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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended October 30, 2015

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 1-11735

 

99 CENTS ONLY STORES LLC

(Exact Name of Registrant as Specified in Its Charter)

 

California
(State or Other Jurisdiction
of Incorporation or Organization)

 

95-2411605
(I.R.S. Employer Identification No.)

 

 

 

4000 Union Pacific Avenue,
City of Commerce, California
(Address of Principal Executive Offices)

 

90023
(Zip Code)

 

Registrant’s Telephone Number, Including Area Code: (323) 980-8145

 

 

(Former name, address and fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  o   No  x

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x    No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No   x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

As of December 9, 2015, there were 100 units outstanding of the registrant’s common units, none of which are publicly traded.

 

 

 



Table of Contents

 

99 CENTS ONLY STORES LLC

Form 10-Q

Table of Contents

 

 

 

Page

Part I - Financial Information

Item 1.

Financial Statements

4

 

Consolidated Balance Sheets as of October 30, 2015 (unaudited) and January 30, 2015

4

 

Consolidated Statements of Comprehensive Income (Loss) for the third quarter and first three quarters ended October 30, 2015 (unaudited) and October 31, 2014 (unaudited)

5

 

Consolidated Statements of Cash Flows for the first three quarters ended October 30, 2015 (unaudited) and October 31, 2014 (unaudited)

6

 

Notes to Consolidated Financial Statements

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

32

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

42

Item 4.

Controls and Procedures

43

Part II — Other Information

Item 1.

Legal Proceedings

44

Item 1A.

Risk Factors

44

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

44

Item 3.

Defaults Upon Senior Securities

44

Item 4.

Mine Safety Disclosures

44

Item 5.

Other Information

44

Item 6.

Exhibits

45

 

Signatures

46

 

2



Table of Contents

 

FORWARD-LOOKING INFORMATION

 

This Quarterly Report on Form 10-Q (this “Report”) contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended.  The words “expect,” “estimate,” “anticipate,” “predict,” “will,” “project,” “plan,” “believe” and other similar expressions and variations thereof are intended to identify forward-looking statements.  Such statements appear in a number of places in this Report and include statements regarding the intent, belief or current expectations of 99 Cents Only Stores LLC and its directors or officers with respect to, among other things, (a) trends affecting the financial condition or results of operations of the Company, and (b) the business and growth strategies of the Company (including the Company’s store opening growth rate) and (c) our investments in our existing stores, warehouse and distribution facilities and information systems, that are not historical in nature.  The term the “Company” refers to 99¢ Only Stores and its consolidated subsidiaries prior to the conversion to a California limited liability company effective October 18, 2013 and to 99 Cents Only Stores LLC and its consolidated subsidiaries on or after such conversion.  Readers are cautioned not to put undue reliance on such forward-looking statements.  Such forward-looking statements are and will be based on the Company’s then-current expectations, estimates and assumptions regarding future events and are applicable only as of the date of such statements.  The Company may not realize its expectations and its estimates and assumptions may not prove correct.  In addition, such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in this Report, for the reasons, among others, discussed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections.  The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.  Readers should carefully review the risk factors described in the Company’s Annual Report on Form 10-K containing the Company’s most recent audited financial statements for the fiscal year ended January 30, 2015 filed with the Securities and Exchange Commission.

 

3



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

99 CENTS ONLY STORES LLC

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

October 30,
2015

 

January 30,
2015

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash

 

$

2,585

 

$

12,463

 

Accounts receivable, net of allowance for doubtful accounts of $80 and $58 at October 30, 2015 and January 30, 2015, respectively

 

1,813

 

1,954

 

Income taxes receivable

 

1,540

 

10,911

 

Deferred income taxes

 

31,115

 

41,583

 

Inventories, net

 

266,236

 

296,040

 

Assets held for sale

 

2,308

 

3,094

 

Other

 

15,697

 

19,039

 

 

 

 

 

 

 

Total current assets

 

321,294

 

385,084

 

Property and equipment, net

 

555,445

 

581,020

 

Deferred financing costs, net

 

13,402

 

15,463

 

Intangible assets, net

 

455,817

 

460,311

 

Goodwill

 

359,745

 

479,745

 

Deposits and other assets

 

7,518

 

7,543

 

 

 

 

 

 

 

Total assets

 

$

1,713,221

 

$

1,929,166

 

 

 

 

 

 

 

LIABILITIES AND MEMBER’S EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

98,901

 

$

139,287

 

Payroll and payroll-related

 

20,115

 

20,004

 

Sales tax

 

6,668

 

14,087

 

Other accrued expenses

 

51,115

 

40,168

 

Workers’ compensation

 

68,705

 

70,491

 

Current portion of long-term debt

 

6,138

 

6,138

 

Current portion of capital and financing lease obligations

 

979

 

380

 

 

 

 

 

 

 

Total current liabilities

 

252,621

 

290,555

 

Long-term debt, net of current portion

 

916,485

 

901,395

 

Unfavorable lease commitments, net

 

6,365

 

8,220

 

Deferred rent

 

26,559

 

23,293

 

Deferred compensation liability

 

762

 

724

 

Capital and financing lease obligation, net of current portions

 

34,474

 

24,681

 

Long-term deferred income taxes

 

191,914

 

170,678

 

Other liabilities

 

3,972

 

1,868

 

 

 

 

 

 

 

Total liabilities

 

1,433,152

 

1,421,414

 

 

 

 

 

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Member’s Equity:

 

 

 

 

 

Member units — 100 units issued and outstanding at October 30, 2015 and January 30, 2015

 

550,144

 

549,135

 

Investment in Number Holdings, Inc. preferred stock

 

(19,200

)

(19,200

)

Accumulated deficit

 

(250,751

)

(21,185

)

Other comprehensive loss

 

(124

)

(998

)

 

 

 

 

 

 

Total equity

 

280,069

 

507,752

 

 

 

 

 

 

 

Total liabilities and equity

 

$

1,713,221

 

$

1,929,166

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



Table of Contents

 

99 CENTS ONLY STORES LLC

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

For the Third Quarter Ended

 

For the First Three Quarters Ended

 

 

 

October 30,
2015

 

October 31,
2014

 

October 30,
2015

 

October 31,
2014

 

Net Sales:

 

 

 

 

 

 

 

 

 

99¢ Only Stores

 

$

480,547

 

$

467,134

 

$

1,452,682

 

$

1,379,823

 

Bargain Wholesale

 

10,918

 

11,144

 

33,474

 

34,559

 

Total sales

 

491,465

 

478,278

 

1,486,156

 

1,414,382

 

Cost of sales

 

359,796

 

328,144

 

1,061,989

 

959,368

 

Gross profit

 

131,669

 

150,134

 

424,167

 

455,014

 

Selling, general and administrative expenses

 

147,149

 

140,372

 

451,865

 

395,251

 

Goodwill impairment

 

120,000

 

 

120,000

 

 

Operating (loss) income

 

(135,480

)

9,762

 

(147,698

)

59,763

 

Other (income) expense:

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

(3

)

 

Interest expense

 

16,549

 

15,717

 

49,302

 

46,613

 

Total other expense, net

 

16,549

 

15,717

 

49,299

 

46,613

 

(Loss) income before provision for income taxes

 

(152,029

)

(5,955

)

(196,997

)

13,150

 

Provision (benefit) for income taxes

 

607

 

(2,141

)

32,569

 

5,350

 

Net (loss) income

 

$

(152,636

)

$

(3,814

)

$

(229,566

)

$

7,800

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized losses on interest rate cash flow hedge

 

(192

)

(176

)

(333

)

(380

)

Less: reclassification adjustment included in net income

 

724

 

240

 

1,207

 

668

 

Other comprehensive income, net of tax

 

532

 

64

 

874

 

288

 

 

 

 

 

 

 

 

 

 

 

Comprehensive (loss) income

 

$

(152,104

)

$

(3,750

)

$

(228,692

)

$

8,088

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



Table of Contents

 

99 CENTS ONLY STORES LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

For the First Three Quarters Ended

 

 

 

October 30,
2015

 

October 31,
2014

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(229,566

)

$

7,800

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

49,179

 

38,451

 

Amortization of deferred financing costs and accretion of OID

 

3,542

 

3,292

 

Amortization of intangible assets

 

1,332

 

1,340

 

Amortization of favorable/unfavorable leases, net

 

1,322

 

529

 

Gain on disposal of fixed assets

 

(5,497

)

(45

)

Loss on interest rate hedge

 

1,119

 

1,105

 

Goodwill impairment

 

120,000

 

 

Long-lived assets impairment

 

509

 

 

Deferred income taxes

 

31,704

 

465

 

Stock-based compensation

 

1,456

 

2,016

 

Changes in assets and liabilities associated with operating activities:

 

 

 

 

 

Accounts receivable

 

141

 

132

 

Inventories

 

29,804

 

(69,030

)

Deposits and other assets

 

3,487

 

(1,051

)

Accounts payable

 

(22,433

)

34,652

 

Accrued expenses

 

3,270

 

9,455

 

Accrued workers’ compensation

 

(1,786

)

(3,366

)

Income taxes

 

9,371

 

(902

)

Deferred rent

 

3,266

 

6,403

 

Other long-term liabilities

 

1,607

 

(4,221

)

Net cash provided by operating activities

 

1,827

 

27,025

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(55,710

)

(76,914

)

Proceeds from sale of property and fixed assets

 

22,320

 

29

 

Net cash used in investing activities

 

(33,390

)

(76,885

)

Cash flows from financing activities:

 

 

 

 

 

Payments of long-term debt

 

(4,604

)

(4,604

)

Proceeds under revolving credit facility

 

404,050

 

112,500

 

Payments under revolving credit facility

 

(385,350

)

(76,500

)

Payments of debt issuance costs

 

(487

)

 

Proceeds from financing lease obligations

 

8,666

 

 

Payments of capital and financing lease obligations

 

(143

)

(65

)

Payments to repurchase stock options of Number Holdings, Inc.

