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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 July 29, 2016

 

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 September 7, 2016, 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

 

Part I - Financial Information

 

 

 

Page

Item 1.

Financial Statements

4

 

Consolidated Balance Sheets as of July 29, 2016 (unaudited) and January 29, 2016

4

 

Consolidated Statements of Comprehensive Income (Loss) for the second quarter and first half ended July 29, 2016 (unaudited) and July 31, 2015 (unaudited)

5

 

Consolidated Statements of Cash Flows for the first half ended July 29, 2016 (unaudited) and July 31, 2015 (unaudited)

6

 

Notes to Consolidated Financial Statements

7

Item 2.

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

35

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

45

Item 4.

Controls and Procedures

46

 

Part II — Other Information

 

Item 1.

Legal Proceedings

47

Item 1A.

Risk Factors

47

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

47

Item 3.

Defaults Upon Senior Securities

47

Item 4.

Mine Safety Disclosures

47

Item 5.

Other Information

47

Item 6.

Exhibits

48

 

Signatures

49

 

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 29, 2016 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)

 

 

 

July 29,
2016

 

January 29,
2016

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash

 

$

2,309

 

$

2,312

 

Accounts receivable, net of allowance for doubtful accounts of $48 and $140 at July 29, 2016 and January 29, 2016, respectively

 

1,481

 

1,674

 

Income taxes receivable

 

2,279

 

3,665

 

Inventories, net

 

175,575

 

196,651

 

Assets held for sale

 

2,308

 

2,308

 

Other

 

18,550

 

18,603

 

Total current assets

 

202,502

 

225,213

 

Property and equipment, net

 

530,858

 

542,570

 

Deferred financing costs, net

 

4,496

 

916

 

Intangible assets, net

 

450,293

 

453,242

 

Goodwill

 

387,772

 

387,772

 

Deposits and other assets

 

8,470

 

7,319

 

Total assets

 

$

1,584,391

 

$

1,617,032

 

LIABILITIES AND MEMBER’S EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

104,839

 

$

79,197

 

Payroll and payroll-related

 

21,124

 

18,421

 

Sales tax

 

9,995

 

13,314

 

Other accrued expenses

 

43,652

 

41,464

 

Workers’ compensation

 

74,632

 

76,389

 

Current portion of long-term debt

 

6,138

 

6,138

 

Current portion of capital and financing lease obligations

 

29,693

 

989

 

Total current liabilities

 

290,073

 

235,912

 

Long-term debt, net of current portion

 

848,005

 

875,843

 

Unfavorable lease commitments, net

 

4,850

 

5,746

 

Deferred rent

 

27,756

 

27,389

 

Deferred compensation liability

 

773

 

709

 

Capital and financing lease obligation, net of current portions

 

36,547

 

34,817

 

Deferred income taxes

 

163,045

 

163,045

 

Other liabilities

 

4,618

 

5,118

 

Total liabilities

 

1,375,667

 

1,348,579

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Member’s Equity:

 

 

 

 

 

Member units — 100 units issued and outstanding at July 29, 2016 and January 29, 2016

 

550,614

 

550,226

 

Investment in Number Holdings, Inc. preferred stock

 

(19,200

)

(19,200

)

Accumulated deficit

 

(322,690

)

(262,411

)

Other comprehensive loss

 

 

(162

)

Total equity

 

208,724

 

268,453

 

Total liabilities and equity

 

$

1,584,391

 

$

1,617,032

 

 

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 Second Quarter Ended

 

For the First Half Ended

 

 

 

July 29,
2016

 

July 31,
2015

 

July 29,
2016

 

July 31,
2015

 

Net Sales:

 

 

 

 

 

 

 

 

 

99¢ Only Stores

 

$

487,460

 

$

477,327

 

$

989,226

 

$

972,135

 

Bargain Wholesale

 

8,998

 

11,195

 

20,161

 

22,556

 

Total sales

 

496,458

 

488,522

 

1,009,387

 

994,691

 

Cost of sales

 

355,258

 

352,647

 

719,220

 

702,193

 

Gross profit

 

141,200

 

135,875

 

290,167

 

292,498

 

Selling, general and administrative expenses

 

159,485

 

154,544

 

316,714

 

304,716

 

Operating loss

 

(18,285

)

(18,669

)

(26,547

)

(12,218

)

Other (income) expense:

 

 

 

 

 

 

 

 

 

Interest income

 

(36

)

 

(38

)

(3

)

Interest expense

 

16,784

 

16,481

 

33,310

 

32,753

 

Loss on extinguishment

 

 

 

335

 

 

Total other expense, net

 

16,748

 

16,481

 

33,607

 

32,750

 

Loss before provision for income taxes

 

(35,033

)

(35,150

)

(60,154

)

(44,968

)

Provision for income taxes

 

52

 

42,951

 

125

 

31,962

 

Net loss

 

$

(35,085

)

$

(78,101

)

$

(60,279

)

$

(76,930

)

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on interest rate cash flow hedge

 

46

 

(65

)

(168

)

(141

)

Less: reclassification adjustment included in net income

 

(49

)

240

 

330

 

483

 

Other comprehensive (loss) income, net of tax

 

(3

)

175

 

162

 

342

 

Comprehensive loss

 

$

(35,088

)

$

(77,926

)

$

(60,117

)

$

(76,588

)

 

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 Half Ended

 

 

 

July 29, 2016

 

July 31, 2015

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(60,279

)

$

(76,930

)

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

 

 

 

 

 

Depreciation

 

33,520

 

32,667

 

Amortization of deferred financing costs and accretion of OID

 

2,941

 

2,305

 

Amortization of intangible assets

 

875

 

887

 

Amortization of favorable/unfavorable leases, net

 

1,193

 

880

 

Loss (gain) on disposal of fixed assets

 

293

 

(48

)

Loss on interest rate hedge

 

514

 

743

 

Loss on extinguishment of debt

 

335

 

 

Long-lived assets impairment

 

 

478

 

Deferred income taxes

 

 

31,785

 

Stock-based compensation

 

388

 

1,408

 

Changes in assets and liabilities associated with operating activities:

 

 

 

 

 

Accounts receivable

 

193

 

293

 

Inventories

 

21,076

 

20,890

 

Deposits and other assets

 

(1,548

)

6,471

 

Accounts payable

 

26,591

 

(38,902

)

Accrued expenses

 

1,328

 

(7,623

)

Accrued workers’ compensation

 

(1,757

)

(1,125

)

Income taxes

 

1,278

 

(27

)

Deferred rent

 

367

 

2,195

 

Other long-term liabilities

 

(272

)

1,046

 

Net cash provided by (used in) operating activities

 

27,036

 

(22,607

)

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(23,960

)

(43,685

)

Proceeds from sale of property and fixed assets

 

612

 

1,439

 

Net cash used in investing activities

 

(23,348

)

(42,246

)

Cash flows from financing activities:

 

 

 

 

 

Payments of long-term debt

 

(3,069

)

(3,069

)

Proceeds under revolving credit facility

 

92,200

 

275,450

 

Payments under revolving credit facility

 

(119,100

)

(225,850

)

Payments of debt issuance costs

 

(4,725

)

 

Proceeds from financing lease obligations

 

31,503

 

8,666

 

Payments of capital and financing lease obligations

 

(500

)

(55

)

Payments to repurchase stock options of Number Holdings, Inc.

