Item 1. Business
General
The Gymboree Corporation (“we,” “us,” “our,” “Gymboree” and “Company”) was organized in October 1979 as a California corporation and re-incorporated as a Delaware corporation in June 1992. We are one of the largest children’s apparel specialty retailers in North America, offering collections of high-quality apparel and accessories under the Gymboree®, Janie and Jack® and Crazy 8® brands. Our brands operate in retail store locations, including outlets, online and franchise channels and are in multiple geographies in the global retail marketplace. We also offer directed parent-child developmental play programs at franchised and Company-operated Gymboree Play & Music® centers in multiple geographies. Gymboree retail stores are operated in China by Gymboree (China) Commercial and Trading Co. Ltd. (“Gymboree China”), while Gymboree (Tianjin) Educational Information Consultation Co. Ltd. (“Gymboree Tianjin”) is Gymboree Play & Music’s master franchisee in China. Gymboree China and Gymboree Tianjin are indirectly controlled by Gymboree Holding, Ltd. and investment funds sponsored by Bain Capital Private Equity, LP (formerly Bain Capital Partners, LLC) (“Bain Capital”). Gymboree China and Gymboree Tianjin have been determined to be variable interest entities (collectively the “VIEs”), and we are a member of a related party group that controls the VIEs and absorbs the economics of the VIEs. However, we have no ownership interest in the VIEs. For further information refer to Note 19 in the consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Gymboree: Gymboree celebrates childhood with fun, age-appropriate apparel and accessories for boys and girls. One-of-a-kind collections feature mix-and-match colors, patterns and graphics, detailed embellishments, comfort, and durability in sizes newborn through 12. Gymboree Outlet stores provide similar high-quality, mix-and-match children’s apparel and accessories in the same size ranges but at outlet prices.
Janie and Jack: Janie and Jack shops offer distinctive, finely crafted clothing and accessories for boys and girls in sizes newborn through 12. Fine fabrics, handmade quality and details such as hand-embroidery and classic prints are utilized to create timeless looks. Shops have a European style reminiscent of a small Parisian boutique.
Crazy 8: Crazy 8 offers cool clothes that kids want to wear and great deals that parents love. Styles are designed for kids who like to wear clothes their own way and for parents who want ease and affordability. Crazy 8 offers exceptional value without sacrificing quality in sizes 6 months through 14 years.
Gymboree Play & Music: Gymboree Play & Music offers children ages newborn through five the opportunity to explore, learn and play in an innovative parent-child program. Gymboree Play & Music offers an array of classes developed by early childhood experts as well as birthday parties and developmental toys, books and music.
As of January 30, 2016, we operated a total of 1,306 retail stores, as follows:
We also operate 3 online stores at www.gymboree.com, www.janieandjack.com and www.crazy8.com. Our online stores offer the entire Gymboree, Janie and Jack and Crazy 8 product offerings, respectively. Each of our brands serves customers through its store and online channels, allowing us to execute on our omnichannel strategy where customers can shop in retail stores and online through desktop or mobile devices. Our omnichannel experience offers our customers the capability to shop for substantially the same products regardless of where they shop. We also have a policy whereby retail stores order merchandise for customers from the online stores and ship the merchandise directly to the customers. In addition, customers can return merchandise purchased online at traditional retail stores.
In addition, as of January 30, 2016, overseas franchisees and Gymboree China operated 84 retail stores, as follows:
(1) Overseas franchisees operated retail stores in the Middle East, South Korea and Latin America.
We also operated 727 franchised and Company-operated Gymboree Play & Music® centers in the United States and 43 other countries.
Suppliers
The majority of our apparel is manufactured to our specifications by 130 independent manufacturers located primarily in Asia (principally China (27%), Vietnam (18%), Bangladesh (14%), Indonesia (12%), and India (8%) for the fiscal year ended January 30, 2016). All product purchases are denominated in U.S. dollars. One buying agent manages a substantial portion of our inventory purchases (approximately 89% for the fiscal year ended January 30, 2016). We have no long-term contracts with suppliers and typically transact business on an order-by-order basis. Factories typically undergo annual audits for social accountability by independent third parties. In addition, all of our products undergo a quality audit performed by our main buying agent or other third parties.
Seasonality and Competition
Our operations are seasonal in nature, with sales from retail operations peaking during the fourth quarter, primarily during the holiday season in November and December. During fiscal 2015, 2014, and 2013, the fourth quarter accounted for approximately 32%, 31%, and 28%, respectively, of net sales from retail operations respectively.
Our apparel brands compete on a national level with Carter’s, The Children’s Place, BabyGap and GapKids (divisions of Gap Inc.), department stores operating in malls, outlet centers or street locations, discount retail chains such as Old Navy (a division of Gap Inc.), Wal-Mart and Target, as well as with a wide variety of local and regional specialty stores, with other retail chains, and with children’s retailers that sell their products by mail order, online or through outlet malls. The principal factors affecting competition for retail sales are product design, product quality, brand image, customer service and pricing. Our goal is to provide our customers with high-quality apparel at a price that reflects excellent value. We design and produce apparel primarily for sale at our retail and online stores as well as for our overseas franchisees.
Trademark and Service Marks
In the United States, we are the owner of a number of trademarks and service marks, including the trademarks and service marks “Gymboree,” “Janie and Jack,” “Crazy 8” and “Gymboree Play & Music,” and the trademarks “Gymbo” and “Gymbucks.”
These marks and certain other of our marks are registered with the United States Patent and Trademark Office. The mark “Gymboree” is also registered, or is the subject of pending applications, in approximately 101 foreign countries. All other trademarks or service marks appearing in this annual report that are not identified as marks owned by us are the property of their respective owners. Each federal registration is renewable indefinitely if the mark is still in use at the time of renewal. The Company’s rights in the “Gymboree,” “Janie and Jack” and “Crazy 8” marks and other marks are a significant part of its business. Accordingly, we intend to maintain the marks and the related registrations. We are not aware of any material claims of infringement or other material challenges to our right to use the “Gymboree,” “Janie and Jack” and “Crazy 8” marks in the United States.
We use a number of other trademarks, certain of which have been registered with the U.S. Patent and Trademark Office and in certain foreign countries. We believe that our registered and common-law trademarks have significant value to our business and that some of our trademarks are instrumental to our ability to both market our products and create and sustain demand for our products.
Employees
As of January 30, 2016, we had approximately 5,492 full-time equivalents made up of 12,863 full and part-time employees. A significant number of seasonal employees are hired during each holiday selling season. None of our employees are represented by a labor union.
Segment and International Financial Information
Certain financial information about our reportable segments is included in Note 18 “Segment Information” to the consolidated financial statements included elsewhere in this annual report. In addition, information about our VIEs is included in Note 19 to the consolidated financial statements included elsewhere in this annual report.
Available Information
We currently make available on our website at www.gymboree.com, under “Company Information-Financial Resources & SEC filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such documents as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”). The public may read and copy any materials filed with the SEC by calling the SEC at 1-800-SEC-0330. We also currently make available under “Company Information-Corporate Governance” our code of ethics as well as other documents and materials relating to corporate governance. References to the Company’s website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this annual report.
Item 1A.
Item 1A. Risk Factors
Our financial performance is subject to various risks and uncertainties. The risks described below are those that we believe are the material risks we face. Any of the risk factors described below could significantly and adversely affect our business, prospects, sales, revenues, gross profit, cash flows, financial condition and results of operations. Furthermore, these risk factors represent risks and uncertainties that could cause actual results to differ materially from those expressed or implied by the forward-looking statements contained in this annual report. See “Cautionary Note Regarding Forward-Looking Statements.”
Risks Related to Our Indebtedness and Certain Other Obligations
Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations.
On November 23, 2010 (the “Transaction Date”), The Gymboree Corporation completed a merger (the “Merger”) with Giraffe Acquisition Corporation (“Acquisition Sub”) in accordance with an Agreement and Plan of Merger (the “Merger Agreement”) with Giraffe Holding, Inc. (“Parent”), and Acquisition Sub, a wholly owned subsidiary of Parent, with the Merger funded through a combination of debt and equity financing (collectively, the “Transactions”). The Company is continuing as the surviving corporation and a 100%-owned indirect subsidiary of the Parent. At the Transaction Date, investment funds sponsored by Bain Capital indirectly owned a controlling interest in Parent.
As a result of the Transactions discussed above, we are highly leveraged. The following chart shows our indebtedness as of January 30, 2016:
(1) As of January 30, 2016, the Company’s senior credit facilities (collectively, the “Senior Credit Facilities”) were comprised of an $820 million secured term loan agreement (“Term Loan”) and a $225 million asset backed revolving credit facility (“ABL Revolving Facility”). Amounts available under the ABL Revolving Facility are subject to customary borrowing base limitations and are reduced by letter of credit utilization. The Term Loan matures on February 23, 2018 and the ABL revolving commitments mature the earlier of (i) September 24, 2020 and (ii) the date that is 60 days before the scheduled final maturity date of any tranche of the Term Loan or the Notes (which mature in December 2018), unless such indebtedness is cumulatively equal to or less than $25.0 million in the aggregate and a reserve against the borrowing base is imposed equal to the amount of such indebtedness.
The Senior Credit Facilities also allow an aggregate of $200 million in uncommitted incremental facilities, the availability of which is subject to our meeting certain conditions.
Our high degree of leverage could have important consequences. For example, it could:
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make it more difficult for us to make payments on our indebtedness;
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increase our vulnerability to general economic and industry conditions;
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require a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;
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expose us to the risk of increased interest rates as the borrowings under our Senior Credit Facilities will be at variable rates of interest;
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restrict us from making strategic acquisitions or cause us to make non-strategic divestitures;
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limit our ability to obtain additional financing for working capital, capital expenditures, research and development, debt service requirements, acquisitions and general corporate or other purposes; and
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limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors who are less highly leveraged.
Despite current indebtedness levels and restrictive covenants, we and our subsidiaries may incur additional indebtedness in the future. This could further exacerbate the risks associated with our substantial financial leverage.
The terms of the indenture governing the Notes and the Senior Credit Facilities permit us to incur a substantial amount of additional debt, including secured debt. Any additional borrowings under the Senior Credit Facilities, and any other secured debt, would be effectively senior to the Notes and any guarantees thereof to the extent of the value of the assets securing such secured debt. If new debt is added to our current debt levels, the risks that we now face as a result of our leverage would intensify.
Our debt agreements contain restrictions that limit our flexibility in operating our business.
Our Senior Credit Facilities and the indenture governing the Notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants provide certain limits on, but do not prohibit, our ability to, among other things, incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, our capital stock, make certain acquisitions or investments, enter into sale-leaseback transactions, materially change our business, incur or permit to exist certain liens, enter into transactions with affiliates or sell our assets to, or merge or consolidate with or into, another company. Further, our ability to comply with such covenants under the indenture governing the Notes may be affected by actions taken by the VIEs which we do not control, but the results of which we have consolidated into our financial statements and which are treated as restricted
subsidiaries under the indenture governing the Notes (see Note 19 to the consolidated financial statements included elsewhere in this annual report). In addition to the foregoing covenants, under certain circumstances, the ABL Revolving Facility requires us to satisfy a financial test. Our ability to satisfy this test may be affected by events outside of our control.
Upon the occurrence of an event of default under the Senior Credit Facilities, the lenders could elect to declare all amounts outstanding under the Senior Credit Facilities to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under the Senior Credit Facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the Senior Credit Facilities. If the lenders under the Senior Credit Facilities accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay the Senior Credit Facilities, as well as our other secured and unsecured indebtedness, including the Notes.
We require a significant amount of cash to service our indebtedness and fund our other liquidity needs, and our ability to generate sufficient cash depends on many factors beyond our control.
Our ability to make cash payments on and to refinance our indebtedness and to fund planned capital expenditures depends on our ability to generate significant operating cash flow in the future. This ability is, to a significant extent, subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
Our business may not generate sufficient cash flow from operations, and future borrowings may not be available under our Senior Credit Facilities, in an amount sufficient to enable us to pay our indebtedness, including the Notes, or to fund our other liquidity needs. In any such circumstance, we may need to refinance all or a portion of our indebtedness on or before maturity. We may not be able to refinance any of our indebtedness, including the Senior Credit Facilities and the Notes, on commercially reasonable terms or at all. If we cannot service our indebtedness, we may have to take actions such as selling assets, seeking additional equity or reducing or delaying capital expenditures, strategic acquisitions and investments. Any such action, if necessary, may not be effected on commercially reasonable terms or at all. Our Senior Credit Facilities and the indenture governing the Notes restrict our ability to sell assets and use the proceeds from such sales.
If we are unable to generate sufficient cash flow or are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants in the instruments governing our indebtedness (including covenants in our Senior Credit Facilities and the indenture governing the Notes), we could be in default under the terms of the agreements governing such indebtedness. In the event of such a default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under our Senior Credit Facilities could elect to terminate their commitments thereunder, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to obtain waivers from the required lenders under our Senior Credit Facilities to avoid being in default. If we breach our covenants under our Senior Credit Facilities and seek such a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under our Senior Credit Facilities, the lenders could exercise their rights, as described above, and we could be forced into bankruptcy or liquidation.
Risks Related to the Business
Global economic conditions may adversely affect our financial performance.
During the recent economic recession, global financial markets experienced extreme volatility, disruption and credit contraction. The volatility and disruption to the capital markets significantly and adversely affected global economic conditions, resulting in additional significant recessionary pressures and declines in employment levels, consumer and business confidence, disposable income and actual and perceived wealth. Demand for children’s apparel, specifically brand name apparel products, is impacted by the overall level of consumer spending. Although there have been some recent improvements, continuing or worsened adverse economic conditions, including higher unemployment, gasoline, energy and health care costs, taxes and tighter credit, could continue to affect consumer confidence and discretionary consumer spending adversely and may adversely affect our sales, cash flows and results of operations. Additionally, renewed turmoil in the financial and credit markets could adversely affect our costs of capital and the sources of liquidity available to us.
Further, we work with a large number of small vendors, some of whom have been or may be significantly impacted by any of the factors described above. If a number of these vendors fail, the delays and costs that we would likely incur in replacing them and in finding replacement goods and services could have a material adverse effect on our business, financial condition and operating results.
Our results may be adversely affected by our failure to anticipate and respond to changes in consumer preferences in a timely manner.
Our sales and profitability depend upon the continued demand by customers for our apparel and accessories. We believe that our success depends in large part upon our ability to anticipate, gauge and respond in a timely manner to changing consumer demands and preferences and upon the appeal of our products. Further, current economic conditions and levels of discretionary spending also affect consumer preferences. We may not be able to anticipate, gauge and respond effectively to changes in consumer preferences, and, as a result, the demand for our apparel or accessories may decline. In addition, since much of our inventory is sourced from vendors located outside the United States, we usually must order merchandise and enter into contracts for the purchase and manufacture of such merchandise, up to nine months in advance of the applicable selling season and frequently before trends are known. A decline in demand for our apparel and accessories or a misjudgment could, among other things, lead to lower sales, excess inventories and higher markdowns, each of which could have a material adverse effect on our business, financial condition and operating results.
Changes in seasonal consumer spending patterns that are beyond our control could harm our business.
Historically, a significant portion of our retail sales have been realized during the holiday season in the months of November and December. We have also experienced periods of increased sales activity in the early spring, during the period leading up to the Easter holiday, and in the early fall, in connection with back-to-school sales. Changes in seasonal consumer spending patterns could result in lower-than-expected sales during these periods. Such circumstances could cause us to have excess inventory, necessitating markdowns to dispose of these excess inventories, which would reduce our profitability. Any failure by us to meet our business plan for, in particular, the third or fourth quarter of any fiscal year could have a material adverse effect on our earnings, which in all likelihood would not be offset by satisfactory results achieved in other quarters of the same fiscal year in which sales are less concentrated. Also, because we typically spend more in labor costs during the holiday season to hire temporary store employees in anticipation of increased holiday business volume, a shortfall in expected sales during that period could result in a disproportionate decrease in our earnings.
If we are unable to manage our inventory effectively, our gross margins could be adversely affected.
We normally order merchandise and enter into contracts for the purchase and manufacture of inventory, up to nine months in advance of the applicable selling season and frequently before trends are known. In addition, our business requires us to carry a significant amount of inventory especially prior to the peak holiday selling season. As a result, we are vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases. If sales do not meet expectations, too much inventory may cause excessive markdowns and, therefore, lower than planned margins. Conversely, if we underestimate consumer demand for our merchandise, particularly higher volume styles, or if our manufacturers fail to supply quality products in a timely manner, we may experience inventory shortages, which might result in lost sales, a negative impact on our customer relationships and/or diminished brand loyalty.
Our business may be negatively impacted by consumer product safety laws, regulations or related legal actions.
Our products are subject to consumer product safety laws, as well as regulations and standards with respect to product quality and safety set by various U.S., state and international government regulatory authorities, including the U.S. Consumer Product Safety Commission. New consumer product safety laws or changes to existing laws and regulations may make certain products unsalable or require us to incur significant compliance costs, which could have a material adverse effect on our earnings. Our inability, or that of our vendors or manufacturers, to comply on a timely basis with such laws and regulatory requirements could result in significant fines or penalties, which could adversely affect our reputation and earnings.
Although we currently test products sold in our stores and at our Gymboree Play & Music sites, we have in the past recalled and may in the future need to recall products that we determine may present safety issues. Any such recall would be costly. If we or the U.S. Consumer Product Safety Commission recall a product sold in our stores, we could incur significant expense, experience negative publicity and be forced to defend product liability lawsuits, any of which could have a material adverse effect on our reputation, financial position and earnings.
Increased production costs may adversely affect our results.
We are affected by inflation and changing prices primarily through purchasing products from our global suppliers, increased operating costs and expenses, fluctuations in interest rates, and fluctuating commodity prices. For example, when prices of raw materials such as cotton increase, the costs to produce many of our products also increase. In addition, increases in energy costs, which can be volatile, may also result in an increase in our transportation costs for distribution, utility costs for our stores, and costs to purchase our products from suppliers. If our customers are resistant to paying higher prices for our products, and if we are unable to absorb increased costs of goods by reducing our manufacturing or supply chain costs or lowering our overall cost structure, our profitability may be materially adversely affected.
Competition and the strength of our competitors may impair our ability to maintain or grow our sales and adversely affect our operating results.
The apparel segment of the specialty retail industry is highly competitive, and retailers are constantly adjusting their promotional activity and pricing strategies in response to changing conditions. E-commerce, including online flash sale sites and mobile applications, is rapidly evolving and, if we do not keep pace, our business, prospects and results of operations could be adversely affected. The principal factors of competition for retail sales are product design, product quality, brand image, customer service and pricing. Our Gymboree, Janie and Jack and Crazy 8 brands compete on a national level with Carter’s, The Children’s Place, BabyGap and GapKids (divisions of Gap Inc.), department stores operating in malls, outlet centers or street locations, discount retail chains such as Old Navy (a division of Gap Inc.), Wal-Mart and Target, as well as a wide variety of local and regional specialty stores, other retail chains, and children’s retailers that sell their products by mail order, online or through outlet malls. Many of these competitors are larger than us and have substantially greater financial, marketing and other resources. As a result, these competitors may be able to adapt to changes in customer preferences more quickly, take advantage of acquisition and other opportunities more readily, devote greater resources to the marketing and sale of their products and adopt more aggressive pricing strategies than we can. Increased competition may put deflationary pressure on our sales prices, reduce sales and gross margins, and increase operating expenses, each of which could have a material adverse effect on our operating results.
Because we purchase our products abroad, our business is subject to heightened risks associated with international business.
Our products are currently manufactured to our specifications by independent factories located primarily in Asia. As a result, our business is subject to the risks generally associated with doing business abroad, currency fluctuations, adverse conditions such as epidemics, natural disasters, wars, acts of terrorism, social or political unrest, disruptions or delays in transportation or customs clearance, local business practices and changes in economic conditions in countries in which our suppliers are located. We cannot predict the effect of such factors on our business relationships with foreign suppliers or on our ability to deliver products into our stores in a timely manner. If even a small portion of our current foreign manufacturing sources or textile mills were disrupted or were to cease doing business with us for any reason, such actions could have a material adverse effect on our operating results and financial position. If we experience significant increases in demand or need to replace an existing vendor, there can be no assurance that additional manufacturing capacity will be available when required on terms that are acceptable to us, or at all, or that any vendor would allocate sufficient capacity to us in order to meet our requirements.
In addition, even if we are able to expand existing or find new manufacturing sources, we may encounter delays in production and added costs as a result of the time it takes to train our vendors in our methods, products, quality control standards, and environmental, labor, health, and safety standards. Moreover, in the event of a significant disruption in the supply of the fabrics or raw materials used by our vendors in the manufacture of our products, our vendors might not be able to locate alternative suppliers of materials of comparable quality at an acceptable price, or at all. Any delays, interruption, or increased costs in the manufacture of our products could have an adverse effect on our ability to meet consumer demand for our products and result in lower sales and net income or higher net loss. In addition, we are currently pursuing strategies to reduce product costs. These strategies may result in sourcing products from factories from which we have not previously purchased products and which may be in countries in which we have not done business before and may subject us to additional risk.
Furthermore, our business is subject to risks associated with foreign governmental regulations, including without limitation exposure to potential liabilities under anti-corruption and anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act, compliance with laws and regulations regarding consumer and data protection, privacy, network security, encryption, payments, restrictions on pricing or discounts and similar laws and regulations in other jurisdictions. Although we have implemented policies and procedures to facilitate our compliance with U.S. and foreign laws and regulations relating to doing business in foreign markets and importing merchandise from various countries, there can be no assurance that our policies and procedures will be effective or that foreign vendors and other third parties with whom we do business will not violate such laws and regulations or our policies. If our policies and procedures are not effective or if there is significant or continuing noncompliance with such standards and laws by one or more vendors, U.S. and foreign governmental regulations could have a negative impact on our reputation, could subject us to liability and could have an adverse effect on our results of operations.
Labor disputes at ports can disrupt shipping and transportation channels, leading us to incur significantly higher freight costs and delay us getting products to market.
The majority of our products are manufactured outside of our principal sales markets. As a result, our products must be transported by third parties over large geographical distances. Shortages in ocean or air freight capacity and volatile fuel costs can result in rapidly changing transportation costs. We may not be able to pass all or any portion of these higher costs on to our customers or adjust our pricing structure in a timely manner in order to remain competitive, either of which could have a material adverse effect on our results of operations. Furthermore, shipping disruptions and delays could also negatively impact sales as each of our brands has significant elements that are seasonal in nature, especially the Gymboree brand, which is known for its mix and match colors and patterns and graphics.
We must timely and effectively deliver merchandise to our stores and customers.
We cannot control all of the various factors that might affect our fulfillment rates for online sales and timely and effective merchandise delivery to our stores. We rely upon third-party carriers for our merchandise shipments to and from stores and reliable data regarding the timing of those shipments. In addition, we are heavily dependent upon three carriers for the delivery of our merchandise to online customers. Labor disputes, union organizing activity, inclement weather, natural disasters and acts of terrorism could affect those carriers’ ability to provide delivery services to meet our shipping needs. Failure to deliver merchandise in a timely and effective manner could damage our reputation and reduce sales.
Our business may be harmed by additional U.S. regulation of foreign trade or delays caused by additional U.S. customs requirements.
Our business is subject to the risk that the United States may adopt additional regulations relating to imported apparel products, including duties, taxes and other charges or restrictions on imported apparel. We cannot predict whether additional U.S. quotas, duties, taxes or other charges or restrictions will be imposed upon the importation of our products in the future, or what effect any such actions would have on our business, financial position and operating results. If the U.S. government imposes any such charges or restrictions, our supply of products could be disrupted and their cost could substantially increase, either of which could have a material adverse effect on our operating results. Unforeseen delays in customs clearance of any goods could have a material adverse effect on our ability to deliver complete shipments to our stores in a timely manner, which in turn could have a material adverse effect on our business and operating results.
Unauthorized access to proprietary, confidential or personal information, including but not limited to through a compromise of our computer network security, could harm our reputation and business, which could have a material adverse effect on our results of operations.
We collect, store and transmit proprietary and confidential information regarding our business and personal information regarding our customers, employees, job applicants, and others, including credit card information and personal identification information. Despite the steps that we and our vendors may have taken to mitigate risks associated with the collection, storage and transmission of such information, there can be no assurance that such information will be protected against unauthorized access, use or disclosure. As with many other companies, we may be subject to attempts to compromise our data security, and we, or a third party with which we share such information, could suffer a cyber attack. Advances in computer capabilities, new technological discoveries, and the increasing sophistication of cyber thieves may increase the risk of such an attack being successful, in which case proprietary and confidential information regarding our business and/or personal information could be misappropriated, or system disruptions could occur. In addition, unauthorized disclosure of proprietary and confidential information regarding our business or of personal information could result from non-technical issues, including intentional or inadvertent disclosure by our employees or by persons with whom we have commercial relationships. A compromise of our computer network security, or of the network security of third parties with which we do business, or other unauthorized disclosure of the proprietary, confidential or personal information that we collect, store, or transmit, could disrupt our operations, result in significant response costs, damage our reputation, impact our ability to retain and attract customers, and expose us to claims from customers, financial institutions, regulators, payment card brands, business partners, employees, and other persons, all of which could adversely impact our results of operations.
We are dependent on a single facility for distribution of our merchandise.
We handle merchandise distribution for all of our stores, including our online stores, from a single facility in Dixon, California. If we are not able to distribute merchandise to our stores or customers due to exceeding our capacity at the distribution facility (such as due to a high level of demand during peak periods), natural disasters, accidents, system failures, disruptions or other events, our sales could decline which may have a materially adverse effect on our earnings, financial position and our reputation. In addition, we use an automated unit sortation system to manage the order processing for our Crazy 8 and Janie and Jack direct-to-consumer businesses. In the event that this unit sortation system becomes inoperable for any reason, we would not be able to ship all direct-to-consumer orders in the timely manner that our customers expect. As a result, we could experience a reduction in our direct-to-consumer business, which could negatively impact sales and profitability.