 

(390

)

(76

)

Net settlement of stock options of Number Holdings, Inc. for tax withholdings

 

(57

)

 

Net cash provided by financing activities

 

21,685

 

31,255

 

Net decrease in cash

 

(9,878

)

(18,605

)

Cash - beginning of period

 

12,463

 

34,842

 

Cash - end of period

 

$

2,585

 

$

16,237

 

Supplemental cash flow information:

 

 

 

 

 

Income taxes (refunded) paid

 

$

(8,500

)

$

6,119

 

Interest paid

 

$

39,084

 

$

36,590

 

Non-cash investing activities for purchases of property and equipment d equipment

 

$

17,953

 

$

(4,945

)

Non-cash investing activities for construction in progress- leased facility

 

$

 

$

24,600

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



Table of Contents

 

99 CENTS ONLY STORES LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.           Basis of Presentation and Summary of Significant Accounting Policies

 

Nature of Business

 

The Company is organized under the laws of the State of California.  Effective October 18, 2013, 99¢ Only Stores converted from a California corporation to a California limited liability company, 99 Cents Only Stores LLC, that is managed by its sole member, Number Holdings, Inc., a Delaware corporation (“Parent”).  The term “Company” refers to 99¢ Only Stores and its consolidated subsidiaries prior to the Conversion (as described in Note 1 to the Annual Report on Form 10-K for the fiscal year ended January 30, 2015) and to 99 Cents Only Stores LLC and its consolidated subsidiaries at the time of or after the Conversion.  The Company is an extreme value retailer of consumable and general merchandise and seasonal products. As of October 30, 2015, the Company operated 389 retail stores with 281 in California, 49 in Texas, 38 in Arizona, and 21 in Nevada.  The Company is also a wholesale distributor of various products.

 

Merger

 

On January 13, 2012, the Company was acquired through a merger (the “Merger”) with a subsidiary of Parent with the Company surviving.  In connection with the Merger, the Company became a subsidiary of Parent, which is controlled by affiliates of Ares Management, L.P. (“Ares”) and Canada Pension Plan Investment Board.  As a result of the Merger, the Company’s common stock was delisted from the New York Stock Exchange and ceased to be a publicly held and traded equity company.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”).  However, certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been omitted or condensed pursuant to the rules and regulations of the Securities and Exchange Commission.  These statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2015.  In the opinion of the Company’s management, these interim unaudited consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the consolidated financial position and results of operations for each of the periods presented.  The results of operations and cash flows for such periods are not necessarily indicative of results to be expected for the full fiscal year ending January 29, 2016 (“fiscal 2016”).

 

Fiscal Year

 

The Company follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Friday closest to the last day of April, July, October or January, as applicable, and a 52-week fiscal year with 364 days, with a 53-week year every five to six years.  Unless otherwise stated, references to years in this Report relate to fiscal years rather than calendar years.  The Company’s fiscal year 2016 began on January 31, 2015, will end on January 29, 2016 and will consist of 52 weeks.  The Company’s fiscal year 2015 (“fiscal 2015”) began on February 1, 2014, ended on January 30, 2015 and consisted of 52 weeks.  The third quarter ended October 30, 2015 (“the third quarter of fiscal 2016”) and the third quarter ended October 31, 2014 (“the third quarter of fiscal 2015”) were each comprised of 91 days.  The period ended October 30, 2015 (“the first three quarters of fiscal 2016”) and the period ended October 31, 2014 (“the first three quarters of fiscal 2015”) were each comprised of 273 days.  References to the Company’s “transition fiscal 2014” are to the Company’s fiscal year ended January 31, 2014.

 

Use of Estimates

 

The preparation of the unaudited consolidated financial statements, in conformity with GAAP, requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash

 

For purposes of reporting cash flows, cash includes cash on hand, cash at the stores and cash in financial institutions.  The majority of payments due from financial institutions for the settlement of debit card and credit card transactions are processed within three business days and therefore are also classified as cash.  Cash balances held at financial institutions are generally in excess of

 

7



Table of Contents

 

federally insured limits.  These accounts are only insured by the Federal Deposit Insurance Corporation up to $250,000.  The Company historically has not experienced any losses in such accounts.  The Company places its temporary cash investments with what it believes to be high credit, quality financial institutions.  Under the Company’s cash management system, checks issued but not presented to the bank may result in book cash overdraft balances for accounting purposes.  The Company reclassifies book overdrafts to accounts payable, which are reflected as an operating activity in its unaudited consolidated statements of cash flows.  Book overdrafts included in accounts payable were $15.6 million and $16.5 million as of October 30, 2015 and January 30, 2015, respectively.

 

Allowance for Doubtful Accounts

 

In connection with its wholesale business, the Company evaluates the collectability of accounts receivable based on a combination of factors.  In cases where the Company is aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, the Company will record an allowance against amounts due and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected.  For all other customers and tenants, the Company recognizes allowances for doubtful accounts based on the length of time the receivables are past due, industry and geographic concentrations, the current business environment and the Company’s historical experiences.

 

Inventories

 

Inventories are valued at the lower of cost or market. Inventory cost is established using a methodology that approximates first in, first out, which for store inventories is based on a retail inventory method.  Valuation allowances for shrinkage as well as excess and obsolete inventory are also recorded.  Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period.  Such estimates are based on experience and the most recent physical inventory results.  Physical inventory counts are completed at each of the Company’s retail stores at least once a year by an outside inventory service company.  The Company performs inventory cycle counts at its warehouses throughout the year.  The Company also performs inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory.  The valuation allowances for excess and obsolete inventory are based on the age of the inventory, sales trends and future merchandising plans.  The valuation allowances for excess and obsolete inventory require management judgment and estimates that may impact the ending inventory valuation and valuation allowances that may affect the reported gross margin for the period.

 

In order to obtain inventory at attractive prices, the Company takes advantage of large volume purchases, closeouts and other similar purchases.  As such, the Company’s inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities.

 

Property and Equipment

 

Property and equipment are carried at cost and are depreciated or amortized on a straight-line basis over the following useful lives:

 

Owned buildings and improvements

Lesser of 30 years or the estimated useful life of the improvement

 

 

Leasehold improvements

Lesser of the estimated useful life of the improvement or remaining lease term

 

 

Fixtures and equipment

3-5 years

 

 

Transportation equipment

3-5 years

 

 

Information technology systems

For major corporate systems, estimated useful life up to 7 years; for functional standalone systems, estimated useful life up to 5 years

 

The Company’s policy is to capitalize expenditures that materially increase asset lives and expense ordinary repairs and maintenance as incurred.

 

Long-Lived Assets

 

The Company assesses the impairment of depreciable long-lived assets when events or changes in circumstances indicate that the carrying value may not be recoverable.  The Company groups and evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual identifiable cash flows are available.  Recoverability is measured by comparing the carrying amount of an asset to expected future net cash flows generated by the asset.  If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference.  Factors that the Company considers important that could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s

 

8



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overall business; and (3) significant changes in the Company’s business strategies and/or negative industry or economic trends.  On a quarterly basis, the Company assesses whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable (Level 3 measurement, see Note 7, “Fair Value of Financial Instruments”).  Considerable management judgment is necessary to estimate projected future operating cash flows.  Accordingly, if actual results fall short of such estimates, significant future impairments could result. During the second quarter of fiscal 2016, due to the underperformance of one store in Texas, the Company concluded that the carrying value of the long-lived assets relating to such store were not recoverable and accordingly recorded an asset impairment charge of $0.5 million. During each of the third quarter and first three quarters of fiscal 2015, the Company did not record any long-lived asset impairment charges.

 

Goodwill and Other Intangible Assets

 

In connection with the Merger purchase price allocation, the fair values of long-lived and intangible assets were determined based upon assumptions related to the future cash flows, discount rates and asset lives using then available information, and in some cases were obtained from independent professional valuation experts.  The Company amortizes intangible assets over their estimated useful lives unless such lives are deemed indefinite.

 

Goodwill and indefinite-lived intangible assets are not amortized but instead tested annually for impairment or more frequently when events or changes in circumstances indicate that the assets might be impaired.  Goodwill is tested for impairment by comparing the carrying amount of the reporting unit to the fair value of the reporting unit to which the goodwill is assigned.  The Company has the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step zero of the goodwill impairment test).  If the Company does not perform a qualitative assessment, or determines, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required.  The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two.  Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of goodwill.  Management has determined that the Company has two reporting units, the wholesale reporting unit and the retail reporting unit.

 

The Company performs the annual test for impairment in January of the fiscal year and determines fair value based on a combination of the income approach and the market approach.  The income approach is based on discounted cash flows to determine fair value. The market approach uses a selection of comparable companies and transactions in determining fair value. The fair value of the trade name is also tested for impairment in the fourth quarter by comparing the carrying value to the fair value. Fair value of a trade name is determined using a relief from royalty method under the income approach, which uses projected revenue allocable to the trade name and an assumed royalty rate (Level 3 measurement, see Note 7, “Fair Value of Financial Instruments”).

 

Amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on undiscounted cash flows, and, if impaired, written down to fair value based on either discounted cash flows or appraised values.  Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows used in the impairment tests (Level 3 measurement, see Note 7, “Fair Value of Financial Instruments”).

 

During the third quarter of fiscal 2016, the Company determined that sufficient indicators of potential impairment for the retail reporting unit existed to require an interim impairment analysis of goodwill and trade name. These indicators included significant declines in profitability in the most recent quarters of fiscal 2016 and a modest recovery to restore expected future operating results to historical levels.  The Company’s first step evaluation was completed assuming the company could be bought or sold in a non-taxable transaction and concluded that the fair value of the retail reporting unit was below its carrying value.

 

The Company performed step two of the goodwill impairment that requires the retail reporting unit’s fair value to be allocated to all of the assets and liabilities of the reporting unit, including any intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination in a non-taxable transaction as applied in the first step, including any significant increases in the fair value of tangible property and intangible assets.  Assessing the fair value of goodwill includes making assumptions about future cash flows, discount rates and asset lives using then best available information.  These assumptions are subject to a high degree of complexity and judgment. Due to the complexity and effort required to estimate the fair value of the retail reporting unit in the second step of the analysis, the fair value estimates were based on preliminary analyses and assumptions that are subject to change. Based on the Company’s preliminary step two analysis, the implied fair value of the retail reporting unit’s goodwill was estimated to be $347.2 million (Level 3 measurement, see Note 7, “Fair Value of Financial Instruments”).  As a result of the Company’s preliminary analysis and best estimate, the Company recorded a $120.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2016, which was reflected as Goodwill Impairment in the consolidated statements of comprehensive income (loss). The goodwill impairment charge did not adversely affect the Company’s debt position, cash flow, liquidity or compliance with financial covenants. The finalization of preliminary goodwill impairment will be completed in the fourth quarter of fiscal 2016 and further adjustments to the preliminary goodwill impairment charge, if any, may be recognized

 

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when the Company’s finalizes the second step of the goodwill impairment test.  The primary factors that contributed to the estimated goodwill impairment loss were the declines in fiscal 2016 operating results and hypothetical projected impact in succeeding years as well as significant increases in the fair value of tangible property since the Merger.  If operating results continue to change versus the Company’s expectations, additional impairment charges may be recorded in the future.

