Grocery Outlet (GO), a grocer selling brand names at deep discounts, was founded in 1946 and now has 380 stores mostly across the West Coast. It’s a family business now run by third generation leadership. After 75 years in business, CEO Eric Lindberg Jr. believes executives at Grocery Outlet need an airplane to visit stores. Lindberg also believes Grocery Outlet should lease the plane from a company he controls.

In its 2020 10-K, Grocery Outlet disclosed the lease agreement and the reason a plane is now necessary:

“During April 2020, we entered into an aircraft dry lease agreement (the "Aircraft Lease") with an entity controlled by our Chief Executive Officer, Mr. Lindberg, to lease a Pilatus PC-12 aircraft. We believe that this agreement provides us better access to visit our stores, many of which are in remote areas or are not easily accessible by car or regular commercial airline service, and to visit prospective real estate sites.”

If Lindberg sincerely believes “many” of his stores “are not easily accessible by car”, Grocery Outlet and its investors have bigger worries than a related-party airplane transaction. The concern is a potential erosion of checks-and-balances that keep family company’s from atrophying decades after their founding. In the latest annual report, investors may infer the jet lease transaction was approved, at least tacitly, by Lindberg’s cousin who is the Board Vice Chairman:

“ Lindberg and S. MacGregor Read Jr., the Vice Chairman of our board of directors, are cousins by marriage.”

The lease also appears inconsistent with Grocery Outlet’s obsession with what it calls “opportunistic purchasing” that allows it to sell name-brand products 40%-70% below the price charged by competitors. The airplane lease, according to the filing, was anything but opportunistic as Grocery Outlet admits it go no better a deal than anyone else might despite the familial relationship:

“We believe that the terms of the aircraft lease are no less favorable than could be obtained from an unrelated third party and we believe that the foregoing arrangement, including related direct operating costs, insurance and crew costs, will reduce our average hourly cost for use of private aircraft, which previously had been primarily conducted through charter arrangements.”

The cost to Grocery Outlet was approximately $100,000 in the eight months since the lease was signed. It’s negligible, especially if investors benefit from team visits to stores built in locations not easily accessible by car. Importantly, should Lindberg stray from his business flight plans, Grocery Outlet investors will not bear the extra costs:

“Mr. Lindberg, to the extent that he operates the aircraft for his personal use, will bear all costs associated with his operation of the aircraft.”

The airplane lease is one of three noteworthy related-party transactions:

-Grocery Outlet has paid non-controlling shareholders $18.7 million over the last three years to lease property that includes 15 stores and a distribution center. As of January 2, 2021, Grocery Outlet has also leased 37 additional store locations it has not yet taken possession of with undiscounted future lease payments totaling $200.4 million.

-As of January 2, 2021, the company had $40.9 million in outstanding loans to its Independent (grocery store) Operators (IOs), including a loss allowance of $8.1 million. Our analysis reveals that over the past three years, Grocery Outlet has written off, on average, $1.2 million a year, which reduces the allowance it reports.

S. MacGregor Read, Jr., CEO Lindberg’s cousin, transitioned to a new role with a lucrative financial package the same month Lindberg leased the plane from himself. In April, Read transitioned from Vice Chairman of the company to Non-Executive Vice Chairman of the Board.

The new role entitled Read to an annual cash retainer of $75,000, an annual restricted stock unit (RSU) award with a grant date fair value of $100,000, plus a little something extra:

“In addition, while you remain Vice Chairman of the Board, you will receive an additional annual cash retainer of $100,000.”

It gets better for Read. Despite Read’s employment relationship with the company ending, Read’s employment was not technically counted as being terminated. This allowed Read, the grandson of Grocery Outlet’s founder Jim Read, to retain his 2.57 million stock options worth an estimated $92.7 million as of this writing.

It’s not uncommon for employees— depending on how their departure is classified— to retain their stock options. We only raise the matter as a governance issue to be considered by investors. With both Read and Lindberg on the board— and Lindberg’s jet deal and Read’s deal for a new role executed in the same month— investors would be wise to weigh the value family members add to the business against the value they extract.

The jet transaction is accounted for as an operating lease liability, which our analysis reveals is being understated due to an inflated discount rate. Grocery Outlet disclosed that it discounts operating leases by 6.91%. This rate is significantly higher than Grocery Outlet’s peers, which report the following discount rates in their most recent filings:

-Costco: 2.23%
-Kroger: 4.3%
-Weis Markets: 3.36%
-Publix: 3.4%

Using an inflated discount rate hide’s a firm’s true liabilities from investors.

Grocery Outlet has $1.38 billion in future operating lease obligations. The present value of those obligations, according to Grocery Outlet, is $924 million. If we use the blended average discount rate for Grocery Outlet’s peer group— 3.32%— we calculate a lease liability of $1.12 billion. It means Grocery Outlet is understating its lease liabilities by approximately $197 million, or 14.2% of its future operating lease obligations and 12.6% of total liabilities.

Separately, Grocery Outlet changed how it calculates adjusted non-GAAP EBITDA and net income in the fourth quarter of 2020. In its 2020 10-K, Grocery Outlet disclosed the new items it counts as well as the items it no longer counts when figuring these key metrics:

“We no longer exclude new store pre-opening expenses from our presentation of adjusted EBITDA and non-GAAP adjusted net income.”

“We also updated our definition of non-GAAP adjusted net income to exclude the tax impact of options exercises and vesting of RSUs.”

“Lastly, debt extinguishment and modification costs were reclassified to the other adjustments line item within the presentation of both adjusted EBITDA and non-GAAP adjusted net income.”

In the fiscal year ending January 2, 2021, the changes reduced Grocery Outlet’s adjusted non-GAAP EBITDA by $1.5 million and adjusted non-GAAP net income by $45.2 million. The impact to non-GAAP diluted EPS was a reduction from $1.60 to $1.14.

Also of note, Grocery Outlet’s fiscal year consisted of a 53rd week which it stripped out of its same store sales calculation. In figuring same-store-sales, Grocery Outlets doesn’t include stores until the fourteenth month, rather than day 366 as it did prior to 2014. It excludes stores closed for extended periods of time. Though some stores were closed temporarily due to the pandemic, Grocery Outlet doesn’t disclose if it excluded any of these stores from its same-store-sales calculation.