 

 

(390

)

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

 

 

(57

)

Net cash (used in) provided by financing activities

 

(3,691

)

54,695

 

Net decrease in cash

 

(3

)

(10,158

)

Cash - beginning of period

 

2,312

 

12,463

 

Cash - end of period

 

$

2,309

 

$

2,305

 

Supplemental cash flow information:

 

 

 

 

 

Income taxes (refunded) paid

 

$

(1,152

)

$

203

 

Interest paid

 

$

30,667

 

$

30,889

 

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

 

$

949

 

$

14,710

 

 

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 29, 2016) 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 July 29, 2016, the Company operated 394 retail stores with 287 in California, 48 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 (“CPPIB”).  As a result of the Merger, the Company’s common stock was delisted from the New York Stock Exchange and the Company 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 29, 2016.  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 27, 2017 (“fiscal 2017”).

 

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 2017 began on January 30, 2016, will end on January 27, 2017 and will consist of 52 weeks.  The Company’s fiscal year 2016 (“fiscal 2016”) began on January 31, 2015, ended on January 29, 2016 and consisted of 52 weeks.  The second quarter ended July 29, 2016 (the “second quarter of fiscal 2017”) and the second quarter ended July 31, 2015 (the “second quarter of fiscal 2016”) were each comprised of 91 days.  The six-month period ended July 29, 2016 (the “first half of fiscal 2017”) and the six-month period ended July 31, 2015 (the “first half of fiscal 2016”) were each comprised of 182 days.

 

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.

 

Reclassification

 

Certain prior year amounts have been reclassified to conform to the current year’s presentation. Specifically, the Company adopted Accounting Standard Update(“ASU”)  No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs” in the first quarter of fiscal 2017, which requires the Company 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. The adoption of this accounting standard resulted in the reclassification of $11.5 million of debt issuance costs (net of accumulated amortization) from deferred financing costs,

 

7



Table of Contents

 

net to long-term debt, net of current portion on the Company’s consolidated balance sheet at January 29, 2016.  The Company also early adopted Accounting Standard Update No. 2015-17, “Balance Sheet Classification of Deferred Taxes” in the first quarter of fiscal 2017, which requires that all deferred tax assets and liabilities be classified as long-term on the balance sheet.  The adoption of this accounting standard resulted in the reclassification of $16.6 million of deferred income tax from current assets to long-term deferred income taxes liability on the Company’s consolidated balance sheet at January 29, 2016.

 

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 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 $8.6 million and $7.9 million as of July 29, 2016 and January 29, 2016, 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 or tenant’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 costs are 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.  The Company includes spoilage, scrap and shrink in its definition of shrinkage.  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 have a material effect on the reported gross margin for the period. These estimates are subject to change based on management’s evaluation of, and response to, a variety of factors and trends, including, but not limited to, consumer preferences and buying patterns, age of inventory, increased competition, inventory management, merchandising strategies and historical sell through trends.  The Company’s ability to adequately evaluate the impact of inventory management and merchandising strategies executed in response to such factors and trends in future periods could have a material impact on such estimates.

 

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

 

8



Table of Contents

 

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 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 each of the second quarter and first half of fiscal 2017, the Company did not record any long-lived asset impairment charges.  During the second quarter of fiscal 2016, due to the underperformance of one store in Texas, the Company concluded that the carrying value of its long-lived assets was not recoverable and accordingly recorded an asset impairment charge of $0.5 million.

 

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.

 

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”).

 

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 retail reporting unit and the wholesale reporting unit.

 

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The Company, assisted by an independent third party valuation firm, 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”). These approaches involve making key 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 and are subject to change.

 

During the third quarter of fiscal 2016, the Company determined that indicators of impairment existed to require an interim impairment analysis of goodwill and trade name, including (i) overall performance deterioration reflected in decreased comparable same-store sales and cannibalization from stores opened in fiscal 2015 under an accelerated expansion program, (ii) increases in inventory shrinkage and buildup of excess inventory, (iii) decreased margin due to disappointing results from sales promotions and (iv) a decision to delay the pace of future store openings.  The first step evaluation concluded that the fair value of the retail reporting unit was below its carrying value.  The Company performed step two of the goodwill impairment test 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, including consideration of the fair value of tangible property and intangible assets.  As a result of this preliminary analysis and based on 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 finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in a $28.0 million adjustment in goodwill, lowering the estimated third quarter of fiscal 2016 goodwill impairment charge from $120.0 million to $92.0 million.

 

The remaining amount of goodwill allocated to the retail reporting unit and wholesale reporting unit was $375.2 million and $12.5 million, respectively, as of January 29, 2016.

 

During the fourth quarter of fiscal 2016, the Company completed step one of its annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of the Company’s reporting units exceeded their carrying amounts.  As discussed above, considerable management judgment is necessary in estimating future cash flows, market interest rates, discount rates and other factors affecting the valuation of goodwill.  The Company’s forecasts used in its fiscal 2016 annual impairment test include growth in net sales, new store openings and same-store sales, positive trends in cost of sales and selling, general and administrative expense.  In each case, these estimates and assumptions could be materially affected by factors such as unforeseen events or changes in general economic conditions, a decline in comparable company market multiples, changes to discount rates, increased competitive forces, inability to maintain pricing structure, deterioration of vendor relationships, failure to adequately manage and improve inventory processes and procedures and changes in customer behavior which could result in changes to management’s strategies.  If operating results continue to change versus the Company’s expectations, additional impairment charges may be recorded in the future.

 

Additionally, during the fourth quarter of fiscal 2016, the Company completed its annual indefinite-lived intangible asset impairment test and determined there was no impairment to the trade name since the fair value of the trade name exceeded its carrying amount.  The results of this test showed that the fair value of trade name exceeded carrying value by approximately 12%.  The relief from royalty method estimates our theoretical royalty savings from ownership of the intangible asset.  Key assumptions used in this model included sales projections, discount rates and royalty rates, and considerable management judgment is necessary in developing and evaluating such assumptions.  If future results are not consistent with current estimates and assumptions, impairment charges maybe recorded in future.

 

During the first half of fiscal 2017, 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.

 

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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.  The fair value of options that vest based on the Company’s and Parent’s achievement of certain performance hurdles were valued using a Monte Carlo simulation method. The fair value of options granted to the current Chief Executive Officer were valued using a binomial model and the Monte Carlo simulation method.  Refer to Note 8, “Stock-Based Compensation” for further discussion of the Company’s 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 shrink, 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 or based on other systematic and rational approaches where possible.

 

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.

 

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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.

 

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 July 29, 2016 and January 29, 2016.

 

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.

 

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.