 

During fiscal 2015, the Company did not record any impairment charges related to goodwill or other intangible assets.

 

Derivatives

 

The Company accounts for derivative financial instruments in accordance with authoritative guidance for derivative instrument and hedging activities.  Financial instrument positions taken by the Company are primarily intended to be used to manage risks associated with interest rate exposures.

 

The Company’s derivative financial instruments are recorded on the balance sheet at fair value, and are recorded in either current or noncurrent assets or liabilities based on their maturity.  Changes in the fair values of derivatives are recorded in net earnings or other comprehensive income (“OCI”), based on whether the instrument is designated and effective as a hedge transaction and, if so, the type of hedge transaction.  Gains or losses on derivative instruments reported in accumulated other comprehensive income (“AOCI”) are reclassified to earnings in the period the hedged item affects earnings.  Any ineffectiveness is recognized in earnings in the period incurred.

 

Income Taxes

 

The Company uses the liability method of accounting for income taxes.  Under the liability method, deferred tax assets and liabilities are recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities.  Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The Company’s ability to realize deferred tax assets is assessed throughout the year and a valuation allowance is established accordingly.  The Company recognizes the impact of a tax position only if it is more likely than not to be sustained upon examination based on the technical merits of the position.  The Company recognizes potential interest and penalties related to uncertain tax positions in income tax expense.  Refer to Note 10, “Income Taxes,” for further discussion of income taxes.

 

Stock-Based Compensation

 

The Company accounts for stock-based payment awards based on their fair value.  The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods.  For awards classified as equity, the Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model or other appropriate valuation models.  The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the stock price.  Stock options are generally granted to employees at exercise prices equal to or greater than the fair market value of the stock at the dates of grant.  Former executive put rights were classified as equity awards and revalued using a binomial model at each reporting period with changes in the fair value recognized as stock-based compensation expense.  The fair value of the options that will vest based on the Company’s and Parent’s achievement of certain performance hurdles were valued using a Monte Carlo simulation method.  Refer to Note 8, “Stock-Based Compensation” for further discussion of stock-based compensation.

 

Revenue Recognition

 

The Company recognizes retail sales in its retail stores at the time the customer takes possession of merchandise.  All sales are net of discounts and returns and exclude sales tax.  Wholesale sales are recognized in accordance with the shipping terms agreed upon on the purchase order. Wholesale sales are typically recognized free on board origin, where title and risk of loss pass to the buyer when the merchandise leaves the Company’s distribution facility.

 

The Company has a gift card program.  The Company does not charge administrative fees on gift cards and the Company’s gift cards do not have expiration dates.  The Company records the sale of gift cards as a current liability and recognizes a sale when a customer redeems a gift card.  The liability for outstanding gift cards is recorded in accrued expenses.

 

Cost of Sales

 

Cost of sales includes the cost of inventory, freight in, obsolescence, spoilage, scrap and inventory shrinkage, and is net of discounts and allowances.  Cost of sales also includes receiving, warehouse costs and distribution costs (which include payroll and associated costs, occupancy, transportation to and from stores and depreciation expense).  Cash discounts for satisfying early payment terms are recognized when payment is made, and allowances and rebates based upon milestone achievements such as reaching a certain volume of purchases of a vendor’s products are included as a reduction of cost of sales when such contractual milestones are reached.

 

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Selling, General and Administrative Expenses

 

Selling, general and administrative expenses include the costs of selling merchandise in stores (which include payroll and associated costs, occupancy and other store-level costs) and corporate costs (which include payroll and associated costs, occupancy, advertising, professional fees and other corporate administrative costs).  Selling, general and administrative expenses also include depreciation and amortization expense relating to these costs.

 

Leases

 

The Company follows the policy of capitalizing allowable expenditures that relate to the acquisition and signing of its retail store leases.  These costs are amortized on a straight-line basis over the applicable lease term.

 

The Company recognizes rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term.  The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent.  Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred rent.  Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.

 

In certain lease arrangements, the Company can be involved with the construction of the building. If it is determined that the Company has substantially all of the risks of ownership during construction of the leased property and therefore is deemed to be the owner of the construction project, the Company records an asset for the amount of the total project costs and an amount related to the value attributed to the pre-existing leased building in property and equipment, net and the related financing obligation as part of current and non-current liabilities.  Once construction is complete, if it is determined that the asset does not qualify for sale-leaseback accounting treatment, the Company amortizes the obligation over the lease term and depreciates the asset over the life of the lease. The Company does not report rent expense for the portion of the rent payment determined to be related to the assets which are owned for accounting purposes. Rather, this portion of the rent payment under the lease is recognized as a reduction of the financing obligation and interest expense.

 

For store closures where a lease obligation still exists, the Company records the estimated future liability associated with the rental obligation on the cease use date (when the store is closed).  Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs.  Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimates of other related exit costs.  If actual timing and potential termination costs or realization of sublease income differ from the Company’s estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.

 

During the second quarter of fiscal 2016, the Company sold and concurrently leased back two retail stores with a carrying value of $7.9 million and received net proceeds from these transactions of $8.7 million.  The Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. The resulting leases are accounted for as financing leases and the Company has recorded a corresponding financing lease obligation of $8.7 million (as a component of current and non-current liabilities).  The Company will amortize the financing lease obligation over the lease term and depreciate the assets over their remaining useful lives.  During the third quarter of fiscal 2016, the Company sold and concurrently leased one store and the resulting lease qualifies and is accounted for as an operating lease.  The net proceeds from the sale-leaseback transaction amounted to $9.0 million.  The Company will amortize deferred gains of $2.6 million relating to the sale-leaseback transaction over the lease term.

 

Self-Insured Workers’ Compensation Liability

 

The Company self-insures for workers’ compensation claims in California and Texas.  The Company establishes a liability for losses from both estimated known and incurred but not reported insurance claims based on reported claims and actuarial valuations of estimated future costs of known and incurred but not yet reported claims.  Should an amount of claims greater than anticipated occur, the liability recorded may not be sufficient and additional workers’ compensation costs, which may be significant, could be incurred.  The Company has not discounted the projected future cash outlays for the time value of money for claims and claim-related costs when establishing its workers’ compensation liability in its financial reports for each of October 30, 2015 and January 30, 2015.

 

Self-Insured Health Insurance Liability

 

The Company self-insures for a portion of its employee medical benefit claims.  The liability for the self-funded portion of the Company health insurance program is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported.  The Company maintains stop loss insurance coverage to limit its exposure for the self-funded portion of its health insurance program.

 

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Pre-Opening Costs

 

The Company expenses, as incurred, pre-opening costs such as payroll, rent and marketing related to the opening of new retail stores.

 

Advertising

 

The Company expenses advertising costs as incurred.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist principally of cash, accounts receivable, interest rate and other derivatives, accounts payable, accruals, debt, and other liabilities.  Cash and derivatives are measured and recorded at fair value.  Accounts receivable and other receivables are financial assets with carrying values that approximate fair value.  Accounts payable and other accrued expenses are financial liabilities with carrying values that approximate fair value.  Refer to Note 7, “Fair Value of Financial Instruments” for further discussion of the fair value of debt.

 

The Company uses the authoritative guidance for fair value, which includes the definition of fair value, the framework for measuring fair value, and disclosures about fair value measurements.  Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants.  Fair value measurements reflect the assumptions market participants would use in pricing an asset or liability based on the best information available.  Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model.

 

Comprehensive Income

 

Other comprehensive income (“OCI”) includes unrealized gains or losses on interest rate derivatives designated as cash flow hedges.

 

2.                                      Goodwill and Other Intangibles

 

The following tables set forth the value of the goodwill and other intangible assets and liabilities, and unfavorable leases, respectively (in thousands):

 

 

 

October 30, 2015

 

January 30, 2015

 

 

 

Gross
Carrying
Amount

 

Impairment
Losses

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Indefinite lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

479,745

 

$

(120,000

)

$

 

$

359,745

 

$

479,745

 

$

 

$

479,745

 

Trade name

 

410,000

 

 

 

410,000

 

410,000

 

 

410,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total indefinite lived intangible assets

 

$

889,745

 

$

(120,000

)

$

 

$

769,745

 

$

889,745

 

$

 

$

889,745

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finite lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks

 

$

2,000

 

$

 

$

(381

)

$

1,619

 

$

2,000

 

$

(306

)

$

1,694

 

Bargain Wholesale customer relationships

 

20,000

 

 

(6,338

)

13,662

 

20,000

 

(5,096

)

14,904

 

Favorable leases

 

46,723

 

 

(16,187

)

30,536

 

46,723

 

(13,010

)

33,713

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total finite lived intangible assets

 

68,723

 

 

(22,906

)

45,817

 

68,723

 

(18,412

)

50,311

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total goodwill and other intangible assets

 

$

958,468

 

$

(120,000

)

$

(22,906

)

$

815,562

 

$

958,468

 

$

(18,412

)

$

940,056

 

 

 

 

October 30, 2015

 

January 30, 2015

 

 

 

Remaining
Amortization
Life
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Remaining
Amortization
Life
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Unfavorable leases

 

1 to 15

 

$

19,835

 

$

(13,470

)

$

6,365

 

1 to 15

 

$

19,835

 

$

(11,615

)

$

8,220

 

 

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3.                                      Property and Equipment, net

 

The following table provides details of property and equipment (in thousands):

 

 

 

October 30,
2015

 

January 30,
2015

 

Land

 

$

177,970

 

$

176,506

 

Buildings

 

111,397

 

117,422

 

Buildings improvements

 

71,828

 

71,985

 

Leasehold improvements

 

185,111

 

