What changed in this filing

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Item 1A. Risk Factors

2023-03-01 compared with 2022-03-02 · 226 added, 221 removed, 375 unchanged (54% of the section changed)

The following risk factors may be important to understanding any statement in this Annual Report on Form 10-K or elsewhere.

A number of factors, whether currently known or unknown, including but not limited to the factors described below, could materially adversely affect our business, business prospects, financial condition, operating results, cash flows and stock price, and may cause actual results, performance or achievements in future periods to differ materially from those assumed, projected or contemplated.

Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that materially and adversely affect our business.

The following risk factors are important to understanding various statements in this Annual Report on Form 10-K or elsewhere.

The factors described below, individually or in the aggregate, could materially adversely affect our business, business prospects, financial condition, operating results, cash flows and stock price, and may cause actual results, performance or achievements in future periods to differ materially from those assumed, projected or contemplated.

Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time.

The following is a summary of the principal risks that could adversely affect our business, operations and financial results:

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• failure to maintain or increase comparable store sales;

• inflation and other changes affecting the market prices of the products we sell;

• failure to open, relocate or remodel stores on schedule and on budget;

• inflation and other changes affecting the market prices of the products we sell;

• risks associated with newly opened stores;

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• failure to participate effectively in the growing online retail marketplace;

• natural or man-made disasters, unusual weather conditions (which may become more frequent due to climate change), power outages, pandemic outbreaks, terrorist acts, global political events or other serious catastrophic events and the concentration of our business operations;

• natural or man-made disasters, unusual weather conditions (which may become more frequent due to climate change), power outages, major health epidemics, pandemic outbreaks, terrorist acts, global political events or other serious catastrophic events and the concentration of our business operations;

• unexpected costs and negative effects if we incur losses not covered by our insurance program;

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• movement of consumer trends toward private labels and away from name-brand products;

• the outbreak of COVID-19 and its variants;

Risks Related to Data Protection, Cybersecurity and our Information Technology Systems

• failure to maintain the security of information we hold relating to personal information or payment card data of our customers, employees and suppliers;

• material disruption to our information technology systems;

Risks Related to Legal and Regulatory Risks

• risks associated with products we and our independent operators ("IOs") sell;

• risks associated with laws and regulations generally applicable to retailers;

• legal proceedings from customers, suppliers, employees, governments or competitors ;

Risks Related to Our IO Model

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• risks associated with actions our IOs could take that could harm our business;

Risks Related to Data Protection, Cybersecurity and our Information Technology Systems

• failure to maintain the security of information we hold relating to personal information or payment card data of our customers, employees and suppliers;

• material disruption to our information technology systems;

Risks Related to Legal and Regulatory Risks

• risks associated with products we and our independent operators ("IOs") sell;

• risks associated with laws and regulations generally applicable to retailers;

• legal proceedings from customers, suppliers, employees, governments or competitors ;

Risks Associated with our Indebtedness

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Risks Related to Accounting, Tax and Financial Statement Matters

• risks associated with tax matters;

• risks associated with tax matters, including changes in tax laws;

• changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters;

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Shortages or disruptions in the availability of quality products that excite our customers and drive customer traffic could have a material adverse effect on our business, financial condition and results of operations.

As our store base continues to grow, our ability to secure opportunistic products in sufficient quantities may become more difficult.

All of our inventory is acquired through purchase orders and we generally do not have long-term contractual agreements with our suppliers that obligate them to provide us with products exclusively or at specified quantities or prices, or at all.

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In order to retain our competitive advantage, we need to continue to develop and maintain relationships with qualified suppliers that can satisfy our standards for quality and our requirements for delivery of products in a timely and efficient manner at attractive prices.

The need to grow existing relationships and develop new relationships with qualified suppliers will be particularly important as we seek to expand our operations and enhance our product offerings in the future.

Manufacturers and distributors of name-brand products have become increasingly consolidated.

The need to grow existing relationships and develop new relationships with qualified suppliers is particularly important as we seek to continue to expand our operations and enhance our product offerings in the future.

Manufacturers and distributors of name-brand, large volume products have become increasingly consolidated.

Further consolidation of manufacturers or distributors could reduce our supply options and detrimentally impact the terms under which we purchase products.

If one or more of our existing significant suppliers were to be unable or unwilling to continue providing products to us on attractive terms, or at all, we may have difficulty finding replacement suppliers on commercially reasonable terms or at all.

The loss of one or more of our existing significant suppliers or our inability to develop relationships with new suppliers could reduce our competitiveness, slow our plans for further expansion and cause our sales and operating results to be materially adversely affected.

The loss of one or more of our existing significant suppliers or our inability to develop relationships with new suppliers could reduce our competitiveness, slow our plans for further expansion and cause our net sales and operating results to be materially adversely affected.

Our supply chain is subject to risks, including distribution and transportation, labor disputes or constraints, union organizing activities, financial liquidity, inclement weather, natural disasters, significant public health and safety events, supply constraints and general economic and political conditions that could limit their ability to provide us with quality products.

As discussed in "Item 1.

Business" and elsewhere in these risk factors, these risks have and may continue to delay or preclude delivery of product to us on a timely basis or at all.

Business" and elsewhere in these risk factors, these risks have in the past delayed or precluded, and may in the future delay or preclude, delivery of product to us on a timely basis or at all.

We may not be able to successfully identify trends to meet consumer demand and maintain an appropriate level of opportunistic products.

We depend on repeat visits by our customer base to drive sales, and we rely on desirable opportunistic products at discounts to excite our customers to make such repeat visits.

Consumer preferences often change rapidly and without warning.

We may not successfully address consumer trends or be able to acquire desirable opportunistic products, and we expect competition for customers to increase as online shopping by customers continues to expand.

Customer demand for certain products has fluctuated as the COVID-19 pandemic has progressed and customer behaviors have changed.

In fiscal 2021, and ongoing to an extent, consumer behavior has been impacted by increased consumer mobility and travel, higher food-away-from-home spend, continued consolidation of grocery store visits, elevated grocery e-commerce usage and higher levels of government stimulus, leading consumers to prioritize convenience over value.

These circumstances have led to a decline in our customer count during fiscal 2021 and it is uncertain whether such changes are temporary.

Further, in response to the COVID-19 pandemic, many CPGs reduced SKU assortment, resulting in lower levels of opportunistic product.

In response to recent macroeconomic conditions, many CPGs reduced SKU assortment, resulting in lower levels of opportunistic product.