 

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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):

 

 

 

July 29, 2016

 

January 29, 2016

 

 

 

Gross
Carrying
Amount

 

Impairment
Losses

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Impairment
Losses

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Indefinite lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

479,745

 

$

(91,973

)

$

 

$

387,772

 

$

479,745

 

$

(91,973

)

$

 

$

387,772

 

Trade name

 

410,000

 

 

 

410,000

 

410,000

 

 

 

410,000

 

Total indefinite lived intangible assets

 

$

889,745

 

$

(91,973

)

$

 

$

797,772

 

$

889,745

 

$

(91,973

)

$

 

$

797,772

 

Finite lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks

 

$

2,000

 

$

(570

)

$

(438

)

$

992

 

$

2,000

 

$

(570

)

$

(405

)

$

1,025

 

Bargain Wholesale customer relationships

 

20,000

 

 

(7,580

)

12,420

 

20,000

 

 

(6,752

)

13,248

 

Favorable leases

 

46,543

 

(566

)

(19,096

)

26,881

 

46,543

 

(566

)

(17,008

)

28,969

 

Total finite lived intangible assets

 

68,543

 

(1,136

)

(27,114

)

40,293

 

68,543

 

(1,136

)

(24,165

)

43,242

 

Total goodwill and other intangible assets

 

$

958,288

 

$

(93,109

)

$

(27,114

)

$

838,065

 

$

958,288

 

$

(93,109

)

$

(24,165

)

$

841,014

 

 

 

 

July 29, 2016

 

January 29, 2016

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unfavorable leases

 

$

19,835

 

$

(14,985

)

$

4,850

 

$

19,835

 

$

(14,089

)

$

5,746

 

 

3.                                      Property and Equipment, net

 

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

 

 

 

July 29,
2016

 

January 29,
2016

 

Land

 

$

170,211

 

$

170,871

 

Buildings

 

111,205

 

111,205

 

Buildings improvements

 

76,573

 

74,157

 

Leasehold improvements

 

200,688

 

192,405

 

Fixtures and equipment

 

208,708

 

194,671

 

Transportation equipment

 

11,726

 

11,835

 

Construction in progress

 

14,582

 

18,073

 

Total property and equipment

 

793,693

 

773,217

 

Less: accumulated depreciation and amortization

 

(262,835

)

(230,647

)

 

 

 

 

 

 

Property and equipment, net

 

$

530,858

 

$

542,570

 

 

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4.                                      Comprehensive Income

 

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

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

July 29,
2016

 

July 31,
2015

 

July 29,
2016

 

July 31,
2015

 

Net loss

 

$

(35,085

)

$

(78,101

)

$

(60,279

)

$

(76,930

)

Unrealized gain (loss) on interest rate cash flow hedge, net of tax effects of $(112), $(43), $(112) and $(94) for the second quarter and first half of each of fiscal 2017 and fiscal 2016, respectively

 

46

 

(65

)

(168

)

(141

)

Reclassification adjustment, net of tax effects of $220, $159, $220 and $321 for the second quarter and first half of each of fiscal 2017 and fiscal 2016, respectively

 

(49

)

240

 

330

 

483

 

Total (losses) gains, net

 

(3

)

175

 

162

 

342

 

Total comprehensive loss

 

$

(35,088

)

$

(77,926

)

$

(60,117

)

$

(76,588

)

 

Amounts in accumulated other comprehensive income (loss) as of January 29, 2016 consisted of unrealized losses on interest rate cash flow hedges.  Reclassifications out of AOCI in each of the second quarter and first half of fiscal 2017 and fiscal 2016 are presented in Note 6, “Derivative Financial Instruments.”

 

5.                                      Debt

 

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

 

 

 

July 29,
2016

 

January 29,
2016

 

ABL Facility

 

$

20,900

 

$

47,800

 

First Lien Term Loan Facility, maturing on January 13, 2019, payable in quarterly installments of $1,535, plus interest through December 31, 2018, with unpaid principal and accrued interest due on January 13, 2019, net of unamortized OID of $3,588 and $4,724 as of July 29, 2016 and January 29, 2016, respectively

 

593,343

 

595,726

 

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

 

250,000

 

250,000

 

Deferred financing costs

 

(10,100

)

(11,545

)

Total debt

 

854,143

 

881,981

 

Less: current portion

 

6,138

 

6,138

 

Long-term debt, net of current portion

 

$

848,005

 

$

875,843

 

 

As of July 29, 2016 and January 29, 2016, the net deferred financing costs are as follows (in thousands):

 

Deferred financing costs

 

July 29,
2016

 

January 29,
2016

 

ABL Facility (included in non-current deferred financing costs)

 

$

4,496

 

$

916

 

First Lien Term Loan Facility (included in long-term debt, net of current portion)

 

3,683

 

4,387

 

Senior Notes (included in long-term debt, net of current portion)

 

6,417

 

7,158

 

Total deferred financing costs, net

 

$

14,596

 

$

12,461

 

 

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 asset 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

 

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Facility has 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 domestic subsidiaries (with customary exceptions, including immaterial subsidiaries) (collectively, the “Credit Facilities Guarantors”).  In addition, the First Lien Term Loan Facility is secured by substantially all of the Company’s assets and the assets of the Credit Facilities Guarantors, including a first priority pledge of all of the Company’s equity interests and the equity interests of the Credit Facilities Guarantors and a first priority security interest in certain other fixed assets, and a second priority security interest in certain current assets.

 

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” (3.50% as of July 29, 2016), (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) a Eurocurrency rate determined by reference to the London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserve requirements, for the interest period relevant to such borrowing.

 

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 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%.

 

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%.  Upon the occurrence of the Second Amendment, the Company’s obligation to make scheduled quarterly payments on the Term Loans was increased to require the Company 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 July 29, 2016, 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 July 29, 2016, the gross 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 2016.

 

The First Lien Term Loan Facility includes certain customary restrictions, among other things, on the Company’s ability and the ability of Parent, the Credit Facilities Guarantors (including the Company’s subsidiary 99 Cents Only Stores Texas Inc.) 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 July 29, 2016, 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.

 

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ABL Facility

 

The ABL Facility initially was to mature on January 13, 2017 and 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, including a first priority security interest in certain current assets, and a second priority pledge of all of the Company’s equity interests and the equity interest of the Credit Facilities Guarantors and a second priority security interest in certain other fixed assets.

 

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 (3.00% as of July 29, 2016) or (ii) the determined base rate (Prime Rate) plus an applicable margin to be determined (2.00% at July 29, 2016), 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 (0.5% for the quarter ended July 29, 2016).  The Company must also pay customary letter of credit fees and agency fees.

 

As of July 29, 2016, borrowings under the ABL Facility were $20.9 million, outstanding letters of credit were $14.6 million and availability under the ABL Facility subject to the borrowing base, was $76.3 million.  As of January 29, 2016, borrowings under the ABL Facility were $47.8 million, outstanding letters of credit were $2.5 million and availability under the ABL Facility subject to the borrowing base, was $90.9 million, prior to giving effect to a subsequent amendment to the ABL Facility on April 8, 2016 that decreased commitments available under the ABL Facility by $25.0 million.

 

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 (i) modified 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, (ii) increased the inventory advance rate during such period for purposes of calculating the borrowing base from 90% to 92.5%, (iii) provided 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 (iv) provided for certain additional technical waivers and amendments in order to effect the foregoing.