For the last several years, we have fulfilled online customer orders for www.gymboree.com through a third-party fulfillment center in Ohio, which we operated through an outsourced arrangement. The arrangement provided us with warehousing, fulfillment and logistics services for these online orders. The arrangement requires us to rely on a third party for critical business functions. If this third party is unable to successfully operate the fulfillment center under this arrangement, we may experience a material adverse effect on our business and operating results. On February 25, 2016, the Company entered into an agreement to terminate the arrangement described above effective upon exiting from the fulfillment center in Ohio, which is expected to be in May 2016. The fulfillment of our www.gymboree.com online customer orders will continue to be processed at the third-party fulfillment center in Ohio through April 30, 2016. The Company expects to transfer the warehousing, logistics and fulfillment of our www.gymboree.com online customer orders to our distribution center in Dixon, California, in May 2016 and will pay an early
termination fee of $8.3 million to the third-party fulfillment center. Disruption or delays in the successful transition of the fulfillment of our www.gymboree.com online customer orders to our distribution center in Dixon, California, may have an adverse impact on sales and our reputation. Furthermore, this transfer increases the risk that capacity constraints, natural disasters, accidents, system failures, disruptions or other events experienced at the Dixon, California distribution facility could have a material adverse effect on our earnings, financial position and reputation.
Damage to our computer systems could severely impair our ability to manage our business.
Our operations depend on our ability to maintain and protect the computer systems we use to manage our purchase orders, store inventory levels, web applications, accounting functions and other critical aspects of our business. Our systems are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and similar events. We have computer systems in each of our stores, with the main corporate and retail database servers for our systems located in San Francisco, California, our logistics system located in Dixon, California, and additional web site support systems located in Redwood City, California, which are located on or near known earthquake fault zones. An earthquake or other disaster could have a material adverse impact on our business and operating results not only by damaging our stores or corporate headquarters, but also by damaging our main servers, which could disrupt our business for an indeterminate length of time. Our applications and systems are fully redundant, however our disaster recovery planning may not be sufficient. In addition, we may have inadequate insurance coverage to compensate for any related losses and expenses. Any of these events could damage our reputation, disrupt our business and be expensive to remedy.
We may be subject to negative publicity or legal action if our manufacturers violate labor laws or engage in practices that our customers believe are unethical.
We require our independent manufacturers to operate their businesses in compliance with the laws and regulations that apply to them. Our sourcing personnel periodically visit and monitor the operations of our independent manufacturers, but we cannot control their business or labor practices. We also rely on independent third parties to audit factories annually for compliance with safety and labor laws. If one of our independent manufacturers violates or is suspected of violating labor laws or other applicable regulations, or if such manufacturer engages in labor or other practices that diverge from those typically acceptable in the United States or any of the other countries in which we operate, we could in turn experience negative publicity or be subject to legal action. Negative publicity or legal actions regarding our manufacturers or the production of our products could have a material adverse effect on our reputation, sales, business, financial position and operating results.
We are dependent on third parties for operational and critical business functions, and their failure to provide services to us, or our inability to timely replace them when necessary, could have a material adverse effect on our business and operating results.
We outsource certain operational functions such as customer service to third-party service providers. If we fail to deploy, manage, or oversee our operations successfully, our business could be adversely affected. We also rely on third parties for critical functions involving credit card processing and store communications. These third parties may experience financial difficulties or business disruptions that could adversely affect their ability to perform their contractual obligations to us, including their obligations to comply with Payment Card Industry (“PCI”) data security standards. Any such failure to provide services to us or to comply with PCI security requirements could negatively affect our reputation and impact our internal communications systems, including our ability to accept payment cards, which could have an adverse impact on business operations and lead to lower sales. Although we believe that other vendors could be identified and retained to provide these services, we may not find an adequate replacement timely, which could result in a material adverse effect on our business and operating results and adverse publicity.
Our online businesses face distinct operating risks.
The successful operation of our online businesses depends on efficient and uninterrupted operation of our order-taking and fulfillment operations. Disruptions or slowdowns in these areas could result from disruptions in telephone service or power outages, loss of internet connectivity, inadequate system capacity, system issues, computer viruses, human error, changes in programming, credit card fraud, natural disasters or adverse weather conditions. Our online businesses are generally vulnerable to additional risks and uncertainties associated with the Internet, including changes in required technology and other technical failures, as well as changes in applicable federal and state regulations, security breaches, and consumer privacy concerns. Problems in any of these areas, especially if such problems occur during the holiday season, could result in a reduction in sales, increased costs and damage to our reputation and brands.
Our ability to successfully implement significant information technology systems is critical to our business.
We rely on our existing management information systems, including software programs, in operating and monitoring all major aspects of our business, including omnichannel, sales, distribution, purchasing, inventory control, merchandising planning and replenishment, as well as various financial systems.
Our information technology infrastructure is in regular need of upgrades, which we plan to continue to implement. Such technology systems changes are complex and could cause disruptions that may adversely affect our business, such as when our new or upgraded systems fail to perform adequately. While we strive to ensure the orderly implementation of various information technology systems, we may not be able to successfully execute these changes without incurring a significant disruption to our business. Even if we are successful with implementation, we may not achieve the expected benefits from these initiatives, despite having expended significant capital. We may also determine that additional investment is required to bring our systems to their desired state, which could result in a significant investment of additional time and money and increased implementation risk. Furthermore, we intend to rely on third parties to fulfill contractual obligations related to some of these system upgrades. Failure of these third parties to fulfill their contractual obligations could lead to significant expenses or losses due to a disruption in business operations.
Fluctuations in comparative store sales and results of operations could cause our business performance to decline substantially.
Our results of operations for our individual stores have fluctuated in the past and can be expected to continue to fluctuate in the future. Numerous factors affect our comparable store sales, including, among others, merchandise assortment, retail prices, fashion trends, weather conditions, mall traffic, the retail sales environment, calendar shifts of holidays or seasonal periods, timing of promotional events, macro-economic conditions, fuel costs and our success in executing our business strategies.
Our ability to deliver strong comparable sales results and margins depends in large part on accurately forecasting demand and fashion trends, selecting effective marketing techniques, providing an appropriate mix of merchandise for our customer base, managing inventory effectively, using effective pricing strategies, optimizing store performance, and retaining our store associates. Failure to meet the expectations of investors, securities analysts, or credit rating agencies in one or more future periods could cause our credit ratings to decline.
We may not be able to successfully operate if we lose key personnel, are unable to hire qualified additional personnel, or experience turnover of our management team.
We have recently had a number of changes to our executive management team. Our continued success is largely dependent on the individual efforts and abilities of our senior management team and certain other key personnel and on our ability to retain current management and to attract and retain qualified key personnel in the future. The loss of certain key employees or our inability to continue to attract and retain other qualified key employees could have a material adverse effect on our growth, operations and financial position.
Our performance is dependent on attracting and retaining a large and growing number of qualified team members.
Many of our team members are in entry-level or part-time positions with historically high rates of turnover. Our ability to meet our labor needs while controlling our costs is subject to external factors such as unemployment levels, minimum wage legislation, health care legislation and changing demographics. In addition, our labor costs are influenced by health care and workers’ compensation costs, both of which have been rising in recent years. Legislative and private sector initiatives regarding healthcare reform could also result in significant changes to the U.S. healthcare system. Any increase in labor costs may adversely impact our profitability, or, if we fail to pay such higher wages, we could suffer increased employee turnover. Excessive store employee turnover could result in higher employee costs associated with finding, hiring and training new store employees. If we cannot hire enough qualified employees, or if there is a disruption in the supply of personnel we hire from third-party providers, especially during our peak season or certain high-volume events, our customer service levels and our operations could be negatively impacted.
We may experience fluctuations in our tax obligations and effective tax rate.
We are subject to income taxes in federal and applicable state and local tax jurisdictions in the United States, Canada, China, Australia, Puerto Rico, Kuwait, Hong Kong and South Korea. We record tax expense based on our estimates of future payments, which include reserves for estimates of uncertain tax positions. At any time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may impact the ultimate settlement of these tax positions. As a result, we expect that there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are re-evaluated. Further, our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings.
We are also subject to sales and use taxes, as well as other local taxes, in applicable jurisdictions in the United States, Canada, China, Puerto Rico and South Korea. At any time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may adversely impact the ultimate settlement of these tax positions and our financial results.
Currency exchange rate fluctuations may adversely affect our business and operating results.
There has been significant volatility in the value of the U.S. dollar against other foreign currencies in the recent past. While our business is primarily conducted in U.S. dollars, we purchase substantially all of our products overseas (primarily from China, Vietnam, Bangladesh, Indonesia, and India). Cost increases caused by currency exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability. Currency exchange rate fluctuations could also disrupt the business of the third-party manufacturers that produce our apparel by making their purchases of raw materials more expensive and more difficult to finance. Such fluctuations could have a material adverse effect on our business and earnings.
The loss of our key buying agent or one or more of our suppliers could disrupt our ability to deliver our inventory supply in a timely fashion, impacting its value.
One buying agent manages a substantial portion of our inventory purchases (approximately 89% in fiscal year 2015). The loss of this buying agent could result in delays in procuring inventory, which could result in a material adverse effect on our business and operating results. In addition, we have no long-term contracts with suppliers and typically transact business on an order-by-order basis, which provides us little pricing protection and could make it easier for a supplier to stop supplying us.
We are, and may continue to be in the future, a party to legal proceedings that could result in unexpected adverse outcomes.
From time to time, we are a party to legal proceedings, including matters involving personnel and employment issues, personal injury, and other proceedings arising in the ordinary course of business. In addition, there are an increasing number of cases being filed in the retail industry generally that contain class action allegations, such as such those relating to privacy and wage and hour laws. We evaluate our exposure to these legal proceedings and establish reserves for the estimated liabilities in accordance with generally accepted accounting principles. Assessing and predicting the outcome of these matters involves substantial uncertainties. Although not currently anticipated by management, unexpected outcomes in these legal proceedings, or changes in management’s evaluations or predictions and accompanying changes in established reserves, could have a material adverse impact on our financial results.
Our growth could be hampered if we are unable to identify new store locations and relocate existing stores in appropriate retail venues and shopping areas.
Our stores must be located in appropriate retail spaces in areas with demographic characteristics consistent with our customer base. These locations tend to be limited to malls and similar venues where the market for available space has historically been very competitive. The location of acceptable store sites and the negotiation of acceptable lease arrangements require considerable time, effort and expense. Our ability to lease desirable retail space for expansion and relocation of stores, and to renew our existing store leases, on favorable economic terms is essential to our revenue and earnings growth. There can be no assurance that we will be able to achieve our store expansion goals, effectively manage our growth, successfully integrate the planned new stores into our operations, or profitably operate our new and remodeled stores. Failure to obtain and renew leases for a sufficient number of stores on acceptable terms could have a material adverse effect on our revenues and operating results.
The lease for our corporate offices is scheduled to expire in April 2018, and we may not be able to secure a new lease on commercially favorable terms.
We lease approximately 162,400 square feet of office space in San Francisco, California, for our corporate office space. Approximately 34,300 square feet of this office space is subleased to a third party. Our office lease and sublease agreements expire in April 2018. Due to the competitive commercial real estate market in the San Francisco Bay Area, we may not be able to negotiate a new lease for our existing corporate headquarters on commercially favorable terms. If we are unable to enter into a new lease at our existing location, our ability to lease a suitable alternative location on favorable terms will depend on many factors which are not within our control, such as conditions in the local real estate market and competition for desirable properties, and any relocation of our current corporate officers could be disruptive to our business operations and result in increased expenses.
Our efforts to expand internationally through franchising and similar arrangements may not be successful and could impair the value of our brands.
We have entered into franchise agreements with unaffiliated third parties to operate stores in certain countries in the Middle East, South Korea and Latin America and with our affiliate (which we do not control or have an ownership interest in) to operate stores in China. Under these agreements, third parties operate stores that sell apparel, purchased from us, primarily under the Gymboree name. We have limited experience managing apparel retail franchise relationships and these arrangements may ultimately not be successful. While we expect that this will be a small part of our business in the near future, we plan to continue to increase these types of arrangements over time as part of our international expansion efforts. The effect of these arrangements on our business and operating results is uncertain and will depend upon various factors, including the demand for our products in new markets and our ability to successfully identify appropriate third parties to act as franchisees, distributors, or in a similar capacity. In addition, certain
aspects of these arrangements are not directly within our control. Other risks that may affect these third parties include general economic conditions in specific countries or markets, changes in diplomatic and trade relationships, and political instability. Moreover, while the agreements we have entered into and plan to enter into in the future provide us with certain termination rights, to the extent that these parties do not operate their stores in a manner consistent with our requirements regarding our Gymboree brand identity and customer experience standards, or with laws and regulations regarding consumer and data protection and privacy, the value of our brands could be impaired. A failure to protect the value of our brands or any other harmful acts or omissions by a franchisee could have an adverse effect on our operating results and our reputation.
We may be unable to protect our trademarks and other intellectual property rights.
We believe that our trademarks and service marks are important to our success and our competitive position due to their name recognition with our customers. We devote substantial resources to the establishment and protection of our trademarks and service marks on a worldwide basis. We are not aware of any material claims of infringement or material challenges to our right to use any of our trademarks and service marks in the United States or abroad. Nevertheless, the actions we have taken to establish and protect our trademarks and service marks may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the trademarks, service marks and proprietary rights of others, particularly as we continue to expand our business outside the United States. Also, others may assert rights in, or ownership of, trademarks and other proprietary rights of ours and we may not be able to successfully resolve these types of conflicts to our satisfaction. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We lease approximately 162,400 square feet of office space in a building in San Francisco, California, for our corporate offices. Approximately 34,300 square feet of this office space is subleased to a third party. Our office lease and sublease agreements expire in April 2018.
We lease approximately 444,000 square-foot of distribution center on approximately 31 acres in Dixon, California, which we use to distribute our products, except for www.gymboree.com customer orders. Our lease agreement of the distribution center expires in May 2030.
For the last several years, we outsourced the fulfillment of www.gymboree.com online customer orders to a third-party fulfillment center in Ohio, under an operating services agreement which provides us with approximately 314,000 square feet of leased space used for warehousing, fulfillment and logistics services. On February 25, 2016, the Company entered into an agreement to terminate the arrangement. The fulfillment of our www.gymboree.com online customer orders will continue to be processed at the third-party fulfillment center in Ohio through April 30, 2016. The Company expects to transfer the warehousing, logistics and fulfillment of our www.gymboree.com online customer orders to our distribution center in Dixon, California, in May 2016 and will pay an early termination fee of $8.3 million to the third-party fulfillment center.
As of January 30, 2016, our 1,306 stores included an aggregate of approximately 2,709,000 square feet of space. Store leases typically have 10-year terms and typically include a termination clause if minimum revenue levels are not achieved during a specified 12-month period during the lease term. Some leases are structured with a minimum rent component plus a percentage rent based on the store’s net sales in excess of a certain threshold. Substantially all of the leases require us to pay insurance, utilities, real estate taxes, and common area repair and maintenance expenses. Approximately 201, 185, and 163 store leases will come up for renewal during fiscal 2016, 2017 and 2018, respectively. We are also in the process of negotiating lease terms for approximately 77 stores currently operating under month-to-month terms. See Note 11 to the consolidated financial statements included elsewhere in this annual report.
Item 3.
Item 3. Legal Proceedings
The Company is subject to various legal proceedings and claims arising in the ordinary course of business. Our management does not expect that the results of any of these legal proceedings, either individually or in the aggregate, would have a material effect on our financial position, results of operations or cash flows.
Item 4.
Item 4. Mine Safety Disclosures
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Gymboree Holding, Ltd., domiciled in the Cayman Islands, through Giraffe Holding, Inc. (“Parent”) and other direct and indirect subsidiaries, indirectly owns all of our outstanding equity interests. Shares of our common stock are not registered on any national securities exchange or otherwise publicly traded, there is no established public trading market for our common stock and none of the shares of our common stock are convertible into shares of any other class of stock or other securities.
During fiscal 2014, we paid cash dividends on our common stock in aggregate amounts of $0.2 million to Parent. We do not have an established annual dividend policy. We may issue dividends to our shareholders from time to time, but are under no obligation to do so, and would do so only to the extent permitted under financing documents and approved by our Board of Directors.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected historical consolidated financial data at the dates and for the periods indicated below and has been derived from our historical audited consolidated financial statements.
The following information should be read in conjunction with “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this report. The following discussion contains forward-looking statements. Our actual results could differ materially from results that may be expressed or implied by such forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements.” The principal factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Item 1A. Risk Factors” and those discussed elsewhere in this report. We undertake no obligation to update or revise forward-looking statements in order to reflect events or circumstances that may subsequently arise or otherwise, except as may be required by law.
Overview
We are one of the largest children’s apparel specialty retailers in North America, offering collections of high-quality apparel and accessories. As of January 30, 2016, we operated a total of 1,306 retail stores, as follows:
In addition, as of January 30, 2016, we operated online stores at www.gymboree.com, www.janieandjack.com, and www.crazy8.com. Overseas franchisees and Gymboree China operated 84 retail stores, as follows:
(1) Overseas franchisees operated retail stores in the Middle East, South Korea and Latin America.
Subsequent to fiscal 2015, Gymboree China’s management made the decision to close 25 of its retail locations. Closures are targeted to be completed by the end of May 2016.
We also offer directed parent-child developmental play programs under the Gymboree Play & Music brand at 727 franchised and Company-operated centers in the United States and 43 other countries.
Our year-end is the Saturday closest to January 31. Fiscal 2015 and 2014, which included 52 weeks each, ended on January 30, 2016 and January 31, 2015, respectively.
Fiscal 2015 Highlights
Total net sales increased to $1.25 billion for the fiscal year ended January 30, 2016 (“fiscal 2015”) from $1.23 billion in fiscal 2014, or 1.5%, driven primarily by increases in our Gymboree Play & Music sales of $10.3 million, retail sales of $6.1 million, and retail franchise sales of $2.1 million.
Comparable store sales (including online sales) increased 1% compared to fiscal 2014. Below is the comparable store sales (including online sales) by brand for each fiscal year:
Our Adjusted EBITDA increased to $102.5 million in fiscal 2015 from $93.7 million in fiscal 2014, an increase of $8.8 million or 9.4%, primarily due to a comparable store sales increase, gross profit expansion, and leveraging our selling, general and administrative expenses (“SG&A”), partially offset by the negative impact from the west coast port slowdown in our retail business during the first two quarters of fiscal 2015.
The following table summarizes store openings and closures by brand and country for fiscal 2015. Note that (i) all Crazy 8 stores are in the United States and (ii) retail stores operated by overseas franchisees and the VIE-operated Gymboree retail stores in China are excluded.
We plan to open approximately 6 new stores in fiscal 2016, primarily in our Janie and Jack and Gymboree Outlet brands, and close approximately 20 to 30 stores, primarily in our Crazy 8 and Gymboree brands. We expect our international franchise partners to open approximately 1 to 5 franchise stores in fiscal 2016.
Results of Operations
Consolidated statements of operations data as a percentage of total net sales for each fiscal year were as follows (amounts in thousands):
Fiscal 2015 compared to Fiscal 2014
Net Sales
Total net sales increased to $1.25 billion for fiscal 2015 from $1.23 billion in fiscal 2014, or 1.5%, driven primarily by increases in our Gymboree Play & Music sales of $10.3 million, retail sales of $6.1 million, and retail franchise sales of $2.1 million.
Net retail sales for fiscal 2015 increased to $1.185 billion from $1.178 billion compared to fiscal 2014, an increase of $6.1 million, or 0.5%, primarily due to an increase in comparable store sales (including online sales) of 1%. Comparable store sales (excluding online sales) increased by 1% in fiscal 2015 compared to the same period in the prior year. Total net stores decreased to 1,306 as of fiscal year-end 2015 from 1,326 as of fiscal year-end 2014. Total square footage decreased to approximately 2.7 million square feet as of fiscal year-end 2015 from approximately 2.8 million square feet as of fiscal year-end 2014.
Gymboree Play & Music net sales for fiscal 2015 increased to $41.2 million from $30.9 million in the same period last year, an increase of $10.3 million or 33.3%, primarily due to growth in the number of Gymboree Tianjin franchisee sites to 260 as of fiscal year-end 2015 from 227 at the same prior year period, combined with stronger performance of existing Gymboree Tianjin sites.
Retail franchise net sales for fiscal 2015 increased to $21.5 million from $19.4 million in the same period last year, an increase of $2.1 million or 11.2%, primarily due to higher sales to our franchisee in the Middle East region. As of fiscal year-end 2015, our overseas franchisees and Gymboree China operated 84 stores compared to 89 stores as of the end of the same period last year.
Gross Profit
Gross profit for fiscal 2015 increased to $486.2 million from $468.5 million in fiscal 2014, primarily as a result of gross profit expansion. As a percentage of net sales, gross profit for fiscal 2015 increased by 90 basis points to 39.0% from 38.1% in the same period last year. The 90 basis points increase was driven primarily by lower cost of goods sold (“COGS”) as a percentage of sales due to the mix of merchandise inventories sold, lower buying and occupancy costs as a percentage of sales, and an increased mix of Gymboree Tianjin and retail franchise sales, partially offset by the negative impact from the west coast port slowdown in our retail business during the first two quarters of fiscal 2015. As we record certain distribution costs as a component of selling, general and administrative expenses (“SG&A”) and do not include such costs in COGS, our COGS and gross profit may not be comparable to those of other companies. Our distribution costs recorded in SG&A expenses represent primarily outbound shipping and handling expenses to our stores, and amounted to $45.5 million and $43.1 million during fiscal 2015 and 2014, respectively.
Selling, General and Administrative Expenses
SG&A principally consists of non-occupancy store expenses, corporate overhead, and certain distribution expenses. SG&A decreased to $444.2 million for fiscal 2015 compared to $448.4 million in the same period last year. As a percentage of net sales, SG&A expenses decreased 90 basis points to 35.6% for fiscal 2015 from 36.5% in the same period last year.
The $4.1 million and 90 basis points decrease for fiscal 2015 compared to the same prior year period are primarily due to a decrease in expenses resulting from combined store closures and fewer store openings in the current year, and a $4.7 million reduction in store asset impairment charges for under-performing stores, partially offset by an increase in marketing expenses.
Goodwill and Intangible Asset Impairment
During fiscal 2015, we did not record any impairment for goodwill and intangible assets.
In connection with our long-range planning process in the third quarter of fiscal 2014, we revised our growth assumptions based on estimates of future operations. The updated assumptions resulted in a plan that reflected slower growth in revenues and margins in the reporting units of our retail stores segment. As a result, we recorded non-cash goodwill impairment charges of $252.3 million, $67.2 million and $59.3 million related to the Gymboree Retail, Gymboree Outlet and Crazy 8 reporting units, respectively, during the third quarter of fiscal 2014. In addition, we recorded a non-cash impairment charge of $212.6 million related to trade names in our retail stores segment during the third quarter of fiscal 2014.
These impairment charges did not have an effect on our business operations, liquidity or financial covenants.
Interest Expense
Interest expense increased to $86.0 million during fiscal 2015 compared to $82.4 million during fiscal 2014. The increase of $3.6 million was primarily related to amortization of our interest rate caps (which mature in December 2016), interest paid on the sale-leaseback financing liability for our Dixon distribution center, and an increase in ABL line of credit borrowings in fiscal 2015. Our average ABL line of credit borrowings increased to $51.9 million during fiscal 2015 compared to $32.0 million during fiscal 2014.
Gain on Extinguishment of Debt
During fiscal 2015, we repurchased Notes (see Note 7 to the consolidated financial statements included elsewhere in this annual report) with an aggregate principal amount of $58.4 million for $15.3 million in cash through open market transactions. We recorded a $41.5 million gain on extinguishment of debt, net of a $1.6 million charge related to the write-off of deferred financing costs associated with the extinguished debt. We did not repurchase any Notes during fiscal 2014. The Notes payable balance as of January 30, 2016 was $287.6 million.
Income Taxes
The effective tax rate for fiscal 2015 and 2014 was -187.1% (expense) and 11.3% (benefit), respectively. The change in effective tax rate in fiscal 2015 as compared to fiscal 2014 was due to a non-recurring tax benefit in fiscal 2014 related to the impairment of indefinite lived intangible assets offset by the impact of tax liabilities and reserves in fiscal 2015 within certain foreign and state jurisdictions. These liabilities and reserves as a percentage of our fiscal 2015 pre-tax book loss of $3.1 million resulted in a large negative effective tax rate in fiscal 2015.
We consider all available positive and negative evidence in evaluating whether a valuation allowance is required, including prior earnings history, actual earnings over the previous 12 quarters on a cumulative basis, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset. As a result of weighing the available objective evidence as of January 30, 2016 and January 31, 2015, our valuation allowance against deferred tax assets was $63.2 million and $58.6 million, respectively. The valuation allowance as of January 30, 2016 represents a valuation allowance against all net deferred tax assets in U.S. federal, unitary U.S. state, and Australian jurisdictions, excluding indefinite-lived deferred tax assets and liabilities, and against the tax benefit on losses from our VIEs. We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.
Fiscal 2014 compared to Fiscal 2013
Net Sales
Total net sales decreased $15.8 million or 1.3% during fiscal 2014 compared to fiscal 2013. This decline was primarily driven by a decrease in net retail sales.
Net retail sales for fiscal 2014 decreased to $1.18 billion from $1.20 billion compared to fiscal 2013, a decrease of $18.7 million, or 1.6%, primarily due to a decrease in comparable store sales (including online sales) of 3%, partially offset by net new door growth of $23.1 million. Comparable store sales (excluding online sales) decreased by 4% in fiscal 2014 compared to the same period in the prior year. Total net stores increased to 1,326 as of fiscal year-end 2014 from 1,323 as of fiscal year-end 2013. Total square footage increased to approximately 2.8 million square feet as of fiscal year-end 2014 from approximately 2.7 million square feet as of fiscal year-end 2013.