We generally make individual purchase decisions for products that become available, and these purchases may be for large quantities that we may not be able to sell on a timely or cost-effective basis.

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We base our purchases of inventory, in part, on our sales forecasts.

If our sales forecasts overestimate customer demand, we may experience higher inventory levels and need to take markdowns on excess or slow-moving inventory,

leading to decreased profit margins.

If our sales forecasts overestimate customer demand, we may experience higher inventory levels and need to take markdowns on excess or slow-moving inventory, leading to decreased profit margins.

Conversely, if our sales forecasts underestimate customer demand, we may have insufficient inventory to meet demand, leading to lost sales, either of which could materially adversely affect our financial performance.

In addition, a majority of the assortment in each Grocery Outlet store is selected by IOs based on local preference and shopping history, and the inability of the IOs to successfully identify trends in the local market could materially adversely affect our financial performance.

In addition, a majority of the assortment in each Grocery Outlet store is selected by IOs based on local

preference and shopping history, and the inability of the IOs to successfully identify trends in the local market could materially adversely affect our financial performance.

Our long-term success depends in part on our ability and the ability of the IOs to maintain or increase comparable store sales, and if we are unable to achieve comparable store growth over the long-term, our profitability and performance could be materially adversely impacted.

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Competition and pricing pressures from competitors and suppliers may also materially adversely impact our comparable sales if we lose customers as a result.

After many years of consecutive growth in comparable store sales, we had year-over-year declines in fiscal 2021, primarily due to outsized financial performance in fiscal 2020 and continued impacts of the COVID-19 pandemic, including changes in consumer behavior, supplier issues and other related challenges.

Our comparable store sales growth could continue to be lower than our historical average or our future target for many reasons, many of which we do not significantly control, including general economic conditions that may not favor our model, operational performance (including by the IOs), price inflation or deflation, or changes in response to competitive factors, changes in our existing supplier relationships or our inability to develop new supplier relationships, industry competition (e-commerce), new competitive entrants near our stores, price changes in response to competitive factors, any comparison year or quarter having above-average net sales results, possible supply shortages or other operational disruptions, the number and dollar amount of customer transactions in our stores, our ability to provide product or service offerings that generate new and repeat visits to our stores and the level of customer engagement that we and the IOs provide in our stores.

After many years of consecutive growth in comparable store net sales, we had year-over-year declines in fiscal 2021, primarily due to outsized financial performance in fiscal 2020 and continued impacts of the COVID-19 pandemic, including changes in consumer behavior, supplier issues and other related challenges.

While fiscal 2022 was a year of comparable positive sales growth, our comparable store sales growth in future years could be lower than our historical average or our future target for many reasons, many of which we do not significantly control, including general economic conditions that may not favor our model, operational performance (including by the IOs), price inflation or deflation, or changes in response to competitive factors, changes in our existing supplier relationships or our inability to develop new supplier relationships, industry competition (e-commerce), new competitive entrants near our stores, price changes in response to competitive factors, any comparison year or quarter having above-average net sales results, possible supply shortages or other operational disruptions, the number and dollar amount of customer transactions in our stores, our ability to provide product or service offerings that generate new and repeat visits to our stores and the level of customer engagement that we and the IOs provide in our stores.

In addition, we may not accurately model cannibalization by our new stores when we open new stores in established markets, which could reduce comparable store sales.

Because we are an extreme value retailer and compete to a substantial degree on price, changes affecting the market prices of the products we sell, many of which we cannot control, including due to inflation or deflation, competition, supplier increases in freight, supply or other operating costs, including energy prices, or worsening economic conditions, could materially adversely affect our financial condition and operating results.

A critical differentiator of our business is our ability to offer value to our customers, including offering prices that are substantially below those offered by some of our competitors.

We carefully monitor the market prices of our products in order to maintain our price advantage and reputation.

Recently, we have experienced varying levels of inflation, resulting in part from various supply disruptions, increased shipping/transportation costs, increased commodity costs, increased labor costs in the supply chain and other disruptions caused by the COVID-19 pandemic and the uncertain economic environment, which we have not been able to fully offset through price increases.

Our IOs have experienced increased costs related to labor and utilities, among others.

If costs of goods continue to increase and our suppliers seek price increases from us, we may not be able to mitigate such increases and have sometimes, and may continue to, increase our prices, which could deter customer traffic and reduce the number and average basket size of customer transactions.

If our competitors substantially lower their prices, we may lose customers and mark down prices.

Our gross margins and profitability also may be adversely impacted by higher supply costs that we cannot fully pass along or if we need to lower product prices due to competition.

As a result of our low-price model, the foregoing competitive pressures may reduce our profitability and materially adversely affect our business, financial condition and results of operations.

Our growth strategy is highly dependent on our ability to identify and open future store locations and relocate or remodel existing store locations in new and existing markets.

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Our ability to open stores in a timely and successful manner depends in part on the following factors:

the ability to attract potential IOs who are strong entrepreneurs;

the availability of attractive store locations (including stores that will not compete significantly with existing stores and that can be reasonably serviced by our distribution network) and rent prices;

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our relationships with current and prospective landlords;

the ability to secure and manage the inventory necessary for the

launch and operation of new stores;

the ability to attract potential IOs who are strong entrepreneurs;

the ability to secure and manage the inventory necessary for the launch and operation of new stores;

the availability of capital funding for expansion;

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Any or all of these factors and conditions could materially adversely affect our growth and profitability.

Our goal is to expand our store base by approximately 10% annually over the next several years.

However, we cannot assure you that we will be able to consistently (on a year-over-year basis) achieve this level of new store growth and believe that we will be below this goal for fiscal 2022.

Recently, as a result of the COVID-19 pandemic, planned construction and opening of new stores have been, and may continue to be, negatively impacted due to labor and materials shortages as well as longer lead times in lease execution, site permitting and construction.

These challenges will impact our new store growth in 2022.

In addition, our planned new store growth in fiscal 2022 is expected to be more back-weighted towards the second half of the year.

Additionally, we may desire to or need to expand into neighboring states and regions in the United States to meet our growth goals, and such expansion heightens the risks, challenges and uncertainties of development.

Our long-term goal is to expand our store base by approximately 10% annually over the next several years.

However, we cannot assure you that we will be able to consistently (on a year-over-year basis) achieve this level of new store growth and we were below that goal for fiscal 2022.

Over the last two years, planned construction and opening of new stores have been, and may continue to be, negatively impacted due to labor and materials shortages as well as longer lead times in lease execution, site permitting and construction.