176,895

 

Fixtures and equipment

 

186,124

 

148,851

 

Transportation equipment

 

11,962

 

12,685

 

Construction in progress

 

25,301

 

46,195

 

 

 

 

 

 

 

Total property and equipment

 

769,693

 

750,539

 

Less: accumulated depreciation and amortization

 

(214,248

)

(169,519

)

 

 

 

 

 

 

Property and equipment, net

 

$

555,445

 

$

581,020

 

 

4.                                      Comprehensive Income

 

The following table sets forth the calculation of comprehensive income, net of tax effects (in thousands):

 

 

 

For the Third Quarter Ended

 

For the First Three Quarters Ended

 

 

 

October 30,
2015

 

October 31,
2014

 

October 30,
2015

 

October 31,
2014

 

Net (loss) income

 

$

(152,636

)

$

(3,814

)

$

(229,566

)

$

7,800

 

Unrealized loss on interest rate cash flow hedge, net of tax effects of $94, $(117), $0 and $(254) for the third quarter and first three quarters of each of fiscal 2016 and fiscal 2015, respectively

 

(192

)

(176

)

(333

)

(380

)

Reclassification adjustment, net of tax effects of $(321), $160, $0 and $445 for the third quarter and first three quarters of each of fiscal 2016 and fiscal 2015, respectively

 

724

 

240

 

1,207

 

668

 

 

 

 

 

 

 

 

 

 

 

Total unrealized gains , net

 

532

 

64

 

874

 

288

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive (loss) income

 

$

(152,104

)

$

(3,750

)

$

(228,692

)

$

8,088

 

 

Amounts in accumulated other comprehensive loss as of October 30, 2015 and January 30, 2015 consisted of unrealized losses on interest rate cash flow hedges.  Reclassifications out of AOCI in each of the third quarter and first three quarters of fiscal 2016 and fiscal 2015 are presented in Note 6, “Derivative Financial Instruments.”

 

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5.                                      Debt

 

Short and long-term debt consists of the following (in thousands):

 

 

 

October 30,
2015

 

January 30,
2015

 

 

 

 

 

 

 

ABL Facility, maturing on January 13, 2017

 

$

75,700

 

$

57,000

 

First Lien Term Loan Facility, maturing on January 13, 2019, payable in quarterly installments of $1,535, plus interest through December 31, 2019, with unpaid principal and accrued interest due on January 13, 2019, net of unamortized OID of $4,612 and $5,606 as of October 30, 2015 and January 30, 2015, respectively

 

596,923

 

600,533

 

Senior Notes (unsecured) maturing on December 15, 2019, unpaid principal and accrued interest due on December 15, 2019

 

250,000

 

250,000

 

Total debt

 

922,623

 

907,533

 

Less: current portion

 

6,138

 

6,138

 

Long-term debt, net of current portion

 

$

916,485

 

$

901,395

 

 

As of October 30, 2015 and January 30, 2015, the net deferred financing costs are as follows (in thousands):

 

Deferred financing costs

 

October 30,
2015

 

January 30,
2015

 

 

 

 

 

 

 

ABL Facility

 

$

1,160

 

$

1,196

 

First Lien Term Loan Facility

 

4,734

 

5,754

 

Senior Notes

 

7,508

 

8,513

 

Total deferred financing costs, net

 

$

13,402

 

$

15,463

 

 

On January 13, 2012 (the “Original Closing Date”), in connection with the Merger, the Company obtained Credit Facilities (as defined below) provided by a syndicate of lenders arranged by Royal Bank of Canada as administrative agent, as well as other agents and lenders that are parties to the agreements governing these Credit Facilities.  The Credit Facilities include (a) a first lien based revolving credit facility (as amended, the “ABL Facility”), and (b) a first lien term loan facility (as amended, the “First Lien Term Loan Facility” and together with the ABL Facility, the “Credit Facilities”).

 

First Lien Term Loan Facility

 

Under the First Lien Term Loan Facility, (i) $525.0 million of term loans were incurred on the Original Closing Date and (ii) $100.0 million of additional term loans were incurred pursuant to an incremental facility effected through an amendment entered into on October 8, 2013 (the “Second Amendment”) (all such term loans, collectively, the “Term Loans”).  The First Lien Term Loan Facility has a term of seven years with a maturity date of January 13, 2019.  All obligations under the First Lien Term Loan Facility are guaranteed by Parent and the Company’s direct or indirect 100% owned subsidiaries, except for immaterial subsidiaries (collectively, the “Credit Facilities Guarantors”).  In addition, the First Lien Term Loan Facility is secured by pledges of certain of the Company’s equity interests and the equity interests of the Credit Facilities Guarantors.

 

The Company is required to make scheduled quarterly payments each equal to 0.25% of the principal amount of the Term Loans, with the balance due on the maturity date.  Borrowings under the First Lien Term Loan Facility bear interest at an annual rate equal to an applicable margin plus, at the Company’s option, either (i) a base rate (the “Base Rate”) determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as the “Prime Rate” (3.25% as of October 30, 2015), (b) the federal funds effective rate plus 0.50% and (c) an adjusted Eurocurrency rate for one month (determined by reference to the greater of the Eurocurrency rate for the interest period subject to certain adjustments) plus 1.00%, or (ii) an Adjusted Eurocurrency Rate.

 

On April 4, 2012, the Company amended the terms of the First Lien Term Loan Facility (the “First Amendment”) and incurred related refinancing costs of $11.2 million.  The First Amendment, among other things, (i) decreased the applicable margin from London Interbank Offered Rate (“LIBOR”) plus 5.50% (or Base Rate plus 4.50%) to LIBOR plus 4.00% (or Base Rate plus 3.00%) and (ii) decreased the LIBOR floor from 1.50% to 1.25%.

 

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On October 8, 2013, the Company entered into the Second Amendment, which among other things, (i) provided $100.0 million of additional term loans as described above, (ii) decreased the applicable margin from LIBOR plus 4.00% (or Base Rate plus 3.00%) to LIBOR plus 3.50% (or Base Rate plus 2.50%) and (iii) decreased the LIBOR floor from 1.25% to 1.00%.  The Company will continue to be required to make scheduled quarterly payments each equal to 0.25% of the amended principal amount of the Term Loans (approximately $1.5 million).

 

In addition, the Second Amendment (i) amended certain restricted payment provisions, (ii) removed the maximum capital expenditures covenant from the agreement governing the First Lien Term Loan Facility, (iii) modified the existing provision restricting the Company’s ability to make dividend and other payments so that from and after March 31, 2013, the permitted payment amount represents the sum of (a) a calculation based on 50% of Consolidated Net Income (as defined in the First Lien Term Loan Facility agreement), if positive, or a deficit of 100% of Consolidated Net Income, if negative, and (b) $20.0 million, and (iv) permitted proceeds of any sale leasebacks of any assets acquired after January 13, 2012, to be reinvested in the Company’s business without restriction.

 

As of October 30, 2015, the interest rate charged on the First Lien Term Loan Facility was 4.50% (1.00% Eurocurrency rate, plus the Eurocurrency loan margin of 3.50%).  As of October 30, 2015, the amount outstanding under the First Lien Term Loan Facility was $596.9 million.

 

Following the end of each fiscal year, the Company is required to make prepayments on the First Lien Term Loan Facility in an amount equal to (i) 50% of Excess Cash Flow (as defined in the agreement governing the First Lien Term Loan Facility), with the ability to step down to 25% and 0% upon achievement of specified total leverage ratios, minus (ii) the amount of certain voluntary prepayments made on the First Lien Term Loan Facility and/or the ABL Facility during such fiscal year.  There was no Excess Cash Flow payment required for fiscal 2015.

 

The First Lien Term Loan Facility includes certain customary restrictions, among other things, on the Company’s ability and the ability of Parent, our subsidiary 99 Cents Only Stores Texas, Inc. (“99 Cents Texas”) and certain future subsidiaries of the Company to incur or guarantee additional indebtedness, make certain restricted payments, acquisitions or investments, materially change the Company’s business, incur or permit to exist certain liens, enter into transactions with affiliates, sell assets, make capital expenditures or merge or consolidate with or into, another company.  As of October 30, 2015, the Company was in compliance with the terms of the First Lien Term Loan Facility.

 

During the first quarter of fiscal 2013, the Company entered into an interest rate swap agreement to limit the variability of cash flows associated with interest payments on the First Lien Term Loan Facility that result from fluctuations in the LIBOR rate.  See Note 6, “Derivative Financial Instruments” for more information on this interest rate swap agreement.

 

ABL Facility

 

The ABL Facility initially provided for up to $175.0 million of borrowings, subject to certain borrowing base limitations.  Subject to certain conditions, the Company could increase the commitments under the ABL Facility by up to $50.0 million.  All obligations under the ABL Facility are guaranteed by Parent and the other Credit Facilities Guarantors.  The ABL Facility is secured by substantially all of the Company’s assets and the assets of the Credit Facilities Guarantors.

 

Borrowings under the ABL Facility bear interest at a rate based, at the Company’s option, on (i) LIBOR plus an applicable margin to be determined (2.00% as of October 30, 2015) or (ii) the determined base rate (Prime Rate) plus an applicable margin to be determined (1.00% at October 30, 2015), in each case based on a pricing grid depending on average daily excess availability for the most recently ended quarter.

 

In addition to paying interest on outstanding principal under the Credit Facilities, the Company is required to pay a commitment fee to the lenders under the ABL Facility on unused commitments.  The commitment fee is adjusted at the beginning of each quarter based upon the average historical excess availability of the prior quarter (0.375% for the quarter ended October 30, 2015).  The Company must also pay customary letter of credit fees and agency fees.

 

As of October 30, 2015, borrowings under the ABL Facility were $75.7 million, outstanding letters of credit were $2.5 million and availability under the ABL Facility subject to the borrowing base, was $106.8 million.  As of January 30, 2015, borrowings under the ABL Facility were $57.0 million, outstanding letters of credit were $2.5 million and availability under the ABL Facility subject to the borrowing base, was $115.5 million.

 

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The ABL Facility includes restrictions on the Company’s ability and the ability of Parent and certain of the Company’s restricted subsidiaries to incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, its capital stock, make certain acquisitions or investments, materially change its business, incur or permit to exist certain liens, enter into transactions with affiliates, sell assets or merge or consolidate with or into another company.

