ||$||5,860 ||$||5,325 ||$||4,757 ||$||4,343 ||$||3,312 ||$||6,645 |
|Purchase obligations||88,446 ||40,917 ||14,559 ||6,221 ||4,550 ||4,358 ||17,841 |
|Total commitments||$||118,688 ||$||46,777 ||$||19,884 ||$||10,978 ||$||8,893 ||$||7,670 ||$||24,486 |
For more information on our long-term obligations, refer to “Note 10 - Long-Term Obligations”, to the Consolidated Financial Statements in Item 8.
Operating lease obligations. Refer to “Note 9 - Leases”, to the Consolidated Financial Statements in Item 8 for information on our operating leases. The obligation above includes amounts for leases that were signed prior to December 31, 2022 for stores that were not yet open on December 31, 2022.
Other factors affecting our liquidity
Tax Receivable Agreement. We may be required to make payments under the Tax Receivable Agreement (“TRA Payments”) to the former owners of Buddy’s (the “Buddy’s Members”). As of December 31, 2022, we had TRA Payments due to the Buddy’s Members of $15.4 million. Refer to “Note 13 - Income Taxes”, to the Consolidated Financial Statements in Item 8 for more information on the Tax Receivable Agreement.
Dividends. On February 24, 2023, our Board approved quarterly cash dividends to common stockholders of $0.625 per share and preferred stockholders of $0.46875 per share. The cash dividends will be paid on or about April 14, 2023 to holders of record of the Company’s common stock and preferred stock on the close of business on March 31, 2023. The payment of dividends is at the discretion of our Board and depends, among other things, on our earnings, capital requirements, and financial condition. Our ability to pay dividends is also subject to compliance with financial covenants that are contained in our credit facility and may be restricted by any future indebtedness that we incur or issuances of our preferred stock. In addition, applicable law requires our Board to determine that we have adequate surplus prior to the declaration of dividends. We cannot provide an assurance that we will pay dividends at any specific level or at all.
Off Balance Sheet Arrangements
The Company remains secondarily liable under various real estate leases that were assigned to franchisees who acquired
stores from the Company. In the event of the failure of an acquirer to pay lease payments, the Company could be obligated to pay the remaining lease payments which extend through 2033 and aggregated $30.2 million as of December 31, 2022. If the Company is required to make payments under these guarantees, the Company could seek to recover those amounts
from the franchisees or in some cases their affiliates. The Company believes that payment by the Company under these guarantees is remote as of December 31, 2022.
Interest Rate Risk
We are exposed to various types of market risk in the normal course of our business, including the impact of interest rate
changes. We may enter into interest rate swaps to manage exposure to interest rate changes. We do not enter into derivative
instruments for any purpose other than cash flow hedging and we do not hold derivative instruments for trading purposes.
Long-term Debt. We utilize short-term and long-term financing to manage our overall interest expense related to our existing variable-rate debt, as well as to hedge the variability in cash flows due to changes in benchmark interest rates related to anticipated debt issuances. Refer to “Note 10 - Long-Term Obligations” to the Consolidated Financial Statements in Item 8 for further details of the components of our long-term debt as of December 31, 2022.
|Changes in Fair Value|
|10 Basis Point Increase in Underlying Rate||10 Basis Point Decrease in Underlying Rate|
|Long-term debt||$||1,847,731 ||$||1,848 ||$||(1,848)|
Critical Accounting Policies and Estimates
The preparation of financial statements requires the application of certain accounting policies that require the use of estimates. Certain of our estimates require a high level of judgment and have the potential to have a material effect on the financial statements if actual results vary significantly from those estimates. A description of what we consider to be our most significant critical accounting policies follows.
Long-Lived and Right-of-Use Assets. We review our long-lived assets, such as property, plant and equipment, purchased intangibles subject to amortization, and operating lease right-of-use assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset group may not be recoverable. We measure recoverability by comparison of the carrying value of an asset to its estimated undiscounted future cash flows expected to be generated by the asset. We recognize and measure potential impairment at the lowest level where cash flows are individually identifiable. If the carrying amount of an asset exceeds its estimated future cash flows, we recognize an impairment charge equal to the amount by which the carrying value of the asset exceeds the fair value of the asset. We determine fair value through various valuation techniques, including discounted cash flow models, quoted market values, and third-party independent appraisals.
Business Combinations-Purchase Price Allocation. For acquisitions which meet the definition of a business combination in accordance with Accounting Standards Codification (“ASC”) 805, we allocate the purchase price to the various tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values. The excess of the purchase price over the fair values of the assets acquired and liabilities assumed represents goodwill derived from the acquisition. The amount by which the net fair value of assets acquired and liabilities assumed exceeds the fair value of consideration transferred as the purchase price is recorded as a bargain purchase gain. Determining the fair value of certain assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions, which are inherently uncertain. Many of the estimates and assumptions used to determine fair values, such as those used for intangible assets are made based on forecasted information and discount rates. In addition, the judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations. Refer to “Note 2 - Acquisitions” to the Consolidated Financial Statements in Item 8 for additional information.