These challenges impacted our new store growth in 2022 and are expected to continue to impact our new store growth in the first half of 2023 with fiscal 2023 store openings weighted towards the second half of the year.

Additionally, we may desire to or need to expand into neighboring states and regions in the United States and/or engage in acquisitions to meet our growth goals, and such expansion heightens the risks, challenges and uncertainties of development.

We may not have the level of cash flow or financing necessary to support our growth strategy.

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If we experience a decline in performance, we may slow or discontinue store openings, or we may decide to close stores that are unable to operate in a profitable manner.

If we fail to successfully implement our growth strategy, including by opening new stores on a timely basis and on budget, our financial condition and operating results may be adversely affected.

If we fail to successfully implement our growth strategy, including by opening new stores on a timely basis and on budget, our operations, financial condition and operating results would be materially and adversely affected.

supplier increases in freight, supply or other operating costs, including energy prices, or worsening economic conditions, could materially adversely affect our financial condition and operating results.

A critical differentiator of our business is our ability to offer value to our customers, including offering prices that are substantially below those offered by some of our competitors.

We carefully monitor the market prices of our products in order to maintain our price advantage and reputation.

Recently, we have experienced varying levels of inflation, resulting in part from various supply disruptions, increased shipping/transportation costs, increased commodity costs, increased labor costs in the supply chain and other disruptions caused by the recent economic environment, which we have not been able to fully offset through price increases.

Our IOs have experienced increased costs related to labor and utilities, among others.

Some of our larger competitors are in a better position to absorb cost increases while maintaining price competitiveness.

If our competitors are more competitive on pricing relative to our pricing, we may lose customers and mark down prices.

Our gross margins and profitability also may be adversely impacted by higher supply costs that we cannot fully pass along or if we need to lower product prices due to competition.

As a result of our low-price model, the foregoing competitive pressures may reduce our profitability and materially adversely affect our business, financial condition and results of operations.

Our newly opened stores may negatively impact our financial results in the short-term and/or may not achieve sales and operating levels consistent with our more mature stores on a timely basis or at all.

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We may experience a higher cost of entry in those markets as we build brand awareness and drive customers to incorporate us into their shopping habits.

For example, in Southern California the IOs have experienced slower growth and profitability than our existing stores as they continue to build brand awareness in the market.

New store openings may negatively impact our financial results in the short-term due to the effect of store opening costs and lower sales and contribution to overall profitability during the initial period following opening.

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If the efficacy of our marketing or promotional activities declines or if such activities of our competitors are more effective than ours, it could have a material adverse effect on our business, financial condition and results of operations.

We do not maintain a loyalty program for customers, and our competitors may be able to offer their customers promotions or loyalty program incentives that could result in fewer shopping trips to or purchases from our stores.

While we recently began piloting a mobile personalization app, which informs customers of new and top selling items, provides curated product recommendations and tracks savings, we do not maintain a traditional loyalty program for customers, and our competitors may be able to offer their customers promotions or loyalty program incentives that could result in fewer shopping trips to or purchases from our stores.

If we are unable to retain the loyalty of our customers, our sales could decrease and we may not be able to grow our store base as planned, which could have a material adverse effect on our business, financial condition and results of operations.

Certain of our competitors have established mobile apps and personalized marketing and there can be no assurance that our investment in this area will be repaid.

If we fail to maintain our reputation and the value of our brand, including protection of our intellectual property, our sales and operating results may decline and the carrying value of our goodwill and other intangible assets may be impaired.

Certain of our competitors have established, long-standing, mobile apps and personalized marketing.

There can be no assurance that our investment in this area will be repaid.

If we fail to maintain our reputation and the value of our brand, including protection of our intellectual property rights, our sales and operating results may decline and the carrying value of our goodwill and other intangible assets may be impaired.

We believe our continued success depends on our ability to maintain and grow the value of our brand.

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If a third party uses such disclaimed terms in its trademarks, we cannot object to such use.

If we fail to protect our trademarks or other intellectual property rights, others may copy or use our trademarks or intellectual property without authorization, which may harm the value of our brand, reputation, competitive advantages and goodwill and adversely affect our financial condition, cash flows or results of operations.

Additionally, if we fail to protect our trademarks or other intellectual property rights, others may copy or use our trademarks or intellectual property without authorization, which may harm the value of our brand, reputation, competitive advantages and goodwill and adversely affect our financial condition, cash flows or results of operations.

Actions we have taken to establish and protect our intellectual property rights may not be adequate.

There may in the future be opposition and cancellation proceedings from time to time with respect to some of our intellectual property rights.

We have initiated, and may in the future initiate, oppositions and cancellation proceedings to thwart third party filings that encroach upon our intellectual property rights.

In some cases, litigation may be necessary to protect or enforce our trademarks and other intellectual property rights.

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If a significant amount of our goodwill and other intangible assets were deemed to be impaired, our financial condition and results of operations could be materially adversely affected.

We are currently experiencing disruptions in our distribution network causing the timely receipt of inventory to our distribution centers and stores to be impaired, which has had and could continue to have an adverse impact on our operating performance.

Significant disruption in our distribution network and our timely receipt of inventory has had in recent years, and could continue to have, an adverse impact on our operating performance.

We rely on our distribution and transportation network to provide goods to our distribution centers and stores in a timely and cost-effective manner.

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Any disruption, unanticipated or unusual expense or operational failure related to this process could affect store operations negatively.

During 2021 COVID-19-related labor shortages and supply chain disruptions caused and continue to cause logistical challenges for us and many other businesses in the retail industry, causing delay in product delivery to our distribution centers, stores and customers.

These logistical challenges have also caused increased costs to deliver goods to our stores resulting from increased fuel costs, increased carrier rates and driver

wages as a result of driver shortages, a decrease in transportation capacity, and slowdowns.

If these circumstance continue, they could have a material adverse impact on our operations and our ability to generate sales and earn profits.

In addition, events beyond our control, such as disruptions in operations due to fire or other catastrophic events or labor disagreements, may result in delays in the delivery of merchandise to our stores.

For example, during fiscal 2021 labor shortages and supply chain disruptions caused logistical challenges for us and many other businesses in the retail industry, causing delay in product delivery to our distribution centers, stores and customers.

These logistical challenges caused increased costs to

deliver goods to our stores resulting from increased fuel costs, increased carrier rates and driver wages as a result of driver shortages, a decrease in transportation capacity, and slowdowns.

If similar circumstances were to occur and persist, they could have a material adverse impact on our operations and our ability to generate sales and earn profits.