 

On October 8, 2013, the ABL Facility was amended to among other things, modify the provision restricting the Company’s ability to make dividend and other payments.  Such payments are subject to achievement of Excess Availability (as defined in the agreement governing the ABL Facility) and a ratio of EBITDA (as defined in the agreement governing the ABL Facility) to fixed charges.

 

On August 24, 2015, the Company amended its ABL Facility to increase commitments available under the ABL Facility by $10.0 million, resulting in an aggregate ABL Facility size of $185.0 million.  The additional commitments implemented pursuant to the amendment have terms identical to the existing commitments under the ABL Facility, including as to interest rate and other pricing terms. The Company paid amendment fees of $0.5 million to lenders under the ABL Facility.

 

In addition, the amendment to the ABL Facility (a) modifies certain springing covenants triggered by reference to excess availability under the ABL Facility agreement so that, from August 24, 2015 to April 30, 2016, the occurrence of any such excess availability trigger is determined solely by reference to the available borrowing base under the ABL Facility rather than by reference to the lesser of the available borrowing base and the available aggregate commitments under the ABL Facility, (b) increases the inventory advance rate during such period for purposes of calculating the borrowing base from 90% to 92.5%, (c) provides for certain additional inspection rights by the administrative agent if there is a material increase in the amount of inventory that is not eligible inventory for purposes of the borrowing base and (d) provides for certain additional technical waivers and amendments in order to effect the foregoing.

 

As of October 30, 2015, the Company was in compliance with the terms of the ABL Facility.

 

Senior Notes

 

On December 29, 2011, the Company issued $250.0 million aggregate principal amount of 11% Senior Notes that mature on December 15, 2019 (the “Senior Notes”).  The Senior Notes are guaranteed by the same subsidiaries that guarantee the Credit Facilities.

 

Pursuant to the terms of the indenture governing the Senior Notes (the “Indenture”), the Company may redeem all or a part of the Senior Notes at certain redemption prices that vary based on the date of redemption.  The Company is not required to make any mandatory redemptions or sinking fund payments, and may at any time or from time to time purchase notes in the open market.

 

The Indenture contains covenants that, among other things, limit the Company’s ability and the ability of certain of its subsidiaries to incur or guarantee additional indebtedness, create or incur certain liens, pay dividends or make other restricted payments and investments, incur restrictions on the payment of dividends or other distributions from restricted subsidiaries, sell assets, engage in transactions with affiliates, or merge or consolidate with other companies.  As of October 30, 2015, the Company was in compliance with the terms of the Indenture.

 

The significant components of interest expense are as follows (in thousands):

 

 

 

For the Third Quarter Ended

 

For the First Three Quarters Ended

 

 

 

October 30,
2015

 

October 31,
2014

 

October 30,
2015

 

October 31,
2014

 

 

 

 

 

 

 

 

 

 

 

First Lien Term Loan Facility

 

$

7,230

 

$

7,345

 

$

21,735

 

$

21,928

 

ABL Facility

 

654

 

366

 

1,843

 

817

 

Senior Notes

 

6,875

 

6,875

 

20,701

 

20,549

 

Amortization of deferred financing costs and OID

 

1,238

 

1,113

 

3,543

 

3,291

 

Other interest expense

 

552

 

18

 

1,480

 

28

 

Interest expense

 

$

16,549

 

$

15,717

 

$

49,302

 

$

46,613

 

 

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6.                                      Derivative Financial Instruments

 

The Company entered into derivative instruments for risk management purposes and uses these derivatives to manage exposure to fluctuation in interest rates.

 

Interest Rate Swap

 

In May 2012, the Company entered into a floating-to-fixed interest rate swap agreement for an initial aggregate notional amount of $261.8 million to limit exposure to interest rate increases related to a portion of the Company’s floating rate indebtedness once the Company’s interest rate cap agreement expires.  The swap agreement, effective November 2013, hedges a portion of contractual floating rate interest commitments through the expiration of the swap agreement in May 2016.  As a result of the agreement, the Company’s effective fixed interest rate on the notional amount of floating rate indebtedness will be 1.36% plus an applicable margin of 3.50%.

 

The Company designated the interest rate swap agreement as a cash flow hedge.  The interest rate swap agreement is highly correlated to the changes in interest rates to which the Company is exposed.  Unrealized gains and losses on the interest rate swap are designated as effective or ineffective.  The effective portion of such gains or losses is recorded as a component of AOCI or loss, while the ineffective portion of such gains or losses is recorded as a component of interest expense.  Future realized gains and losses in connection with each required interest payment will be reclassified from AOCI or loss to interest expense.

 

Covert Transition Payments

 

In September 2015, the Company entered into an employment agreement with Geoffrey J. Covert’s as the President and Chief Executive Officer of each of the Company and Parent. In connection with this agreement, Mr. Covert is entitled to receive amounts under a transition program based on the value of certain equity awards from his former employer that he forfeited in connection with his previous employment.  The maximum amount of payments due under this agreement is approximately $5.0 million, payable over a period of four years. The Company accounts for these transition payments as derivatives that are not designated as hedging instruments and has measured the obligation at fair value at October 30, 2015. The Company recognizes the expense associated with these payments over the requisite service period.

 

Fair Value

 

The fair value of the interest rate swap agreement is estimated using industry standard valuation models using market-based observable inputs, including interest rate curves (Level 2, as defined in Note 7, “Fair Value of Financial Instruments”).  The fair value of the transition payments is estimated using a valuation model that includes unobservable inputs (Level 3, as defined in Note 7, “Fair Value of Financial Instruments”).

 

A summary of the recorded amounts included in the consolidated balance sheets is as follows (in thousands):

 

 

 

October 30,
2015

 

January 30,
2015

 

 

 

 

 

 

 

Derivatives designated as cash flow hedging instruments

 

 

 

 

 

Interest rate swap (included in other current liabilities)

 

$

1,221

 

$

1,591

 

Interest rate swap (included in other liabilities)

 

$

 

$

596

 

Accumulated other comprehensive loss, net of tax (included in member’s equity)

 

$

124

 

$

998

 

Derivatives not designated as hedging instruments

 

 

 

 

 

Transition payments (included in other current liabilities)

 

$

516

 

$

 

Transition payments (included in other liabilities)

 

$

197

 

$

 

 

A summary of recorded amounts included in the unaudited consolidated statements of comprehensive income (loss) is as follows (in thousands):

 

 

 

For the Third Quarter Ended

 

For the First Three Quarters Ended

 

 

 

October 30,
2015

 

October 31,
2014

 

October 30,
2015

 

October 31,
2014

 

 

 

 

 

 

 

 

 

 

 

Derivatives designated as cash flow hedging instruments:

 

 

 

 

 

 

 

 

 

Loss related to effective portion of derivative recognized in OCI

 

$

192

 

$

176

 

$

333

 

$

380

 

Loss related to effective portion of derivatives reclassified from AOCI to interest expense

 

$

724

 

$

240

 

$

1,207

 

$

668

 

(Gain) loss related to ineffective portion of derivative recognized in interest expense

 

$

(27

)

$

22

 

$

(88

)

$

(110

)

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

Loss recognized in selling, general and administrative expenses

 

$

713

 

$

 

$

713

 

$

 

 

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7.                                      Fair Value of Financial Instruments

 

The Company complies with authoritative guidance for fair value measurement and disclosures which establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy are described below:

 

Level 1: Defined as observable inputs such as quoted prices in active markets for identical assets or liabilities.

 

Level 2: Defined as observable inputs other than Level 1 prices.  These include quoted prices for similar assets or liabilities in an active market, quoted prices for identical assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3: Defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

The Company uses the best available information in measuring fair value.  The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis (in thousands):

 

 

 

October 30, 2015

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Other assets — assets that fund deferred compensation

 

$

762

 

$

762

 

$

 

$

 

LIABILITIES

 

 

 

 

 

 

 

 

 

Other current liabilities — interest rate swap

 

$

1,221

 

$

 

$

1,221

 

$

 

Other current liabilities — transition payments

 

$

516

 

$

 

$

 

$

516

 

Other long-term liabilities — transition payments

 

$

197

 

$

 

$

 

$

197

 

Other long-term liabilities — deferred compensation

 

$

762

 

$

762

 

$

 

$

 

 

Level 1 measurements include $0.8 million of deferred compensation assets that fund the liabilities related to the Company’s deferred compensation, including investments in trust funds.  The fair values of these funds are based on quoted market prices in an active market.

 

Level 2 measurements include interest rate swap agreement estimated using industry standard valuation models using market-based observable inputs, including interest rate curves.

 

Level 3 measurements include transition payments to Mr. Covert (See Note 6, “Derivative Financial Instruments”) estimated using a valuation model that includes Level 3 unobservable inputs.  Significant assumptions used in the analysis include projected stock prices, stock volatility and the Company’s credit spread.

 

The Company did not have any transfers in and out of Levels 1 and 2 during the first three quarters of fiscal 2016.

 

The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis as of January 30, 2015 (in thousands):

 

 

 

January 30, 2015

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Other assets — assets that fund deferred compensation

 

$

724

 

$

724

 

$

 

$

 

LIABILITES

 

 

 

 

 

 

 

 

 

Other current liabilities — interest rate swap

 

$

1,591

 

$

 

$

1,591

 

$

 

Other long-term liabilities — interest rate swap

 

$

596

 

$

 

$

596

 

$

 

Other long-term liabilities — deferred compensation

 

$

724

 

$

724

 

$

 

$

 

 

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Level 1 measurements include $0.7 million of deferred compensation assets that fund the liabilities related to the Company’s deferred compensation, including investments in trust funds.  The fair values of these funds are based on quoted market prices in an active market.

 

Level 2 measurements include interest rate swap agreement estimated using industry standard valuation models using market-based observable inputs, including interest rate curves.

 

There were no Level 3 assets or liabilities as of January 30, 2015.