 

On April 8, 2016, the Company amended its ABL Facility to, among other things, decrease the commitments available under the ABL Facility by $25.0 million, resulting in an aggregate facility size of $160.0 million, and extend the maturity date of the ABL Facility to April 8, 2021; provided however, the ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of the First Lien Term Loan Facility and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes (as defined below), unless the First Lien Term Loan Facility and Senior Notes have been repaid or refinanced in full or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021 (the date of such repayment or refinancing, the “Term/Notes Refinancing Date”) (such amendment, the “Fourth Amendment”).  The Fourth Amendment also modified the interest rate margins payable under the ABL Facility.  The initial applicable margin for borrowings under the ABL Facility is 2.0% with respect to base rate borrowings and 3.0% with respect to Eurocurrency rate borrowings.  Commencing with the first day of the first fiscal quarter commencing after the closing of the Fourth Amendment, the applicable margin for borrowings thereunder is subject to adjustment each fiscal quarter, based on average historical excess availability during the preceding fiscal quarter.  Furthermore, the applicable margin will be reduced by 0.50% after the Term/Notes Refinancing Date.

 

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In addition, the Fourth Amendment (i) reduced the incremental revolving commitment capacity from $50.0 million to $25.0 million, but provides that any such incremental revolving commitment may take the form of a “last-out” term loan, (ii) added restrictions on certain negative covenants in respect of investments, restricted payments and prepayments of indebtedness, including the First Lien Term Loan Facility and the Senior Notes, in each case, until the occurrence of Term/Notes Refinancing Date, (iii) reduced the letter of credit sublimit from $50.0 million to $45.0 million and (iv) provided for certain additional technical waivers and amendments in order to effect the foregoing.

 

In connection with the Fourth Amendment and in the first quarter of fiscal 2017, the Company recognized a loss on debt extinguishment of approximately $0.3 million related to a portion of the unamortized debt issuance costs. The Company recorded $4.7 million of debt issuance costs in connection with the Fourth Amendment in the first quarter of fiscal 2017 as part of non-current deferred financing costs.

 

As of July 29, 2016, 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 (the “Subsidiary Guarantors”).

 

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 July 29, 2016, the Company was in compliance with the terms of the Indenture.

 

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

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

July 29,
2016

 

July 31,
2015

 

July 29,
2016

 

July 31,
2015

 

First Lien Term Loan Facility

 

$

6,907

 

$

7,257

 

$

14,136

 

$

14,505

 

ABL Facility

 

569

 

668

 

1,124

 

1,189

 

Senior Notes

 

6,875

 

6,875

 

13,750

 

13,826

 

Amortization of deferred financing costs and OID

 

1,638

 

1,159

 

2,940

 

2,305

 

Other interest expense

 

795

 

522

 

1,360

 

928

 

Interest expense

 

$

16,784

 

$

16,481

 

$

33,310

 

$

32,753

 

 

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, hedged 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 was 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 was highly correlated to the changes in interest rates to which the Company is exposed.  Unrealized gains and losses on the interest rate swap were designated as effective or ineffective.  The effective portion of such gains or losses was recorded as a component of AOCI or loss, while the ineffective portion of such gains or losses was recorded as a component of interest expense.  Realized gains and losses in connection with each required interest payment were reclassified from AOCI or loss to interest expense.

 

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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 July 29, 2016 and January 29, 2016. 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 was 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):

 

 

 

July 29,
2016

 

January 29,
2016

 

 

 

 

 

 

 

Derivatives designated as cash flow hedging instruments

 

 

 

 

 

Interest rate swap (included in other current liabilities)

 

$

 

$

569

 

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

 

$

 

$

162

 

Derivatives not designated as hedging instruments

 

 

 

 

 

Transition payments (included in other current liabilities)

 

$

715

 

$

1,033

 

Transition payments (included in other long-term liabilities)

 

$

112

 

$

172

 

 

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

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

July 29,
2016

 

July 31,
2015

 

July 29,
2016

 

July 31,
2015

 

 

 

 

 

 

 

 

 

 

 

Derivatives designated as cash flow hedging instruments:

 

 

 

 

 

 

 

 

 

(Gain) loss related to effective portion of derivative recognized in OCI

 

$

(46

)

$

65

 

$

168

 

$

141

 

(Gain) loss related to effective portion of derivatives reclassified from AOCI to interest expense

 

$

(49

)

$

240

 

$

330

 

$

483

 

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

 

$

65

 

$

(15

)

$

36

 

$

(61

)

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

Loss recognized in selling, general and administrative expenses

 

$

665

 

$

 

$

1,534

 

$

 

 

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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) as of July 29, 2016:

 

 

 

July 29, 2016

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Other assets — assets that fund deferred compensation

 

$

773

 

$

773

 

$

 

$

 

LIABILITIES

 

 

 

 

 

 

 

 

 

Other current liabilities — transition payments

 

$

715

 

$

 

$

 

$

715

 

Other long-term liabilities — transition payments

 

$

112

 

$

 

$

 

$

112

 

Other long-term liabilities — deferred compensation

 

$

773

 

$

773

 

$

 

$

 

 

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

 

There were no Level 2 assets or liabilities as of July 29, 2016.

 

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 half of fiscal 2017.

 

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) as of January 29, 2016:

 

 

 

January 29, 2016

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Other assets — assets that fund deferred compensation

 

$

709

 

$

709

 

$

 

$

 

LIABILITES

 

 

 

 

 

 

 

 

 

Other current liabilities — interest rate swap

 

$

569

 

$

 

$

569

 

$

 

Other current liabilities — transition payments

 

$

1,033

 

$

 

$

 

$

1,033

 

Other long-term liabilities — transition payments interest rate swap

 

$

172

 

$

 

$

 

$

172

 

Other long-term liabilities — deferred compensation

 

$

709

 

$

709

 

$

 

$

 

 

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

 

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

 

Transition Payments

 

For the Second Quarter Ended

 

For the First Half Ended

 

Description

 

July 29, 2016

 

July 31, 2015

 

July 29, 2016

 

July 31, 2015

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

(1,222

)

$

 

$

(1,205

)

$

 

Transfers in and/or out of Level 3

 

 

 

 

 

Total realized/unrealized gains (loss):

 

 

 

 

 

 

 

 

 

Included in earnings (1)

 

(665

)

 

(1,534

)

 

Included in other comprehensive loss

 

 

 

 

 

Purchases, redemptions and settlements:

 

 

 

 

 

 

 

 

 

Settlements

 

1,060

 

 

1,912

 

 

Ending balance

 

$

(827

)

$

 

$

(827

)

$

 

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

 

$

(314

)

$

 

$

(564

)

$

 

 


(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 and deferred financing costs.

 

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 July 29, 2016 and January 29, 2016.

 

The fair value of the First Lien Term Loan Facility was estimated at $465.6 million, or $131.3 million lower than its carrying value, as of July 29, 2016, based on quoted market prices of the debt (Level 1 inputs).  The fair value of the First Lien Term Loan Facility was estimated at $393.0 million, or $207.0 million lower than its carrying value, as of January 29, 2016, based on quoted market prices of the debt (Level 1 inputs).