In addition, events beyond our control, such as disruptions in operations due to fire, adverse weather conditions or other catastrophic events or labor disagreements, may result in delays in the delivery of merchandise to our stores.

While we maintain business interruption insurance, in the event our distribution centers are shut down for any reason, such insurance may not be sufficient, and any related insurance proceeds may not be timely paid to us.

Furthermore, there can be no guarantee that we will be able to renew the leases or third-party distribution and transportation contracts, as applicable, on our distribution centers on attractive terms or at all, which may increase our expenses and cause temporary disruptions in our distribution network.

As we continue to implement our store growth strategy, effectively managing our distribution network and distribution centers will become more complex.

As we continue to implement our store growth strategy, our distribution centers may not have sufficient capacity to optimally support all of our stores and effectively managing our distribution network and distribution centers will become more complex.

Our new store locations receiving shipments may be further away from our distribution centers, which may increase transportation costs and may create transportation scheduling strains, or may require us to add additional facilities to the network.

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Typically, the largest portion of a store's operating expense that we bear is the cost associated with leasing the location.

Our total lease payment obligations for all operating leases in existence as of January 1, 2022 was $113.2 million for fiscal year 2022 and $1.3 billion in aggregate for fiscal years 2023 through 2039, and these obligations will increase as we open new stores that are leased.

Our total lease payment obligations for all operating leases in existence as of December 31, 2022 was $117.2 million for fiscal 2023 and $1.3 billion in aggregate for fiscal years 2024 through 2041, and these obligations will increase as we open new stores that are leased.

We are also generally responsible for property taxes, insurance and common area maintenance for our leased properties.

If we are unable to make the required payments under our leases, the lenders or owners of the relevant leased properties, distribution centers or administrative offices may, among other things, repossess those assets, which could adversely affect our ability to conduct our operations.

In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under our First Lien Credit Agreement (defined below), which could cause the counterparties under those agreements to accelerate the obligations due thereunder.

In addition, our failure to make payments under our operating leases could trigger defaults under other leases or under our Credit Agreement (defined below), which could cause the counterparties under those agreements to accelerate the obligations due thereunder.

The operating leases for our store locations, distribution centers and administrative offices expire at various dates through 2041.

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Over time, current store locations may not continue to be desirable because of changes in demographics within the surrounding area or a decline in shopping traffic.

While we have the right to terminate some of our leases under specified

conditions, we may not be able to terminate a particular lease if or when we would like to do so.

While we have the right to terminate some of our leases under specified conditions, we may not be able to terminate a particular lease if or when we would like to do so.

If we decide to close stores, we are generally required to continue to perform obligations under the applicable leases, which generally include paying rent and operating expenses for the balance of the lease term.

When we assign leases or sublease space to third parties, we can remain liable on the lease obligations if the assignee or sublessee does not perform.

We have very limited experience competing in the growing online retail marketplace and we have committed limited resources to such efforts to date.

Recently, we entered into a pilot partnership with Instacart to test online shopping at a limited number of stores.

Certain of our competitors and a number of pure online retailers have already established robust online operations and have increased their online sales as a result of the COVID-19 pandemic.

As the COVID-19 pandemic has progressed, customer behaviors have changed causing a decrease in the number of our stores visited as online purchases have increased for retailers that compete with us.

When we assign leases or sublease space to third parties, we may have to pay a portion of the rent and other expenses and we can remain liable on the lease obligations if the assignee or sublessee does not perform.

We have very limited experience competing in the growing online retail marketplace.

During fiscal 2021 and 2022, we entered into partnerships with three third party grocery delivery companies to provide online shopping at our stores.

Certain of our competitors and a number of pure online retailers have established robust online operations and significantly increased their online sales and presence in recent years.

Increased competition from online grocery retailers and our lack of a robust online retail presence may reduce our customers' desire to purchase products from us.

If we decide to expand our online shopping business, we will be exposed to new risks and challenges.

Furthermore, there can be no assurance that any investments that we make to test or expand our online shopping capabilities will be repaid.

Furthermore, there can be no assurance that any investments that we make to expand our online shopping capabilities will result in a positive return on investment.

These factors could have a material adverse effect on our business, financial condition and results of operations.

Natural or man-made disasters, unusual weather conditions, power outages, pandemics, terrorist acts, political events and other serious catastrophic events could disrupt our business, may expose us to unexpected costs and negatively affect our financial performance.

Natural or man-made disasters, unusual weather conditions, power outages, major health epidemics, pandemics, terrorist acts, political events and other serious catastrophic events could disrupt our business, may expose us to unexpected costs and negatively affect our financial performance.

The current concentration of our stores creates an exposure to local or regional impacts of such events and local economic downturns.

Our business has been and could in the future be severely impacted by natural or man-made disasters and unusual weather conditions (which may become more frequent due to climate change), power outages, pandemic outbreaks (including the COVID-19 pandemic), terrorist acts, global political events and other serious catastrophic events beyond our control.

Our business has been and could in the future be severely impacted by natural or man-made disasters and unusual weather conditions (which may become more frequent due to climate change), power outages, pandemic outbreaks, terrorist acts, global political events and other serious catastrophic events beyond our control.

In the event of a natural or man-made disaster, governments have and, in the future, may declare a state of emergency and impose regulations on business operations.

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With respect to future outbreaks, to the extent that a pathogen is, or is perceived to be, food-borne, the price and availability of certain food products may be impacted and could cause our customers to consume less of such product.

As of January 1, 2022, we operated 245 stores and distributed product from four distribution centers in California in addition to having our administrative offices in California, making California our largest market, representing 59% of our total stores.

As of December 31, 2022, we operated 257 stores and distributed product from four distribution centers in California in addition to having our administrative offices in California, making California our largest market, representing 58% of our total stores.

As a result, our business is currently more susceptible to any unforeseen events or circumstances of the types described above that negatively affect these areas as well as regional conditions, economic downturns or disruptions, such as changes in demographics, population and employee bases, wage increases, property tax increases, and changes in economic conditions, than the operations of more geographically diversified competitors.

For example, there have been significant fires across the west coast of the United States from 2018 through 2021.

In 2018, our store in Paradise, California, burned down entirely and we have also suffered inventory losses related to power outages and evacuations due to fires.

In 2021, there were additional significant fires in California and the Pacific Northwest causing a number of stores to be closed and requiring evacuations.

For example, the Caldor fire caused our South Lake Tahoe store to close for a week resulting in inventory losses due to the evacuation.