 

The following table summarizes the activity for the period of changes in fair value of the Company’s Level 3 instruments (in thousands):

 

 

 

For the First Three Quarters Ended

 

Transition Payments

 

October 30, 2015

 

October 31, 2014

 

Description

 

 

 

 

 

Beginning balance

 

$

 

$

 

Transfers in and/or out of Level 3

 

 

 

Total realized/unrealized gains (loss):

 

 

 

 

 

Included in earnings (1)

 

(713

)

 

Included in other comprehensive loss

 

 

 

Purchases, sales, issues and settlements:

 

 

 

 

 

Settlements

 

 

 

Ending balance

 

$

(713

)

$

 

Total amount of unrealized gains (losses) for the period included in earnings relating to liabilities held at the reporting period

 

$

(713

)

$

 

 


(1)         Losses are included in selling, general and administrative expenses.

 

The outstanding debt under the Credit Facilities and the Senior Notes is recorded in the financial statements at historical cost, net of applicable unamortized discounts.

 

The ABL Facility is tied directly to market rates and fluctuates as market rates change; as a result, the carrying value of the ABL Facility approximates fair value as of October 30, 2015 and January 30, 2015.

 

The fair value of the First Lien Term Loan Facility was estimated at $487.2 million, or $114.3 million lower than the carrying value, as of October 30, 2015, based on quoted market prices of the debt (Level 1 inputs).  The fair value of the First Lien Term Loan Facility approximated the carrying value, as of January 30, 2015, based on quoted market prices of the debt (Level 1 inputs).

 

The fair value of the Senior Notes was estimated at $141.2 million, or $108.8 million lower than the carrying value, as of October 30, 2015, based on quoted market prices of the debt (Level 1 inputs).  The fair value of the Senior Notes was estimated at $264.7 million, or $14.7 million greater than the carrying value, as of January 30, 2015, based on quoted market prices of the debt (Level 1 inputs).

 

See Note 5, “Debt” for more information on the Company’s debt.

 

8.                                      Stock-Based Compensation

 

Number Holdings, Inc. 2012 Equity Incentive Plan

 

On February 27, 2012, the board of directors of Parent adopted the Number Holdings, Inc. 2012 Stock Incentive Plan (the “2012 Plan”).  The 2012 Plan authorizes equity awards to be granted for up to 85,000 shares of Class A Common Stock of Parent and 85,000 shares of Class B Common Stock of Parent.  As of October 30, 2015, options for 56,551 shares of each of Class A Common Stock and Class B Common Stock were issued to certain members of management and directors.  Options upon vesting may be exercised only for units consisting of an equal number of Class A Common Stock and Class B Common Stock.  Class B Common Stock has de minimis economic rights and the right to vote solely for election of directors.

 

Employee Option Grants

 

Options granted to employees generally become exercisable over a four or five year service period and have terms of ten years from date of the grant.

 

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Table of Contents

 

Under the standard form of option award agreement for the 2012 Plan, Parent has a right to repurchase from the participant all or a portion of (i) Class A and Class B Common Stock of Parent issued upon the exercise of the options awarded to a participant and still held by such participant or his or her transferee and (ii) vested but unexercised options.  The repurchase price for the shares of Class A and Class B Common Stock of Parent received from option exercises prior to termination of employment is the fair market value of such shares as of the date of such termination, and, for the vested but unexercised options, the repurchase price is the difference between the fair market value of the Class A and Class B Common Stock of Parent as of the date of termination of employment and the exercise price of the option.  However, upon (i) a termination of employment for cause, (ii) a voluntary resignation without good reason, or (iii) upon discovery that the participant engaged in detrimental activity, the repurchase price is the lesser of the exercise price paid by the participant to exercise the option or the fair market value of the Class A and Class B Common Stock of Parent.  If Parent elects to exercise its repurchase right for any shares acquired pursuant to the exercise of an option, it must do so no later than (i) 180 days after the date of participant’s termination of employment if the option is exercised prior to the date of termination, or (ii) no later than 90 days from the latest date that such option can be exercised if the option is exercised after the date of termination.  If Parent elects to exercise its repurchase right for any vested and unexercised option, it must do so for no longer than the latest date that such option can be exercised.  The options also contain transfer restrictions that lapse upon registration of an offering of Parent common stock under the Securities Act of 1933 (a “liquidity event”).

 

The Company defers recognition of substantially all of the stock-based compensation expense related to these stock options. The nature of repurchase rights and transfer restrictions create a performance condition that is not considered probable of being achieved until a liquidity event or certain employment termination events are probable of occurrence. These options are accounted for as equity-based awards. The fair value of these stock options was estimated at the date of grant using the Black-Scholes pricing model. There were 19,675 time-based employee options outstanding as of October 30, 2015.

 

In the second quarter of fiscal 2015, 750 options were granted that would have vested subject to the Company’s and Parent’s achievement of performance hurdles.  In the first quarter of fiscal 2016, 1,250 options were granted that would have vested subject to the Company’s and Parent’s achievement of performance hurdles.  The Company deferred recognition of these performance-based options until it was probable that that the performance hurdles would be achieved.  The fair value of these performance-based options was estimated at the date of grant using a Monte Carlo simulation method. These performance-based options were forfeited in the second quarter of fiscal 2016.

 

Director Option Grants

 

Options granted to board members generally become exercisable over a five year service period and have terms of ten years from date of the grant.  Options granted to these board members do not contain repurchase rights that would allow the Parent to repurchase these options at less than fair value. The Company recognizes stock-based compensation expense for these option grants over the service period. These options are accounted for as equity awards.  The fair value of these stock options was estimated at the date of grant using the Black-Scholes pricing model.

 

Former Chief Executive Officer Equity Awards

 

On October 9, 2013, in connection with Stéphane Gonthier’s employment as President and Chief Executive Officer of the Company and Parent, the Compensation Committee of Parent’s Board of Directors granted to Mr. Gonthier stock options to purchase an aggregate of 21,505 shares of each of the Class A and Class B Common Stock.  Subject to the continued employment of Mr. Gonthier, (a) 75% of the options would have vested according to a timetable of 30% on the first anniversary of the grant date, 20% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date and (b) 25% of these options would have vested subject to the Company’s and Parent’s achievement of performance hurdles.  These options are subject to the terms of the 2012 Plan and the award agreement under which they were granted.

 

On May 25, 2015, Mr. Gonthier resigned from his positions as a director and as the President and Chief Executive Officer of the Company, Parent, and each of the Company’s subsidiaries. Twenty percent of the options to purchase common stock of Parent held by Mr. Gonthier that are subject to time-based vesting accelerated and vested as of the date of Mr. Gonthier’s resignation.  All of Mr. Gonthier’s time-based options were forfeited on August 24, 2015.  All of Mr. Gonthier’s performance-based options were forfeited on November 21, 2015.

 

The Company recorded stock-based compensation for the time-based options in accordance with the four year vesting period.  The Company had deferred recognition of performance-based options until it was probable that the performance hurdles would be achieved.  The time-based and performance-based options were accounted for as equity awards.  The fair value of these time-based options was estimated at the date of grant using the Black-Scholes pricing model.  The fair value of performance-based options was estimated at the date of grant using a Monte Carlo simulation method.

 

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Table of Contents

 

New Chief Executive Officer Equity Awards

 

In September 2015, the Company entered into an employment agreement with Geoffrey J. Covert as the President and Chief Executive Officer of each of the Company and Parent.  In connection with this agreement, Mr. Covert was granted two options, each to purchase 15,500 shares of Class A and Class B Common Stock of Parent.  One of the grants has an exercise price of $1,000 per share.  The other grant has an exercise price equal to $750 per share plus the amount by which the fair market value of the underlying share exceeds $1,000 on the date of exercise.  One-half of each grant vests on each of the first four installments of the grant date, and the other half of each grant vests based on the achievement of certain performance targets.  The vesting of the options is subject to Mr. Covert’s continued employment through the applicable vesting date.  The options are subject to the terms of the 2012 Plan and the award agreements under which they were granted.

 

The Company has deferred recognition of the stock-based compensation expense for these time-based and performance-based stock options. The nature of the repurchase rights and transfer restrictions create a performance condition that is not considered probable of being achieved until a liquidity event or certain employment termination events are probable of occurrence. Additionally, the Company has deferred recognition of the stock-based compensation expense for performance-based options until it is probable that the performance targets will be achieved.

 

Accounting for stock-based compensation

 

Determining the fair value of options at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise and the associated volatility.  At the grant date, the Company estimates an amount of forfeitures that will occur prior to vesting.  During the third quarter and first three quarters of fiscal 2016, the Company recorded stock-based compensation expense of less than $0.1 million and $1.5 million, respectively.  During the third quarter and first three quarters of fiscal 2015, the Company recorded stock-based compensation expense of $0.6 million and $2.0 million, respectively.

 

The following summarizes stock option activity in the first three quarters of fiscal 2016:

 

 

 

Number of
Shares

 

Weighted Average
Exercise Price

 

Weighted Average
Remaining
Contractual Life
(Years)

 

Options outstanding at the beginning of the period

 

48,130

 

$

1,171

 

 

 

Granted

 

36,800

 

$

946

 

 

 

Exercised

 

(660

)

$

1,000

 

 

 

Cancelled

 

(27,719

)

$

1,209

 

 

 

 

 

 

 

 

 

 

 

Outstanding at the end of the period

 

56,551

 

$

1,007

 

8.20

 

 

 

 

 

 

 

 

 

Exercisable at the end of the period

 

6,970

 

$

1,049

 

6.70

 

 

The following table summarizes the stock awards available for grant under the 2012 Plan as of October 30, 2015:

 

 

 

Number of Shares

 

Available for grant as of January 30, 2015

 

36,840

 

Authorized

 

 

Granted

 

(36,800

)

Cancelled

 

27,719

 

Available for grant at October 30, 2015

 

27,759

 

 

9.                                      Related-Party

 

Parent Stock Repurchase Agreement

 

In March 2015, in connection with Mr. Michael Kvitko’s resignation as Executive Vice President and Chief Merchandising Officer of the Company and all positions with Parent, Parent purchased all of the vested options to purchase shares of Class A Common Stock and Class B Common Stock held by Mr. Kvitko, for an aggregate consideration of $0.4 million.

 

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Table of Contents

 

Credit Facility

 

In connection with the Merger, the Company entered into the First Lien Term Loan Facility, under which various funds affiliated with Ares were lenders.  As of January 30, 2015 these affiliates held approximately $1.4 million of term loans under the First Lien Term Loan Facility.  The terms of the term loans are the same as those held by unaffiliated third party lenders under the First Lien Term Loan Facility.  As of October 30, 2015, these affiliates no longer held any term loans under the First Lien Term Loan Facility.