 

The fair value of the Senior Notes was estimated at $131.9 million, or $118.1 million lower than the carrying value, as of July 29, 2016, based on quoted market prices of the debt (Level 1 inputs).  The fair value of the Senior Notes was estimated at $103.1 million, or $146.9 million lower than the carrying value, as of January 29, 2016, 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 (the “Board”) adopted the Number Holdings, Inc. 2012 Stock Incentive Plan (the “2012 Plan”). On July 26, 2016, the 2012 Plan was amended to increase the aggregate number of shares authorized for issuance under the 2012 Plan to 87,500 shares of Class A Common Stock of Parent and 87,500 shares of Class B Common Stock of Parent.  Prior to the increase, the 2012 Plan authorized 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 July 29, 2016, options for 82,120 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 subject to time-vesting conditions granted to employees generally become exercisable over a four or five year service period and have terms of ten years from the date of grant. Options with performance-vesting conditions granted to employees generally become exercisable based on the achievement of certain performance targets and have terms of ten years from the date of grant.

 

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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. 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. 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 21,791 time-based and 17,834 performance-based employee options outstanding (for individuals other than board members, Mr. Covert and Ms. Thornton) as of July 29, 2016.

 

During the second quarter of fiscal 2017, Parent provided certain employee option holders an opportunity to exchange their outstanding non-qualified stock options for options with an exercise price of $757 per share. On July 26, 2016, the Compensation Committee of Parent canceled 15,555 of the outstanding options with an exercise price higher than $757 per share and granted new options to holders of the canceled options with an exercise price of $757 per share.  The new options have a grant date of July 26, 2016, are vested to the same extent as the canceled options and have terms of ten years. New options subject to time-vesting conditions vest over a five-year service period and performance-vested options vest upon achievement of certain performance targets. The exchange was treated as a modification of stock options for accounting purposes and had no impact on compensation expense.  The fair value of new time-vested and performance-vested options was estimated at the date of modification using the Black-Scholes pricing model.

 

In the fourth quarter of fiscal 2016, 5,000 options were granted to the new Chief Merchandising Officer of the Company and Parent, which will vest based on the achievement of certain performance targets.  The Company has deferred recognition of the stock-based compensation expense for these performance-based stock options due to repurchase rights and transfer restrictions included in the terms of the award.  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 these performance-based options until it is probable that the performance targets will be achieved.  The fair value of these performance-based options was estimated at the date of grant using the Black-Scholes pricing model. On July 26, 2016, the Compensation Committee of Parent amended these options to conform the vesting conditions for the performance-vested options with those granted to other employees. The amendment of the performance hurdles was treated as a modification of stock options for accounting purposes and had no impact on compensation expense.  The Company has continued to defer recognition of the stock-based compensation expense for the amended performance-based options.  The fair value of these performance-based options was estimated at the date of modification using the Black-Scholes pricing model.

 

Director Option Grants

 

Options granted to board members generally become exercisable over a three, four or five year service period and have terms of ten years from the date of grant.  Options granted to 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.  On July 26, 2016, the Compensation Committee of Parent amended 1,000 previously granted board member options with exercise prices in excess of $757 per share to lower the exercise price to $757 per share. The reduction in the exercise price was treated as a modification of stock options for accounting purposes.  The modification, based on the fair value of the options both immediately before and after such modification, resulted in a total incremental compensation expense of less than $0.1 million in the second quarter of fiscal 2017.

 

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Chief Financial Officer Equity Awards

 

In October 2015, the Company entered into an employment agreement with Felicia Thornton as the Chief Financial Officer and Treasurer of each of the Company and Parent. In connection with this agreement, Ms. Thornton was granted options to purchase 10,000 shares of Class A and Class B Common Stock of Parent.  One-half of the options vest on each of the first four anniversaries of Ms. Thornton’s start date, and the other half of the options vest based on the achievement of certain performance targets. Options granted to Ms. Thornton contain repurchase rights as described above that would allow the Parent to repurchase these options at less than fair value, except that repurchase rights at less than fair value in the case of voluntary resignation without good reason lapse after November 2, 2017.

 

The Company records stock-based compensation for the time-based options in accordance with the four year vesting period.  The Company has deferred recognition of the stock-based compensation expense for the performance-based options until it is probable that the performance targets will be achieved.  The time-based and performance-based options are accounted for as equity awards.  The fair value of these time-based and performance-based options was estimated at the date of grant using the Black-Scholes pricing model.

 

On July 26, 2016, the Compensation Committee of Parent amended Ms. Thornton’s performance-based options to conform the vesting conditions for the performance-vested options with those granted to other employees.  The amendment of the performance targets was treated as a modification of stock options for accounting purposes and had no impact on compensation expense.  The Company has continued to defer recognition of the stock-based compensation expense for the amended performance-based options.  The fair value of these amended performance-based options was estimated at the date of modification using the Black-Scholes pricing model.

 

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 due to repurchase rights and transfer restrictions included in the terms of the award. 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.  The fair value of the grant with an exercise price of $1,000 per share was estimated at the date of grant using a binomial model.  The fair value of the other grant was estimated at the date of grant using a Monte Carlo simulation method.

 

On July 26, 2016, the Compensation Committee of Parent amended Mr. Covert’s performance-based options to conform the vesting conditions for the performance-vested options with those granted to other employees.  The amendment of the performance hurdles was treated as a modification of stock options for accounting purposes and had no impact on compensation expense.  The Company has continued to defer recognition of the stock-based compensation expense for the amended performance-based options.  The fair value of the grant with an exercise price of $1,000 per share was estimated at the date of modification using a binomial model.  The fair value of the other grant was estimated at the date of modification using a Monte Carlo simulation method.

 

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 second quarter and first half of fiscal 2017, the Company recorded stock-based compensation expense of $0.2 million and $0.4 million, respectively.  During the second quarter and first half of fiscal 2016, the Company recorded stock-based compensation expense of $0.8 million and $1.4 million, respectively.

 

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Table of Contents

 

The following summarizes stock option activity in the first half of fiscal 2017:

 

 

 

Number of
Shares

 

Weighted Average
Exercise Price

 

Weighted Average
Remaining
Contractual Life
(Years)

 

Options outstanding at the beginning of the period

 

69,585

 

$

910

 

 

 

Granted

 

29,740

(a)

$

757

 

 

 

Exercised

 

 

$

 

 

 

Cancelled

 

(17,205

)(b)

$

1,147

 

 

 

Outstanding at the end of the period

 

82,120

 

$

801

 

9.4

 

Exercisable at the end of the period

 

9,523

 

$

763

 

9.6

 

 


(a)         Includes 12,916 options granted to employees that will vest based on the achievement of certain performance targets.

(b)         Includes cancellation of 15,555 options in exchange for options with new terms.

 

The following table summarizes the stock awards available for grant under the 2012 Plan as of July 29, 2016:

 

 

 

Number of Shares

 

Available for grant as of January 29, 2016

 

14,725

 

Authorized

 

2,500

 

Granted

 

(29,740

)

Cancelled

 

17,205

 

Available for grant at July 29, 2016

 

4,690

 

 

9.                                      Related-Party Transactions

 

First Lien Term Loan 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 29, 2016, these affiliates no longer held any term loans under the First Lien Term Loan.  As of July 29, 2016, funds affiliated with Ares and CPPIB held approximately $131.2 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.