For example, there have been significant fires across the west coast of the United States from 2018 through 2022, causing a number of stores to be closed as well as suffer inventory losses related to power outages and evacuations.

In 2018, our store in Paradise, California, burned down entirely.

The frequency and severity of wildfires may increase in the future due to climate change.

The United States and other countries have experienced, and may experience in the future, major health epidemics related to viruses or other pathogens.

Epidemics, or the perception that such epidemics may occur, may cause people to avoid gathering in public places, which may adversely affect our customer traffic, our ability and that of our IOs to adequately staff our stores and operations, and our ability to transport product on a timely basis.

Any of these factors may disrupt our business and materially adversely affect our financial condition and results of operations and the occurrence of any of these events in a region where our stores or other operations are concentrated may increase the impact of such disruption and adverse effect.

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Our insurance coverage reflects deductibles, self-insured retentions, limits of liability and similar provisions that we believe are reasonable based on our operations.

However, there are types of losses we may incur but against which we cannot be insured or which we believe are not economically reasonable to insure, such as losses due to certain cyber events, acts of war, employee and certain other crime, certain wage and hour and other employment-related claims, including class actions, actions based on certain consumer protection laws and some natural and other disasters or similar events.

However, there are types of losses we may incur but against which we cannot be insured or which we believe are not economically reasonable to insure, such as losses due to acts of war, employee and certain other crime, certain wage and hour and other employment-related claims, including class actions, actions based on

certain consumer protection laws and some natural and other disasters or similar events.

If we incur these losses and they are material, our business could suffer.

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Unanticipated changes in any applicable actuarial assumptions and management estimates, could result in materially different expenses than expected under these programs, which could have a material adverse effect on our results of operations and financial condition.

We and our IOs are experiencing and may continue to experience challenges in recruiting and retaining qualified employees.

If we or our IOs are unable to attract, train and retain qualified employees, our financial performance may be negatively affected.

Our future growth, performance and positive customer experience depends on our and the IOs' ability to attract, train, retain and motivate qualified employees who understand and appreciate our culture and are able to represent our brand effectively and establish credibility with our business partners and customers.

We and the IOs are currently facing intense competition for management personnel and hourly employees.

In addition, we and our IOs also had in fiscal 2021, and continue to have, staffing challenges including overtime pay, increased payroll attributable to employees who are compensated for their time to receive vaccines, and staffing shortages for a variety of reasons that are attributable to the COVID-19 pandemic and the related economic environment.

There was also a surge of positive COVID-19 cases related to the Delta variant around the country, including states in which we operate, during the third quarter of fiscal 2021 and an additional surge of positive COVID-19 cases related to the Omicron variant in the fourth quarter of fiscal 2021 and continuing in fiscal 2022, creating additional uncertainty and having a negative impact on staffing.

We and the IOs face intense competition for management personnel and hourly employees.

If we and the IOs are unable to attract and retain adequate numbers of qualified employees, our operations, customer service levels and support functions could suffer.

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As we continue to grow, enter different regions and operate distribution centers, unions may attempt to organize the employees of our different IOs or our distribution centers within certain regions.

If we determine to open more Company-operated stores, we may have additional employees represented by unions.

We cannot predict the adverse effects that any future organizational activities will have on our business, financial condition and operating results.

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We do not maintain key person insurance on any of our key personnel.

Effective January 1, 2023, Mr.

Sheedy was appointed President and Chief Executive Officer following the retirement of Mr.

Lindberg as Chief Executive Officer and his transition to Chairman of the Board.

There can be no assurance that our executive succession planning, retention or hiring efforts will be successful.

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While we have not previously been materially adversely affected by periods of decreased consumer spending, any factor that could materially adversely affect the disposable income of our customers could decrease our customers' spending and number of trips to our stores, which could result in lower sales, increased markdowns on products, a reduction in profitability due to lower margins and may require increased selling and promotional expenses.

These factors include but are not limited to unemployment, minimum wages, significant public health and safety events, inflation and deflation, trade wars and interest and tax rates.

Many of the factors identified above also affect commodity rates, transportation costs, costs of labor, insurance and healthcare, the strength of the U.S.

dollar, lease costs, measures that create barriers to or increase the costs associated with international trade, changes in laws, regulations and policies and other economic factors, all of which may impact our cost of goods sold and our selling, general and administrative expenses, which could materially adversely affect our business, financial condition and results of operations.

These factors include but are not limited to unemployment, minimum wages, significant public health and safety events, inflation and deflation, the threat, outbreak or escalation of terrorism, military conflicts, or other hostilities and related international sanctions (such as the ongoing Russia-Ukraine conflict), trade wars and interest and tax rates.

Many of the factors identified above also affect commodity rates, costs of transportation, leasing, labor, insurance and healthcare, the strength of the U.S.

dollar, measures that create barriers to or increase the costs associated with international trade, changes in laws, regulations and policies and other economic factors, all of which may impact our cost of goods sold and our selling, general and administrative expenses, which could materially adversely affect our business, financial condition and results of operations.

These factors could also materially adversely affect our ability to plan and execute our strategic initiatives, invest in and open new stores, prevent current stores from closing, and may have other material adverse consequences which we are unable to fully anticipate or control, all of which may materially adversely affect our sales, cash flow, results of operations and performance.

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Some of the other food retailers may have been in the region longer and may benefit from enhanced brand recognition in such regions.

For example, we recently expanded in Southern California and, as of January 1, 2022, had 91 stores in that area.

Our new stores in this market are competing against more established retailers.

Some food retailers may have greater financial or marketing resources than the IOs do and may be able to devote greater resources to sourcing, promoting and selling their products than the IOs.

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Any failure to appropriately address some or all of these risks could have a material adverse effect on our sales, business, results of operations and financial condition.

The outbreak caused by COVID-19 and its variants has disrupted and could continue to disrupt our operations and adversely affect our business and financial condition.

The COVID-19 pandemic has negatively impacted the economy, disrupted consumer behaviors and supply chains, and created volatility among the financial markets.

We and our IOs have faced and will continue to face staffing challenges including labor shortages additional sick pay and overtime pay for a variety of reasons that are attributable to the COVID-19 pandemic.

In early 2021, many counties in California and Washington enacted ordinances mandating "hazard pay" for grocery workers.

While most of the hazard pay ordinances did not apply to our IOs and have since expired, if there is another COVID surge, counties may try to implement new ordinances in the future and such ordinances may apply to our IOs or may cause our larger competitors to offer more competitive compensation, causing staffing issues for our IOs.