Goodwill and Non-amortizing Intangible Assets. Goodwill and non-amortizing intangible assets are initially recorded at their fair values. These assets are not amortized but are evaluated as of the end of July of each fiscal year, and a more frequent evaluation is performed if an event occurs or circumstances change that would more likely than not reduce the assets’ fair values below their carrying values. Such events or circumstances could include, but are not limited to, significant negative industry or economic trends, unanticipated changes in the competitive environment and a significant sustained decline in the market price of our stock.
For goodwill, 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 weighted average of values determined from an income approach and a market approach 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.
For non-amortizing intangible assets, the Company evaluates its tradenames for impairment by comparing the 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 ASC 350, “Intangibles - Goodwill and Other (Topic 350).”
Refer to “Note 7 - Goodwill and Intangible Assets” to the Consolidated Financial Statements in Item 8 for additional information.
Recently Issued Accounting Standards
Refer to “Note 1 - Organization and Significant Accounting Policies”, to the Consolidated Financial Statements in Item 8.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is incorporated by reference to the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report.
Item 8. Financial Statements and Supplementary Data.
TABLE OF CONTENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Franchise Group, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Franchise Group, Inc. and subsidiaries (the “Company”) as of December 31, 2022 and December 25, 2021 and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows, for each of the three fiscal years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and December 25, 2021 and the results of its operations and its cash flows for each of the three fiscal years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2023, expressed an adverse opinion on the Company’s internal control over financial reporting because of a material weakness.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Goodwill – American Freight Reporting Unit – Refer to Notes 1 and 7 to the financial statements
Critical Audit Matter Description
The Company performed a quantitative impairment evaluation of the goodwill for the American Freight reporting unit by comparing the estimated fair value of the reporting unit to its carrying value. The Company determined the fair value of the American Freight reporting unit using an income approach and a market approach. The determination of the fair value requires management to make significant estimates and assumptions related to projected cash flows, discount rates and growth rates. Changes in these assumptions could have a significant impact on either the fair value, the amount of any goodwill impairment charge, or both. The goodwill balance was $737.4 million as of December 31, 2022, of which $300.8 million was related to the American Freight reporting unit. The carrying value of the American Freight reporting unit exceeded its fair value as of the measurement date which resulted in a $70.0 million goodwill impairment.
Given the significant judgments made by management to estimate the fair value of the American Freight reporting unit, performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to projected cash flows, discount rates and growth rates of the American Freight reporting unit required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the projected cash flows and growth rates (“forecasts”), and the selection of a discount rate for the American Freight reporting unit included the following, among others:
•We tested the effectiveness of controls over management’s goodwill impairment evaluation, including those over the determination of the fair value of American Freight, such as controls related to management’s forecasts and selection of the discount rate.
•We evaluated management’s ability to accurately forecast by comparing actual results to management’s historical forecasts.
•We evaluated the reasonableness of management’s forecasts by comparing the forecasts to (1) historical results, (2) internal communications to management and the Board of Directors and (3) forecasted information included in industry reports.
•With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) valuation methodology, (2) discount rate, and (3) market multiples by:
•Testing the source information underlying the determination of the discount rate and market multiples and the mathematical accuracy of the calculations.
•Developing a range of independent estimates and comparing those to the discount rate and market multiples selected by management.
/s/ Deloitte & Touche LLP
February 28, 2023
We have served as the Company’s auditor since 2019.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Franchise Group, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Franchise Group, Inc. and subsidiaries (the “Company”) as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, because of the effect of the material weakness identified below on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the fiscal year ended December 31, 2022, of the Company and our report dated February 28, 2023, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The Company identified a material weakness in its controls over financial reporting involving the preparation of its Statement of Cash Flows. As a result of this deficiency, there was a misclassification of cash flows associated with interest payments on the Company’s secured borrowing resulting in an overstatement of cash flows provided by operating activities and an overstatement of cash flows used in financing activities for the three and six months ended March 26, 2022 and June 25, 2022, respectively, within its Statement of Cash Flows.
This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for the fiscal year ended December 31, 2022, of the Company, and this report does not affect our report on such financial statements.
/s/ Deloitte & Touche LLP
February 28, 2023
FRANCHISE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended December 31, 2022, December 25, 2021, and December 26, 2020
|(In thousands, except per share data)||12/31/2022||12/25/2021||12/26/2020|
|Product||$||3,832,291 ||$||3,012,471 ||$||1,899,662 |
|Service and other||535,961 ||209,103 ||65,798 |