 

Senior Notes

 

As of July 29, 2016 and January 29, 2016 various funds affiliated with Ares and CPPIB 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 half of fiscal 2017 was a provision rate of (0.2)% compared to a provision rate of rate of (71.1)% for the first half of fiscal 2016.  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 establishment of a valuation allowance against deferred tax assets in the second quarter of fiscal 2016 as discussed below, and the effect of not recognizing the benefit of losses incurred in fiscal 2017 in jurisdictions where the Company concluded it is 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 quarters prior to the recording of a valuation allowance in the second quarter of fiscal 2016, the Company weighed all available positive and negative evidence and determined that it was more likely than not that the deferred tax assets were fully realizable.  In fiscal 2016, the Company’s management had begun to take meaningful steps to focus on the operational execution of the initiatives launched in fiscal 2015, which were expected to drive performance improvements over the

 

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second and third quarters of fiscal 2016.  However, in the second quarter of fiscal 2016, the Company’s experienced (i) margin declines due to short-term sales promotions, (ii) delays in sales growth due to cannibalization from new store openings, (iii) increased inventory shrinkage from a buildup of inventory levels, and (iv) increases in support costs as a percentage of sales.  As a result of these second quarter of fiscal 2016 events, the Company decided to adjust merchandise pricing strategies, delay the pace of future store openings for the remainder of fiscal 2016, revise inventory shrinkage processes and establish selling, general and administrative cost control measures.  The Company concluded that until the performance issues identified in the second quarter of fiscal 2016 showed improvement, it was more likely than not that the Company would not realize its net deferred tax assets, and therefore the Company recorded a $31.7 million increase to provision for income taxes in order to establish a valuation allowance against such net deferred tax assets.

 

As of January 29, 2016, the valuation allowance increased to $81.8 million, which was primarily related to an increase in losses incurred during 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 indefinite-lived 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.

 

As of July 29, 2016 and January 29, 2016, the Company had not accrued any liabilities related to unrecognized tax benefits, and had also not accrued any interest and penalties related to uncertain tax positions for the relevant periods. 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 2011 forward.

 

11.                               Commitments and Contingencies

 

Credit Facilities

 

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

 

Mid-Term Cash Incentive Plan and Special Bonus Letters

 

On July 26, 2016, the Compensation Committee of the Board (the “Compensation Committee”) adopted the 99 Cents Only Stores LLC 2016 Mid-Term Cash Incentive Plan (the “Mid-Term Cash Incentive Plan”). The Mid-Term Cash Incentive Plan is intended to promote the success of the Company by rewarding certain employees for their service to the Company and to provide incentives for such employees to remain in the employ or other service of the Company and to contribute to the performance of the Company. Under the Mid-Term Cash Incentive Plan, if the Company achieves an initial Adjusted EBITDA (as defined in the Mid-Term Cash Incentive Plan) goal for either fiscal 2017 or the fiscal year ending January 26, 2018 (the “Initial Mid-Term Plan Goal”), 50% of a participant’s award will be eligible for payment. No amounts will be paid under the Mid-Term Cash Incentive Plan if the Initial Mid-Term Plan Goal is not achieved. If the Company achieves the Initial Mid-Term Plan Goal and then achieves the same Adjusted EBITDA goal for the fiscal year immediately following the year in which the Initial Mid-Term Plan Goal was achieved, the remaining 50% of the participant’s award will be eligible for payment. Payment of eligible awards will only be made to the extent the Company’s Free Cash Flow (as defined in the Mid-Term Cash Incentive Plan) exceeds the amount eligible for payment, as measured at the end of each second quarter and fourth quarter of each fiscal year after an amount becomes eligible for payment until the end of the fiscal year ending January 31, 2020.  The maximum payout under the Mid-Term Cash Incentive Plan is $22.4 million. No amounts have been accrued under the Mid-term Cash Incentive Plan as of July 29, 2016.

 

On July 26, 2016, the Compensation Committee approved special bonus letters for three executives.  Pursuant to the terms thereof, if a Refinancing Transaction (as defined in the special bonus letters) occurs prior to October 1, 2018, each of the applicable executives will be eligible to receive a special bonus payable within 30 days of such transaction.  The special bonuses to be earned by the applicable executives total $4.0 million. No amounts have been accrued as of July 29, 2016.

 

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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As of July 29, 2016 and January 29, 2016, the Company had recorded a liability of $74.5 million and $76.3 million, respectively, for estimated workers’ compensation claims in California.  The Company has limited self-insurance exposure in Texas and had recorded a liability of $0.1 million as of each of July 29, 2016 and January 29, 2016 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 July 29, 2016 and January 29, 2016, the Company had recorded a liability of $0.4 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.

 

Sale of Warehouse Facility

 

On July 6, 2016, the Company sold and concurrently licensed (through January 31, 2017) a warehouse facility in the City of Commerce, California with a carrying value of $12.1 million and received net proceeds from this transaction of $28.5 million. In addition to the proceeds, $1.0 million purchase price consideration has been held in escrow for the buyer to make certain repairs, and any amount not used for such repairs will be paid to the Company. The Company expects the buyer to complete such repairs within 18 months of the closing date. 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 lease is accounted for as a financing lease and the Company has recorded a financing lease obligation of $28.5 million (as a component of current liabilities) as of July 29, 2016.  The Company will derecognize the assets and financing lease obligation at the earlier of when the lease term ends or when the Company no longer has continuing involvement and depreciate the assets over their remaining useful lives.

 

Legal Matters

 

Wage and Hour Matters

 

Shelley Pickett v. 99¢ Only Stores.  Plaintiff Shelley Pickett, 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 Private Attorneys General Act of 2004 (“PAGA”) claim that the Company violated section 14 of Wage Order 7-2001 by failing to provide seats for its cashiers behind checkout counters.  Pickett 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.  On June 27, 2013, Pickett 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 Pickett 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 Pickett of its position by a letter dated as of July 30, 2013, but she refused 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 September 30, 2014, the court denied the Company’s motion for judgment on the pleadings as to its cross-complaint and granted leave to Pickett to amend her complaint to add another representative plaintiff, Tracy Humphrey.  Plaintiffs filed their amended complaint on October 8, 2014, and the Company answered on October 10, 2014, denying all material allegations.  On April 4, 2016, in an unrelated matter involving similar claims against a different employer, the California Supreme Court issued a ruling that provides guidance to lower courts as to California’s employee seating requirement, which is a largely untested area of law.  The instant action had been stayed pending the issuance of the California Supreme Court ruling.  The stay has been lifted and the parties have agreed to mediate this matter on October 19, 2016.  A post-mediation status conference and, if needed, a trial setting conference, are scheduled for November 3, 2016.  The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, that could result from 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 the 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

 

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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 and through the mediator, as well as a court-ordered settlement conference, were unsuccessful.  Discovery resumed and plaintiff’s motion for class certification has been fully briefed.  Plaintiff has also brought a motion to strike the evidence submitted in support of the Company’s opposition to class certification.  The Court has asked the parties to consider mediating this matter prior to ruling on the class certification motion and the motion to strike.  Absent any agreement to mediate, both motions are currently set to be heard on October 24, 2016.  On October 26, 2015, plaintiffs’ counsel filed another action 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.  By stipulation of the parties, the Guerra action has been transferred to Riverside Superior Court and will be consolidated with the Barriga action.  The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, that could result from such lawsuit.