In addition, federal and state governments have enacted legislation to provide additional company paid benefits for employees and former employees impacted by the COVID-19 pandemic.

The COVID-19 pandemic has caused people to avoid or limit gathering in public places, to consolidate and reduce shopping trips, and to increase online shopping, all of which has impacted our customer traffic.

Since the start of the pandemic, supply for inventory, including opportunistic inventory, has been, and may in the future again be, negatively impacted at times when overall demand for inventory is increased, which could negatively impact our net sales and margin.

Our planned construction and opening of new stores have been and may continue to be negatively impacted due to increased time periods to get materials such as steel, obtain permits and licenses and set up utilities.

A significant subset of our corporate employee population remains in a remote or hybrid work environments in an effort to mitigate the spread of COVID-19, which may exacerbate certain risks to our business, including an increased risk of phishing and other cybersecurity attacks.

In the event that an employee, IO, or IO employee tests positive for COVID-19, we have had to, and may in the future have to, temporarily close one or more stores, offices or distribution centers for cleaning and/or quarantine one or more employees.

Outbreaks of COVID-19 may further disrupt or limit product supply and vendor services which could have a negative impact on our financial results.

In addition, if one or more of our employees, IOs, IOs' employees or customers becomes ill from COVID-19 and attributes their exposure to such illness to us or one of our stores, we and/or our IOs could be subject to allegations of failure to adequately mitigate the risk of such exposure.

The extent of COVID-19's effect on our operational and financial performance in the future will depend on future developments, including the duration, spread and intensity of the pandemic, any emerging variants, any future government actions affecting consumers and the economy generally, changing economic conditions and any resulting inflationary impacts, timing and effectiveness of vaccines, all of which are uncertain and difficult to predict.

Due to the impact of COVID-19, our operating performance and financial results during fiscal years 2020 and 2021 and the volatility within those periods may not be meaningful indicators of future results.

The magnitude and duration of the pandemic and its impact on our business, results of operations, financial position, and cash flows are uncertain as this situation continues to evolve globally, which makes it more challenging for us to estimate future performance of the business and develop growth strategies for the future.

Although the potential effects that COVID-19 may continue to have on us are not clear, such impacts could materially adversely affect our business, financial condition and results of operations.

Risks Related to Our IO Model

If the IOs are not successful in managing their business, our financial results and brand image could be negatively affected.

The financial health and operational effectiveness of the IOs is critical to their and our success.

The IOs are business entities owned by entrepreneurs who generally live in the same community as the store that they operate as our independent contractor.

IOs are responsible for operating their store consistent with our brand standards, hiring and supervising store-level employees, merchandising and selling products, conducting local marketing, connecting with their community and complying with applicable laws, and managing and paying the expenses associated with their business.

Although we select IOs through a rigorous vetting and training process, and continue to help IOs develop their business skills after they enter into an Operator Agreement with us, it is difficult to predict in advance whether a particular IO will be successful.

If an IO is unable to successfully establish, manage and operate the store, their store's performance and quality of service could be materially adversely affected.

In addition, any poor performance could negatively affect our financial results and our brand reputation.

Failure of the IOs to repay notes outstanding to us may materially adversely affect our financial performance.

We extend financing to IOs for their initial startup costs in the form of notes payable to us that bear interest at rates between 3.00% and 9.95%.

There can be no assurance that any IO, will achieve long-term store volumes or profitability that will allow them to repay any amounts due nor is there any assurance that any IO will be able to repay amounts due through other means.

The outstanding aggregate balance of notes receivable from IOs has increased over time as we have accelerated new store growth combined with increases to initial IO capital and working capital requirements.

This balance may continue to increase as we open new stores.

Further, during the COVID-19 pandemic we temporarily reduced interest rates on certain outstanding IO notes.

There were $37.5 million and $34.2 million of notes to IOs outstanding as of December 31, 2022 and January 1, 2022, respectively, with allowances of $13.2 million and $11.3 million as of December 31, 2022 and January 1, 2022, respectively.

If we are unable to attract and retain qualified IOs, our financial performance may be negatively affected.

Our future growth and performance depend on our ability to attract, develop and retain qualified IOs who understand and appreciate our culture and are able to represent our brand effectively, in particular because the vast majority of our IOs operate a single store.

A material decrease in profitability of the IOs may make it more difficult for us to attract and retain qualified IOs.

While we use a variety of methods to attract and develop the IOs, including through our Aspiring Operators in Training ("AOT") program, there can be no assurance that we will continue to be able to recruit and retain a sufficient number of qualified AOTs and other candidates to open successful new locations in order to meet our growth targets.

Our ability to maintain our current performance and achieve future growth additionally depends on the IOs' ability to meet their labor needs while controlling wage and labor-related costs.

If the IOs are unable to avoid excess inventory shrink, our business and results of operations may be adversely affected.

The IOs order merchandise solely from us, which we, in turn, deliver to IOs on a consignment basis.

As a result, we retain ownership of all merchandise until the point in time that merchandise is sold to a customer.

The IOs, however, are responsible for inventory management at their stores.

Any spoiled, damaged or stolen merchandise, markdowns or price changes impact gross profit and, therefore, IO commission.

We generally split these losses equally with IOs, however, excessive levels of shrink are deducted from commissions paid to IOs.

Excessive shrink generally indicates poor inventory management and the IO's failure to use due care to secure their store against theft.

If IOs were to not effectively control or manage inventory in their stores, they could experience higher rates of inventory shrink which could have a material adverse effect on their financial health, which in turn, may materially and adversely affect our business and results of operations.

Our Operator Agreements may be terminated by either party and upon short notice, and any loss or changeover of an IO may cause material business disruptions.

Each Operator Agreement is subject to termination by either party without cause upon 75 days' notice.

We may also terminate immediately "for cause." The "for cause" termination triggers include, among other things, a failure to meet our brand standards, misuse of our trademarks and actions that in our reasonable business judgment threaten to harm our business reputation.

If we or an IO terminates the Operator Agreement then we must approve a new IO for that store.

Any IO changeover consumes substantial time and resources.

Often, a changeover will involve more than one transition, as an IO may move from an existing store, thereby creating an opening at the IO's previous store.

A failure to transition a store successfully to another IO can negatively impact the customer experience or compromise our brand standards.

Termination of an Operator Agreement could therefore result in the reduction of our sales and operating cash flow, and may materially adversely affect our business, financial condition and results of operations.

Legal proceedings initiated against the IOs could materially impact our business, reputation, financial condition, results of operations and cash flows.