Gymboree Play & Music net sales for fiscal 2014 increased to $30.9 million from $25.7 million during fiscal 2013, an increase of $5.2 million or 20.3%, primarily due to growth in Gymboree Tianjin.
Retail franchise net sales for fiscal 2014 decreased to $19.4 million from $21.7 million during fiscal 2013, a decrease of $2.4 million or 10.8%, primarily due to lower sales to our franchisee in the Middle East region. As of fiscal year-end 2014, our overseas franchisees and Gymboree China operated 89 stores compared to 71 stores as of fiscal year-end 2013.
Gross Profit
Gross profit for fiscal 2014 decreased to $468.5 million from $476.0 million during fiscal 2013, primarily as a result of the net sales decrease described above. As a percentage of net sales, gross profit for fiscal 2014 decreased by 10 basis points to 38.1% from 38.2% during fiscal 2013 primarily due to deleveraging of buying and occupancy expenses and increased promotional activity. As we record certain distribution costs as a component of SG&A and do not include such costs in COGS, our COGS and gross profit may not be comparable to those of other companies. Our distribution costs recorded in SG&A expenses represent primarily outbound shipping and handling expenses to our stores, and amounted to $43.1 million and $37.9 million during fiscal 2014 and 2013, respectively.
Selling, General and Administrative Expenses
SG&A principally consists of non-occupancy store expenses, corporate overhead, and certain distribution expenses. SG&A increased to $448.4 million for fiscal 2014 compared to $443.9 million during fiscal 2013. As a percentage of net sales, SG&A expenses increased 80 basis points to 36.5% for fiscal 2014 from 35.7% during fiscal 2013 primarily due to a deleveraging of expenses on lower comparable store sales, increased expenses related to our third-party fulfillment center which commenced operations during the third quarter of fiscal 2013, and incremental marketing expenses.
Goodwill and Intangible Asset Impairment
In connection with our long-range planning process in the third quarter of fiscal 2014, we revised our growth assumptions based on estimates of future operations. The updated assumptions resulted in a plan that reflected slower growth in revenues and margins in the reporting units of our retail stores segment. As a result, we recorded non-cash goodwill impairment charges of $252.3 million, $67.2 million and $59.3 million related to the Gymboree Retail, Gymboree Outlet and Crazy 8 reporting units, respectively, during the third quarter of fiscal 2014. In addition, we recorded a non-cash impairment charge of $212.6 million related to trade names in our retail stores segment during the third quarter of fiscal 2014.
During fiscal 2013, we recorded non-cash goodwill impairment charges of $85.3 million, $38.8 million, and $16.1 million related to the Crazy 8, Gymboree Retail, and Gymboree Outlet reporting units, respectively. The impairment of goodwill was primarily driven by weak results in fiscal 2013, particularly in the fourth quarter. During fiscal 2013, we also recorded a non-cash impairment charge of $17.0 million related to trade names in our retail stores segment.
These impairment charges did not have an effect on our business operations, liquidity or financial covenants.
Interest Expense
Interest expense increased to $82.4 million during fiscal 2014 compared to $81.6 million during fiscal 2013. The increase of $0.8 million was primarily related to our interest rate caps.
Loss on Extinguishment of Debt
During fiscal 2013, we repurchased Notes with an aggregate principal amount of $25.0 million for $24.8 million in cash, which resulted in a $0.2 million gain on extinguishment of debt and a $1.0 million charge related to the write-off of deferred financing costs. We did not repurchase any Notes during fiscal 2014.
Income Taxes
The effective tax rate for fiscal 2014 and 2013 was 11.3% (benefit) and 0.7% (benefit), respectively. The change in effective tax rate as of fiscal year-end 2014 was related to goodwill and trade name impairment charges. The change in effective tax rate as of fiscal year-end 2013 was due to recording a valuation allowance against net deferred tax assets in jurisdictions where it is more likely than not that these assets will not be realized (see Note 13 to the consolidated financial statements included elsewhere in this annual report).
We consider all available positive and negative evidence in evaluating whether a valuation allowance is required, including prior earnings history, actual earnings over the previous 12 quarters on a cumulative basis, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset. As a result of weighing the available objective evidence as of January 31, 2015 and February 1, 2014, our valuation allowance against deferred tax assets was $58.6 million and $31.9 million, respectively. The valuation allowance as of January 31, 2015 represents a valuation allowance against all net deferred tax assets in U.S. federal, unitary U.S. state and Australian jurisdictions, excluding indefinite-lived deferred tax assets and liabilities, and against the tax benefit on losses from our VIEs. We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.
Liquidity and Capital Resources
Overview
We finance our business with existing cash, cash from operations and the funds available under our Senior Credit Facilities. We had cash and cash equivalents of $18.2 million and $18.5 million as of January 30, 2016 and January 31, 2015, respectively (including amounts held by the VIEs). Cash and cash equivalents held by the VIEs, of which we are the primary beneficiary, and the results of which we have consolidated into our financial statements, were $9.6 million and $10.0 million as of January 30, 2016 and January 31, 2015, respectively (see Note 19 to the consolidated financial statements included elsewhere in this annual report). The assets of the VIEs can only be used by the VIEs. Net working capital as of January 30, 2016 and January 31, 2015 totaled $29.4 million and $43.0 million, respectively (including $6.2 million and $5.1 million, respectively, from our VIEs).
We and our subsidiaries, the VIEs, and our affiliates may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
We believe that cash generated by operations, the remaining funds available under our Senior Credit Facilities and existing cash and cash equivalents will be sufficient to meet working capital requirements, service our debt, and finance capital expenditures over the next twelve months. However, if we face unanticipated cash needs such as the funding of a capital investment, or if our suppliers request one or more letters of credit, our existing cash and cash equivalents and available borrowings may be insufficient. In addition, we cannot assure that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under the Senior Credit Facilities in amounts sufficient to enable us to repay our indebtedness when due, including the Notes, or to fund other liquidity needs. See “Item 1A. Risk Factors-Risks Related to Our Indebtedness and Certain Other Obligations.” We also regularly evaluate market conditions, our liquidity profile, and various financing alternatives, for opportunities to enhance our capital structure. We are continuing to actively pursue various financing alternatives, including refinancing and/or repurchasing our outstanding Notes, divestitures of certain of our assets and operations, as well as other opportunities to improve our capital structure. If opportunities are favorable, we may consummate one or more of these initiatives and the amounts involved may be material.
Cash and Cash Equivalents
Changes in our cash and cash equivalents for each fiscal year were as follows (in thousands):
Cash flows provided by (used in) operating activities
Net cash provided by operating activities during fiscal 2015 was $29.1 million compared to net cash used in operating activities of $21.8 million in the same period last year. The change in cash flows from operating activities during fiscal 2015 was primarily due to gross profit expansion, the timing of purchases of merchandise inventories, and the timing of payment of accounts payable and accrued liabilities.
Net cash used in operating activities for fiscal 2014 was $21.8 million compared to net cash provided by operating activities of $74.9 million in fiscal 2013. The decrease in cash attributable to changes in assets and liabilities was primarily due to an increase in merchandise inventory and a reduction in accounts payable. These increases were partially offset by reduced prepaid rent. The increase in merchandise inventory was primarily due to earlier receipt of Spring goods compared to fiscal 2013 and investments in Winter products in our Gymboree brand.
Cash flows used in investing activities
Net cash used in investing activities during fiscal 2015 was $22.6 million compared to $31.9 million in the same period last year. The net change during fiscal 2015 was primarily due to lower capital expenditures, which decreased by $10.6 million to $21.4 million compared to $32.0 million in the same period last year. The decrease was due to fewer store openings and an increase in related party loan receivable of $1.7 million (see Note 17 to the consolidated financial statements included elsewhere in this annual report).
Net cash used in investing activities during fiscal 2014 was $31.9 million compared to $53.1 million during fiscal 2013 and was primarily due to capital expenditures, which decreased to $32.0 million during fiscal 2014 compared to $52.6 million during fiscal 2013 due to fewer store openings.
We estimate capital expenditures for fiscal 2016 will be approximately $30 to $35 million. We expect capital expenditures to be used primarily for our systems infrastructure, lease required remodels of existing stores and, to a lesser extent, new store growth.
Cash flows (used in) provided by financing activities
Net cash used in financing activities during fiscal 2015 was $5.8 million compared to net cash provided by financing activities of $33.3 million during fiscal 2014. In fiscal 2015, we repurchased Notes with an aggregate principal amount of $58.4 million for $15.3 million in cash through open market transactions (see Note 7 to the consolidated financial statements included elsewhere in this annual report). In addition, we made a $14.0 million of net payments on our ABL Revolving Facility and a $1.7 million payment for deferred financing costs related to the amendment of ABL Revolving Facility, partially offset by gross proceeds of $26.8 million related to the sale of the Company’s distribution center in Dixon, California (reduced by $0.9 million payment for deferred financing costs (see Notes 7 and 8 to the consolidated financial statements included elsewhere in this annual report).
Net cash provided by financing activities during fiscal 2014 was $33.3 million compared to net cash used in financing activities of $16.6 million during fiscal 2013. Net cash provided by financing activities for fiscal 2014 was primarily due to net proceeds of $33.0 million from our ABL Revolving Facility.
Credit Facilities
ABL Facility
In September 2015, we amended the ABL Revolving Facility (the “First Amendment”) to extend the maturity date of the ABL revolving commitments from March 2017 to the earlier of (i) September 24, 2020 and (ii) the date that is 60 days before the scheduled final maturity date of any tranche of the Term Loan (which matures in February 2018) or the Notes (which mature in December 2018), unless such indebtedness is cumulatively equal to or less than $25.0 million in the aggregate and a reserve against the borrowing base is imposed equal to the amount of such indebtedness.
The ABL Revolving Facility, as amended by the First Amendment, provided financing of up to $225 million in a revolving line of credit. Line of credit availability under the ABL Revolving Facility is subject to a borrowing base consisting of certain assets of the Company, any subsidiary co-borrowers and any subsidiary guarantors that are available to collateralize the borrowings thereunder, and is reduced by the level of outstanding letters of credit. As of January 30, 2016, line of credit borrowings outstanding under the ABL Revolving Facility were $19.0 million and letter of credit utilization was $27.6 million. Undrawn line of credit availability under the ABL Revolving Facility, after being reduced by outstanding borrowings and letter of credit utilization, was $125.5 million as of January 30, 2016. Average line of credit borrowings during fiscal 2015 under the ABL Revolving Facility amounted to $51.9 million. We anticipate utilizing our line of credit under the ABL Revolving Facility throughout the course of fiscal 2016 to support seasonal working capital needs and expect to have borrowings outstanding at year-end.
Line of credit borrowings under the ABL Revolving Facility bear interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Bank of America, N.A., (2) the federal funds effective rate plus 0.50%, and (3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00%, or (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs (“Adjusted LIBOR”), in each case plus an applicable margin. As of January 30, 2016, the weighted average interest rate on our line of credit borrowings outstanding under the ABL Revolving Facility was 3.5%. In addition to paying interest on outstanding line of credit borrowings under the ABL Revolving Facility, we are required to pay a commitment fee on unutilized commitments thereunder, which is between 0.250% and 0.375% per annum under the amended ABL Revolving Facility.
If at any time the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the ABL Revolving Facility exceeds the lesser of (a) the commitment amount and (b) the borrowing base, we will be required to repay outstanding loans and/or cash collateralized letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount. The ABL Revolving Facility contains financial and other covenants that, among other things, restrict our ability to incur additional indebtedness and pay dividends. As of January 30, 2016, the ABL Revolving Facility also contained a financial covenant that required the Company to test its consolidated fixed charge coverage ratio when availability under the facility fell below a specified threshold. As of January 30, 2016, we were not required to test compliance with this financial covenant.
On April 22, 2016, we entered into a second amendment to the ABL Revolving Facility (the ABL Revolving Facility, as so amended, the “ABL Facility” or the “Second Amendment”). The Second Amendment provides for a senior secured term loan (the “ABL Term Loan”) of $50.0 million, subject to a borrowing base, the proceeds of which may be used to finance the acquisition of working capital assets, including the purchase of inventory and equipment, in each case in the ordinary course of business, to finance capital expenditures, to finance permitted acquisitions and for general corporate purposes, including repurchases of the Notes.
The Second Amendment provides that the ABL Term Loan will bear interest (computed on the basis of the actual number of days elapsed over a year of 360 days) at a 90-day LIBOR contract rate as determined by the agent for the ABL Term Loan monthly on the first day of each calendar month, plus 10.25% per annum, or, in certain circumstances, at the prime rate, plus 9.25% per annum. The Second Amendment also provides for a new availability covenant, whereby so long as any amount of the ABL Term Loan remains outstanding, the Company and its restricted subsidiaries must maintain, at all times, (i) Combined Availability (or, an amount equal to (a) the ABL Term Loan borrowing base minus the sum of (b) the aggregate outstanding principal amount under the ABL Facility (including the ABL Term Loan, revolving line of credit borrowings and letter of credit utilization)) in excess of the greater of (x) $17.5 million and (y) 10% of the ABL Term Loan borrowing base; and (ii) Availability (or, an amount equal to the lesser of (A) (I) the revolving credit ceiling minus (II) the aggregate principal amount outstanding under the revolving line of credit and letter of credit utilization and (B) (I) the revolving line of credit borrowing base minus (II) the aggregate principal amount outstanding under the revolving line of credit and letter of credit utilization) in excess of the greater of (x) $17.5 million and (y) 10% of the lesser of (A) the applicable revolving line of credit borrowing base and (B) the revolving credit ceiling (which as of the date hereof is $225.0 million). The Second Amendment further provides that the Company’s consolidated fixed charge coverage ratio will not be tested as long as the ABL Term Loan remains outstanding. The maturity date for the ABL Term Loan is the same as the maturity date of the ABL revolving commitments discussed above, and all other material affirmative and negative covenants and events of default under the ABL Facility remain substantially unchanged. In addition, the restrictions on amendments to the ABL Facility were amended to provide the agent for the ABL Term Loan and the ABL Term Loan lenders certain consent rights relating to, among other terms and provisions, the borrowing bases, the availability covenant and certain negative covenants.
Term Loan
We also have an agreement with several lenders for an $820 million senior secured Term Loan, with a maturity date of February 2018. As of January 30, 2016, $769.1 million was outstanding under the Term Loan. The Term Loan allows us to request additional tranches of term loans in an aggregate amount not to exceed $200 million, subject to the satisfaction of certain conditions, provided such amount will be subject to reduction by the amount of any additional commitments incurred under the ABL Revolving Facility. The interest rate for borrowings under the Term Loan is, at the Company’s option, a base rate plus an additional marginal rate of 2.5% or the Adjusted LIBOR rate (with a 1.5% floor) plus an additional rate of 3.5%. As of January 30, 2016, the interest rate under our Term Loan was 5%.
The Term Loan requires us to make quarterly payments equal to 0.25% of the original $820 million principal amount of the Term Loan made on the closing date plus accrued and unpaid interest thereon, with the balance due in February 2018. The Term Loan also has mandatory and voluntary pre-payment provisions, including a requirement that we prepay the Term Loan with a certain percentage of our annual excess cash flow. We calculated our excess cash flow using fiscal 2015 operating results and concluded we
are not required to make any excess cash flow payments on the Term Loan during fiscal 2016. Voluntary prepayments and the excess cash flow prepayments made in prior fiscal years were applied toward our remaining quarterly amortization payments payable under the Term Loan through fiscal 2016. Our next quarterly payment payable under the Term Loan is due in the first quarter of fiscal 2017.
The Term Loan contains covenants that, among other things, restrict our ability to incur additional indebtedness and pay dividends.
Notes
In fiscal 2010, we issued $400 million aggregate principal amount of 9.125% Notes due in December 2018. Interest on the Notes is payable semi-annually. As of January 30, 2016, the Notes payable balance outstanding was $287.6 million.
Summary Disclosures about Contractual Obligations and Commercial Commitments
The following table reflects a summary of our contractual obligations and commitments as of January 30, 2016:
(1) Other lease-required expenses such as utilities, real estate taxes and common area repairs and maintenance are excluded. Additionally, sublease rental receipts totaling approximately $4.9 million through April 2018 are excluded. See Note 11 to the consolidated financial statements included elsewhere in this annual report for discussion of the Company’s operating leases.
(2) Inventory purchase obligations include outstanding purchase orders for merchandise inventories that are enforceable and legally binding on the Company and that specify all significant terms (including fixed or minimum quantities to be purchased), fixed, minimum or variable price provisions, and the approximate timing of the transaction.
(3) Other purchase obligations include annual commitments of approximately $8.8 million through the second quarter of 2019 under the operating services agreement related to a third party fulfillment center (see Notes 11 and 14 to the consolidated financial statements included elsewhere in this annual report). The table above does not reflect the impact of the subsequent termination of the operating service agreement. On February 25, 2016 (see Note 11 to the consolidated financial statements included elsewhere in this annual report), the Company entered into an agreement to terminate the operating services agreement effective upon exiting from the fulfillment center in Ohio, which is expected to be in May 2016. The Company will continue to pay a monthly minimum fee of approximately $0.7 million until fulfillment of orders ceases on April 30, 2016 and will pay an early termination fee of $8.3 million to the third-party fulfillment center. The Company could continue to pay the monthly minimum fee or a pro-rata amount if fulfillment of orders continues to be processed in the third-party fulfillment center after April 30, 2016 through no fault of the third party fulfillment center.
Also included in other purchase obligations are commitments for professional services, information technology and fixtures and equipment.
(4) Long-term debt as of January 30, 3016 is consists of a $769.1 million Term Loan, an ABL Revolving Facility that provides a revolving line of credit of up to $225 million, and an aggregate principal amount of $287.6 million of our Notes. The table above includes $19.0 million of outstanding revolver borrowings from our ABL Facility. The amounts presented in the table above exclude an original issue discount of $0.7 million (see Note 7 to the consolidated financial statements included elsewhere in this annual report) and $27.6 million of commercial and standby letters of credit related to normal business transactions, which expires in fiscal 2016 (see Note 6 to the consolidated financial statements included elsewhere in this annual report).
The table above does not reflect the repurchase of any Notes subsequent to fiscal 2015. See Note 22 to the consolidated financial statements included elsewhere in this annual report.
(5) Interest payments on long-term debt are estimated based on: (a) the outstanding principal balance of the Term Loan, which was $769.1 million as of January 30, 2016, and also take into consideration scheduled principal payments in fiscal 2017 through 2018, and (b) the outstanding principal balance of $287.6 million on the Notes as of January 30, 2016. The interest rate for borrowings under the Term Loan is, at the Company’s option, a base rate plus an additional marginal rate of 2.5% or the Adjusted LIBOR rate (with a 1.5% floor) plus an additional rate of 3.5%. Interest payments for borrowings under the Term Loan, in the table above, are estimated using the Company’s January 30, 2016 rate of 5%. Interest payments on the Company’s Notes are made semi-annually at a rate of 9.125% of the principal amount outstanding.
The table above does not reflect the repurchase of any Notes subsequent to fiscal 2015. See Note 22 to the consolidated financial statements included elsewhere in this annual report.
(6) Sale-leaseback financing liability and interest payments pertain to the sale of the distribution center in Dixon, California, which we leaseback from the purchaser for a period of 15 years (see Note 8 to the consolidated financial statements included elsewhere in this annual report). Under the terms of the lease agreement, the Company is required to maintain an unconditional irrevocable letter of credit for a period up to 10 years. Due to the Company’s continuing involvement through the irrevocable letter of credit, the Company has accounted for the sale-leaseback as a financing liability.
As of January 30, 2016, we had unrecognized tax benefits of $3.7 million, accrued interest of $0.9 million, and accrued penalties of $0.5 million. These amounts have been excluded from the contractual obligations table because a reasonably reliable estimate of the timing of future tax settlements cannot be determined.
The expected timing of payment of the obligations discussed above is estimated based on current information. The timing of payments and actual amounts paid may differ depending on the timing of receipt of services, or, for some obligations, changes to agreed-upon amounts.
Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (Non-GAAP Measure)
In the table below, we present Adjusted EBITDA (which is defined as net loss attributable to The Gymboree Corporation before interest expense, interest income, income taxes, and depreciation and amortization (EBITDA) adjusted for the other items described below), which is considered a non-GAAP financial measure. We present Adjusted EBITDA in this annual report because we consider it an important supplemental measure of performance used by management and we believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in the retail industry. Adjusted EBITDA is calculated in substantially the same manner as “EBITDA” under the indenture governing the Notes and “Consolidated EBITDA” under the agreement governing our Senior Credit Facilities. We believe the inclusion of supplementary adjustments applied to EBITDA in presenting Adjusted EBITDA is appropriate to provide additional information to investors about certain non-cash items and to provide additional information with respect to our ability to meet our future debt service and to comply with various covenants in documents governing our indebtedness. However, Adjusted EBITDA is not a presentation made in accordance with GAAP, and our computation of Adjusted EBITDA may vary from others in the retail industry. Adjusted EBITDA should not be considered an alternative to operating income or net income (loss), as a measure of operating performance or cash flow, or as a measure of liquidity. Adjusted EBITDA has important limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. For example, Adjusted EBITDA:
•
does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;
•
does not reflect changes in, or cash requirements for, our working capital needs;
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does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
•
excludes income tax payments that represent a reduction in cash available to us; and
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does not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of ongoing operations.
The following table provides a reconciliation of net loss attributable to The Gymboree Corporation to Adjusted EBITDA for the fiscal years indicated (in thousands):
Critical Accounting Policies
Critical accounting policies are those accounting policies and estimates that management believes are important to the portrayal of the Company’s financial condition and results of operations and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain. Management has discussed the development and selection of the critical accounting policies and estimates applicable to the Company as of the date of the completion of the audit for the fiscal year ended January 30, 2016 with the Company’s Audit Committee.
Goodwill
On November 23, 2010, we completed a merger (the “Merger”) with Giraffe Acquisition Corporation in accordance with an Agreement and Plan of Merger with Giraffe Holding, Inc. (“Parent”) and Acquisition Sub, a wholly owned subsidiary of Parent. In connection with the Merger, we allocated goodwill to our reporting units, which we concluded were the same as our operating segments: Gymboree Retail (including an online store), Gymboree Outlet, Janie and Jack (including an online store), Crazy 8 (including an online store), Gymboree Play & Music and International Retail Franchise. We allocated goodwill to the reporting units by calculating the fair value of each reporting unit and deriving the implied fair value of each reporting unit’s goodwill as of the Merger. As of January 30, 2016, we had goodwill of $372.7 million related to the Merger.
Goodwill is tested for impairment on an annual basis at the end of our tenth fiscal period (fiscal November) and at an interim date if indicators of impairment exist. Events that could result in an interim period impairment review include significant changes in the business climate, declines in our operating results, or an expectation that the carrying amount may not be recoverable. We assess potential impairment by considering present economic conditions as well as future expectations.
Goodwill is tested by performing a two-step goodwill impairment test. The first step of the two-step goodwill impairment test is to compare the fair value of the reporting unit to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step of the two-step goodwill impairment test is required to measure the goodwill impairment loss. The second step includes valuing all the tangible and intangible assets and liabilities of the reporting unit as if the reporting unit had been acquired in a business combination. Then, the implied fair value of the reporting unit’s goodwill is compared to the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of the goodwill, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying amount.
Calculating the fair value of a reporting unit and the implied fair value of reporting unit goodwill requires significant judgment. The use of different assumptions, estimates or judgments in either step of the goodwill impairment testing process, such as the estimated future cash flows of reporting units, the discount rate used to discount such cash flows, or the estimated fair value of the reporting units’ tangible and intangible assets and liabilities, could significantly increase or decrease the estimated fair value of a reporting unit or its net assets.
We performed our annual goodwill impairment test during the fourth quarter of fiscal 2015 (fiscal November) and determined that there was no goodwill impairment for any of our reporting units. Based on the results of the first step of the Company’s impairment test performed, we determined that the fair value of our reporting units each exceeded their carrying values by more than 30%.
The annual goodwill impairment analysis for the reporting units was based on our projection of revenues, gross margin, operating costs and cash flows considering historical and estimated future results, general economic and future market conditions, as well as the impact of planned business and operational strategies. We based our projections on assumptions we believed to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Actual results may differ from those estimates. The valuations employed typical methodologies to measure fair value and considered market factors and reporting unit specific fact patterns. We primarily used an income approach and market approach to value these reporting units. Assumptions used in the market approach include valuation multiples based on an analysis of multiples for comparable public companies and similar transactions. Finally, specific weights were applied to the components of each approach to estimate the total fair value. These weights are based on estimates and are developed based on the specific characteristics, risks and uncertainties of each reporting unit.
The fair value of the Gymboree Retail, Gymboree Outlet, Janie and Jack, Crazy 8, Play & Music, and International Retail Franchise reporting units were $581.0 million, $140.0 million, $274.0 million, $143.0 million, $64.0 million, and $75.0 million, respectively, which exceeded the carrying values of $436.6 million, $106.6 million, $77.2 million, $69.9 million, $40.3 million, and $26.7 million, respectively.
Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets primarily represent trade names for each of our brands. We do not amortize intangible assets with indefinite useful lives. We test indefinite-lived intangible assets for impairment on annual basis at the end of our tenth
fiscal period (fiscal November), and more frequently if indicators of potential impairment exist and indicate that it is more likely than not that the asset is impaired. Impairment of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to the discounted future cash flows that the asset is expected to generate using the relief from royalty method. If we determine that an individual asset is impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Calculating the fair value of indefinite-lived intangible assets requires significant judgment. The use of different assumptions, estimates or judgments, such as the estimated future cash flows, royalty rates or the discount rate used to discount such cash flows, could significantly increase or decrease the estimated fair value of our indefinite-lived intangible assets.