 

Phillip Clavel v. 99 Cents Only Stores LLC, et al.  Former warehouse worker Phillip Clavel filed an action against the Company on March 30, 2016, on behalf of himself and all other alleged aggrieved employees, seeking civil penalties under the PAGA for the following alleged Labor Code violations: failure to pay regular, overtime and minimum wages for all hours worked, failure to provide proper meal and rest periods, failure to pay wages timely during employment and upon termination, failure to provide proper wage statements, failure to reimburse business expenses, and failure to provide notice of the material terms of employment under the Wage Theft Prevention Act.  Mr. Clavel alleges that his claims arose during two periods of employment—one from March 2015 through mid-October 2015, during which he was employed by the Company as a forklift operator in the Commerce Distribution Center, and a second period from late October 2015 through February 2016, when he was similarly employed (through a staffing agency, BaronHR) at the Company’s Washington Boulevard warehouse.  On June 9, 2016, Plaintiff filed a First Amended Complaint.  The Company answered the First Amended Complaint on June 14, 2016, generally denying the allegations in the complaint and asserting a number of affirmative defenses.  A case management conference was held on August 8, 2016, and continued to October 11, 2016.  BaronHR was recently served with the Complaint, and the parties are in the process of exploring early ADR options.  The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, that could result from such lawsuit.

 

Environmental Matters

 

People of the State of California v. 99 Cents Only Stores LLC.  This action was brought by the San Joaquin District Attorney and a number of other public prosecutors against the Company alleging that the Company had violated hazardous waste statutory and regulatory requirements at its retail stores in California.  The Company settled this case through the entry of a stipulated judgment in December 2014 which contained injunctive relief requiring the Company to comply with applicable hazardous waste requirements at these stores. On June 29, 2015, the District Attorney informed the Company of alleged hazardous waste violations identified during a March 2015 inspection of a recently-opened store in Sonora, Tuolumne County and requested a meeting with the Company.  Since that time, the Company has been cooperating with the District Attorney to provide information regarding the alleged violations.  The District Attorney has demanded that the Company pay $187,500 to resolve this matter and to agree to additional injunctive relief in the existing settlement.  In connection with this matter, the Company has accrued an immaterial amount.  Although any monetary damages ultimately paid by the Company may exceed the accrued amount, it is not currently possible to estimate the amount of any such excess or the impact that any injunctive relief may have on the Company’s business, financial condition and results of operations.

 

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.

 

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12.                               Assets Held for Sale

 

Assets held for sale as of July 29, 2016 and January 29, 2016 consisted of vacant land in Rancho Mirage, California and land in Bullhead, Arizona with an aggregate carrying value of $2.3 million.

 

13.                               Other Accrued Expenses

 

Other accrued expenses as of July 29, 2016 and January 29, 2016 are as follows (in thousands):

 

 

 

July 29,
2016

 

January 29,
2016

 

Accrued interest

 

$

6,789

 

$

6,875

 

Accrued occupancy costs

 

13,535

 

11,433

 

Accrued legal reserves and fees

 

8,188

 

8,371

 

Accrued interest swap

 

 

569

 

Accrued California Redemption Value

 

2,646

 

2,225

 

Accrued transportation

 

3,786

 

3,508

 

Other

 

8,708

 

8,483

 

Total other accrued expenses

 

$

43,652

 

$

41,464

 

 

14.                               New Authoritative Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers.” 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 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 annual period ended January 27, 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.” 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 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 adopted this guidance retrospectively in the first quarter of fiscal 2017. As a result, the presentation of $11.5 million of debt issuance costs (net of accumulated amortization) have been reclassified from deferred financing costs, net to long-term debt, net of current portion as of January 29, 2016.

 

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 will adopt ASU 2015-11 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.

 

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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 adopted this guidance retrospectively in the first quarter of fiscal 2017.  As a result, the presentation of $16.6 million of deferred income taxes was reclassified from current assets to long-term deferred income tax liabilities as of January 29, 2016.

 

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU revises an entity’s accounting on the classification and measurement of financial instruments. Although the ASU retains many current requirements, it significantly revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments. This ASU becomes effective for public entities in the fiscal year beginning after December 15, 2017. Early adoption is not permitted except for the provisions related to the presentation of certain fair value changes for financial liabilities measured at fair value. The Company will adopt ASU 2016-01 in the first quarter of fiscal 2019 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which requires lessees to recognize right-of-use assets and lease liabilities, for all leases, with the exception of short-term leases, at the commencement date of each lease.  This ASU requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee.  This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease.  This ASU is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods.  Early adoption is permitted.  The amendments of this update should be applied using a modified retrospective approach, which requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented.  The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements and is anticipating a material impact because the Company is party to a significant number of lease contracts.

 

In March 2016, the FASB issued ASU 2016-04, “Recognition of Breakage for Certain Prepaid Stored-Value Products,” which is designed to provide guidance and eliminate diversity in the accounting for the derecognition of financial liabilities related to certain prepaid stored-value products using a revenue-like breakage model.  Breakage should be recognized in proportion to the pattern of rights expected to be exercised by the product holder to the extent that it is probable a significant reversal of the recognized breakage amount will not subsequently occur. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted, and is to be applied retrospectively or using a modified retrospective approach.  The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-08, “Revenue Recognition: Clarifying the new Revenue Standard’s Principal-Versus-Agent Guidance.” The amendments finalize the guidance in the new revenue standard on assessing whether an entity is a principal or an agent in a revenue transaction. The conclusion impacts whether an entity reports revenue on a gross or net basis.  The effective date and transition of these amendments is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers,” as amended by the one-year deferral and early adoption provisions in ASU 2015-14. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting”. This ASU will require companies to recognize the income tax effects of awards in the income statement when the awards vest or are settled. The guidance requires companies to present excess tax benefits as an operating activity and cash paid to a taxing authority to satisfy statutory withholding as a financing activity on the statement of cash flows. The guidance will also allow entities to make an alternative policy election to account for forfeitures as they occur.  This ASU is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period. The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements.

 

In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing”. This ASU provides guidance on accounting for licenses of intellectual property and identifying performance obligations.  The amendments clarify how an entity should evaluate its promise when granting a license of intellectual property. They also clarify when a promised good or service is separately identifiable and allow entities to disregard items that are immaterial in the context of the contract.  The effective date and transition of these amendments is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers,” as amended by the one-year deferral and early adoption provisions in ASU 2015-14. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.

 

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In May 2016, the FASB issued ASU No. 2016-11, “Revenue Recognition and Derivatives and Hedging: Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting”.  This ASU rescinds certain SEC guidance from the applicable Accounting Standards Codification in response to announcements made by the SEC staff at the Emerging Issues Task Force’s March 3, 2016 meeting, and which supersedes certain SEC observer comments on the topics of revenue and expense recognition for freight services in process, accounting for shipping and handling fees and costs, accounting for consideration given by a vendor to a customer and accounting for gas-balancing arrangements upon the adoption of ASU 2014-09. The effective date and transition of these amendments is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers,” as amended by the one-year deferral and early adoption provisions in ASU 2015-14. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.

