Fair Value Measurements of Financial Assets and Liabilities

6 Months Ended

Jun. 27, 2020

Fair Value Measurements of Financial Assets and Liabilities

The Company uses a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect pricing based upon a reporting entity’s own market assumptions.

The Company is required to measure certain assets and liabilities at fair value or disclose the fair values of certain assets and liabilities recorded at cost. Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated assuming the transaction occurs in the principal or most advantageous market for the asset or liability and includes consideration of non-performance risk and credit risk of both parties. A three-tier fair value hierarchy prioritizes the inputs used in measuring fair value. These tiers include:

•Level 1 - Valuation inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.

•Level 2 - Valuation inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in inactive markets, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the instruments.

•Level 3 - Valuation inputs are unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are determined using model-based techniques that include discounted cash flow models and similar techniques.

The fair value estimates of financial instruments are not necessarily indicative of the amounts we might pay or receive in actual market transactions. The use of different market assumptions and/or estimation methodologies may have a material impact on the estimated fair value amounts.

Cash Equivalents and Restricted Cash

The carrying amount of cash equivalents approximates fair value due to the short-term maturity of the instruments. All cash and cash equivalents are denominated in U.S. currency.

Accounts Receivable, Net

The carrying amount of accounts receivable approximates fair value due to the short-term nature of those items and the effect of related allowances for credit losses.

Accounts Payable and Other Payables and Accrued Expenses

The carrying amounts of accounts payable and other payables and accrued expenses approximate fair value due to the short-term nature of those items.

Tangible Long-lived and Right of Use (“ROU”) Store Assets

The non-recurring fair value measurements associated with these tangible long-lived and ROU store assets are classified as Level 3 measurements in the fair value hierarchy. Refer to Note 1. “Description of Business and Basis of Presentation”.

Long-term Debt - Term Loan and Revolving Credit Facility

Since the borrowings under our term loan and revolving credit facility utilize variable interest rate setting mechanisms such as LIBOR, the fair values of these borrowings are deemed to approximate the carrying values. We also considered the effect of our own credit risk on the fair values of our term loan and revolving credit facility. Refer to Note 4. “Long-term Debt”.

Long-term Debt - 2025 Notes

The Company has $402.5 million in aggregate principal amount of 2.50% convertible senior notes due on May 15, 2025 (the “2025 Notes”) issued and outstanding as of June 27, 2020. The estimated fair value of the 2025 Notes was approximately $464.4 million as of June 27, 2020. The estimated fair value of the 2025 Notes is based on the prices the 2025 Notes have traded in the market as of June 27, 2020, as well as overall market conditions on the date of valuation, stated coupon rates, the number of coupon payments each year and the maturity dates, and represents a Level 2 measurement. Refer to Note 4. “Long-term Debt” for more information on the 2025 Notes.

Finance Lease Obligations

The fair value of finance lease obligations is based on estimated future contractual cash flows discounted at an appropriate market rate of interest (Level 2 inputs). The estimated fair values of our finance leases were $36.9 million and $38.2 million as of June 27, 2020 and December 28, 2019, respectively, compared to carrying values of $32.6 million and $33.3 million, respectively.

Interest Rate Derivatives

The Company is party to pay-fixed and receive-floating interest rate swap agreements to offset the variability of cash flows in LIBOR-indexed debt interest payments, subject to a 1.0% floor, attributable to changes in the benchmark interest rate from March 13, 2017 to March 13, 2021 related to its credit agreement. During the first quarter of 2020, in accordance with the original agreements with the counterparties, the notional amount of one swap decreased from $105.0 million to $70.0 million. There were no other changes in the terms of the agreements. Also, during the first quarter of 2020, the Company entered into a forward-starting interest rate collar that will hedge variability of cash flows of LIBOR-indexed debt interest payments from March 13, 2021 to July 18, 2024, following the maturity of the interest rate swap agreements, with an aggregate notional amount of $375 million.

We recognize as assets or liabilities at fair value the estimated amounts we would receive or pay upon a termination of interest rate derivatives prior to their scheduled expiration dates. Fair value is based on information that is model-driven and whose inputs are observable (Level 2 inputs).

During the second quarter of 2020, as a result of the partial repayment of the Company’s LIBOR based debt balances, certain forecasted hedged transactions were deemed not probable of occurring. The Company subsequently discontinued hedge accounting on $78.0 million of interest rate swap notional and $58.0 million of interest rate collar notional, reclassifying net unrealized losses of approximately $2.5 million from AOCL to interest expense, net during the three and six months ended June 27, 2020. Additionally, due to changes in the interest rates applicable to the Company’s term loan and revolver, the interest rate collar ceased to be a highly effective hedge. Losses on the change in fair value of the interest rate collar of approximately $2.6 million were recorded in interest expense, net during the quarter ended June 27, 2020. Interest expense, net related to derivatives considered to be highly effective hedges for the three and six months ended June 27, 2020 was $2.0 million and $3.9 million, respectively.

Changes in the cash flows of interest rate swap derivatives are expected to be highly effective in offsetting the changes in interest payments on a principal balance equal to the designated derivative’s notional amount, attributable to the hedged risk. Derivatives qualifying as hedges are included in the same section of the Condensed Consolidated Statements of Cash Flows as the underlying assets and liabilities being hedged. Cash flows during the six months ended June 27, 2020 related to derivatives not qualifying as hedges were included in the operating section of the Condensed Consolidated Statements of Cash Flows and were not material. As of June 27, 2020, the Company expects to reclassify $4.6 million of unrealized losses on derivative instruments, net of tax, from AOCL into earnings in the next 12 months as the derivative instruments mature. See Note 13. “Accumulated Other Comprehensive Loss” for further details.

Our positions related to interest rate derivative contracts are as follows:


In thousands			Balance Sheet Classification			As of June 27, 2020			As of December 28, 2019
Derivatives designated as hedging instruments under ASC 815
	Interest rate swaps	Other Payables and Accrued Expenses		$	5,497		$	6,382
	Interest rate swaps	Other Liabilities		—			1,603
Total derivative liabilities designated as hedging instruments							$	5,497		$	7,985

Derivatives not designated as hedging instruments under ASC 815
	Interest rate swap	Other Payables and Accrued Expenses		$	892		$	—
	Interest rate collar	Other Payables and Accrued Expenses		839			—
	Interest rate collar	Other Liabilities		10,374			—
Total derivative liabilities not designated as hedging instruments							$	12,106		$	—