We performed our annual impairment test of indefinite-lived intangible assets (trade names) during the fourth quarter of fiscal 2015 and concluded that these assets were not impaired. In connection with our annual impairment test, we determined that the estimated fair values of Gymboree Retail, Gymboree Outlet, Janie and Jack, Crazy 8 and Play & Music trade names were $229.5 million, $40.5 million, $61.6 million, $19.8 million and $46.8 million, respectively, which exceeded the carrying values of $202.2 million, $38.3 million, $42.2 million, $18.5 million and $36.2 million, respectively.
Store Asset Impairment
Store assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the undiscounted future cash flows from the asset group are less than the carrying value, a loss is recognized equal to the difference between the carrying value of the asset group and its fair value. The fair value of the asset group is estimated based on discounted future cash flows using a discount rate commensurate with the risk. The asset group is determined at the store level, which is the lowest level for which identifiable cash flows are available. Decisions to close a store or facility can also result in accelerated depreciation over the revised useful life. For locations to be closed that are under long-term leases, we record a charge for lease buyout expense or the difference between our rent and the rate at which we expect to be able to sublease the properties and related costs, as appropriate. Most closures occur upon the lease expiration. The estimate of future cash flows is based on historical experience and typically third-party advice or market data. These estimates can be affected by factors such as future store profitability, real estate demand and economic conditions that can be difficult to predict.
During fiscal 2015, 2014, and 2013, we recorded impairment charges of $1.3 million, $6.0 million, and $7.6 million, respectively, related to assets of under-performing stores.
Income Taxes
We recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We establish valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. We consider all available positive and negative evidence in evaluating whether a valuation allowance is required, including prior earnings history, actual earnings over the previous 12 quarters on a cumulative basis, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset.
As of January 30, 2016 and January 31, 2015, the total valuation allowance against certain deferred tax assets was $63.2 million and $58.6 million, respectively. A valuation allowance has not been established for certain foreign and state jurisdictions. Changes in valuation allowances from period to period are included in the tax provision in the period of change.
We are subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions such as the timing and amount of deductions and allocation of taxable income to the various tax jurisdictions. As of January 30, 2016 and January 31, 2015, we had unrecognized tax benefits of $6.4 million and $5.6 million, respectively. Determining income tax expense for tax contingencies requires management to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits. Actual results could materially differ from these estimates and could significantly affect the effective tax rate and cash flows in future years.
Merchandise Inventories
Merchandise inventories are recorded at the lower of cost or market (“LCM”), with cost determined on a weighted-average basis. We review our inventory levels to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and record an adjustment when the future estimated selling price is less than cost. We take a physical count of inventories in all stores once a year and perform cycle counts throughout the year in our Dixon distribution center. We also perform an annual physical count of inventories at our third-party fulfillment center in Ohio. We record an inventory shrink adjustment based upon physical counts and also provide for estimated shrink adjustments for the period between the last physical inventory count and each balance sheet date. Our inventory shrink estimate can be affected by changes in merchandise mix and changes in actual shrink trends. Our LCM estimate can be affected by changes in consumer demand and the promotional environment.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We enter into forward foreign exchange contracts with respect to certain purchases in United States dollars of inventory to be sold in our retail stores in Canada. The purpose of these contracts is to protect our margins on the eventual sale of the inventory from fluctuations in the exchange rate for Canadian and U.S. dollars. The term of the forward exchange contracts is generally less than one year. Our U.S. entity also enters into forward foreign exchange contracts with respect to short-term intercompany balances between our Canadian and U.S. entities. The purpose of these contracts is to protect us from fluctuations in the exchange rate for Canadian and U.S. dollars upon the settlement of such balances.
The table below summarizes the notional amounts and fair values of our forward foreign exchange contracts in U.S. dollars (in thousands except weighted-average rate data):
Interest Rate Risk
We are subject to interest rate risk in connection with our long-term debt. Our principal interest rate risk relates to the Term Loan outstanding under the Senior Credit Facilities. As of January 30, 2016, we had $769.1 million outstanding under our Senior Credit Facilities, bearing interest at variable rates. The interest rate for borrowings under the Term Loan is, at our option, a base rate plus an additional marginal rate of 2.5% or the Adjusted LIBOR rate (with a 1.5% floor) plus an additional rate of 3.5%. As of January 30, 2016, the interest rate under our Term Loan was 5.0%. A 0.125% increase in the Adjusted LIBOR rate, above the 1.5% floor, would have increased annual interest expense by approximately $1.0 million, assuming $769.1 million of indebtedness thereunder was outstanding for the whole year. The Term Loan allows us to request additional tranches of term loans in an aggregate amount not to exceed $200 million, subject to the satisfaction of certain conditions, provided that such amount will be subject to reduction by the amount of any additional commitments incurred under the ABL Revolving Facility. No such incremental facilities are currently in effect.
In December 2010, we purchased four interest rate caps to hedge against rising interest rates associated with our senior secured term loan above the 5% strike rate of the caps through December 23, 2016, the maturity date of the caps. The notional amount of these caps is $700 million.
As of January 30, 2016 and January 31, 2015, accumulated other comprehensive loss included approximately $4.6 million and $8.2 million, respectively, in unrealized losses related to the interest rate caps and forward foreign exchange contracts.
Impact of Inflation
The impact of inflation on results of operations has not been significant in any of the last three fiscal years.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Gymboree Corporation:
We have audited the accompanying consolidated balance sheets of The Gymboree Corporation and subsidiaries (the “Company”) as of January 30, 2016 and January 31, 2015, and the related consolidated statements of operations, comprehensive loss, stockholders’ (deficit) equity, and cash flows for each of the three fiscal years in the period ended January 30, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Gymboree Corporation and subsidiaries as of January 30, 2016 and January 31, 2015, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 30, 2016, in conformity with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
April 27, 2016
THE GYMBOREE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
See notes to consolidated financial statements.
THE GYMBOREE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
See notes to consolidated financial statements.
THE GYMBOREE CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
See notes to consolidated financial statements.
THE GYMBOREE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See notes to consolidated financial statements.
THE GYMBOREE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT) EQUITY
(In thousands, except share data)
See notes to consolidated financial statements.
THE GYMBOREE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of the Business
The Gymboree Corporation (the “Company,” “we” or “us”) is a specialty retailer, offering collections of high-quality apparel and accessories for children. As of January 30, 2016, we operated a total of 1,306 retail stores, as follows:
In addition, as of January 30, 2016, we operated online stores at www.gymboree.com, www.janieandjack.com and www.crazy8.com. Overseas franchisees and Gymboree China operated 84 retail stores, as follows:
(1) Overseas franchisees operated retail stores in the Middle East, South Korea and Latin America.
We also offer directed parent-child developmental play programs at 727 franchised and Company-operated Gymboree Play & Music® centers in the United States and 43 other countries. Gymboree (Tianjin) Educational Information Consultation Co. Ltd. (“Gymboree Tianjin”) is Gymboree Play & Music’s master franchisee in China. Gymboree China and Gymboree Tianjin are collectively referred to as the “VIEs.”
Subsequent to fiscal 2015, Gymboree China’s management made the decision to close 25 of its retail locations. Closures are targeted to be completed by the end of May 2016.
Basis of Presentation
On November 23, 2010 (the “Transaction Date”), The Gymboree Corporation completed a merger (the “Merger”) with Giraffe Acquisition Corporation (“Acquisition Sub”) in accordance with an Agreement and Plan of Merger (the “Merger Agreement”) with Giraffe Holding, Inc. (“Parent”), and Acquisition Sub, a wholly owned subsidiary of Parent, with the Merger funded through a combination of debt and equity financing (collectively, the “Transactions”). The Company is continuing as the surviving corporation and a 100%-owned indirect subsidiary of the Parent. At the Transaction Date, investment funds sponsored by Bain Capital Private Equity, LP (formerly Bain Capital Partners, LLC) (“Bain Capital”) indirectly owned a controlling interest in Parent.
Principles of Consolidation
The accompanying consolidated financial statements include entities in which we retain a controlling financial interest or entities that meet the definition of a VIE for which we are deemed to be the primary beneficiary. In performing our analysis of whether we are the primary beneficiary, at initial investment and at each quarterly reporting period, we consider whether we individually have the power to direct the activities of the VIE that most significantly affects the entity’s performance and also have the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. We also consider whether we are a member of a related party group that collectively meets the power and benefits criteria and, if so, whether we are most closely associated with the VIE. Intercompany accounts and transactions have been eliminated.
Fiscal Year
Our fiscal year ends on the Saturday closest to January 31. Fiscal years 2015, 2014, and 2013 ended on January 30, 2016, January 31, 2015, and February 1, 2014, respectively. Fiscal years 2015, 2014, and 2013 include 52 weeks. References to years in the Consolidated Financial Statements relate to fiscal years rather than calendar years.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Financial Instruments
Cash Equivalents
Cash equivalents consist of highly liquid investment instruments with a maturity of three months or less at date of purchase. Our cash equivalents are placed primarily in money market funds. We value these investments at their original purchase prices plus interest that has accrued at the stated rate. Income related to these securities is recorded in interest income in the consolidated statements of operations.
Derivative Financial Instruments
We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting for cash flow hedges generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the earnings effect of the hedged forecasted transactions.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents. At times, cash balances held at financial institutions are in excess of federally insured limits.
In fiscal 2015, 2014, and 2013, we purchased approximately 89%, 82%, and 66%, respectively, of our inventory through one agent, which may potentially subject us to risks of concentration related to sourcing of our inventory.
Accounts Receivable
We record accounts receivable net of an allowance for doubtful accounts. Accounts receivable primarily include amounts due from franchisees for royalties and consumer product sales, amounts due from major credit card companies, duty drawback receivables (refund of certain custom duties paid to the U.S. Customs and Border Protection upon importation of merchandise inventories), rebate receivables from our vendors, a related party receivable from Lionbridge Financing Leasing (China) Co., Ltd. (an indirect majority-owned company of Bain Capital Lionbridge Cayman Ltd.), and receivables from our co-branded credit card agreements. We estimate our allowance for doubtful accounts by considering a number of factors, including the length of time accounts receivable are past due and our previous loss history. The provision for doubtful accounts receivable is included in selling, general and administrative expenses (“SG&A”). Write-offs were insignificant for all periods presented.
Merchandise Inventories
Merchandise inventories are recorded at the lower of cost or market (“LCM”), with cost determined on a weighted-average basis. We review our inventory levels to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and record an adjustment when the future estimated selling price is less than cost. We take a physical count of inventories in all stores once a year and perform cycle counts throughout the year in our Dixon distribution center. We also perform an annual physical count of inventories at our third-party fulfillment center in Ohio. We record an inventory shrink adjustment based upon physical counts and also provide for estimated shrink adjustments for the period between the last physical inventory count and each balance sheet date. Our inventory shrink estimate can be affected by changes in merchandise mix and changes in actual shrink trends. Our LCM estimate can be affected by changes in consumer demand and the promotional environment.
Property and Equipment
Property and equipment acquired after the Transaction Date are recorded at cost. Property and equipment acquired in the Merger are stated at estimated fair value as of the Transaction Date, less accumulated depreciation and amortization recorded subsequent to the Merger. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from approximately 3 to 25 years, except for our buildings and building improvements in Dixon, California, which have useful lives of 39 years. Leasehold improvements, which include an allocation of directly-related internal payroll costs for employees dedicated to real estate construction projects, are amortized over the lesser of the applicable lease term, which ranges from 5 to 13 years, or the estimated useful life of the improvements. Assets recorded under capital leases are amortized over the lease term. Software costs are amortized using the straight-line method based on an estimated useful life of 3 to 7 years. Repair and maintenance costs are expensed as incurred.
The Company capitalizes development-stage website development costs such as direct external costs and direct payroll related costs. When development is substantially complete, the Company amortizes the website costs on a straight-line basis over the expected life, which is generally 3 years. Preliminary project costs and post-implementation costs such as training, maintenance and support are expensed as incurred.
Store Asset Impairment
Store assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the undiscounted future cash flows from the asset group are less than the carrying value, a loss is recognized equal to the difference between the carrying value of the asset group and its fair value. The fair value of the asset group is estimated based on discounted future cash flows using a discount rate commensurate with the risk. The asset group is determined at the store level, which is the lowest level for which identifiable cash flows are available. Decisions to close a store or facility can also result in accelerated depreciation over the revised useful life. For locations to be closed that are under long-term leases, we record a charge for lease buyout expense or the difference between our rent and the rate at which we expect to be able to sublease the properties and related costs, as appropriate. Most closures occur upon the lease expiration. The estimate of future cash flows is based on historical experience and typically third-party advice or market data. These estimates can be affected by factors such as future store profitability, real estate demand and economic conditions that can be difficult to predict.
Goodwill and Other Intangible Assets
Goodwill
We allocated goodwill to our reporting units, which we concluded were the same as our operating segments (see Note 18): Gymboree Retail (including an online store), Gymboree Outlet, Janie and Jack (including an online store), Crazy 8 (including an online store), Gymboree Play & Music and International Retail Franchise. We allocated goodwill to the reporting units by calculating the fair value of each reporting unit and deriving the implied fair value of each reporting unit’s goodwill as of the Merger.
Goodwill is tested for impairment on an annual basis at the end of our tenth fiscal period (fiscal November) and at an interim date if indicators of impairment exist. Events that could result in an impairment review include significant changes in the business climate, declines in our operating results, or an expectation that the carrying amount may not be recoverable. We assess potential impairment by considering present economic conditions as well as future expectations.
Goodwill is tested by performing a two-step goodwill impairment test. The first step of the two-step goodwill impairment test is to compare the fair value of the reporting unit to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step of the two-step goodwill impairment test is required to measure the goodwill impairment loss. The second step includes valuing all the tangible and intangible assets and liabilities of the reporting unit as if the reporting unit had been acquired in a business combination. Then, the implied fair value of the reporting unit’s goodwill is compared to the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of the goodwill, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying amount.
Calculating the fair value of a reporting unit and the implied fair value of reporting unit goodwill requires significant judgment. The use of different assumptions, estimates or judgments in either step of the goodwill impairment testing process, such as the estimated future cash flows of reporting units, the discount rate used to discount such cash flows, or the estimated fair value of the reporting units’ tangible and intangible assets and liabilities, could significantly increase or decrease the estimated fair value of a reporting unit or its net assets.
Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets primarily represent trade names for each of our brands. We do not amortize intangible assets with indefinite useful lives. We test indefinite-lived intangible assets for impairment on an annual basis at the end of our tenth fiscal period (fiscal November), and more frequently if indicators of potential impairment exist and indicate that it is more likely than not that the asset is impaired. Impairment of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to the discounted future cash flows that the asset is expected to generate using the relief from royalty method. If we determine that an individual asset is impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Calculating the fair value of indefinite-lived intangible assets requires significant judgment. The use of different assumptions, estimates or judgments, such as the estimated future cash flows, royalty rates or the discount rate used to discount such cash flows, could significantly increase or decrease the estimated fair value of our indefinite-lived intangible assets.
Other Intangible Assets and Liabilities
Other intangible assets primarily represent franchise agreements, reacquired franchise rights, below market leases and a co-branded credit card agreement. Other intangible liabilities represent above market leases and are included in lease incentives and other liabilities. Other intangible assets and liabilities are amortized on a straight-line basis over their estimated useful lives.
We review other intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability of these other intangible assets is measured by comparing the carrying amount of the asset to the future undiscounted cash flows that the asset is expected to generate. If the undiscounted future cash flows are less than the carrying amount, the purchased other intangible assets with finite lives are considered to be impaired. The amount of the impairment is measured as the difference between the carrying amount of these assets and their estimated fair value. The fair value of the asset is estimated based on discounted future cash flows using a discount rate commensurate with the risk. Our estimate of future cash flows requires assumptions and judgment, including forecasting future sales and expenses and estimating useful lives of the assets. The use of different assumptions, estimates or judgments, such as the estimated future cash flows or the discount rate used to discount such cash flows, could significantly increase or decrease the estimated fair value of our other intangible assets with finite lives.
Income Taxes
We recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We establish valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. We consider all available positive and negative evidence in evaluating whether a valuation allowance is required, including prior earnings history, actual earnings over the previous 12 quarters on a cumulative basis, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset. Based on the weight of the positive and negative evidence, we recorded a valuation allowance in fiscal 2015 and 2014 as described in Note 13. We are subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions such as the timing and amount of deductions and allocation of taxable income to the various tax jurisdictions. As of January 30, 2016 and January 31, 2015, we had unrecognized tax benefits of $6.4 million and $5.6 million, respectively. Determining income tax expense for tax contingencies requires management to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits. Actual results could materially differ from these estimates and could significantly affect the effective tax rate and cash flows in future years.
Rent Expense
Many of our operating leases contain free rent periods and predetermined fixed increases of the minimum rental rate during the initial lease term. For these leases, we recognize the related rental expense on a straight-line basis over the life of the lease, starting at the time we take possession of the property. Certain leases provide for contingent rents that are not measurable at inception. These amounts are excluded from minimum rent and are included in the determination of rent expense when it is probable that an expense has been incurred and the amount is reasonably estimable.
Lease Allowances
As part of many lease agreements, we receive allowances from landlords. The allowances are included in lease incentives and other liabilities and are amortized as a reduction of rent expense on a straight-line basis over the term of the lease, starting at the time we take possession of the property.
Self-Insurance
We are partially self-insured for workers’ compensation insurance. We record a liability, determined actuarially, for claims filed and claims incurred, but not yet reported. This liability totaled $7.5 million and $6.6 million as of January 30, 2016 and January 31, 2015, respectively. Any actuarial projection of losses is subject to a high degree of variability due to external factors, including future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns. We also record a liability for employee-related health care benefits that are partially self-insured or fully self-insured, by considering claims filed and estimates of claims incurred, but not yet reported. This liability totaled $1.4 million as of January 30, 2016 and January 31, 2015. If the actual amount of claims filed exceeds our estimates, reserves in the accompanying consolidated balance sheets may not be sufficient and additional accruals may be required in future periods. These liabilities are included in accrued and other current liabilities in the accompanying consolidated balance sheets.
Foreign Currency
Assets and liabilities of foreign subsidiaries are translated into United States dollars at the exchange rates effective on the balance sheet date. Revenues, costs of sales, expenses and other income are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded as other comprehensive income (loss) within stockholders’ (deficit) equity. Foreign currency transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the local functional currency are included in other expense, net within the consolidated statements of operations.
Revenue Recognition
Revenue is recognized at the point of sale in retail stores. Online revenue is recorded when merchandise is received by the customer. Online customers generally receive merchandise within three to six days of shipment. Shipping fees received from customers are included in net sales and the associated shipping costs are included in cost of goods sold. We also sell gift cards in our retail store locations, through our online stores and through third parties. Revenue is recognized in the period that the gift card is redeemed. We recognize unredeemed gift card and merchandise credit balances when we can determine the portion of the liability for which redemption is remote (generally three years after issuance). These amounts are recorded as “other income” within SG&A expenses and totaled $2.9 million, $2.6 million, and $1.9 million, during fiscal 2015, 2014, and 2013, respectively. Sales are presented net of sales return reserve, which is estimated based on historical return trends. Net retail sales also include revenue from our co-branded credit card agreements. We present taxes collected from customers and remitted to governmental authorities on a net basis (excluded from revenues).
Below is a summary of activity in the sales return reserve for the fiscal years ended (in thousands):
Sales return reserve is included in accrued and other current liabilities in the accompanying consolidated balance sheets.
For the Gymboree Play & Music operations, initial franchise and transfer fees for all sites sold in a territory are recognized as revenue when the franchisee has paid the initial franchise or transfer fee, in the form of cash and/or a note payable, the franchisee has fully executed a franchise agreement and we have substantially completed our obligations under such agreement. We receive royalties based on each franchisee’s gross receipts from operations. Such royalty fees are recognized when earned. We also recognize revenues from consumer products and equipment sold to franchisees at the time title transfers to the franchisees.
For the retail franchise business, revenues consist of initial franchise fees, royalties and/or sales of authorized product. Initial franchise fees relating to area franchise sales are recognized as revenue when the franchisee has met all material conditions and we have substantially completed our obligations under such agreement, typically upon store opening. Royalties are generally based on each franchisee’s gross receipts from operations and are recorded when earned. Revenues from consumer products sold to franchisees are recorded at the time title transfers to the franchisees. We present taxes withheld by international franchises and remitted to governmental authorities on a gross basis (included in revenues).
Loyalty Program
Customers who enroll in the Gymboree Rewards program earn points with every purchase at Gymboree and Gymboree Outlet stores, as well as online at www.gymboree.com. Those customers who reach a cumulative purchase threshold receive a rewards certificate that can be used towards the future purchase of goods at Gymboree and Gymboree Outlet stores as well as online within 45 days from the date it is issued. We estimate the cost of rewards that will ultimately be redeemed and record this cost as a reduction of net retail sales as reward points are earned. This liability was approximately $2.0 million and $1.8 million as of January 30, 2016 and January 31, 2015, respectively, and is included in accrued and other current liabilities in the accompanying consolidated balance sheets.
Co-Branded Credit Card
We have co-branded credit card agreements (the “Agreements”) with a third-party bank and Visa U.S.A. Inc. for the issuance of a Visa credit card bearing the Gymboree logo and administration of an associated incentive program for cardholders. We recognize revenues related to the Agreements as follows:
•
New account fees are reported in retail sales and are when collection is reasonably assured and all conditions under the Agreements are met.
•
Credit card usage fees are recognized as retail revenues as actual credit card usage occurs.
•
Rewards earned are recorded as gift card liabilities and recognized as retail revenues when the gift cards are redeemed.
During fiscal 2015, 2014, and 2013, we recognized approximately $3.5 million, $1.9 million, and $1.5 million, respectively, in revenue from these Agreements. These amounts are included in net retail sales in the accompanying consolidated statements of operations.
Cost of Goods Sold
Cost of goods sold (“COGS”) includes cost of goods, buying department expenses (including related depreciation), occupancy expenses (including amortization of below and above market leases), and shipping costs. Cost of goods consists of cost of merchandise, inbound freight and other inventory-related costs, such as shrinkage costs and lower of cost or market adjustments. Buying expenses include costs incurred to design, produce and allocate merchandise. Occupancy expenses consist of rent and other lease-required costs, including common area maintenance and utilities. Shipping costs consist of third-party delivery services to customers. As we record certain distribution expenses as a component of SG&A expenses and do not include such costs in cost of goods sold, our cost of goods sold and gross profit may not be comparable to those of other companies. Distribution expenses recorded as a component of SG&A expenses amounted to $45.5 million, $43.1 million, and $37.9 million during fiscal 2015, 2014, and 2013, respectively.
Selling, General and Administrative Expenses
SG&A expenses consist of non-occupancy-related costs associated with our retail stores, distribution center and shared corporate services. These costs include payroll and benefits, depreciation and amortization, credit card fees, advertising, store pre-opening costs and other general expenses. Our distribution costs recorded in SG&A expenses represent primarily outbound shipping and handling expenses to our stores.
Store Pre-opening Costs
Store pre-opening costs are expensed as incurred.
Advertising
We capitalize direct costs for the development, production, and circulation of direct response advertising and amortize such costs over the expected sales realization cycle, typically four to six weeks. Deferred direct response costs, included in prepaid expenses, were $1.0 million and $0.9 million as of January 30, 2016 and January 31, 2015, respectively.
All other advertising costs are expensed as incurred. Advertising costs totaled approximately $31.1 million, $24.4 million, and $20.5 million, during fiscal 2015, 2014, and 2013, respectively.
Share-Based Compensation
We recognize compensation expense on a straight-line basis for options and awards with time-based service conditions.
Recently Issued Accounting Standards
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). Under this ASU, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged and lessees will no longer be provided with a source of off-balance sheet financing. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. Although we have not yet determined the impact of the new standard, we believe this ASU will have a significant impact on our consolidated financial statements due to the substantial number of leases that we have.
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This ASU requires deferred tax assets and liabilities, as well as any related valuation allowance, to be classified as non-current on our consolidated balance sheet. This ASU does not change the existing requirement that only permits offsetting within a jurisdiction. Accordingly, this ASU requires each tax jurisdiction to have one net non-current deferred tax asset or liability. To ease administrative burdens, we early adopted and applied this ASU on a prospective basis effective as of our fiscal year ended January 30, 2016. Accordingly, the prior period amounts in the Company’s Consolidated Balance Sheets within this Annual Report on Form 10-K were not adjusted to conform to the new accounting standard. The adoption of this accounting standard was not material to the Company’s consolidated financial statements.
In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, which requires all inventory to be measured at the lower of cost and net realizable value, except for inventory that is accounted for using the last-in, first-out (LIFO) or the retail inventory method which will be measured under existing accounting standards. This ASU would be applied prospectively and is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. We have not yet determined the impact of the new standard on our consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The amendments do not affect the current guidance on the recognition and measurement of debt issuance costs. This ASU would be applied retrospectively to all prior periods and is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted. This ASU will require the Company to reclassify deferred financing costs, currently presented as assets on the condensed consolidated balance sheets, and net those costs with long-term debt. This ASU will have no effect on the Company’s consolidated statements of operations or its liquidity.
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which provides guidance on the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The amendments are effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted. We do not believe that this ASU will have an impact on our consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, to provide guidance on principles and definitions to reduce diversity in the timing and content of disclosures when evaluating whether there is substantial doubt about an organization’s ability to continue as a going concern. This ASU is effective in the annual period ending after December 15, 2016, with early adoption permitted. We have not yet determined the impact of the new standard on our consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. generally accepted accounting principles and International Financial Reporting Standards. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers-Deferral of Effective Date, which defers the effective date of ASU 2014-09 by one year, for fiscal years and interim periods within those years, beginning after December 15, 2017. The deferral allows early adoption at the original effective date. We have not yet determined the impact of the new standard on our consolidated financial statements.
2. Fair Value Measurements
We record our money market funds, interest rate caps and forward foreign exchange contracts at fair value. Fair value is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. Accounting guidance prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data.