 

Senior Notes

 

Various funds affiliated with Ares and Canada Pension Plan Investment Board have collectively acquired $102.1 million aggregate principal amount of the Company’s Senior Notes in open market transactions.  From time to time, these or other affiliated funds may acquire additional Senior Notes.

 

10.                               Income Taxes

 

The effective income tax rate for the first three quarters of fiscal 2016 was a provision rate of (16.5)% compared to a provision rate of 40.7% for the first three quarters of fiscal 2015.  Income tax expense for the interim periods was computed using the effective tax rate estimated to be applicable for the full fiscal year.  The change in the effective tax rate is primarily due to the tax effect of the non-deductible goodwill impairment, the establishment of a valuation allowance against deferred tax assets as discussed below, and the effect of not recognizing the benefit of losses incurred in fiscal 2016 in jurisdictions where we concluded is it more likely than not that such benefits would not be realized.

 

The Company assesses its ability to realize deferred tax assets throughout the fiscal year.  As a result of this assessment during the second quarter of fiscal 2016, the Company concluded that it was more likely than not that the Company would not realize its deferred tax assets. In the first three quarters of fiscal 2016, the Company recorded a $31.7 million increase to its provision for income taxes in order to establish a valuation allowance against such deferred tax assets and, additionally, realize the benefit of losses incurred in fiscal 2016.  The Company will continue to evaluate all of the positive and negative evidence in future periods and will make a determination as to whether it is more likely than not that all or a portion of its deferred tax assets will be realized in such future periods. At such time as the Company determines that it is more likely than not that all or a portion of its deferred tax assets are realizable, the valuation allowance will be reduced or released in its entirety, and the corresponding benefit will be reflected in the Company’s tax provision. Deferred tax liabilities associated with intangibles cannot be considered a source of taxable income to support the realization of deferred tax assets because these deferred tax liabilities will not reverse until some indefinite future period when these assets are either sold or impaired for book purposes.  The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from using its loss carryforwards or utilizing other deferred tax assets in the future.

 

The Company’s policy is to recognize interest and penalties related to uncertain tax positions as a component of income tax expense.  As of October 30, 2015 and January 31, 2015, the Company has not accrued any interest and penalties related to uncertain tax positions.

 

The Company files income tax returns in the U.S. federal jurisdiction and in various states.  The Company is subject to examinations by the major tax jurisdictions in which it files for the tax years 2010 forward.  The federal tax returns for the period ended March 27, 2010 and period ended March 31, 2012 were examined by the Internal Revenue Service resulting in no changes to the reported tax.

 

11.                               Commitments and Contingencies

 

Credit Facilities

 

The Credit Facilities and commitments are discussed in detail in Note 5, “Debt.”

 

Workers’ Compensation

 

The Company self-insures its workers’ compensation claims in California and Texas and provides for losses of estimated known and incurred but not reported insurance claims.  The Company does not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing its workers’ compensation liability.

 

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Table of Contents

 

As of October 30, 2015 and January 30, 2015, the Company had recorded a liability of $68.6 million and $70.4 million, respectively, for estimated workers’ compensation claims in California.  The Company has limited self-insurance exposure in Texas and had recorded a liability of less than $0.1 million as of each of October 30, 2015 and January 30, 2015 for workers’ compensation claims in Texas.  The Company purchases workers’ compensation insurance coverage in Arizona and Nevada and is not self-insured in those states.

 

Self-Insured Health Insurance Liability

 

The Company self-insures for a portion of its employee medical benefit claims.  As of each of October 30, 2015 and January 30, 2015, the Company had recorded a liability of $0.5 million for estimated health insurance claims.  The Company maintains stop loss insurance coverage to limit its exposure for the self-funded portion of its health insurance program.

 

Legal Matters

 

Wage and Hour Matters

 

Shelley Pickett v. 99¢ Only Stores.  Plaintiff, a former cashier for the Company, filed a representative action complaint against the Company on November 4, 2011 in the Superior Court of the State of California, County of Los Angeles alleging a PAGA claim that the Company violated section 14 of Wage Order 7-2001 by failing to provide seats for its cashiers behind checkout counters.  The plaintiff seeks civil penalties of $100 to $200 per violation, per each pay period for each affected employee, and attorney’s fees.  The court denied the Company’s motion to compel arbitration of Pickett’s individual claims or, in the alternative, to strike the representative action allegations in the Complaint, and the Court of Appeals affirmed the trial court’s ruling.  The Company’s petition for review of the decision in the California Supreme Court was denied on January 15, 2014, and remittitur issued on January 27, 2014.  On June 27, 2013, the plaintiff entered into a settlement agreement and release with the Company in another matter.  Payment has been made to the plaintiff under that agreement and the other action has been dismissed.  The Company’s position is that the release the plaintiff executed in that matter waives the claims she asserts in this action, waives her right to proceed on a class or representative basis or as a private attorney general and requires her to dismiss this action with prejudice as to her individual claims.  The Company notified the plaintiff of its position by a letter dated as of July 30, 2013, but she has yet to dismiss the lawsuit.  On February 11, 2014, the Company answered the complaint, denying all material allegations, and filed a cross-complaint against Pickett seeking to enforce her agreement to dismiss this action.  Through the cross-complaint, the Company seeks declaratory relief, specific performance and damages.  Pickett has answered the cross-complaint, asserting a general denial of all material allegations and various affirmative defenses.  On March 12, 2014, in an unrelated matter involving similar claims against a different employer, the California Supreme Court agreed to rule on several questions that will provide guidance to lower courts as to California’s employee seating requirement, which is a largely untested area of law.  Accordingly, on May 20, 2014, the parties stipulated to stay this matter pending the final resolution of the California Supreme Court proceeding, with the exception of the Company’s motion for judgment on the pleadings on the cross-complaint and Ms. Pickett’s motion for leave to substitute in a new representative plaintiff.  On September 30, 2014, the court denied the motion for judgment on the pleadings and granted the motion for leave to amend.  Plaintiffs filed their amended complaint on October 8, 2014, and the Company answered on October 10, 2014, denying all material allegations.  The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, that it could face as a result of such lawsuit.

 

Sofia Wilton Barriga v. 99¢ Only Stores.  Plaintiff, a former store associate, filed an action against the Company on August 5, 2013, in the Superior Court of the State of California, County of Riverside alleging on behalf of plaintiff and all others allegedly similarly situated under the California Labor Code that the Company failed to pay wages for all hours worked, provide meal periods, pay wages timely upon termination, and provide accurate wage statements.  The plaintiff also asserted a derivative claim for unfair competition under the California Business and Professions Code.  The plaintiff seeks to represent a class of all non-exempt employees who were employed in California in the Company’s retail stores who worked the graveyard shift at any time from January 1, 2012, through the date of trial or settlement.  Although the class period as originally pled would extend back to August 5, 2009, the parties have agreed that any class period would run beginning January 1, 2012, because of the preclusive effect of a judgment in a previous matter.  The plaintiff seeks to recover alleged unpaid wages, statutory penalties, interest, attorney’s fees and costs, and restitution.  On September 23, 2013, the Company filed an answer denying all material allegations.  A case management conference was held on October 4, 2013, at which the court ordered that discovery may proceed as to class certification issues only.  After discovery commenced, a mediation was held on March 12, 2015, resulting in a confidential mediator’s proposal, which the parties verbally accepted.  The parties were unable to negotiate and finalize a written settlement agreement.  Subsequent settlement discussions directly with the plaintiff and through the mediator, as well as a court-ordered settlement conference, were unsuccessful.  The Court has set a status conference for January 12, 2016, and at that time will set a discovery plan and deadline for the filing of motions regarding class certification if the parties are unable to agree prior to that time on such a plan and deadline.  On October 26, 2015, plaintiffs’ counsel filed another action, this time in Los Angeles Superior Court, entitled Ivan Guerra v. 99 Cents Only Stores LLC (Case No. BC599119), which asserts PAGA claims based in part on the allegations at issue in the Barriga action.  While the Guerra case is not yet at issue, plaintiffs have agreed to stipulate to the transfer of the action to Riverside Superior Court and to consolidate it with the Barriga action.  The Company cannot predict the outcome of these lawsuits or the amount of potential loss, if any, that it could face as a result of such lawsuits.

 

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Other Matters

 

The Company is also subject to other private lawsuits, administrative proceedings and claims that arise in its ordinary course of business.  A number of these lawsuits, proceedings and claims may exist at any given time.  While the resolution of such a lawsuit, proceeding or claim may have an impact on the Company’s financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business is expected to have a material adverse effect on the Company’s financial position, results of operations or overall liquidity.

 

12.                               Assets Held for Sale

 

Assets held for sale as of October 30, 2015 consisted of vacant land in Rancho Mirage, California and land in Bullhead, Arizona with a carrying value of $2.3 million.  Assets held for sale as of January 30, 2015 consisted of vacant land in Rancho Mirage, California and property containing land and a building in Pasadena-Shaver, Texas with a carrying value of $3.1 million.

 

In April 2015, the Company completed the sale of property in Pasadena-Shaver, Texas and received net proceeds of $1.4 million.  The carrying value of the Pasadena-Shaver property was $1.4 million.

 

In September 2015, the Company completed the sale of a cold storage distribution center in City of Commerce, California and received net proceeds of $11.8 million.  The carrying value of the cold storage distribution center was $6.5 million.

 

13.                               Other Accrued Expenses

 

Other accrued expenses as of October 30, 2015 and January 30, 2015 are as follows (in thousands):

 

 

 

October 30,
2015

 

January 30,
2015

 

Accrued interest

 

$

14,073

 

$

8,363

 

Accrued occupancy costs

 

15,225

 

11,766

 

Accrued legal reserves and fees

 

7,043

 

6,006

 

Accrued interest swap

 

1,221

 

1,591

 

Accrued California Redemption Value

 

2,450

 

951

 

Other

 

11,103

 

11,491

 

Total other accrued expenses

 

$

51,115

 

$

40,168

 

 

14.                               New Authoritative Standards

 

In April 2014, the Final Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”).  ASU 2014-08 changes the requirements for reporting discontinued operations.  Under ASU 2014-08, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has or will have a major effect on an entity’s operations and financial results.  ASU 2014-08 is effective for all disposals or classifications as held for sale of components of an entity that occur within fiscal years beginning after December 15, 2014, and early adoption is permitted.  The Company adopted ASU 2014-08 in the first quarter of fiscal 2016.  There is no material impact on the Company or its consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”).  ASU 2014-09 is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. The ASU also requires expanded disclosures about revenue recognition. In adopting ASU 2014-09, companies may use either a full retrospective or a modified retrospective approach.  ASU 2014-09 was to be effective for the first interim period within annual reporting periods beginning after December 15, 2016, and early adoption is not permitted In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date”, which defers the effective date of ASU 2014-09 for all entities by one year. The Company is currently evaluating this guidance and the impact it will have on its consolidated financial statements.