We and the IOs are subject to a variety of litigation risks, including, but not limited to, individual personal injury, product liability, intellectual property, employment-related actions, litigation with or involving our relationship with IOs and property disputes and other legal actions in the ordinary course of our respective businesses.

If the IOs are unable to provide an adequate remedy in a legal action, the plaintiffs may attempt to hold us liable.

We maintain that under current applicable laws and regulations we are not joint employers with the IOs, and should not be held liable for their actions.

However, these types of claims may increase costs and affect the scope and terms of insurance or indemnifications we and the IOs may have.

Our Operator Agreements require each IO to maintain certain insurance types and levels.

Losses arising from certain extraordinary hazards, employment matters or other matters, however, may not be covered, and insurance may not be available (or may be available only at prohibitively expensive rates) with respect to many other risks, or IOs may fail to procure the required insurance.

Moreover, any loss incurred could exceed policy limits and policy payments made to IOs may not be made on a timely basis.

Any legal actions against the IOs may negatively affect the reputation of our brand, which could result in a reduction of our sales and operating cash flow, which could be material and which could adversely affect our business, financial condition and results of operations.

In the past, certain business models that use independent contractors to sell directly to customers have been subject to challenge under various laws, including laws relating to franchising, misclassification and joint employment.

If our business model is determined to be a franchise, if IOs are found not to be independent contractors, but our employees, or if we are found to be a joint employer of an IO's employees, our business and operations could be materially adversely affected.

The IOs are independent contractors.

Independent contractors and the companies that engage their services have come under increased legal and regulatory scrutiny in recent years as courts have adopted new standards for these classifications and federal legislators continue to introduce legislation concerning the classification of independent contractors as employees, including legislation that proposes to increase the tax and labor penalties against employers who intentionally or unintentionally misclassify employees as independent contractors and are found to have violated employees' overtime or wage requirements.

Federal and state tax and other regulatory authorities and courts apply a variety of standards in their determination of independent contractor status.

For example, the California state legislature enacted AB-5, which became effective in California on January 1, 2020.

AB-5 codified a new test for determining worker classification that is much narrower than the traditional standard in defining the scope of who is classified as an independent contractor.

There has been limited guidance to date regarding interpretation or enforcement, and there is a significant degree of uncertainty regarding its application.

In addition, AB-5 has been the subject of widespread national discussion and it is possible that other jurisdictions may enact similar laws.

There is a risk that a governmental agency or court could disagree with our assessment that IOs are independent contractors or that other laws and regulations could change.

If any IOs were determined to be our employees, we would incur additional exposure under federal and state tax, workers' compensation, unemployment benefits, labor, employment, environmental and tort laws, which could potentially include prior periods, as well as potential liability for employee benefits and tax withholdings.

Even if IOs are properly classified as independent contractors, there is a risk that a governmental agency or court might disagree with our assessment that each IO is the sole employer of its workers and seek to hold us jointly and separately responsible as a co-employer of an IO's workers.

In this case, we would incur additional exposure under federal and state tax, workers' compensation, unemployment benefits, labor, employment and tort laws, which could potentially include prior periods, as well as potential liability for employee benefits and tax withholdings since joint employers are each separately responsible for their co-employees' benefits.

A misclassification ruling would mean that both IOs and IOs' employees are our employees.

We continue to observe and monitor our compliance with current applicable laws and regulations, but we cannot predict whether laws and regulations adopted in the future, or standards adopted by the courts, regarding the classification of independent contractors will materially adversely affect our business or operations.

Further, if we were to become subject to franchise laws or regulations, it would require us to provide additional disclosures, register with state franchise agencies, impact our ability to terminate our Operator Agreements and may increase the expense of, or adversely impact our recruitment of new IOs.

Our success depends on our ability to maintain positive relationships with the IOs and any failure to maintain our relationships on positive terms could materially adversely affect our business, reputation, financial condition and results of operations.

The IOs develop and operate their stores under terms set forth in our Operator Agreements.

These agreements give rise to relationships that involve a complex set of mutual obligations and depend on mutual cooperation and trust.

We have a standard Operator Agreement that we use with the IOs, which contributes to uniformity of brand standards.

We generally have positive relationships with the IOs, based in part on our common understanding of our mutual rights and obligations under the Operator Agreement.

However, we and the IOs may not always maintain a positive relationship or always interpret the Operator Agreement in the same way.

Our failure to maintain positive relationships with the IOs could individually or in the aggregate cause us to change or limit our business practices, which may make our business model less attractive to the IOs or stockholders or more costly to operate.

Active and/or potential disputes with IOs could damage our brand image and reputation.

The success of our business depends in large part on our ability to maintain IOs in profitable stores.

If we fail to maintain our IO relationships on acceptable terms, or if one or more of the more profitable IOs were to terminate their Operator Agreements, become insolvent or otherwise fail to comply with brand standards, our business, reputation, financial condition and results of operations could be materially and adversely affected.

The IOs could take actions that could harm our business.

The IOs are contractually obligated to operate their stores in accordance with the brand standards set forth in the Operator Agreements.

However, IOs are independent contractors whom we do not control.

The IOs operate and oversee the daily operations of their stores and have sole control over all of their employees and other workforce decisions.

As a result, IOs make decisions independent of us that bear directly on the ultimate success and performance of their store.

Nevertheless, the nature of the brand license creates a symbiotic relationship between our outcome and each IO.

Indeed, because we and each of the IOs associate our separate businesses with the Grocery Outlet name and brand reputation, the failure of any IO to comply with our brand standards could potentially have repercussions that extend beyond that IO's own market area and materially adversely affect not only our business, but the business of other IOs and the general brand image and reputation of the Grocery Outlet name.

This, in turn, could materially and adversely affect our business and operating results.

If any particular IO operates a store in a manner inconsistent with our brand standards, we cannot assure you that we will be able to terminate the Operator Agreement of that IO without disruptions to the operations and sales of that IO's store or other stores.

Risks Related to Data Protection, Cybersecurity and our Information Technology Systems

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It is possible that cyber attackers might compromise our security measures and obtain the personal and/or confidential information of the customers, employees and suppliers that we hold or our business information.

Cyber attacks are rapidly evolving and those threats and the means for obtaining access to information in digital and other storage media are becoming increasingly sophisticated and may not immediately produce signs of intrusion.