Level 3 - Inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. Valuation techniques could include the use of discounted cash flow models and similar techniques.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the fair value measurement in its entirety is classified is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The tables below present our assets and liabilities measured at fair value on a recurring basis as of January 30, 2016 and January 31, 2015, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands). There were no transfers into or out of Level 1 and Level 2 during fiscal 2015 or 2014.
Our cash equivalents, which are primarily placed in money market funds, are valued at their original purchase prices plus interest that has accrued at the stated rate.
The fair value of our interest rate caps was determined using the market standard methodology of discounting future cash receipts. The variable cash receipts were based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves and volatilities. In addition, credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, were incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of these contracts for the effect of nonperformance risk, we have considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees.
Although we have determined the majority of the inputs used to value our interest rate caps fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with these derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties. However, as of January 30, 2016 and January 31, 2015, we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our interest rate cap positions and determined the credit valuation adjustment was not significant to the overall valuation. As a result, we classified our interest rate caps derivative valuations in Level 2 of the fair value hierarchy.
The fair value of our forward foreign exchange contracts was determined using the market approach and Level 2 inputs. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities.
The carrying value of cash and cash equivalents, receivables, line of credit borrowings and payables balances approximate their estimated fair values due to the short maturities of these instruments. We estimate the fair value of our long-term debt using current market yields. These current market yields are considered Level 2 inputs. The estimated fair value of long-term debt is as follows (in thousands):
We had no other financial assets or liabilities measured at fair value as of January 30, 2016 and January 31, 2015.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
Our non-financial assets, which primarily consist of goodwill, other intangible assets and property and equipment, are not required to be measured at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis whenever events or changes in circumstances indicate their carrying value may not be fully recoverable, and at least annually for goodwill and indefinite-lived intangible assets, non-financial assets are assessed for impairment and, if applicable, written-down to and recorded at fair value, considering external market participant assumptions.
During fiscal 2015, we determined that there was no goodwill impairment for all of our reporting units and there was no impairment on our indefinite-lived intangible assets (trade names) (see Note 3).
During fiscal 2014, we recorded $378.8 million of goodwill impairment related to our Gymboree Retail, Gymboree Outlet, and Crazy 8 reporting units and $212.6 million of impairment related to our indefinite-lived intangible assets (see Note 3).
During fiscal 2013, we recorded $140.2 million of goodwill impairment related to our Gymboree Retail, Gymboree Outlet, and Crazy 8 reporting units and $17.0 million of impairment related to our indefinite-lived intangible assets (see Note 3).
During fiscal 2015, 2014, and 2013, we recorded impairment charges of $1.3 million, $6.0 million, and $7.6 million, respectively, related to assets of under-performing stores. The fair market value of these non-financial assets was determined using the income approach and Level 3 inputs, which required management to make significant estimates about future cash flows. Management estimates the amount and timing of future cash flows based on historical operating results and its experience and knowledge of the retail market in which each store operates. During fiscal 2013, we also recorded $3.1 million of impairment related to an abandonment of assets. These impairment charges are included in SG&A expenses in the accompanying consolidated statement of operations.
3. Goodwill and Intangible Assets and Liabilities
Goodwill
Goodwill allocated to our reportable segments as of January 30, 2016, January 31, 2015, and February 1, 2014, is as follows (in thousands):
During fiscal 2015, we determined that there was no goodwill impairment for any of our reporting units. Goodwill impairment during fiscal 2014 and 2013 are as follows (in thousands):
Goodwill Impairment
We performed our annual goodwill impairment test during the fourth quarter of fiscal 2015 (fiscal November) and determined that there was no goodwill impairment for any of our reporting units. Based on the results of the first step of the Company’s impairment test performed, we determined that the fair value of our reporting units each exceeded their carrying values by more than 30%.
The annual goodwill impairment analysis for the reporting units was based on our projection of revenues, gross margin, operating costs and cash flows considering historical and estimated future results, general economic and future market conditions, as well as the impact of planned business and operational strategies. We based our projections on assumptions we believed to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Actual results may differ from those estimates. The valuations employed typical methodologies to measure fair value and considered market factors and reporting unit specific fact patterns. We primarily used an income approach and market approach to value these reporting units. Assumptions used in the market approach include valuation multiples based on an analysis of multiples for comparable public companies and similar transactions. Finally, specific weights were applied to the components of each approach to estimate the total fair value. These weights are based on estimates and are developed based on the specific characteristics, risks and uncertainties of each reporting unit.
The fair value of the Gymboree Retail, Gymboree Outlet, Janie and Jack, Crazy 8, Play & Music, and International Retail Franchise reporting units were $581.0 million, $140.0 million, $274.0 million, $143.0 million, $64.0 million, and $75.0 million, respectively, which exceeded the carrying values of $436.6 million, $106.6 million, $77.2 million, $69.9 million, $40.3 million, and $26.7 million, respectively.
During fiscal 2014, we recognized goodwill impairment in the Gymboree Retail, Gymboree Outlet, and Crazy 8 reporting units, components of our retail stores reporting segment, of approximately $252.3 million, $67.2 million and $59.3 million, respectively (see Note 2).
During fiscal 2013, due to the impact of weak results in fiscal 2013, particularly in the fourth quarter, we recognized goodwill impairment in the Crazy 8, Gymboree Retail and Gymboree Outlet reporting units, components of our retail stores reporting segment, of $85.3 million, $38.8 million and $16.1 million, respectively (see Note 2).
Intangible Assets and Liabilities
Intangible assets and liabilities consist of the following (in thousands):
The decrease in the gross carrying amount of customer relationships, below market leases, franchise agreements and reacquired franchise rights, and above market leases from January 31, 2015 to January 30, 2016 reflects the write-off of certain fully amortized intangibles.
Indefinite-Lived Intangible Assets Impairment
We performed our annual impairment test of indefinite-lived intangible assets (trade names) during the fourth quarter of fiscal 2015 and concluded that these assets were not impaired. In connection with our annual impairment test, we determined that the estimated fair values of Gymboree Retail, Gymboree Outlet, Janie and Jack, Crazy 8 and Play & Music trade names were $229.5 million, $40.5 million, $61.6 million, $19.8 million and $46.8 million, respectively, which exceeded the carrying values of $202.2 million, $38.3 million, $42.2 million, $18.5 million and $36.2 million, respectively.
During fiscal 2014, we recognized a $212.6 million impairment charge related to trade names of our retail stores segment.
Due to the impact of weak results in fiscal 2013, particularly in the fourth quarter, we recognized a $17.0 million impairment charge related to trade names of our retail stores segment, which is included as a component of goodwill and intangible asset impairment.
The Company assigned the following useful lives to its intangible assets:
Useful Life
Location of
Amortization
Expense
Trade names
Indefinite
-
Below market leases
Remaining lease term
COGS
Co-branded credit card agreement
6.5 years
SG&A
Retail franchise agreement
6 years
SG&A
Gymboree Play & Music reacquired franchise rights
Remaining contractual term
SG&A
Gymboree Play & Music franchise agreements
14 years
SG&A
Above market leases
Remaining lease term
COGS
Net amortization income (expense) is presented below for the fiscal years ended (in thousands):
We estimate that amortization expense (income) related to intangible assets and liabilities will be as follows in each of the next five fiscal years and thereafter (in thousands):
4. Accrued and Other Current Liabilities
Accrued and other current liabilities consist of the following (in thousands):
5. 401(k) Plan
We maintain a voluntary defined contribution 401(k) plan (the “Plan”) covering employees who have met certain service and eligibility requirements. Employees may elect to contribute up to 75% of their compensation to the Plan, not to exceed the dollar limit set by law. Beginning in January 2013, we contribute $1.00 to the plan for each $1.00 contributed by an employee, up to 4% of the employee’s salary. Matching contributions to the Plan totaled approximately $2.5 million, $2.3 million, and $2.1 million during fiscal 2015, 2014, and 2013, respectively.
6. Line of Credit
In September 2015, we entered into the first amendment (the “First Amendment”) to our senior secured asset-based revolving credit facility (“ABL Revolving Facility”) to extend the maturity date of the ABL revolving commitments from March 2017 to the earlier of (i) September 24, 2020 and (ii) the date that is 60 days before the scheduled final maturity date of any tranche of the Term Loan (which matures in February 2018) or the Notes (which mature in December 2018), unless such indebtedness is cumulatively equal to or less than $25.0 million in the aggregate and a reserve against the borrowing base is imposed equal to the amount of such indebtedness.
The ABL Revolving Facility, as amended by the First Amendment, provided financing of up to $225 million in a revolving line of credit. Line of credit availability under the ABL Revolving Facility is subject to a borrowing base consisting of certain assets of the Company, any subsidiary co-borrowers and any subsidiary guarantors that are available to collateralize the borrowings thereunder, and is reduced by the level of outstanding letters of credit. Line of credit borrowings outstanding under the ABL Revolving Facility as of January 30, 2016 and January 31, 2015 were $19.0 million and $33.0 million, respectively. The line of credit available under the ABL Revolving Facility is reduced by letter of credit utilization totaling $27.6 million as of January 30, 2016. Undrawn line of credit availability under the ABL Revolving Facility, after being reduced by outstanding borrowings and letter of credit utilization, was $125.5 million as of January 30, 2016. Average line of credit borrowings during fiscal 2015 and 2014 under the ABL Facility amounted to $51.9 million and $32.0 million, respectively.
Line of credit borrowings under the ABL Revolving Facility bear interest at a rate per annum equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Bank of America, N.A., (2) the federal funds effective rate plus 0.50%, and (3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00%, or (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs (“Adjusted LIBOR”), in each case plus an applicable margin. As of January 30, 2016, the weighted average interest rate on our line of credit borrowings outstanding under the ABL Revolving Facility was 3.5%. In addition to paying interest on outstanding line of credit borrowings under the ABL Revolving Facility, we are required to pay a commitment fee on unutilized commitments thereunder, which is between 0.250% and 0.375% per annum under the amended ABL revolving Facility.
If at any time the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the ABL Revolving Facility exceeds the lesser of (a) the commitment amount and (b) the borrowing base, we will be required to repay outstanding loans and/or cash collateralized letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount. The ABL Revolving Facility contains financial and other covenants that, among other things, restrict our ability to incur additional indebtedness and pay dividends. As of January 30, 2016, the ABL Revolving Facility also contains a financial covenant that required the Company to test its consolidated fixed charge coverage ratio when availability under the facility fell below a specified threshold. As of January 30, 2016, we were not required to test compliance with this covenant. The obligations under the ABL Revolving Facility are secured, subject to certain exceptions, by substantially all of our assets. Our 100%-owned domestic subsidiaries have fully and unconditionally guaranteed our obligations under the ABL Revolving Facility (see Note 20).
On April 22, 2016, we entered into a second amendment to the ABL Revolving Facility (the ABL Revolving Facility, as so amended, the “ABL Facility” or the “Second Amendment”). The Second Amendment provides for a senior secured term loan (the “ABL Term Loan”) of $50.0 million, subject to a borrowing base, the proceeds of which may be used to finance the acquisition of working capital assets, including the purchase of inventory and equipment, in each case in the ordinary course of business, to finance capital expenditures, to finance permitted acquisitions and for general corporate purposes, including repurchases of the Notes.
The Second Amendment provides that the ABL Term Loan will bear interest (computed on the basis of the actual number of days elapsed over a year of 360 days) at a 90-day LIBOR contract rate as determined by the agent for the ABL Term Loan monthly on the first day of each calendar month, plus 10.25% per annum, or, in certain circumstances, at the prime rate, plus 9.25% per annum. The Second Amendment also provides for a new availability covenant, whereby so long as any amount of the ABL Term Loan remains outstanding, the Company and its restricted subsidiaries must maintain, at all times, (i) Combined Availability (or, an amount equal to (a) the ABL Term Loan borrowing base minus the sum of (b) the aggregate outstanding principal amount under the ABL Facility (including the ABL Term Loan, revolving line of credit borrowings and letter of credit utilization)) in excess of the greater of (x) $17.5 million and (y) 10% of the ABL Term Loan borrowing base; and (ii) Availability (or an amount equal to the lesser of (A) (I) the revolving credit ceiling minus (II) the aggregate principal amount outstanding under the revolving line of credit and letter of credit utilization and (B) (I) the revolving line of credit borrowing base minus (II) the aggregate principal amount outstanding under the revolving line of credit and letter of credit utilization) in excess of the greater of (x) $17.5 million and (y) 10% of the lesser of (A) the applicable revolving line of credit borrowing base and (B) the revolving credit ceiling (which as of the date hereof is $225.0 million). The Second Amendment further provides that the Company’s consolidated fixed charge coverage ratio will not be tested as long as the ABL Term Loan remains outstanding. The maturity date for the ABL Term Loan is the same as the maturity date of the ABL revolving commitments discussed above, and all other material affirmative and negative covenants and events of default under the ABL Facility remain substantially unchanged. In addition, the restrictions on amendments to the ABL Facility were amended to provide the agent for the ABL Term Loan and the ABL Term Loan lenders certain consent rights relating to, among other terms and provisions, the borrowing bases, the availability covenant and certain negative covenants.
7. Long-Term Debt
Long-term debt consists of (in thousands):
Term Loan
We have an agreement with several lenders for an $820 million senior secured Term Loan, with a maturity date of February 2018. The Term Loan allows us to request additional tranches of term loans in an aggregate amount not to exceed $200 million, subject to the satisfaction of certain conditions, provided such amount will be subject to reduction by the amount of any additional commitments incurred under the ABL Facility. The interest rate for borrowings under the Term Loan is, at our option, a base rate plus an additional marginal rate of 2.5% or the Adjusted LIBOR rate (with a 1.5% floor) plus an additional rate of 3.5%. As of January 30, 2016, the interest rate under our Term Loan was 5%.
The Term Loan requires us to make quarterly payments equal to 0.25% of the original $820 million principal amount of the Term Loan made on the closing date plus accrued and unpaid interest thereon, with the balance due in February 2018. The Term Loan also has mandatory and voluntary pre-payment provisions, including a requirement that we prepay the Term Loan with a certain percentage of our annual excess cash flow. We calculated our excess cash flow using fiscal 2015 operating results and concluded we are not required to make any excess cash flow payments on the Term Loan during fiscal 2016. Voluntary prepayments and the excess cash flow prepayments made in prior fiscal years were applied toward our remaining quarterly amortization payments payable under the Term Loan through fiscal 2016. Our next quarterly payment payable under the Term Loan is due in the first quarter of fiscal 2017.
The obligations under the Term Loan are secured, subject to certain exceptions, by substantially all of our assets and those of our 100%-owned domestic subsidiaries. Our 100%-owned domestic subsidiaries also have fully and unconditionally guaranteed the Company’s obligations under the Term Loan.
Notes
In fiscal 2010, we issued $400 million aggregate principal amount of 9.125% senior notes due in December 2018 (the “Notes”). Interest on the Notes is payable semi-annually. If the Company or our subsidiaries sell certain assets, we generally must either invest the net cash proceeds from such sale in our business within a certain period of time, use the proceeds to prepay senior secured debt, or make an offer to purchase a principal amount of the Notes equal to the excess net cash proceeds at a redemption price equal to 100% of the principal amount of the Notes redeemed plus accrued and unpaid interest. Upon a change in control, we may also be required to make an offer to purchase all of the Notes at a redemption price equal to 101% of the principal amount of the Notes redeemed plus accrued and unpaid interest. We may redeem the Notes, in whole or in part, upon at least 30 days prior notice, at the redemption prices (expressed as percentages of principal amount of the Notes to be redeemed) set forth below, plus accrued and unpaid interest thereon to the applicable redemption date, if redeemed during the twelve-month period beginning on December 1 of each of the years indicated below:
The Notes are unsecured senior obligations of The Gymboree Corporation. The Company’s 100%-owned domestic subsidiaries have fully and unconditionally guaranteed the Company’s obligations under the Notes (see Note 20). The guarantees of
the Notes are joint and several and will terminate upon the following circumstances: (A) the sale, exchange, disposition or transfer (by merger or otherwise) of (x) the capital stock of the guarantor providing the applicable guarantee, if after such sale, exchange, disposition or transfer such guarantor is no longer a subsidiary of The Gymboree Corporation, or (y) all or substantially all of the assets of such guarantor, (B) the release or discharge of the guarantee by such guarantor of the other indebtedness which resulted in the creation of the subsidiary guarantee by such guarantor under the Indenture, (C) the designation of such guarantor as an “unrestricted subsidiary” under the Indenture or (D) the legal defeasance, covenant defeasance or satisfaction and discharge of the Indenture, in each such case specified in clauses (A) through (D) above in accordance with the requirements therefore set forth in the Indenture.
During fiscal 2015, we repurchased Notes with an aggregate principal amount of $58.4 million for $15.3 million in cash through open market transactions (the “2015 Repurchase”). We recorded a $41.5 million gain on extinguishment of debt, net of $1.6 million charge related to the write-off of deferred financing costs associated with the extinguished debt.
During fiscal 2013, we repurchased Notes with an aggregate principal amount of $25 million for $24.8 million in cash through privately negotiated transactions (the “2013 Repurchase”). We recorded a $0.8 million loss on extinguishment of debt, net of a $1.0 million charge related to the write-off of deferred financing costs associated with the extinguished debt.
Future minimum principal payments on long-term debt, excluding accretion of original issue discount (“OID”) of $0.7 million, as of January 30, 2016, are as follows (in thousands):
The table above does not reflect the reduction in principal amount of the Notes as a result of the repurchase of Notes subsequent to the end of fiscal 2015 (see Note 22).
Interest Expense on Long-Term Debt and ABL
Total interest expense reported in the consolidated statements of operations includes interest expense on long-term debt and borrowings under the ABL Revolving Facility of $84.4 million, $81.9 million, and $81.6 million during fiscal 2015, 2014, and 2013, respectively. Amortization of deferred financing costs and accretion of OID are also included in interest expense.
Deferred Financing Costs and OID
Deferred financing costs allocated to the Term Loan and Notes are amortized over the term of the related financing agreements using the effective interest method. Deferred financing costs incurred a result of The First Amendment of ABL in September 2015 amounted to $1.7 million. The remaining amortization period allocated to the ABL Revolving Facility (as amended by the First Amendment), which is amortized on a straight-line basis, is 1.9 years. Deferred financing costs allocated to the sale-leaseback financing liability are amortized on a straight-line basis over 10 years (see Note 8). The weighted-average remaining amortization period of the Term Loan, Notes, and ABL is approximately 2.3 years as of January 30, 2016. Amortization of deferred financing costs is recorded in interest expense and was approximately $7.4 million, $6.8 million, and $6.5 million during fiscal 2015, 2014, and 2013, respectively.
Amortization of deferred financing costs for each of the next five fiscal years is estimated to be as follows (in thousands):
8. Sale-leaseback of Dixon Distribution Center
On May 5, 2015, the Company entered into an agreement to sell its distribution center in Dixon, California for gross proceeds of $26.8 million, less closing costs of $0.9 million, or net proceeds of $25.9 million, and entered into a leaseback of the property from the purchaser for a period of 15 years. Approximately $10.9 million of the net proceeds were restricted under the Term Loan to fund capital expenditures or reduce the Term Loan. The total amount of restricted funds was used to fund capital expenditures during fiscal 2015.
Under the terms of the lease agreement, the Company is required to maintain a $3.5 million unconditional irrevocable letter of credit that reduces our line-of-credit borrowing base for a period up to 10 years. Due to the Company’s continuing involvement through the irrevocable letter of credit, the Company has accounted for the sale-leaseback as a financing liability. Payments made by the Company are allocated between interest expense and a reduction to the sale-leaseback financing liability. In the period that there is no longer continuing involvement by the Company, the distribution center and the sale-leaseback financing liability will be removed from our condensed consolidated balance sheets, resulting in a gain on the sale of the distribution center, with a portion of the gain deferred and amortized over the remaining lease term.
Payments made by the Company related to the sale-leaseback financing liability during fiscal 2015 totaled $1.3 million, $1.2 million out of which was included in interest expense.
As of January 30, 2016, future payments on the sale-leaseback financing liability, excluding renewals, are as follows (in thousands):
As of January 30, 2016, the net carrying value of the Dixon distribution center assets that are included in property and equipment on our consolidated balance sheets amounted to $18.9 million.
9. Derivative Financial Instruments
We enter into forward foreign exchange contracts with respect to certain purchases in United States dollars (“U.S. dollars”) of inventory to be sold in our retail stores in Canada. The purpose of these contracts is to protect our margins on the eventual sale of the inventory from fluctuations in the exchange rate for Canadian and U.S. dollars. The term of these forward foreign exchange contracts is generally less than one year. These contracts are treated as cash-flow hedges. Amounts reported in accumulated other
comprehensive loss related to these forward foreign exchange contracts will be reclassified to COGS over a three-month period. We also enter into forward foreign exchange contracts with respect to short-term intercompany balances between U.S. and Canada. The purpose of these contracts is to protect us from fluctuations in the exchange rates upon the settlement of such balances. These contracts are not designated as hedges. Consequently, changes in the fair value of these contracts are included in other income.
In December 2010, we paid approximately $12.1 million to enter into interest rate caps to hedge against rising interest rates associated with the $700 million principal of our Term Loan (see Note 7) above the strike rate of the cap through December 23, 2016, the maturity date of the caps. The interest rate caps were designated on the date of execution as cash-flow hedges. The premium, and any related amounts reported in accumulated other comprehensive loss, are being amortized to interest expense through December 23, 2016, as interest payments are made on the underlying Term Loan. During fiscal 2015, 2014, and 2013, we reclassified approximately $3.9 million, $2.1 million, and $1.1 million, respectively, from accumulated other comprehensive loss to interest expense. We estimate that approximately $4.7 million will be reclassified from accumulated other comprehensive loss to interest expense within the next 12 months.
For a derivative instrument designated as a cash-flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of other comprehensive income (loss) and is subsequently recognized in earnings when the hedged exposure is recognized in earnings. Gains or losses on the derivative representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in earnings.
We had the following outstanding derivatives designated as cash flow hedges (U.S. dollars in thousands):
There were no forward foreign exchange contracts that were not designated as hedges as of January 30, 2016 and January 31, 2015.
The table below presents the fair value of all of our derivative financial instruments as well as their classification on the consolidated balance sheets (in thousands) (see Note 2).
The tables below present the effect of all of our derivative financial instruments on the consolidated statements of operations and comprehensive loss (in thousands). No amounts were reclassified from accumulated other comprehensive loss into earnings as a result of forecasted transactions that failed to occur or as a result of hedge ineffectiveness (see Note 15).
10. Lease Incentives and Other Liabilities
Lease incentives and other liabilities consist of the following (in thousands):
11. Leases
Operating Leases
We lease our retail store locations, corporate headquarters, certain warehouse space and certain fixtures and equipment under operating leases. The leases expire at various dates through fiscal 2026. Store leases typically have 10-year terms and some include a cancellation clause if minimum revenue levels are not achieved during a specified 12-month period during the lease term. Some leases are structured with a minimum rent component plus a percentage rent based on the store’s net sales in excess of a certain threshold. Substantially all of the leases require us to pay insurance, utilities, real estate taxes, and common area repair and maintenance expenses. In January 2016, we subleased part of our corporate headquarters under an operating lease to a third party which will expire in April 2018.
Future minimum rental payments, net of rental receipts totaling approximately $4.9 million through fiscal 2018, under non-cancelable operating leases as of January 30, 2016 are as follows (in thousands):
Rent expense, including other lease required expenses such as common area maintenance expenses, real estate taxes, and utilities, were as follows for the fiscal years ended (in thousands):
Capital Lease
During fiscal 2013, we outsourced the fulfillment of www.gymboree.com online customer orders to a third-party fulfillment center in Ohio, under an operating services agreement. The agreement provides us with warehousing, fulfillment and logistics services. Certain assets under the operating services agreement, including leasehold improvements, equipment and software, are treated as a capital lease which commenced in the third quarter of fiscal 2013 and ends in fiscal 2019. Assets recorded under this capital lease were recorded at the present value of minimum lease payments and are amortized over the lease term. Amortization of the capital lease assets, which is included in SG&A in our consolidated statements of operations, amounted to $0.7 million, and $0.7 million during fiscal 2015 and 2014, respectively. As of January 30, 2016 and January 31, 2015, the following assets under capital lease are included under the line property and equipment in our consolidated balance sheets (in thousands):
Annual future minimum obligations under capital lease for each of the next five years, as of January 30, 2016, are as follows (in thousands):
The Company capitalized asset retirement costs and recorded a related asset retirement obligation of $2.0 million at inception of the capital lease for restoration of the leased property to its original condition upon completion of the agreement. These items are included in leasehold improvements and lease incentives and other liabilities, respectively in our consolidated balance sheets. As of January 30, 2016, the asset retirement obligation increased to $2.1 million as a result of accretion expense during fiscal 2015.
On February 25, 2016, the Company entered into an agreement to terminate the operating services agreement described above effective upon exiting from the fulfillment center in Ohio, which is expected to be in May 2016. The fulfillment of our www.gymboree.com online customer orders will continue to be processed at the third-party fulfillment center in Ohio through April 30, 2016. The Company expects to transfer the warehousing, logistics and fulfillment of our www.gymboree.com online customer orders to our distribution center in Dixon, California in May 2016. The Company will continue to pay a monthly minimum fee of approximately $0.7 million until April 30, 2016 and will pay an early termination fee of $8.3 million to the third-party fulfillment center. Payment of the termination fee will relieve the Company of all future obligations to the third-party fulfillment center.
12. Share-Based Compensation
2010 Equity Incentive Plan
Parent maintains the Giraffe Holding, Inc. 2010 Equity Incentive Plan (the “2010 Plan”) under which non-qualified stock options and other equity-based awards may be granted to eligible employees and directors of, and consultants and advisors to, Parent and its subsidiaries. A maximum of 11,622,231 shares of Parent’s Class A common stock (“Class A common stock”) and 1,291,359 shares of Parent’s Class L common stock (“Class L common stock”) may be delivered in satisfaction of awards granted under the 2010 Plan. As of January 30, 2016, there were 3,449,853 shares of Class A common stock and 383,317 shares of Class L common stock available for the grant of future awards under the 2010 Plan. Shares of stock delivered under the 2010 Plan may be authorized but unissued shares of stock or previously issued shares of stock acquired by Parent.