 

In June 2014, the FASB issued ASU No. 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such,

 

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the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, and early adoption is permitted. The Company will adopt ASU 2014-12 in the first quarter of fiscal 2017 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This ASU requires management to assess whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued.  If substantial doubt exists, additional disclosures are required. This ASU is effective for annual periods ending after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted.  The Company will adopt this standard in the first quarter of fiscal 2018 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.

 

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement - Extraordinary and Unusual Items: Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” This ASU eliminates the concept of extraordinary items under GAAP, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations.  This ASU is effective for annual periods ending after December 15, 2015, and interim periods within those fiscal years, with early adoption permitted. The Company will adopt this standard in the first quarter of fiscal 2017 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.

 

In February 2015, the FASB issued ASU No. 2015-02, “Amendments to the Consolidation Analysis.”  This ASU amended the process that a reporting entity must perform to determine whether it should consolidate certain types of legal entities.  The amendment modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships, among other provisions.  This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, and early adoption permitted.  The Company will adopt this standard in the first quarter of fiscal 2017 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.

 

In April 2015, the FASB issued ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03.)” This ASU requires companies to present debt issuance costs related to a recognized debt liability on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts. Debt issuance costs will continue to be amortized to interest expense using the effective interest method. In August 2015, FASB issued ASU No. 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangement (“ASU 2015-15”). ASU 2015-15 clarifies the presentation and measurement of debt issuance costs incurred in connection with line-of-credit arrangements given the lack of guidance on this topic in ASU 2015-03. For line-of-credit arrangements, an entity can continue to present debt issuance costs as an asset and amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. These standards are effective for public companies for annual periods beginning after December 15, 2015 as well as interim periods within those annual periods using the retrospective approach. The Company is currently evaluating the impacts of the new guidance on its consolidated financial statements.

 

In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.”  This ASU simplifies the subsequent measurement of inventories by replacing the lower of cost or market test with a lower of cost or net realizable value test.  Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.  The guidance is effective for reporting periods beginning after December 15, 2016 and interim periods within those fiscal years, with early adoption permitted. This ASU should be applied prospectively. The Company is currently evaluating the impacts of the new guidance on its consolidated financial statements.

 

In September 2015, the FASB issued ASU No. 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments.”  This ASU eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. This ASU is effective for fiscal years beginning after December 15, 2015, and early adoption is permitted.  The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.  The Company will adopt this standard in the first quarter of fiscal 2017 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.

 

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In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes.”  This ASU simplifies the presentation of deferred income taxes by requiring that all deferred tax liabilities and assets be classified as long-term on the balance sheet. This guidance is effective for fiscal years beginning after December 15, 2017, and allows for either prospective or retrospective adoption, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

15.                               Financial Guarantees

 

On December 29, 2011, the Company issued $250.0 million principal amount of the Senior Notes.  The Senior Notes are irrevocably and unconditionally guaranteed, jointly and severally, by each of the Company’s existing and future restricted subsidiaries that are guarantors under the Credit Facilities and certain other indebtedness.

 

As of October 30, 2015 and January 30, 2015, the Senior Notes are fully and unconditionally guaranteed by the Company’s 100% owned subsidiaries (the “Subsidiary Guarantors”), except for immaterial subsidiaries.

 

The tables in the following pages present the condensed consolidating financial information for the Company and the Subsidiary Guarantors together with consolidating entries, as of and for the periods indicated.  The subsidiaries that are not Subsidiary Guarantors are minor.  The condensed consolidating financial information may not necessarily be indicative of the financial position, results of operations or cash flows had the Company, and the Subsidiary Guarantors operated as independent entities.

 

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CONDENSED CONSOLIDATING BALANCE SHEETS

As of October 30, 2015

(In thousands)

(Unaudited)

 

 

 

Issuer

 

Subsidiary
Guarantors

 

Non-
Guarantor
Subsidiaries

 

Consolidating
Adjustments

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

1,303

 

$

1,246

 

$

36

 

$

 

$

2,585

 

Accounts receivable, net

 

1,711

 

102

 

 

 

1,813

 

Income taxes receivable

 

1,540

 

 

 

 

1,540

 

Deferred income taxes

 

31,115

 

 

 

 

31,115

 

Inventories, net

 

234,212

 

32,024

 

 

 

266,236

 

Assets held for sale

 

2,308

 

 

 

 

2,308

 

Other

 

14,438

 

1,245

 

14

 

 

15,697

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current assets

 

286,627

 

34,617

 

50

 

 

321,294

 

Property and equipment, net

 

496,096

 

59,321

 

28

 

 

555,445

 

Deferred financing costs, net

 

13,402

 

 

 

 

13,402

 

Equity investments and advances to subsidiaries

 

565,157

 

482,517

 

1,424

 

(1,049,098

)

 

Intangible assets, net

 

453,752

 

2,065

 

 

 

455,817

 

Goodwill

 

359,745

 

 

 

 

359,745

 

Deposits and other assets

 

7,100

 

410

 

8

 

 

7,518

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,181,879

 

$

578,930

 

$

1,510

 

$

(1,049,098

)

$

1,713,221

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBER’S EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

93,165

 

$

5,736

 

$

 

$

 

$

98,901

 

Intercompany payable

 

483,189

 

501,681

 

1,985

 

(986,855

)

 

Payroll and payroll-related

 

18,890

 

1,225

 

 

 

20,115

 

Sales tax

 

6,010

 

658

 

 

 

6,668

 

Other accrued expenses

 

46,530

 

4,568

 

17

 

 

51,115

 

Workers’ compensation

 

68,630

 

75

 

 

 

68,705

 

Current portion of long-term debt

 

6,138

 

 

 

 

6,138

 

Current portion of capital and financing lease obligation

 

979

 

 

 

 

979

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

723,531

 

513,943

 

2,002

 

(986,855

)

252,621

 

Long-term debt, net of current portion

 

916,485

 

 

 

 

916,485

 

Unfavorable lease commitments, net

 

6,303

 

62

 

 

 

6,365

 

Deferred rent

 

24,369

 

2,185

 

5

 

 

26,559

 

Deferred compensation liability

 

762

 

 

 

 

762

 

Capital and financing lease obligation, net of current portion

 

34,474

 

 

 

 

34,474

 

Long-term deferred income taxes

 

191,914

 

 

 

 

191,914

 

Other liabilities

 

3,972

 

 

 

 

3,972

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

1,901,810

 

516,190

 

2,007

 

(986,855

)

1,433,152

 

 

 

 

 

 

 

 

 

 

 

 

 

Member’s Equity:

 

 

 

 

 

 

 

 

 

 

 

Member units

 

550,144

 

 

1

 

(1

)

550,144

 

Additional paid-in capital

 

 

99,943

 

 

(99,943

)

 

Investment in Number Holdings, Inc. preferred stock

 

(19,200

)

 

 

 

(19,200

)

Accumulated deficit

 

(250,751

)

(37,203

)

(498

)

37,701

 

(250,751

)

Other comprehensive loss

 

(124

)

 

 

 

(124

)

 

 

 

 

 

 

 

 

 

 

 

 

Total equity

 

280,069

 

62,740

 

(497

)

(62,243

)

280,069

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and equity

 

$

2,181,879

 

$

578,930

 

$

1,510

 

$

(1,049,098

)

$

1,713,221

 

 

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CONDENSED CONSOLIDATING BALANCE SHEETS

As of January 30, 2015

(In thousands)

 

 

 

Issuer

 

Subsidiary
Guarantors

 

Non-
Guarantor
Subsidiaries

 

Consolidating
Adjustments

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

11,333

 

$

1,097

 

$

33

 

$

 

$

12,463

 

Accounts receivable, net

 

1,844

 

110

 

 

 

1,954

 

Income taxes receivable

 

10,911

 

 

 

 

10,911

 

Deferred income taxes

 

41,583

 

 

 

 

41,583

 

Inventories, net

 

263,284

 

32,756

 

 

 

296,040

 

Assets held for sale

 

1,680

 

1,414

 

 

 

3,094

 

Other

 

18,023

 

1,005

 

11

 

 

19,039

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current assets

 

348,658

 

36,382

 

44

 

 

385,084

 

Property and equipment, net

 

517,739

 

63,251

 

30

 

 

581,020

 

Deferred financing costs, net

 

15,463

 

 

 

 

15,463

 

Equity investments and advances to subsidiaries

 

451,053

 

357,842

 

 

(808,895

)

 

Intangible assets, net

 

458,043

 

2,268

 

 

 

460,311

 

Goodwill

 

479,745

 

 

 

 

479,745

 

Deposits and other assets

 

7,040

 

503

 

 

 

7,543

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,277,741

 

$

460,246

 

$

74

 

$

(808,895

)

$

1,929,166

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBER’S EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

136,884

 

$

2,403

 

$

 

$

 

$

139,287

 

Intercompany payable

 

357,909

 

377,382

 

567

 

(735,858

)

 

Payroll and payroll-related

 

18,489

 

1,515

 

 

 

20,004

 

Sales tax

 

13,562

 

525

 

 

 

14,087

 

Other accrued expenses

 

37,756

 

2,375

 

37

 

 

40,168

 

Workers’ compensation

 

70,416

 

75

 

 

 

70,491

 

Current portion of long-term debt

 

6,138

 

 

 

 

6,138

 

Current portion of capital and financing lease obligation

 

380

 

 

 

 

380

 

 

 

 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

641,534

 

384,275

 

604

 

(735,858

)

290,555

 

Long-term debt, net of current portion

 

901,395