Moreover, an employee, contractor or third party with whom we work or to whom we outsource business operations may fail to monitor their or our systems effectively, may fail to maintain appropriate safeguards, may misuse the personal and/or confidential information to which they have access, may attempt to circumvent our security measures, may purposefully or inadvertently allow unauthorized access to our or their systems or to personal and/or confidential information or may otherwise disrupt our business operations.

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In November 2021, California voters passed Proposition 24, also known as the California Privacy Rights Act ("CPRA"), which amends and expands the CCPA.

The CCPA and CPRA provide new and enhanced data privacy rights to California residents, such as giving California consumers the right to access and/or delete their personal information, affording consumers the right to opt out of certain sales of personal information, as well as sharing for cross context behavioral advertising, and prohibiting covered businesses from discriminating against consumers (e.g., charging more for services) for exercising any of their CCPA/CPRA rights.

The CPRA goes into effect January 1, 2023 and adds definitions for "sensitive information" as well as "contractors," and bolsters the requirements for agreements that cover the exchange of data.

CPRA also establishes a California Privacy Protection Agency, which will be responsible for enforcement activities, rulemaking, and public awareness related to privacy and data protection.

The CCPA and CPRA provide new and enhanced data privacy rights to California residents, such as giving California consumers and employees the right to access and/or delete their personal information, affording consumers and employees the right to opt out of certain sales of personal information, as well as sharing for cross context behavioral advertising, and prohibiting covered businesses from discriminating against consumers (e.g., charging more for services) for exercising any of their CCPA/CPRA rights.

The CPRA went into effect January 1, 2023 and added definitions for "sensitive information" as well as "contractors," and bolstered the requirements for agreements that cover the exchange of data.

CPRA also established a California Privacy Protection Agency, which is responsible for enforcement activities, rulemaking, and public awareness related to privacy and data protection.

Any failure to comply with the laws and regulations surrounding the protection of personal information, privacy and data security could subject us to legal and reputational risks and costs, including significant fines for non-compliance, any of which could have a negative impact on revenues and profits.

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We are also subject to payment card association operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change over time.

For example, we and the IOs are subject to Payment Card Industry Data Security Standards, which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder

In addition, if our internal systems are breached or compromised, we and the IOs may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our customers, and our business and operating results could be materially adversely affected.

Any material disruption to our information technology systems as a result of external factors or challenges or difficulties in maintaining or updating our existing technology, including modernizing components of our existing system architecture, or developing or implementing new technology could have a material adverse effect on our business or results of operations.

In addition, if our internal systems are breached or compromised, we and the IOs may be liable for card re-issuance

costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our customers, and our business and operating results could be materially adversely affected.

Security breaches and other disruptions to our information technology networks and systems, including a disruption related to cybersecurity, could interfere with our operations and the operations of the IOs and our suppliers, any of which could have a material adverse effect on our business and financial performance.

Cyber-attacks are rapidly evolving and becoming more frequent.

Such threats and the means for obtaining access to information in digital and other storage media are becoming increasingly sophisticated and may not immediately produce signs of intrusion.

A cyber incident could be caused by malicious outsiders (including state-sponsored espionage or cyberwarfare) or insiders using sophisticated methods to circumvent firewalls, encryption and other security defenses.

Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures.

With more employees working remotely at times, there may be increased opportunities for unauthorized access and cyber-attacks.

Further, the United States government has warned of the potential risk of Russian cyberattacks stemming from the ongoing Russian-Ukraine conflict.

It is possible that cyber attackers might compromise our security measures and obtain the personal and/or confidential information of the customers, IOs, employees and suppliers that we hold or our business information.

Moreover, such cyber-attacks may disrupt access to our and/or our suppliers' networks and systems.

Such disruptions could result in delays or cancellations of customer orders or delays or interruptions in the shipment of orders.

In addition, cyber-attacks may cause us to incur significant remediation costs, result in delays and disruptions to key business operations, and divert attention of management and key information technology resources.

These cyber-incidents could also subject us to liability, expose us to significant expense, and cause significant harm to our reputation and our business.

We rely on the integrity, security and consistent operation of a variety of information technology systems and back-up systems for the efficient functioning of our business, including point of sale, inventory management, purchasing, financials, logistics, accounts payable and human resources information systems.

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Although we have taken steps designed to reduce the risk of these events occurring, there can be no guarantee that we or a third party on which we rely will not suffer one of these events.

While we maintain cyber risk insurance intended to provide coverage in the event of a breach or other data security incident, there can be no assurance that these policies will cover all incidents that might occur or that the coverage limits under such policies will be adequate for any incidents, claims or damages that we might experience.

Additionally, we are exposed to vulnerabilities with respect to our IO's information technology systems.

Any material challenges or difficulties in maintaining or updating our existing technology, including modernizing components of our existing system architecture, or developing or implementing new technology could have a material adverse effect on our business or results of operations.

We modify, update and replace our systems and infrastructure from time to time, including by adding new hardware, software and applications;

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Any lost confidence on the part of our customers would be difficult and costly to reestablish.

Issues regarding the quality or safety of any food items sold by us, regardless of the cause, could have a substantial and adverse effect on our sales and operating results.

Issues regarding the quality or safety of any food items sold by us, regardless of the cause, could have a substantial and adverse effect on our sales and operating results, as well as our reputation.

There is increasing governmental scrutiny, regulation of and public awareness of food safety.

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While our IOs and suppliers may indemnify us for certain adverse outcomes, we may still bear significant expenses related to such proceedings.

Risks Related to Our IO Model

If the IOs are not successful in managing their business, our financial results and brand image could be negatively affected.

The financial health and operational effectiveness of the IOs is critical to their and our success.

The IOs are business entities owned by entrepreneurs who generally live in the same community as the store that they operate as our independent contractor.

If an IO is unable to successfully establish, manage and operate the store, their store's performance and quality of service could be materially adversely affected.

In addition, any poor performance could negatively affect our financial results and our brand reputation.

Failure of the IOs to repay notes outstanding to us may materially adversely affect our financial performance.

We extend financing to IOs for their initial startup costs in the form of notes payable to us that bear interest at rates between 3.00% and 9.95%.

The outstanding aggregate balance of notes receivable from IOs has increased over time as we have accelerated new store growth and initial IO capital and working capital requirements have increased.

This balance may continue to increase as we open new stores.

Further, during the COVID-19 pandemic we temporarily reduced interest rates on certain outstanding IO notes.

There were $34.2 million and $37.2 million of notes to IOs outstanding as of January 1, 2022 and January 2, 2021, respectively, with allowances of $11.3 million and $7.6 million as of January 1, 2022 and January 2, 2021, respectively.