Class L common stock is a combination of preferred stock and common stock. Each share of Class L common stock, whenever issued, has a “liquidation preference” that initially equals $36.00 and will grow at a rate equal to fifteen percent (15%) per year, compounded quarterly. Each share of Class L common stock also includes all of the economic rights included in one share of Class A common stock.
Class A common stock behaves like standard common stock. Class A common stock does not have a specified liquidation preference like the Class L common stock described above. The shares of Class A common stock will participate in all future appreciation of the value of Parent after the Class L common stock liquidation preference has been satisfied. The holders of Class A common stock and Class L common stock generally vote as a single class.
Upon liquidation, after the payment of all required distributions to the holders of Class L common stock, the holders of all of the common shares (both Class A and Class L) will receive all remaining distributions ratably as a single class. The Class A and Class L common stock will share ratably in any non-liquidating distributions. Class L common stock will convert into Class A common stock if Parent is taken public in the future. Upon a sale of all or substantially all of the business or assets of Parent and its subsidiaries, holders of a majority of the shares of Class L common stock may elect to convert the Class L common stock into Class A common stock.
Stock Options
The following table summarizes the stock option activity during fiscal 2015:
(1) The expected to vest options are the result of applying the pre-vesting forfeiture rate assumptions to total unvested options outstanding.
The outstanding options granted by Parent to employees of the Company allow each grantee to purchase units of shares of Parent’s Class A and Class L common stock. Each unit consists of 9 shares of Parent’s Class A and 1 share of Class L common stock. The fair value of a unit was determined to be $8.50, $8.50, and $45.00 for fiscal 2015, 2014, and 2013, respectively, by the Company using the Option Pricing Method, which considers the various equity securities as call options on the total equity value, giving consideration to the rights and preferences of each class of equity. The various classes of equity are modeled as call options that give their owners the right, but not the obligation, to buy the underlying equity value at a predetermined (or exercise) price. The options each have a term of ten years and vest over a five-year period based only on time-based service conditions.
The weighted-average fair value of options granted under the 2010 Plan was estimated to be $6.11, $4.43, and $30.49 per unit on the date of grant using the Black-Scholes option valuation model for fiscal 2015, 2014, and 2013, respectively. For purposes of this model, no dividends have been assumed. Expected stock price volatility was determined based on the historical and implied volatilities of comparable companies and based on each of the guideline company’s longest term traded options, where available. The risk-free interest rate was based on United States Treasury yields in effect at the time of the grant for notes with comparable terms as the awards.
The fair value of each stock option granted was estimated using the assumptions below for the fiscal years ended:
As of January 30, 2016, there was approximately $7.1 million of unrecognized compensation cost (net of estimated forfeitures) related to stock options, which is expected to be recognized over a weighted-average period of 4.0 years.
Restricted Units
Stock-based compensation cost for restricted units (“RUs”) is measured based on the value of the Company’s stock on the grant date. RU awards vest over a three-year period based only on time-based service conditions. The expense for these awards, net of estimated forfeitures, is recorded over the requisite service period based on the number of awards that are expected to be earned.
As of January 30, 2016 and January 31, 2015, there were approximately 6,000 and 19,000 RUs, respectively, with a grant date fair value of $45.00 per unit that were outstanding. During fiscal 2015, there were approximately 13,000 RUs with a grant date fair value of $45.00 per unit that vested.
As of January 30, 2016, there was approximately $0.2 million of unrecognized compensation cost (net of estimated forfeitures) related to unvested RUs that is expected to be recognized over a weighted average period of 0.8 years. The total fair value of RUs that vested during fiscal 2015 and fiscal 2014 was $0.1 million and $0.1 million, respectively.
Share-Based Compensation Expense
Share-based compensation expense included as a component of SG&A expenses was $3.4 million, $4.6 million, and $5.8 million during fiscal 2015, 2014, and 2013, respectively. We include an estimate of forfeitures in determining share-based compensation expense.
The share-based compensation expense during fiscal 2015 includes $0.2 million of upfront incremental share-based compensation expense related to a modification of certain employee stock options on May 27, 2015. The terms of the modification include a change in exercise price for certain employees with stock options that were outstanding as of May 27, 2015. As of January 30, 2016, there were approximately $0.7 million of unrecognized incremental compensation expense that will be recognized over an average period of 3.7 years.
The share-based compensation expense during fiscal 2014 includes $0.3 million of upfront incremental share-based compensation expense related to a modification of certain employee stock options on December 12, 2014. The terms of the modification include changes in exercise price and vesting period for certain employees with stock options that were outstanding as of December 12, 2014. As of January 30, 2016, there were approximately $0.5 million of unrecognized incremental compensation expense that will be recognized over an average period of 3.9 years.
We recognized $0.1 million of income tax benefit and $0.4 million of income tax expense, before valuation allowance, related to share-based compensation expense during fiscal 2015 and 2014, respectively. We recognized $1.4 million of income tax benefits, before valuation allowance, related to share-based compensation expense during fiscal 2013. In the third quarter of fiscal 2013, we established a valuation allowance against certain deferred tax assets, which eliminates existing tax benefits related to share-based compensation expense in the current and prior years. For fiscal 2015, 2014, and 2013 we reported no excess tax benefits as financing cash inflows.
2013 Gymboree China Phantom Equity Incentive Plan
Units awarded under the Company’s 2013 Gymboree China Phantom Equity Incentive Plan (the “Phantom Plan”) represent a hypothetical equity interest in Gymboree Hong Kong Limited, the unconsolidated direct parent of the VIEs (“Gymboree HK”). The Company is a member of a related party group that controls Gymboree HK. Units may be granted to eligible employees and directors of, and consultants and advisors to, the Company and its subsidiaries. Each award gives the holder of the award the conditional right to receive, in accordance with the terms of the Phantom Plan and the award, a specified interest in the value of the “Pool.” For this purpose, the “Pool” means an amount of cash equal to 10% of the amount by which the sum of the amount of cash and the fair market value of marketable securities, in each case, received by Bain Fund X, L.P. and its permitted transferees in respect of shares of common stock of Gymboree HK they beneficially own exceeds a number equal to $12 million plus the amount of any additional equity investment, whether direct or indirect, by the Bain Fund X, L.P. and its permitted transferees in Gymboree HK. Under a form of award adopted under the Phantom Plan on September 12, 2013, each award will conditionally vest as to 20% of the Units subject to the award on each of the first five anniversaries of the date specified by the Plan administrator, subject to continued employment or service with the Company through the applicable anniversary. The Compensation Committee of the Board of Directors of the Company currently serves as the administrator of the Phantom Plan.
Each award will only vest and become payable if a “Payment Event” (e.g., an occurrence of sale or a qualified IPO as defined in the Phantom Plan) occurs at a time when the award is outstanding. Upon the occurrence of a Payment Event, the Company is obligated to make a payment in cash to the holder of the award equal to the product of (i) the value of the Pool and (ii) (A) the number of conditionally vested Units that were outstanding under the participant’s award immediately prior to the Payment Event divided by (B) 1,000,000. All Units subject to the award will conditionally vest in full upon the occurrence of a “Sale” (as defined in the Phantom Plan). If the Payment Event is not a Sale, any portion of an award that is not then conditionally vested will remain eligible to conditionally vest in accordance with its original conditional vesting schedule. With respect to Units that conditionally vest after the occurrence of a Payment Event, if any, on the date such Units conditionally vest, the Company will make a payment in cash to the holder of the award equal to the product of (i) the value of the Pool and (ii) (A) the number of Units that conditionally vested on such date divided by (B) 1,000,000.
A summary of activity under the Phantom Plan was as follows:
Since payment is contingent upon a Payment Event, share-based compensation expense will be recorded on these awards in the period that a Payment Event occurs.
13. Income Taxes
The pre-tax (loss) income attributable to foreign and domestic operations was as follows for the fiscal years ended (in thousands):
The provision for (benefit from) income taxes consists of the following for the fiscal years ended (in thousands):
A reconciliation of the statutory federal income tax rate with our effective income tax rate was as follows for the fiscal years ended:
Temporary differences and carryforwards, which give rise to deferred tax assets and liabilities, were as follows (in thousands):
As of January 30, 2016 and January 31, 2015, the total valuation allowance against deferred tax assets was $63.2 million and $58.6 million, respectively. We establish a valuation allowance when it is more likely than not that all or a portion of deferred tax assets will not be realized. We consider all available positive and negative evidence in evaluating whether a valuation allowance is required, including prior earnings history, actual earnings over the previous 12 quarters on a cumulative basis, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset. We continue to have a valuation allowance against all net deferred tax assets in U.S. federal, unitary state, and Australian jurisdictions, excluding indefinite-lived deferred tax assets and liabilities, and against the tax benefit on losses from our VIEs. We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.
As of January 30, 2016, our net operating loss carryforwards and tax credit carryforwards, with expiration dates, were as follows (in millions):
We had unrecognized tax benefits of $6.4 million, $5.6 million, and $6.6 million as of fiscal year-end 2015, 2014, and 2013, respectively. Below is a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended (in thousands):
As of fiscal year-end 2015, 2014, and 2013, $4.1 million, $3.5 million, and $3.6 million, respectively, of unrecognized tax benefits would affect the effective tax rate if recognized. Additionally, as of fiscal year-end 2015, 2014, and 2013, $2.3 million, $2.1 million, and $3.0 million, respectively, of unrecognized tax benefits would result in adjustments to other tax accounts if recognized.
We recognize interest and penalties on income tax contingencies in income tax expense. We recognized income tax expense of $229,000, an income tax expense of $33,000, and an income tax benefit of $102,000 during fiscal 2015, 2014, and 2013, respectively, related to interest expense on income taxes. We also recognized income tax benefits of $81,000, $58,000, and $70,000 during fiscal 2015, 2014, and 2013, respectively, related to penalties on income taxes. As of January 30, 2016, we had a liability for interest on income taxes of $859,000 and a liability for penalties on income taxes of $487,000. As of January 31, 2015, we had a liability for interest on income taxes of $919,000 and a liability for penalties on income taxes of $568,000. As of February 1, 2014, we had a liability for interest on income taxes of $889,000 and a liability for penalties on income taxes of $626,000.
We believe that it is reasonably possible that the total amount of unrecognized tax benefits of $6.4 million as of January 30, 2016 will decrease by as much as $0.8 million during the next twelve months due to the resolution of certain tax contingencies and lapses of applicable statutes of limitations.
The Company and its domestic subsidiaries file income tax returns with federal, state and local tax authorities within the United States. Our foreign affiliates file income tax returns in various foreign jurisdictions, the most significant of which is Canada. With few exceptions, we are no longer subject to United States federal, state, local or foreign examinations by tax authorities for tax years before 2008.
14. Commitments and Contingencies
Commitments
Amounts representing estimated inventory and other purchase obligations used in the normal course of business as of January 30, 2016 are as follows:
(1) Inventory purchase obligations include outstanding purchase orders for merchandise inventories that are enforceable and legally binding on the Company and that specify all significant terms (including fixed or minimum quantities to be purchased), fixed, minimum or variable price provisions, and the approximate timing of the transaction.
(2) Other purchase obligations include annual commitments of approximately $8.8 million through the second quarter of fiscal 2019 under the operating services agreement related to a third party fulfillment center (see Note 11). Also included in other purchase obligations are commitments for professional services, information technology and fixtures and equipment.
As described in Note 11, the Company terminated the operating services agreement on February 25, 2016. The table above does not reflect the impact of the termination of the operating service agreement.
Contingencies
From time to time, we are subject to various legal actions arising in the ordinary course of our business. Many of these legal actions raise complex factual and legal issues, which are subject to uncertainties. We cannot predict with reasonable assurance the outcome of these legal actions brought against us. Accordingly, any settlements or resolutions in these legal actions may occur and affect our net income in the quarter of such settlement or resolution. However, we do not believe that the outcome of any legal actions would have a material effect on our consolidated financial statements taken as a whole.
15. Accumulated Other Comprehensive Loss
The following table shows the components of accumulated other comprehensive loss (“OCI”), net of tax, as of the fiscal years ended (in thousands):
Changes in accumulated OCI balance by component were as follows for the fiscal years ended (in thousands):
16. Dividends
During fiscal 2014 and 2013, we distributed $0.2 million and $0.9 million, respectively, in the form of a dividend to our indirect parent, Giraffe Holding, Inc. (“Parent”). The dividend was used by Parent’s shareholders, which are investment funds sponsored by Bain Capital Private Equity, LP (“Bain Capital”), to repurchase shares.
During fiscal 2013, we distributed $6.7 million in the form of a dividend to Parent, which was used by Parent’s shareholders to fund part of their equity investment in the VIE (see Note 19).
Equity investments received by the VIEs as capital contributions from affiliate of Parent during fiscal 2014 and 2013 were $1.0 million and $15.9 million, respectively. The VIEs did not receive any capital contributions during fiscal 2015.
17. Related Party Transactions
Management Agreement
On October 23, 2010, Acquisition Sub and Parent entered into a management agreement with Bain Capital pursuant to which Bain Capital agreed to provide certain management services to Acquisition Sub and Parent until December 31, 2020 (unless terminated earlier), with evergreen one-year extensions thereafter. We have assumed the obligations of Acquisition Sub under this agreement by operation of law as a result of the Transaction. In April 2012, Parent, Bain Capital and the Company entered into a first amended and restated management agreement. Pursuant to such agreement (as amended and restated), Bain Capital is entitled to receive an aggregate annual management fee equal to $3.0 million, which fee will be reduced by $270,000 until such time as Bain Capital notifies the Company in writing, and reimbursement for out-of-pocket expenses incurred by it or its affiliates in connection with the provision of services pursuant to the agreement or otherwise related to its investment. These amounts are recorded as a component of SG&A expenses in our consolidated statement of operations.
The management agreement provides that Bain Capital is entitled to receive fees in connection with certain subsequent financing, acquisition, disposition and change of control transactions of 1% of the gross transaction value of any such transaction. The management agreement includes customary exculpation and indemnification provisions in favor of Bain Capital and its affiliates. The management agreement may be terminated by Bain Capital at any time and will terminate automatically upon an initial public offering or a change of control unless the Company and the counterparty to the management agreement determine otherwise. Upon termination, each provider of management services will be entitled to a termination fee calculated based on the present value of the annual fees due during the remaining period from the date of termination to December 31, 2020, or the then-applicable scheduled date for termination of the management agreement.
Franchise Agreements
In April 2014, Gymboree Play Programs, Inc. (“GPPI”), a wholly owned subsidiary of the Company, entered into a 10-year Master Franchise agreement with Gymboree Tianjin, an affiliate of the Company and indirect subsidiary of Gymboree Holding, Ltd. Under the Master Franchise Agreement, Gymboree Tianjin is given the rights as the master franchisor of Play & Music centers in the People’s Republic of China (“PRC”) Territory, specifically the rights to award and service unit franchises in the PRC, as well as the rights to operate primary Play & Music centers in the PRC. GPPI receives a percentage of royalties and franchise fees earned by Gymboree Tianjin. Prior to the April 2014 Master Franchise Agreement, GPPI and Gymboree Tianjin had a Master Service Agreement (as amended in November 2012), whereby Gymboree Tianjin was allowed to enter into agreements directly with the unit franchises and issue tax invoices to the unit franchises. Gymboree Tianjin paid GPPI fees for consulting services provided under the Master Service Agreement. All intercompany revenues and expenses have been eliminated in consolidation.
In December 2011, we entered into a ten-year Retail Store Franchise Agreement with Gymboree China, an affiliate of the Company and indirect subsidiary of Gymboree Holding, Ltd., to develop, own and operate Gymboree branded retail stores and website(s) to market and sell Gymboree branded products in the PRC Territory under the Gymboree license and trademarks. Under the terms of the agreement, Gymboree China will purchase inventory from us and pay us royalties on retail sales within the PRC Territory. All intercompany revenues and expenses have been eliminated in consolidation.
Related Party Transactions - Excluding VIEs
We incurred approximately $3.1 million, $3.1 million, and $3.6 million in management fees and reimbursement of out-of-pocket expenses from Bain Capital during the fiscal 2015, 2014, and 2013, respectively. As of January 30, 2016 and January 31, 2015, we had a payable balance of $0.2 million, to Bain Capital.
We incurred approximately $1.8 million, $1.9 million, and $2.6 million in expenses related to services purchased from LogicSource, a company owned by funds associated with Bain Capital, during the fiscal 2015, 2014, and 2013, respectively. As of January 30, 2016 and January 31, 2015, we had a payable balance of $0.1 million and $0.3 million, respectively, to LogicSource.
As of January 31, 2015, we had a receivable balance of $0.2 million from our indirect parent, Giraffe Holding, Inc., which relates primarily to income taxes and withholding taxes.
Related Party Transactions -VIEs
In September 2015, Gymboree Tianjin entered into an unsecured entrusted loan agreement with Lionbridge Financing Leasing (China) Co., Ltd. (“Lionbridge”), an indirect majority-owned company of Bain Capital Lionbridge Cayman Ltd., and Shanghai Pudong Development Bank (“SPD Bank”) for $1.7 million, whereby Lionbridge was the borrower and SPD Bank was the trustee. The loan bears interest at 10% per annum and matures in March 2016. The loan receivable is included in accounts receivable in the consolidated balance sheet as of January 30, 2016.
During 2015, Gymboree Tianjin sold $0.2 million of equipment to Lionbridge who subsequently leased the equipment to Gymboree Tianjin’s Play & Music franchisees. As a result of these transactions, Gymboree Tianjin had a $0.2 million receivable due from Lionbridge as of year-end which is included in the consolidated balance sheet as of January 30, 2016.
Our VIEs incurred $0.5 million in management fees from Bain Capital Advisors (China) Ltd. during each of the fiscal years ended 2015, 2014, and 2013, respectively.
As of January 30, 2016 and January 31, 2015, our VIEs had a balance of $1.1 million payable to their indirect parent, Gymboree Investment Holding GP, Ltd., related to funds used to pay operating costs of the VIEs.
As of January 30, 2016 and January 31, 2015, our VIEs had a payable balance of $0.4 million due to Gymboree Hong Kong Limited, the unconsolidated direct parent of the VIEs, related to funds used to pay operating costs of the VIEs. The Company is part of a related party group that controls Gymboree Hong Kong Limited.
18. Segment Information
We have four reportable segments: retail stores (including online stores), Gymboree Play & Music, International Retail Franchise (“Retail Franchise”), and one reportable segment related to the activities of our consolidated VIEs. These reportable segments were identified based on how our business is managed and evaluated by our chief operating decision maker, who is the Chief Executive Officer. The retail stores segment includes four operating segments (brands), which sell high-quality apparel for children: Gymboree Retail (including an online store), Gymboree Outlet, Janie and Jack (including an online store), and Crazy 8 (including an online store). These four operating segments have been aggregated into one reportable segment because these operating segments have similar historical economic characteristics and/or are expected to have similar economic characteristics and similar long-term financial performance in the future. Gross profit is the principal measure we consider in determining whether the economic characteristics are similar. In addition, each retail store segment has similar products, production processes and type and class of customer. Corporate overhead (costs related to our distribution centers and shared corporate services) is included in the retail stores segment.
Below is a summary of net sales and gross profit of each reportable segment for the fiscal years ended (in thousands):
Net retail sales of the retail stores segment by brand and the VIE were as follows for the fiscal years ended (in thousands):
(1) This includes the net retail sales for Gymboree Retail and Gymboree Outlet operating segments.
Interest expense, depreciation and amortization expense and capital expenditures have not been separately disclosed above as the amounts primarily relate to the retail segment. Intersegment revenues for each reportable segment were as follows for the fiscal years ended (in thousands):
Below is a summary of total assets of each reportable segment as of the fiscal years ended (in thousands):
We attribute retail store revenues to individual countries based on the selling location. Gymboree Play & Music sales are attributable to the U.S. geographic segment. For Gymboree International Retail Franchise, all sales were attributed to the U.S. geographic segment. VIE sales are attributable to the international geographic segment.
Net sales of our two geographical areas, United States and international, were as follows during the fiscal years ended (in thousands):
Property and equipment, net, of our two geographical areas were as follows as of the fiscal years ended (in thousands):
19. Variable Interest Entities
Gymboree retail stores are operated in China by Gymboree China, while Gymboree Tianjin is Gymboree Play & Music’s master franchisee in China. Gymboree China, Gymboree Tianjin and the Company are indirectly controlled by Gymboree Holding, Ltd. and investment funds sponsored by Bain Capital. Gymboree China and Gymboree Tianjin have been determined to be variable interest entities, and we (as well as our 100%-owned subsidiaries) are a member of a related party group that controls the VIEs and absorbs the economics of the VIEs. Based on our relationship with the VIEs, we determined we are most closely associated with the VIEs, and therefore, consolidate them as the primary beneficiary. However, as we have a 0% ownership interest in the VIEs, 100% of
the results of operations of the VIEs are recorded as noncontrolling interest. The assets of the VIEs can only be used by the VIEs. The liabilities of the VIEs are comprised mainly of short-term accrued expenses, and their creditors have no recourse to our general credit or assets.
The following tables reflect the impact of the VIEs on the condensed consolidated statements of operations for the fiscal years ended January 30, 2016, January 31, 2015, and February 1, 2014 and the condensed consolidated balance sheets as of January 30, 2016 and January 31, 2015 (in thousands):
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEETS
(In thousands)
20. Condensed Guarantor Data
The Company’s 100%-owned domestic subsidiaries have fully and unconditionally guaranteed the Notes, subject to the customary automatic release provisions described above (see Note 7). The following condensed consolidating financial information presents the financial position, results of operations, comprehensive income (loss) and cash flows of The Gymboree Corporation and the guarantor and non-guarantor subsidiaries. The VIE financial results are included in those of the non-guarantor subsidiaries. Intercompany transactions are eliminated.
During fiscal 2015, our guarantor subsidiaries distributed $3.2 million dividend and $25.9 million capital distribution to The Gymboree Corporation. During fiscal 2014, our guarantor subsidiaries distributed $3.0 million dividend to The Gymboree Corporation.
During fiscal 2015 and 2014, non-guarantor subsidiaries distributed $7.4 million and $1.8 million in the form of capital distributions to The Gymboree Corporation.
Also during fiscal 2014, our Canadian subsidiary, which is part of the non-guarantor subsidiaries, issued common shares to The Gymboree Corporation valued at $18.5 million. No cash was exchanged since we immediately net settled $15.3 million and $3.2 million of intercompany liabilities payable to The Gymboree Corporation related to business operations and to our Advanced
Pricing Agreement, respectively. The $18.5 million is a non-cash investing and financing activity for purposes of the condensed consolidating statements of cash flows. During fiscal 2014, our Canadian subsidiary repurchased common shares from The Gymboree Corporation valued at $3.2 million.
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED JANUARY 30, 2016
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED JANUARY 31, 2015
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED FEBRUARY 1, 2014
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEAR ENDED JANUARY 30, 2016
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE LOSS
FOR THE YEAR ENDED JANUARY 31, 2015
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEAR ENDED FEBRUARY 1, 2014
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEETS
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEETS
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JANUARY 30, 2016
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JANUARY 31, 2015
(In thousands)
THE GYMBOREE CORPORATION
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED FEBRUARY 1, 2014
(In thousands)
The Company and its guarantor subsidiaries participate in a cash pooling program. As part of this program, cash balances are generally swept on a daily basis between the guarantor subsidiary bank accounts and those of the Company. In addition, we pay expenses on behalf of our guarantor and non-guarantor subsidiaries on a regular basis. These types of transactions have been accounted for as intercompany transfers within investing and financing activities.
The Company’s transactions include interest, tax payments and intercompany sales transactions related to administrative costs incurred by the Company, which are billed to guarantor and non-guarantor subsidiaries on a cost plus basis. All intercompany transactions are presumed to be settled in cash and therefore are included in operating activities. Non-operating cash flow changes have been classified as investing and financing activities.
21. Quarterly Financial Information (Unaudited)
The quarterly financial information presented below is derived from the Consolidated Statements of Operations (in thousands).
During the fourth quarter of fiscal 2015, we repurchased Notes with an aggregate principal amount of $58.4 million for $15.3 million in cash through open market transactions and recorded a $41.5 million gain on extinguishment of debt, net of a $1.6 million charge related to the write-off of deferred financing costs associated with the extinguished debt.
During the third quarter of fiscal 2014, we recorded non-cash charges related to goodwill impairment of $378.8 million and trade name impairment of $212.6 million (see Note 3). In addition, during the third quarter of fiscal 2014, we recorded an income tax benefit of $78.2 million related to trade name impairment.
22. Subsequent Events
Subsequent to year-end, we made additional purchases of Notes, such that together with repurchases of Notes made in the fourth quarter of fiscal 2015, we have repurchased $135.4 million aggregate principal amount of Notes for $41.5 million since the beginning of the fourth quarter of fiscal 2015, capturing approximately $93.9 million of discount.
On April 26, 2016, the Company announced a cash tender offer (the “Tender Offer”) to purchase the maximum aggregate principal amount of its outstanding Notes that it can purchase for $40,000,000, excluding accrued interest. The Tender Offer is scheduled to expire at 11:59 p.m., New York City time, on May 23, 2016, unless extended by the Company in its sole discretion. The Tender Offer is subject to a number of conditions and, if consummated, is expected to be financed with the proceeds from the ABL Term Loan.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the Principal Executive Officer and the Principal Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can provide only reasonable assurance of achieving their control objectives. Based on the Company’s evaluation, the Principal Executive Officer and Principal Financial Officer concluded the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. In addition, the Company’s Principal Executive Officer and Principal Financial Officer concluded as of the end of the period covered by this report that the Company’s disclosure controls and procedures are also effective to ensure information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is accumulated and communicated to the Company’s management, including the Principal Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
The management of The Gymboree Corporation is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of January 30, 2016. In making this assessment, management used the criteria established in Internal Control - Integrated Framework released in 2013 (the “2013 Framework”) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Management believes that, as of January 30, 2016, the Company maintained effective internal control over financial reporting based on the criteria established in the 2013 Framework.