 

In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients”.  This ASU provides narrow scope improvements and technical expedients on assessing collectability, the presentation of sales tax and other similar taxes collected from customers, non-cash consideration, contract modifications and completed contracts at transition, and the disclosure requirement for the effect of the accounting change for the period of adoption. The effective date and transition of these amendments is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers,” as amended by the one-year deferral and early adoption provisions in ASU 2015-14. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments”.  This ASU replaces the current incurred loss impairment methodology of recognizing credit losses when a loss is probable, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to assess credit loss estimates. The standard will be effective for fiscal years beginning after December 15, 2019, with early adoption permitted for periods after December 15, 2018. The Company is currently in the process of evaluating the impact 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 July 29, 2016 and January 29, 2016, the Senior Notes are fully and unconditionally guaranteed by the Subsidiary Guarantors.

 

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 July 29, 2016

(In thousands)

(Unaudited)

 

 

 

Issuer

 

Subsidiary
Guarantors

 

Non-
Guarantor
Subsidiaries

 

Consolidating
Adjustments

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

1,288

 

$

989

 

$

32

 

$

 

$

2,309

 

Accounts receivable, net

 

1,300

 

181

 

 

 

1,481

 

Income taxes receivable

 

2,279

 

 

 

 

2,279

 

Inventories, net

 

154,536

 

21,039

 

 

 

175,575

 

Assets held for sale

 

2,308

 

 

 

 

2,308

 

Other

 

17,179

 

1,363

 

8

 

 

18,550

 

Total current assets

 

178,890

 

23,572

 

40

 

 

202,502

 

Property and equipment, net

 

475,894

 

54,941

 

23

 

 

530,858

 

Deferred financing costs, net

 

4,496

 

 

 

 

4,496

 

Equity investments and advances to subsidiaries

 

676,419

 

607,744

 

2,242

 

(1,286,405

)

 

Intangible assets, net

 

448,432

 

1,861

 

 

 

450,293

 

Goodwill

 

387,772

 

 

 

 

387,772

 

Deposits and other assets

 

8,109

 

346

 

15

 

 

8,470

 

Total assets

 

$

2,180,012

 

$

688,464

 

$

2,320

 

$

(1,286,405

)

$

1,584,391

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBER’S EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

99,523

 

$

5,316

 

$

 

$

 

$

104,839

 

Intercompany payable

 

608,784

 

623,555

 

2,752

 

(1,235,091

)

 

Payroll and payroll-related

 

19,699

 

1,425

 

 

 

21,124

 

Sales tax

 

9,474

 

521

 

 

 

9,995

 

Other accrued expenses

 

40,000

 

3,637

 

15

 

 

43,652

 

Workers’ compensation

 

74,492

 

140

 

 

 

74,632

 

Current portion of long-term debt

 

6,138

 

 

 

 

6,138

 

Current portion of capital and financing lease obligation

 

29,693

 

 

 

 

29,693

 

Total current liabilities

 

887,803

 

634,594

 

2,767

 

(1,235,091

)

290,073

 

Long-term debt, net of current portion

 

848,005

 

 

 

 

848,005

 

Unfavorable lease commitments, net

 

4,825

 

25

 

 

 

4,850

 

Deferred rent

 

25,672

 

2,084

 

 

 

27,756

 

Deferred compensation liability

 

773

 

 

 

 

773

 

Capital and financing lease obligation, net of current portion

 

36,547

 

 

 

 

36,547

 

Deferred income taxes

 

163,045

 

 

 

 

163,045

 

Other liabilities

 

4,618

 

 

 

 

4,618

 

Total liabilities

 

1,971,288

 

636,703

 

2,767

 

(1,235,091

)

1,375,667

 

 

 

 

 

 

 

 

 

 

 

 

 

Member’s Equity:

 

 

 

 

 

 

 

 

 

 

 

Member units

 

550,614

 

 

1

 

(1

)

550,614

 

Additional paid-in capital

 

 

99,943

 

 

(99,943

)

 

Investment in Number Holdings, Inc. preferred stock

 

(19,200

)

 

 

 

(19,200

)

Accumulated deficit

 

(322,690

)

(48,182

)

(448

)

48,630

 

(322,690

)

Other comprehensive income

 

 

 

 

 

 

Total equity

 

208,724

 

51,761

 

(447

)

(51,314

)

208,724

 

Total liabilities and equity

 

$

2,180,012

 

$

688,464

 

$

2,320

 

$

(1,286,405

)

$

1,584,391

 

 

30



Table of Contents

 

CONDENSED CONSOLIDATING BALANCE SHEETS

As of January 29, 2016

(In thousands)

 

 

 

Issuer

 

Subsidiary
Guarantors

 

Non-
Guarantor
Subsidiaries

 

Consolidating
Adjustments

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

1,266

 

$

1,009

 

$

37

 

$

 

$

2,312

 

Accounts receivable, net

 

1,568

 

106

 

 

 

1,674

 

Income taxes receivable

 

3,665

 

 

 

 

3,665

 

Deferred income taxes

 

 

 

 

 

 

Inventories, net

 

171,691

 

24,960

 

 

 

196,651

 

Assets held for sale

 

2,308

 

 

 

 

2,308

 

Other

 

17,296

 

1,294

 

13

 

 

18,603

 

Total current assets

 

197,794

 

27,369

 

50

 

 

225,213

 

Property and equipment, net

 

484,764

 

57,780

 

26

 

 

542,570

 

Deferred financing costs, net

 

916

 

 

 

 

916

 

Equity investments and advances to subsidiaries

 

604,542

 

527,905

 

1,836

 

(1,134,283

)

 

Intangible assets, net

 

451,245

 

1,997

 

 

 

453,242

 

Goodwill

 

387,772

 

 

 

 

387,772

 

Deposits and other assets

 

6,932

 

379

 

8

 

 

7,319

 

Total assets

 

$

2,133,965

 

$

615,430

 

$

1,920

 

$

(1,134,283

)

$

1,617,032

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND MEMBER’S EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

74,313

 

$

4,884

 

$

 

$

 

$

79,197

 

Intercompany payable

 

528,767

 

545,012

 

2,381

 

(1,076,160

)

 

Payroll and payroll-related

 

17,024

 

1,397

 

 

 

18,421

 

Sales tax

 

12,801

 

513

 

 

 

13,314

 

Other accrued expenses

 

38,714

 

2,718

 

32

 

 

41,464

 

Workers’ compensation

 

76,314

 

75

 

 

 

76,389

 

Current portion of long-term debt

 

6,138

 

 

 

 

6,138

 

Current portion of capital and financing lease obligation

 

989

 

 

 

 

989

 

Total current liabilities

 

755,060

 

554,599

 

2,413

 

(1,076,160

)

235,912

 

Long-term debt, net of current portion

 

875,843

 

 

 

 

875,843

 

Unfavorable lease commitments, net

 

5,702

 

44

 

 

 

5,746

 

Deferred rent

 

25,218

 

2,168

 

3

 

 

27,389

 

Deferred compensation liability

 

709

 

 

 

 

709

 

Capital and financing lease obligation, net of current portion

 

34,817

 

 

 

 

34,817

 

Deferred income taxes

 

163,045

 

 

 

 

163,045

 

Other liabilities

 

5,118

 

 

 

 

5,118

 

Total liabilities

 

1,865,512

 

556,811

 

2,416

 

(1,076,160

)

1,348,579

 

 

 

 

 

 

 

 

 

 

 

 

 

Member’s Equity:

 

 

 

 

 

 

 

 

 

 

 

Member units