Changes in Internal Control over Financial Reporting
During the Company’s fourth quarter of fiscal 2015, there was no change in the Company’s internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Directors and Executive Officers
Our current directors serve until their successors are duly elected and qualified or until the earlier of their resignation, death or removal. Directors are elected at an annual meeting of stockholders.
Below is a list of the names, ages as of March 31, 2016 and positions, and a brief account of the business experience, of the individuals who serve as our executive officers and directors:
(1) Effective February 1, 2016, Mr. Zhu has transitioned to the role of a Senior Advisor to the Company.
Mark Breitbard joined The Gymboree Corporation in January 2013 as Chief Executive Officer. Prior to joining The Gymboree Corporation, Mr. Breitbard served as President of Gap North America since 2012, and previously as Executive Vice President of GapKids and BabyGap from 2010 until 2011. From 2009 until 2010, Mr. Breitbard served as Chief Merchandising & Creative Officer of its Old Navy brand. Mr. Breitbard joined Gap from Levi Strauss & Co., where he served as President of the Retail Division from 2007 until 2009 and was responsible for all aspects of its retail division, including design, merchandising, marketing, stores and e-commerce.
Andrew North joined The Gymboree Corporation in November 2014 as Chief Financial Officer. Prior to joining The Gymboree Corporation, Mr. North served as Chief Financial Officer of Lucky Brand from October 2011 to June 2014 and as a consultant since June 2014. Prior to that position, Mr. North served in a variety of roles with Carter’s, Inc., a children’s apparel retailer, from 2002 to July 2011, including Vice President of Finance, Senior Vice President of Finance and Interim Chief Financial Officer of Carter’s from August 2008 to January 2009.
Weizhong (“Wilson”) Zhu joined The Gymboree Corporation in November 2013 as Chief Sourcing and Production Officer. Prior to joining The Gymboree Corporation, Mr. Zhu served as Executive Vice President Private Brands and Global Sourcing of Michaels Stores since 2007.
Kimberly Sentovich joined The Gymboree Corporation in May 2015 as Executive Vice President of Stores and Logistics. Prior to joining The Gymboree Corporation, Ms. Sentovich served as Senior Vice President of Pacific Division from January 2010 to April 2015 and as Vice President, Region General Manager from November 2008 to December 2009 of Wal-Mart Stores, Inc. Ms. Sentovich also served in a variety of roles with The Home Depot, Inc. from January 1993 to September 2008, including as Vice President of Merchandising and Regional Vice President of Operations.
Elizabeth Schumacher joined The Gymboree Corporation in April 2015 as Executive Vice President, General Manager of Gymboree and Gymboree Outlet. Prior to joining The Gymboree Corporation, Ms. Schumacher served as Senior Vice President and General Manager of Merchandising at J. C. Penney Company, Inc. from July 2012 to January 2014. Ms. Schumacher also served various roles at American Eagle Outfitters, Inc. from January 2005 to June 2012, including as Senior Vice President of Merchandising from 2006 to 2012. Ms. Schumacher also served as Vice President and General Manager of Merchandising of the BabyGap Division of Gap, Inc. from 2002 to 2005.
Peter Sassi joined The Gymboree Corporation in November 2015 as Chief Planning Officer. Prior to joining The Gymboree Corporation, Mr. Sassi served as Senior Vice President of Stores for Williams-Sonoma brand at Williams-Sonoma, Inc. until July 2015. Prior to that position, Mr. Sassi also served as Senior Vice President of Inventory Management for Williams-Sonoma brand at Williams-Sonoma, Inc. for more than 10 years. Mr. Sassi also served lead planning and distribution roles at Gap, Inc. and Macy’s, Inc. prior to joining Williams-Sonoma, Inc.
Joshua Bekenstein has been a director on our Board and a director of Parent since November 2010. Mr. Bekenstein is currently a Managing Director at Bain Capital, having joined the firm at its inception in 1984. Mr. Bekenstein serves as a board member of Bob’s Discount Furniture, Bombardier Recreational Products, Inc., Bright Horizons Family Solutions, Inc., Burlington Stores, Inc., Dollarama, Inc., The Michaels Companies, Inc., and Waters Corporation. Prior to joining Bain Capital, Mr. Bekenstein spent two years as a consultant at Bain & Company. Mr. Bekenstein received an M.B.A. from Harvard Business School and a B.A. from Yale University. Mr. Bekenstein possesses valuable financial expertise, including extensive experience with capital markets transactions and investments in both public and private companies. Mr. Bekenstein’s service as a member of the boards of directors of several other companies provides him with substantial knowledge of a full range of corporate and board functions.
Maxine Clark has been a director on our Board and a director of Parent since November 2014. Ms. Clark is a founder of and served as a Chief Executive Officer at Build-A-Bear Workshop Inc. from 1997 to June 2013. Ms. Clark served as the President at Build-A-Bear Workshop Inc. from its inception in 1997 until April 2004 and served as its Chairman from April 2000 to 2012. Prior to founding Build-A-Bear Workshop Inc. in 1997, Ms. Clark served as the President and Chief Merchandising Officer at Payless Shoesource Inc. from November 1992 to January 1996. Ms. Clark served as an Executive Vice President at Softlines for Venture Stores, Inc. from 1988 to 1992. Ms. Clark has been a member of the board of directors of Foot Locker, Inc. since 2013. Ms. Clark has been a member of the Board of Directors of Teach for America since 2005. Ms. Clark also serves as a member of the board of several non-profit organizations, including the board of trustees of Washington University in St. Louis, the board of directors of PBS.org and Nine Network of Public Media, the board of directors of Parents as Teachers and the board of directors of Beyond Housing. Ms. Clark earned a Bachelor’s degree in journalism from the University of Georgia, an Honorary Doctor of Laws from Saint Louis University-St Louis and an Honorary Doctor of Humane Letters, Education from University of Missouri-Saint Louis.
Jordan Hitch has been a director on our Board and a director of Parent since November 2010. Mr. Hitch previously served as a Managing Director of Bain Capital, having joined the firm in 1997. Prior to joining Bain Capital, Mr. Hitch was a consultant at the consulting firm Bain & Company where he worked in the financial services, healthcare and utility industries. Previously, Mr. Hitch worked for Nalco Chemical Co., a water treatment and process improvement company, as an Area Manager. Mr. Hitch received an MBA, with distinction, from the University of Chicago Graduate School of Business. He received a Bachelor’s degree in Mechanical Engineering from Lehigh University. Mr. Hitch also serves as a director of the Burlington Stores, Bright Horizons Family Solutions, Inc. and Gymboree China.
Marko Kivisto has been a director on our Board since February 2011 and a director of Parent since December 2010. Mr. Marko Kivisto has been a Principal of AVALT Holdings since September 2015. Mr. Kivisto has been the Senior Vice President of Corporate Development at C&S Wholesale Grocers since July 2014 where he is responsible for the company’s merger and acquisition and capital market related activities. Prior to joining C&S Wholesale Grocers, Mr. Kivisto worked at Bain Capital for over seven years where he was an investment principal. Prior to joining Bain Capital, Mr. Kivisto was a manager at Bain & Company for six years where he advised clients on corporate strategy, mergers and acquisition, turnaround management, and operations improvement. Mr. Kivisto received an MBA from The Wharton School at the University of Pennsylvania. He received a B.S. degree in Chemical Engineering from Queen’s University.
Lewis Klessel has been a director on our Board and a director of Parent since June 2014. Mr. Klessel currently serves as a managing director at Bain Capital. Prior to becoming a managing director in December 2011, Mr. Klessel served in various capacities, most recently as an operating partner at Bain Capital from December 2007 to December 2011. Prior to joining Bain Capital in October 2005, Mr. Klessel held a variety of operating and strategy leadership positions from 1997 to 2005 at The Home Depot, Inc., including as President of HD Supply’s Facilities Maintenance business, Divisional Merchandise Manager and head of Home Depot’s Strategic Business Development function. Prior to 1997, Mr. Klessel was a strategy consultant with McKinsey & Company and a senior auditor with Ernst & Young. Mr. Klessel received an MBA from Harvard Business School where he was a Baker Scholar. He received a B.S. degree from The Wharton School at the University of Pennsylvania and is a Certified Public Accountant. Mr. Klessel is currently on the Board of Directors for Guitar Center and The Michaels Companies, Inc.
Mark Weikel has been a director on our Board and a director of Parent since November 2014. Mr. Weikel has been a Senior Business Advisor at Luxottica Group SpA from April 2014 to December 2014. Mr. Weikel was President and Chief Executive Officer of Retail Optical North America at Luxottica Group SpA from January 2013 to March 2014. Mr. Weikel served as President and General Manager of Lenscrafters at Luxottica Group SpA from January 2011 until January 2013. He served as Senior Vice President and General Manager of Sunglass Hut North America at Luxottica Group SpA from February 2010 until January 2011. Mr. Weikel provided oversight and leadership to the finance, planning and allocation, business planning and operations, sourcing and production, human resources, brand marketing, visual merchandising, product/merchandising and stores functions in his roles at Luxottica Group SpA. Mr. Weikel has been a member of the Board of Directors of 2020 On-Site Optometry since December 2015. Mr. Weikel has been a member of the board of directors of Tractor Supply Company since February 2014, and serves on its compensation committee and audit committee. Mr. Weikel graduated with a B.S. degree in accounting from Indiana State University in Evansville, completed the executive program from the University of Michigan at Ann Arbor and is a Certified Public Accountant in the state of Indiana.
CORPORATE GOVERNANCE
Our Board is responsible for governing the Company’s business and affairs. Highlights of the Company’s corporate governance practices are described below.
Board Committees
Currently, our Board has two active standing committees, each of which is required by its charter to consist of no fewer than two directors.
Compensation Committee
Our Board of Directors has a separately designated Compensation Committee. The Compensation Committee consists of two members: Messrs. Bekenstein and Hitch.
Under its charter, the Compensation Committee assists the Board in developing and evaluating potential candidates for executive positions. The Compensation Committee also reviews and recommends to the Board for approval the compensation for all executive positions.
Audit Committee
Our Board of Directors has a separately designated Audit Committee. The Audit Committee consists of three members: Messrs. Kivisto, Klessel and Weikel.
Our Board has determined that each member of the Audit Committee is financially literate and has sufficient business and financial expertise to effectively perform his duties as a member of the Audit Committee. As the Company is privately held, our Board has determined that it is not necessary to designate one or more of our Audit Committee members as an “audit committee financial expert” at this time. Our Board has not determined whether any of our Audit Committee members is an independent director due to their affiliations with Bain Capital.
Under its charter, the Audit Committee is generally responsible for overseeing the Company’s financial reporting process and assists the Board in fulfilling the Board’s oversight responsibilities with respect to: (i) the integrity of the Company’s financial statements; (ii) the Company’s compliance with legal and regulatory requirements; (iii) the qualifications and independence of the Company’s independent registered public accounting firm; and (iv) the performance of the independent registered public accounting firm and of the Company’s internal audit function.
Code of Conduct
We adopted a Code of Ethics for Senior Financial Officers which applies to the Chief Executive Officer, Chief Financial Officer, Vice President, Corporate Controller, and Vice President, Finance (and any persons performing similar functions) (together, the “Senior Financial Officers”) of The Gymboree Corporation. Senior Financial Officers are also subject to the Business and Ethics Code of Conduct applicable to all employees and directors. The Business and Ethics Code of Conduct contains provisions relating to ethical conduct, conflicts of interest and compliance with laws. A copy of our Business & Ethics Code of Conduct and our Code of Ethics for Senior Financial Officers are available on our Internet website at www.gymboree.com under “Company Information - Corporate Governance.”
Item 11.
Item 11. Executive Compensation
EXECUTIVE COMPENSATION
Introduction
In general, this section focuses on, and provides a description of, our executive compensation philosophy and objectives and a discussion of each of the key elements of our compensation programs for fiscal 2015 as they applied to the individuals identified in the Summary Compensation Table, referred to in this report as the “named executive officers.” Our named executive officers for fiscal 2015 were:
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Mark Breitbard, Chief Executive Officer;
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Andrew North, Chief Financial Officer;
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Wilson Zhu, Chief Sourcing and Production Officer; (1)
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Kimberly Sentovich, Executive Vice President of Stores and Logistics; (2)
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Elizabeth Schumacher, Executive Vice President, General Manager of Gymboree and Gymboree Outlet; (3)
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Peter Sassi, Chief Planning Officer; (4) and
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Joelle Maher, former Chief Operating Officer. (5)
(1) Effective February 1, 2016, Mr. Zhu transitioned to the role of a Senior Advisor to the Company.
(2) Ms. Sentovich joined the Company on May 4, 2015.
(3) Ms. Schumacher joined the Company on April 29, 2015.
(4) Mr. Sassi joined the Company on November 2, 2015.
(5) Ms. Maher’s employment with the Company terminated effective June 1, 2015.
Compensation Discussion and Analysis
General Philosophy and Objectives
During fiscal 2015, the Compensation Committees of the board of directors of each of Gymboree and Parent (together, the “Compensation Committee”) in consultation with the boards of directors and our Chief Executive Officer (other than with respect to his own compensation) were responsible for determining the compensation of our named executive officers, including base salary, cash bonus opportunities and long-term incentive awards. The philosophy of the Compensation Committee was that executive compensation should be used to attract, reward and retain highly-qualified executives in a performance-oriented environment that recognizes individual performance as well as achievement of specific Company goals. Consistent with this philosophy, we tied a significant portion of senior executive compensation during fiscal 2015 to our financial and business performance.
Our compensation program for our named executive officers, which principally consists of a mix of base salary, cash bonus opportunities and long-term incentives, is designed to provide total compensation at levels competitive with those at comparable companies with which we compete for executive talent. While the Compensation Committee considers the overall mix of compensation components in its review of compensation matters, we have not adopted any formal policies or guidelines for allocating compensation between short-term and long-term compensation, between cash and non-cash compensation or among different forms of cash and non-cash compensation.
An executive officer’s compensation level relative to other executive officers is also influenced by that officer’s position, related responsibilities, and prior employment experience. The Compensation Committee also considers overall past compensation and incentives and seeks to appropriately motivate executives to achieve high levels of Company performance. The Compensation Committee, through its members’ involvement with numerous portfolio companies of our sponsor, has access to compensation-related information that influences the Compensation Committee’s design of our overall compensation program for employees generally, and for executive officers in particular.
In fiscal 2015, we did not benchmark our executive compensation against peer companies. Compensation amounts historically have been highly individualized and discretionary, based largely on the collective experience and judgment of our Compensation Committee members, along with input from our Chief Executive Officer and other executive officers, as appropriate. Approvals by the Compensation Committee are therefore predominantly based on the experience of the members of the Compensation Committee and alignment with our overall strategic direction and goals.
In addition, our review of compensation generally relies on both quantitative and qualitative indicators of individual and Company performance in determining total compensation, including the achievement of pre-established earnings targets and other performance metrics, succession planning and retention.
Components of Executive Compensation
During fiscal 2015, we compensated our named executive officers principally through a combination of base salary, cash bonus opportunities and long-term incentive awards. We believe that offering executive officers a total compensation package that includes a significant portion of at-risk, performance-based awards aligns the interests of the officers with those of our stockholders.
Base Salaries
The first key component of executive compensation is base salary. The amount of base salary paid to each of our named executive officers for fiscal 2015 is set forth in the “Summary Compensation Table” below.
The amount of the base salary we paid to each of our named executive officers in fiscal 2015 was subject to the terms of an employment agreement, offer letter or letter agreement between us and the named executive officer. These employment contracts were negotiated with each named executive officer at the time he or she joined the Company or assumed a role as an executive officer. The Compensation Committee determined the level of each named executive officer’s base salary by relying on the experience of its members in setting compensation with other executives with similar roles at other portfolio companies of our sponsor with which they are involved and based on the outcome of negotiations with the named executive officers. Ms. Schumacher’s annual base salary was increased from $400,000 to $420,000 in November 2015 due to her successful performance during fiscal 2015 and internal pay equity considerations among our senior executives.
Cash Bonuses
The second key component of executive compensation for fiscal 2015 was our cash bonus program. The Gymboree Compensation Committee granted award opportunities to our named executive officers with respect to fiscal 2015 under The Gymboree Corporation Executive Bonus Plan (the “Executive Bonus Plan”). The Executive Bonus Plan provides financial incentives to executive officers and other members of management who are in a position to drive our financial performance and meet strategic goals.
For fiscal 2015, the Compensation Committee selected Adjusted EBITDA targets because it believed that this measure strongly correlates with stockholder value creation and improvement in this measure aligns with our overall growth strategy. We see Adjusted EBITDA as among the most critical of our financial metrics because we believe it captures our success at balancing growth and profitability. Please see “Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (Non-GAAP Measure)” above for a reconciliation of Adjusted EBITDA to our net loss.
For fiscal 2015, the Compensation Committee approved a cash bonus program under the Executive Bonus Plan that would result in cash bonuses being payable at 100% if our target Adjusted EBITDA goal was met and 200% if our maximum Adjusted EBITDA goal was met, with cash bonuses becoming payable if a threshold Adjusted EBITDA goal was met. If our actual Adjusted EBITDA had been achieved at a level between the target Adjusted EBITDA goal and the threshold Adjusted EBITDA goal or the maximum Adjusted EBITDA goal, respectively, the amount of cash bonuses payable to our named executive officers would have been adjusted to reflect that level of achievement in accordance with a payout curve approved by the Compensation Committee.
The following table illustrates the cash bonus opportunities and payouts to our named executive officers for fiscal 2015:
(1) The target bonuses for Mss. Sentovich and Schumacher were increased from 40% to 50% effective November 8, 2015, and their annual bonuses for the Company’s 2015 fiscal year were based on the increased targets, retroactive to the beginning of the fiscal year. We determined that the increases in the target bonuses for Mss. Sentovich and Schumacher were appropriate in light of their successful performance during fiscal 2015 and internal pay equity considerations among our senior executives.
In addition, in connection with her hiring, we agreed to pay Ms. Schumacher a signing bonus in the amount of $150,000. We determined that this one-time payment was an important component of securing her services, given our requirement that she relocate from Texas to the San Francisco Bay Area.
Equity Compensation
2010 Equity Incentive Plan
The third key component of our executive compensation program is long-term incentive compensation. We provide long-term incentives primarily in the form of stock options and restricted “Units” (defined below). We believe that the use of stock options and restricted Units serves to align the interests of our named executive officers with those of the Company and its stockholders by directly linking individual compensation to the Company’s long-term performance (and the resulting performance of Parent), as reflected in stock price and increased stockholder value.
All of our equity incentive awards are made under the 2010 Equity Incentive Plan (the “2010 EIP”). Under the 2010 EIP, each award is made with respect to units of Parent common stock (each, a “Unit”), each consisting of 9 shares of Class A Common Stock and 1 share of Class L Common Stock of Parent. In fiscal 2015, we granted 20,000 stock options to Mr. Breitbard. We also granted 40,000 stock options, 30,000 stock options, and 30,000 stock options to Ms. Sentovich, Ms. Schumacher, and Mr. Sassi, respectively, under the 2010 EIP pursuant to the terms of their respective offer letter. The Compensation Committee determined the size of the equity awards granted to Mr. Breitbard, Ms. Sentovich, Ms. Schumacher, and Mr. Sassi in fiscal 2015 after considering the Company’s retention and hiring needs, and by relying on the experiences of the Compensation Committee’s members in issuing such awards to other executives with similar roles at other portfolio companies of our sponsor with which the members are involved.
In May 2015, Parent reduced the exercise price of all stock options held by substantially all of our active employees, including all named executive officers (other than Mss. Sentovich and Schumacher, whose stock options were granted in June 2015, and Mr. Sassi who was not employed by us at the time). The exercise price of all options so modified is now $8.50 per Unit, which was the fair market value of a Unit on the date of the modification. The Compensation Committee determined that the stock option modifications were an appropriate means of re-aligning the incentives of employees with Parent’s current circumstances and giving our leadership team a meaningful stake in our future growth in light of unforeseen challenges to our business affecting the incentive value of previously granted stock options. The Compensation Committee viewed the modification of exercise prices as an appropriate adjustment to the stock option exchange program that was completed in December 2014, under which all active employees were given the opportunity to exchange their stock options for stock options with a lower exercise price and a longer vesting schedule.
Other than the grants described above, there were no other grants made to our named executive officers in fiscal 2015.
2013 Gymboree China Phantom Equity Incentive Plan
In fiscal 2013, the Company adopted the 2013 Gymboree China Phantom Equity Plan (the “Phantom Plan”) in order to allow participants to share in the growth in Gymboree Hong Kong Limited (“Gymboree HK”). Participants do not own shares or other equity in Gymboree HK, but are granted a conditional right to receive a specified interest in the value of a “Pool.” The Pool represents a portion of the cash value received by Bain Fund X, L.P. and its permitted transferees. The awards are granted in the form of phantom units in the Pool, and conditionally vest in equal percentages over the first five anniversaries of a date specified in the grant. The phantom units only vest and become payable upon a sale or a qualified IPO of Gymboree HK or the common parent of Gymboree HK and the Company.
Mr. North was granted an award under the Phantom Plan in fiscal 2015 in connection with his commencement of employment in late 2014. Each of Mss. Sentovich and Schumacher was granted an award under the Phantom Plan in fiscal 2015 in connection with her commencement of employment in May 2015 and April 2015, respectively. Mr. Breitbard was also granted an award under the Phantom Plan in fiscal 2015. Mr. Breitbard’s award was granted after evaluating market conditions and to further the Company’s objective of retaining Mr. Breitbard. Each of our named executive officers, with the exception of Mr. Sassi and Mss. Sentovich and Schumacher, continued to conditionally vest in awards granted to them in fiscal 2013, subject to the terms of the applicable award agreements.
Other Benefits
Severance Benefits
We believe that reasonable severance benefits support employee retention. We continue to believe that the severance benefits we provide are competitive with those offered by comparable companies.
Each of our named executive officers (other than Ms. Maher) is entitled to severance benefits under the terms of an employment agreement or The Gymboree Corporation Management Severance Plan (the “Severance Plan”), which is described below in “Potential Payments upon Termination of Employment or a Change in Control”). In connection with the termination of her employment, Ms. Maher received certain severance benefits pursuant to the terms of the Severance Plan and a separation agreement with the Company, as described below in “Potential Payments upon Termination of Employment or a Change in Control.”
The only contractual benefits for a named executive officer in the event of a termination of employment and/or a change of control are under the agreements and plans noted above and described in more detail in “Potential Payments upon Termination of Employment or a Change in Control.”
Retirement Plans
In fiscal 2015, we maintained a 401(k) plan in which named executive officers were eligible to participate on the same basis as our other U.S.-based employees. Under the matching formula under the 401(k) plan, we match 100% of the first 4% of a participant’s compensation that he or she contributes to the 401(k) plan. We believe that our 401(k) plan serves as an important tool to attract and retain our named executive officers, and that we would be at a competitive disadvantage if we did not offer a retirement plan.
Perquisites and Other Benefits
During fiscal 2015, our named executive officers received certain other benefits and perquisites. The primary perquisite for executives at and above the level of Vice President consisted of reimbursement of up to 1% of base salary for tax-related and other financial planning services. We also reimbursed employees at and above the level of Vice President for all medical, dental and vision insurance premiums and we paid life and disability insurance premiums for all eligible employees. Certain other benefit programs had been made available to eligible employees, including our named executive officers, including discounts on our products. We believe that the cost of providing these perquisites and other benefits is reasonable relative to their value to our named executive officers.
Tax Treatment
Because our common stock is not currently publicly traded, our executive compensation arrangements are not subject to the provisions of Section 162(m) of the Internal Revenue Code, which limit the deductibility of compensation paid to certain individuals to $1 million, excluding qualifying performance-based compensation and certain other compensation.
Advisory Vote on Executive Compensation
The Company is not subject to the “say on pay” rules under Section 14A of the Securities Exchange Act of 1934 and therefore the Company’s stockholders were not required to vote on the Company’s executive compensation in fiscal 2015.
Executive Compensation Tables
The following table sets forth information regarding compensation for each of our named executive officers for fiscal years 2015, 2014, and 2013 (to the extent applicable). All numbers are rounded to the nearest dollar.
SUMMARY COMPENSATION TABLE FOR FISCAL YEARS 2015, 2014, AND 2013
(1) Reflects the dollar amount of base salary paid in the fiscal year, including any salary increases and decreases effective during the year. Amounts paid to Mss. Sentovich, Schumacher and Maher and Mr. Sassi in fiscal 2015 reflect their employment for only a portion of our fiscal year.
(2) The amount shown for fiscal 2015 reflect Ms. Schumacher’s signing bonus ($150,000) paid to her in connection with her hiring in fiscal 2015. The amounts shown for fiscal 2013 reflect the following: for Ms. Maher, the amount of the signing bonus ($100,000) paid to her in connection with her hiring in fiscal 2013 plus the amount of her guaranteed annual bonus ($250,000) under her offer letter; for Mr. Zhu, the amount of the signing bonus paid to him under his offer letter.
(3) Reflects the aggregate grant date fair value of restricted Units granted under our 2010 EIP, as determined under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718, Stock Compensation, which is referred to as “FASB ASC Topic 718,” rather than an amount paid to or realized by the named executive officer. The fair value of restricted Units at the grant date is equal to the number of restricted Units granted multiplied by the fair market value of a Unit on the date of grant (excluding the effect of estimated forfeitures based on service-based vesting conditions).
(4) Except as noted below, reflects the aggregate grant date fair value of stock options granted under our 2010 EIP computed in accordance with FASB ASC Topic 718, rather than an amount paid to or realized by the named executive officer. The fair value of stock options is calculated based on the Black-Scholes option valuation model: (i) with respect to fiscal 2015, using the assumptions disclosed in Note 12 to the Company’s audited financial statements included in this annual report; (ii) with respect to fiscal 2014, using the assumptions disclosed in Note 11 to the Company’s audited financial statements included in the Company’s annual report on Form 10-K filed with the SEC on April 30, 2015; and (iii) with respect to fiscal 2013, using the assumptions disclosed in Note 12 to the Company’s audited financial statements included in the Company’s annual report on Form 10-K filed with the SEC on May 2, 2014. The fair values in this column exclude the effect of estimated forfeitures. Amounts shown for fiscal 2015 with respect to Messrs. Breitbard, North and Zhu, as well as Ms. Maher, reflect the incremental fair value of the modification of the stock options granted to the named executive officer computed in accordance with FASB ASC Topic 718, as described above under “Compensation Discussion and Analysis - Components of Executive Compensation - Equity Compensation - 2010 Equity Incentive Plan.” Amounts shown for fiscal 2014 with respect to Messrs. Breitbard and Zhu and Ms. Maher reflect the incremental fair value of the replacement stock options granted to the named executive officer over the options tendered in the option exchange program noted above under “Compensation Discussion and Analysis - Components of Executive Compensation - Equity Compensation - 2010 Equity Incentive Plan.”
(5) The amounts shown for fiscal 2015 for Messrs. Breitbard, North, Zhu, and Sassi and Mss. Sentovich and Schumacher reflect the amount of non-equity incentive earned under the Executive Bonus Plan for fiscal 2015. Under the terms of the Executive Bonus Plan, Mss. Sentovich’s and Schumacher’s and Mr. Sassi’s bonus opportunities were pro-rated to reflect the portion of fiscal 2015 that he or she was employed.
(6) The “All Other Compensation” column for fiscal 2015 with respect to each of our named executive officers reflects payment of the following amounts:
(1) Reflects medical, dental, and vision insurance premiums, the full cost of which is reimbursed to the executive by the Company.
(2) In connection with Ms. Maher’s departure, she received a one-time payment of $91,667, which was paid to her on July 31, 2015. In connection with her cessation of employment, Ms. Maher also received severance in accordance with the terms of her participation in the Severance Plan, as well as an additional payment equal to $81,593.
GRANTS OF PLAN-BASED AWARDS FOR FISCAL 2015
The following table provides information regarding grants of plan-based awards for each of our named executive officers for fiscal 2015:
(1) Reflects award opportunities for each named executive officer under the Executive Bonus Plan for fiscal 2015. Under the terms of the Executive Bonus Plan, Mss. Sentovich’s, Schumacher’s, and Maher’s and Mr. Sassi’s bonus opportunities were pro-rated to reflect the portion of fiscal 2015 that each executive was employed.
(2) Reflects the incremental fair value of the stock options held by the named executive officer that were modified in fiscal 2015, as described above under “Compensation Discussion and Analysis - Components of Executive Compensation - Equity Compensation - 2010 Equity Incentive Plan.”
(3) Reflects the aggregate grant date fair value of stock options granted under our 2010 EIP computed in accordance with FASB ASC Topic 718, rather than an amount paid to or realized by the named executive officer.
Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table
Employment Agreement with Mr. Breitbard. The Company and Parent entered into an employment agreement with Mr. Breitbard that became effective on January 14, 2013. The agreement has no specified term and provides Mr. Breitbard with an annual salary of $850,000 and an annual cash bonus with a target of 100% and a maximum of 200% of his annual base salary.
The severance and restrictive covenant provisions of Mr. Breitbard’s employment agreement are described below in the “Potential Payments upon Termination or Change of Control.”
Offer Letter with Mr. North. The Company entered into an offer letter with Mr. North on October 16, 2014. The offer letter does not provide for employment for a specified term. The offer letter provides Mr. North with an annual salary of $400,000 and an annual cash bonus with a target of 50% of his annual base salary, with a maximum annual cash bonus equal to 100% of his annual base salary.
Under Mr. North’s offer letter, he agreed to become subject to certain restrictive covenants. He is also entitled to participate in the Severance Plan. See “Potential Payments upon Termination or Change of Control” below.
Offer Letter with Mr. Zhu. On September 28, 2013, the Company entered into an offer letter with Mr. Zhu. The offer letter does not provide for employment for a specified term. The offer letter provides Mr. Zhu with an annual salary of $388,000 and an annual cash bonus with a target of 50% of his annual base salary, with a maximum annual cash bonus equal to 100% of his annual base salary.
Under Mr. Zhu’s offer letter, he agreed to become subject to certain restrictive covenants and is entitled to participate in the Severance Plan. See “Potential Payments upon Termination or Change of Control” below.
Offer Letter with Ms. Sentovich. The Company entered into an offer letter with Ms. Sentovich dated March 25, 2015. The offer letter does not provide for employment for a specified term. The offer letter provides Ms. Sentovich with an annual salary of $431,000 and an annual cash bonus with a target of 40% of her annual base salary, with a maximum annual cash bonus equal to 80% of her annual base salary, pro-rated based on her time in her position. Effective November 8, 2015, Ms. Sentovich’s cash bonus target rate was increased from 40% to 50% of her annual base salary and a maximum annual cash bonus opportunity equal to 100% of her annual base salary, with such changes being applied retroactively to the beginning of fiscal year 2015 for purposes of determining her fiscal 2015 bonus.
Under her offer letter, Ms. Sentovich was also entitled to receive a one-time grant of options to purchase 40,000 Units, subject to time-based vesting over five years. On June 17, 2015, in satisfaction of this obligation, Ms. Sentovich was granted 40,000 Parent stock options with a per Unit exercise price of $8.50.
Under Ms. Sentovich’s offer letter, she is also entitled to participate in the Severance Plan. See “Potential Payments upon Termination or Change of Control” below.
Offer Letter with Ms. Schumacher. The Company entered into an offer letter with Ms. Schumacher dated March 27, 2015. The offer letter does not provide for employment for a specified term. The offer letter provides Ms. Schumacher with an annual salary of $400,000 and an annual cash bonus with a target of 40% of her annual base salary, with a maximum annual cash bonus equal to 80% of her annual base salary, pro-rated based on her time in her position. In addition, the offer letter obligated us to pay Ms. Schumacher a one-time signing bonus in the amount of $150,000, which she will be required to repay to the Company if her employment is terminated by the Company for cause or if she voluntarily terminates her employment within twelve months of the commencement of her employment with the Company. Effective November 8, 2015, Ms. Schumacher’s annual salary was increased from $400,000 to $420,000. In addition, her cash bonus target rate was increased from 40% to 50% of her annual base salary with a maximum annual cash bonus opportunity equal to 100% of her annual base salary, with such changes being applied retroactively to the beginning of fiscal year 2015 for purposes of determining her fiscal 2015 bonus.
Under her offer letter, Ms. Schumacher was also entitled to receive a one-time grant of options to purchase 30,000 Units, subject to time-based vesting over five years. On June 17, 2015, in satisfaction of this obligation, Ms. Schumacher was granted 30,000 Parent stock options with a per Unit exercise price of $8.50.
Under Ms. Schumacher’s offer letter, she is also entitled to participate in the Severance Plan. See “Potential Payments upon Termination or Change of Control” below.
Offer Letter with Mr. Sassi. The Company entered into an offer letter with Mr. Sassi dated October 18, 2015. The offer letter does not provide for employment for a specified term. The offer letter provides Mr. Sassi with an annual salary of $420,000 and an annual cash bonus with a target of 50% of his annual base salary, with a maximum annual cash bonus equal to 100% of his annual base salary, pro-rated based on his time in his position.
Under his offer letter, Mr. Sassi was also entitled to receive a one-time grant of options to purchase 30,000 Units, subject to time-based vesting over five years. On November 13, 2015, in satisfaction of this obligation, Mr. Sassi was granted 30,000 Parent stock options with a per Unit exercise price of $8.50.
Under Mr. Sassi’s offer letter, he is also entitled to participate in the Severance Plan. See “Potential Payments upon Termination or Change of Control” below.
Offer Letter with Ms. Maher. On June 18, 2013, the Company entered into an offer letter with Ms. Maher. The offer letter does not provide for employment for a specified term. The offer letter provided Ms. Maher with an annual salary of $550,000 and an annual cash bonus with a target of 75% of her annual base salary, with a maximum annual cash bonus equal to 150% of her annual base salary.
Ms. Maher received severance payments in connection with her resignation, which was effective June 1, 2015. See “Potential Payments upon Termination or Change of Control” below.
Units Granted Under Phantom Plan. As described above, in fiscal 2013, the Compensation Committee granted awards of phantom units under the Phantom Plan to each of our named executive officers other than Messrs. North and Sassi and Mss. Sentovich and Schumacher who were not employed by us at the time. Mr. North and Mss. Sentovich and Schumacher were granted phantom units under the Phantom Plan in fiscal 2015. In fiscal 2015, Mr. Breitbard was granted an award of an additional 15,488 phantom units under the Phantom Plan. The number of phantom units subject to each named executive officer’s award (other than Ms. Maher’s) is as follows: Mr. Breitbard (187,573 phantom units), Mr. North (38,719 phantom units), Mr. Zhu (40,010 phantom units), Ms. Sentovich (15,488 phantom units), and Ms. Schumacher (11,616 phantom units). Following the termination of her employment, Ms. Maher continues to hold 10,153 phantom units. Mr. Sassi has not been granted any phantom units.
OUTSTANDING EQUITY AWARDS AT 2015 FISCAL YEAR-END
The following table provides information regarding the number of Units underlying outstanding equity awards for each named executive officer as of January 30, 2016:
(1) All stock options and restricted Units referenced in this table were granted under the 2010 EIP.
(2) The exercise price per Unit of each stock option is equal to or greater than the fair market value of a Unit on the grant date.
(3) All options have a maximum 10-year term.
(4) All restricted Units are subject to a three-year vesting schedule, with one-third vesting annually on the anniversary of the date Mr. Zhu commenced employment with us (November 18, 2013), subject to the named executive officer’s continued employment or other service with the Company through the applicable vesting date.
(5) Reflects the number of restricted Units outstanding on January 30, 2016, multiplied by the fair market value of a Unit as of that date ($8.50).
OPTION EXERCISES AND STOCK VESTED IN FISCAL 2015
The following table provides information regarding the number of restricted Units in which our named executive officer vested during the fiscal year that ended on January 30, 2016. None of our named executive officers exercised any stock options during fiscal 2015.
(1) Pursuant to the terms of his respective employment agreement or offer letter, Mr. Breitbard and Mr. Zhu were granted 22,223 and 16,667 restricted Units, respectively, which vest as to one-third of the restricted Units on each of the first three anniversaries of the date the named executive officer commenced employment with us (January 14, 2013, in the case of Mr. Breitbard, and November 18, 2013, in the case of Mr. Zhu), subject to the named executive officer’s continued employment with the Company through the applicable vesting date.
(2) Amounts represent the number of restricted Units vesting during fiscal 2015 multiplied by the fair market value of a Unit on the vesting date ($8.50 in each case).
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE OF CONTROL
The potential payments upon termination of employment or change of control that we would owe to each of our named executive officers are described below and are quantified in the table included further below. The terms “cause”, “good reason”, “disability” and “change of control” have the meanings set forth in the applicable plans or agreements.
Severance and Restrictive Covenants.
Employment Agreement with Mr. Breitbard. Pursuant to Mr. Breitbard’s employment agreement, in the event that Mr. Breitbard’s employment is terminated by the Company without cause or if he resigns for good reason, he will be entitled to receive severance in an aggregate amount equal to the sum of 1.5 times his annual base salary payable in equal installments over 18 months, a pro-rated annual bonus for the year of termination based on actual performance (not to exceed 100% of his target annual bonus) and the annual bonuses Mr. Breitbard would have been entitled to receive based on actual performance had he remained employed for the 18-month period following the termination of his employment (unless such termination occurs within 90 days prior to or 18 months following a change of control of Parent, in which case the bonus will be based on target). If Mr. Breitbard’s employment is terminated by the Company without cause, or due to his death or disability, or if he resigns for good reason, all of his unvested restricted Units will become fully vested and a pro-rated portion of his options will become vested. Under the terms of his agreement, Mr. Breitbard is obligated not to solicit Company employees during and for 18 months following the termination of his employment with the Company and not to disclose confidential and proprietary information during and following his employment. Mr. Breitbard’s right to the severance and accelerated vesting of his equity incentive awards in the event of his termination of employment without cause by the Company or his resignation for good reason are contingent upon him executing and not revoking an effective release of claims, not violating the non-solicitation provision that applies to him, and not materially violating the confidentiality provisions that apply to him.
If Mr. Breitbard’s employment is terminated due to death or disability, he will be entitled to receive a pro-rated annual bonus for the year of termination based on actual performance.
All bonus-related amounts are payable at the same time such amounts are paid under the annual bonus plan.
Offer Letters with Mr. North, Mr. Zhu, Ms. Sentovich, Ms. Schumacher and Mr. Sassi. Under the offer letters with Mr. North, Mr. Zhu, Ms. Sentovich, Ms. Schumacher, and Mr. Sassi, the named executive officer is entitled to participate in the Severance Plan, which is described below. In addition, Mr. North and Mr. Zhu are each obligated not to solicit Company employees during and for 12 months following the termination of his employment with the Company and not to disclose confidential and proprietary information during and following his employment.
Consulting Arrangement with Ms. Maher. In connection with her departure, the Company engaged Ms. Maher to provide certain transition consulting services to the Company and its affiliates. In consideration of such services, Ms. Maher entered into a consulting agreement pursuant to which she was entitled to a one-time payment of $91,667, which was paid to her on July 31, 2015.
Severance Plan. Under the Severance Plan, each of Mr. North, Mr. Zhu, Ms. Sentovich, Ms. Schumacher and Mr. Sassi is entitled to receive a severance benefit equal to 100% of his or her base salary (payable as salary continuation) in the event of a termination by the Company without cause or by the executive for good reason as well as, provided that he or she timely elects COBRA coverage, continued Company-paid health and certain other insurance benefits for 12 months following such termination. Each named executive officer’s right to payment under the Severance Plan is contingent upon the executive signing and not revoking an effective release of claims and not violating the restrictive covenants that apply to him or her. The Severance Plan will remain in effect indefinitely, although it may be terminated at any time at the discretion of the Board or an authorized committee thereof.
Restricted Unit Agreement with Mr. Zhu. In the event that Mr. Zhu’s employment is terminated by the Company without cause or due to his death or disability, as of the date of termination, his restricted Units will fully vest to the extent then unvested and outstanding.
Effect of Change in Control on Outstanding Equity Awards. In the event of a change of control of Parent, Mr. Breitbard’s restricted Units and options will become fully vested immediately prior to the change of control. All stock options held by our named executive officers would vest in full upon the occurrence of a change of control of Parent.
Effect of Change in Control on Outstanding Phantom Units. Because the value of the phantom units granted under the Phantom Plan was not readily determinable as of the last business day of our 2015 fiscal year, no amounts are disclosed below relating to their potential vesting in connection with a change in control of the parent of the Company.
Potential Payments Table. Amounts payable in connection with a termination of employment or a change of control shown in the table below assume a qualifying termination of employment on January 30, 2016, the last business day of our 2015 fiscal year. Because the fair market value of a Unit did not exceed the exercise price of any of outstanding stock options held by named executive officers as of January 30, 2016, our named executive officers would receive no current benefit on account of such acceleration and therefore no amounts are shown in the table below in respect of the value of accelerated stock options. Amounts shown in the table also do not include (i) accrued but unpaid salary or (ii) other benefits earned or accrued by the named executive officer during his or her employment that are available to all salaried employees and that do not discriminate in scope, terms or operations in favor of executive officers.
(1) Amounts of severance shown above assume, in each case, an involuntary termination of employment by the Company without cause or by the executive for good reason that would entitle the executive to benefits under his or her employment agreement or the Severance Plan, as applicable. Severance amounts consist of (i) 300% of Mr. Breitbard’s current base salary (equal to 1.5 times his current base salary and the annual bonus he would have received had he remained employed with the Company for an 18-month period following the date of termination, assuming performance at target), payable under his employment agreement, and (ii) 100% of base salary for Mr. North, Mr. Zhu, Ms. Sentovich, Ms. Schumacher and Mr. Sassi payable under the Severance Plan. In the event of a qualifying termination of Mr. Breitbard’s employment, the bonus portion of his severance would be based on the Company’s actual performance had he remained employed for the 18-month period following the termination of his employment (unless such termination occurs within 90 days prior to or 18 months following a change of control of Parent, in which case the bonus portion of his severance would be based on target).
(2) Benefits continuation amounts assume 12 months (18 months, in the case of Mr. Breitbard) of continued coverage under the Company’s medical, dental and vision plans for each of Mr. Breitbard, Mr. North, Mr. Zhu, Ms. Sentovich, Ms. Schumacher and Mr. Sassi. Medical, dental and vision insurance costs are calculated using the current post-termination continued benefit rate prescribed by the applicable plan.
(3) Acceleration of Mr. Zhu’s restricted Units applies only in the event of a termination by the Company without cause or due to his death or disability. The value of the acceleration of unvested restricted Units is determined by multiplying the number of unvested restricted Units held by the named executive officer by the fair market value of a Unit as of January 30, 2016 ($8.50).
(4) In connection with Ms. Maher’s departure, she received a one-time payment of $91,667, which was paid to her on July 31, 2015. In connection with her cessation of employment, Ms. Maher also received severance in accordance with the terms of her participation in the Severance Plan, as well as an additional payment equal to $81,593.
2015 DIRECTOR COMPENSATION
The following table shows information regarding the compensation earned by the non-employee directors who served on the board of directors of Parent during fiscal 2015. The compensation received by our Chief Executive Officer as an employee during fiscal 2015 is included in the “Summary Compensation Table” above; he did not receive any additional compensation for his service on the board of directors of Parent. Only non-employee directors not affiliated with our sponsor receive compensation for their service on the board of directors of Parent. None of the members of the Board of Directors of the Company receives separate compensation for such service.
(1) The exercise price of all options held by Directors was modified in 2015 to $8.50 per Unit, which was the fair market value of a Unit on the date of the modification. Amounts shown for fiscal 2015 reflect the incremental fair value of the modification of the stock options granted to the non-employee director computed in accordance with FASC ASC Topic 718.
Under letter agreements with Parent, Ms. Clark and Mr. Weikel are each entitled to receive an annual retainer fee of $60,000, and as of the end of fiscal 2015 each held 12,500 options to acquire Units. These options vest in equal installments on each of the first five anniversaries of the grant date, subject to the director’s continued service on our board through the applicable vesting date and were 20% vested as of the end of the fiscal year. Under his letter agreement with Parent, Mr. Weikel is also entitled to $10,000 each year in respect of his service on the Audit Committee of Parent’s Board of Directors.
Compensation Committee Report
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management. Based on that review and those discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this report. This report is provided by the following two members, who constitute the Compensation Committee:
The foregoing has been furnished by the Compensation Committee.
Jordan Hitch
Joshua Bekenstein
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
PRINCIPAL STOCKHOLDERS
Gymboree Holding, Ltd., a Cayman Islands exempted company, controls us through its ownership of Gymboree Investment Holdings, LLC, a Delaware limited liability company which holds approximately 99% of the outstanding common stock of Parent as of March 31, 2016. Parent in turn indirectly owns 100% of our outstanding equity interests. The following table sets forth information with respect to the ownership of both Gymboree Holding, Ltd. and Parent as of March 31, 2016 for (a) each person known by us to own beneficially more than a 5% equity interest in Gymboree Holding, Ltd. and Parent, (b) each member of our Board of Directors (some of whom are also members of the Board of Directors of Gymboree Holding, Ltd. and the Board of Directors of Parent), (c) each of our named executive officers, and (d) all of our, Gymboree Holding, Ltd. and Parent executive officers and directors as a group. The beneficial ownership percentages reflected in the table below are based on 103,724,838 Class A Common Shares, 11,524,982 Class L Common Shares and 1,209,796 Class C Common Shares of Gymboree Holding, Ltd. (referred to collectively in this report as “Holding Common Shares”) and 104,950,017 Class A Common Shares, 11,661,113 Class L Common Shares of Parent (referred to collectively in this report as “Parent Common Shares”), in each case outstanding as of March 31, 2016.
The amounts and percentages of shares beneficially owned are reported on the basis of SEC regulations governing the determination of beneficial ownership of securities. Under SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares voting power or investment power, which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Securities that can be so acquired are deemed to be outstanding for purposes of computing such person’s ownership percentage, but not for purposes of computing any other person’s percentage. Under these rules, more than one person may be deemed to be a beneficial owner of the same securities and a person may be deemed to be a beneficial owner of securities as to which such person has no economic interest.
The rights of holders of the Holding Common Shares are governed by certain organizational documents and agreements, including the Amended and Restated Memorandum and Articles of Association of Gymboree Holding, Ltd., amended by special resolution dated December 23, 2011, the Shareholders Agreement by and among Gymboree Holding, Ltd., Gymboree Investment Holdings, LLC , the Bain Stockholders (as defined in note (1) below), Giraffe Holding, Inc., and certain co-investors, entered into on December 23, 2011, and the Registration and Participation Rights Agreement by and among Gymboree Holding, Ltd., Gymboree Investment Holdings, LLC, the Bain Stockholders (as defined in note (1) below), Giraffe Holding, Inc., and certain co-investors. See “Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Arrangements with Investors
Simultaneously with and following the consummation of the Merger, and the contribution and exchange (see Note 1), we and certain of our parent entities entered into equityholder agreements with those persons and entities that became equityholders of the Company or Parent after the completion of the Transaction. These equityholder agreements contain agreements among the parties with respect to election of directors, participation rights, right of first refusal upon disposition of shares, permitted transferees, registration rights and other actions requiring the approval of equityholders.
Management Agreement
On October 23, 2010, Acquisition Sub and Parent entered into a management agreement with Bain Capital Private Equity, LP (formerly Bain Capital Partners, LLC) (“Bain Capital”), pursuant to which Bain Capital agreed to provide certain management services to Acquisition Sub and Parent until December 31, 2020 (unless terminated earlier), with evergreen one-year extensions thereafter. We have assumed the obligations of Acquisition Sub under this agreement by operation of law as a result of the Transaction. In April 2012, Parent, Bain Capital and the Company entered into a first amended and restated management agreement. Pursuant to such agreement (as amended and restated), Bain Capital is entitled to receive an aggregate annual management fee equal to $3 million, which fee will be reduced by $270,000 until such time as Bain Capital notifies the Company in writing, and management reimbursement for out-of-pocket expenses incurred by it or its affiliates in connection with the provision of services pursuant to the agreement or otherwise related to its investment. We incurred approximately $3.1 million, $3.1 million, and $3.6 million in management fees and reimbursement of out-of-pocket expenses during fiscal 2015, 2014, and 2013, respectively.
The management agreement provides that Bain Capital is entitled to receive fees in connection with certain subsequent financing, acquisition, disposition and change of control transactions of 1% of the gross transaction value of any such transaction. The management agreement includes customary exculpation and indemnification provisions in favor of Bain Capital and its affiliates. The management agreement may be terminated by Bain Capital at any time and will terminate automatically upon an initial public offering or a change of control unless the Company and the counterparty to the management agreement determine otherwise. Upon termination, each provider of management services will be entitled to a termination fee calculated based on the present value of the annual fees due during the remaining period from the date of termination to December 31, 2020 or the then-applicable scheduled date for termination of the management agreement.
Stockholders Agreement
On November 23, 2010, Parent, the Company, certain investment funds sponsored by Bain Capital (collectively the “Bain Funds”), Giraffe Intermediate A, Inc., Giraffe Intermediate B, Inc. and certain co-investors entered into a stockholders agreement. The agreement, among other things, creates certain rights and restrictions on the shares of Parent’s common stock held by the parties thereto, including transfer restrictions, tag-along and drag-along rights, and put and call rights.
On December 23, 2011, Parent, the Company, Bain Funds, Giraffe Intermediate A, Inc., Giraffe Intermediate B, Inc. and Gymboree Investment Holdings, LLC amended and restated this stockholders agreement to, among other things, include Gymboree Investment Holdings, LLC as a party thereto and to reflect the changed ownership structure (Gymboree Investment Holdings, LLC is owned directly by Gymboree Holding, Ltd.). The material terms of the agreement were left unchanged.
Registration and Participation Rights Agreement
On November 23, 2010, Parent, the Company, the Bain Funds, Giraffe Intermediate A, Inc., Giraffe Intermediate B, Inc. and certain co-investors entered into a registration and participation rights agreement. Pursuant to the agreement, the Bain Funds have a right to participate in any future issuances or sales of the capital stock of Parent or any of its subsidiaries or any securities convertible into or exchangeable for any such securities, including options. The agreement also gives certain investors demand and piggyback registration rights with respect to their and certain other persons’ interests in Parent.
On December 23, 2011, Parent, the Company, Bain Funds, Giraffe Intermediate A, Inc., Giraffe Intermediate B, Inc., and Gymboree Investment Holdings, LLC amended and restated this agreement to, among other things, include Gymboree Investment Holdings, LLC as a party thereto and to reflect the changed ownership (Gymboree Investment Holdings, LLC is owned directly by Gymboree Holding, Ltd.). The material terms of the agreement were left unchanged.
Indemnification of Directors and Officers; Directors’ and Officers’ Insurance
Under the Merger Agreement, the directors and officers of the Company and its subsidiaries who served as such prior to the consummation of the Transaction are entitled to continued indemnification and insurance coverage.
Franchise Agreements
In April 2014, Gymboree Play Programs, Inc. (“GPPI”), a wholly owned subsidiary of the Company, entered into a 10-year Master Franchise agreement with Gymboree Tianjin, an affiliate of the Company and indirect subsidiary of Gymboree Holding, Ltd. Under the Master Franchise Agreement, Gymboree Tianjin is given the rights as the master franchisor of Play & Music centers in the People’s Republic of China (“PRC”) Territory, specifically the rights to award and service unit franchises in the PRC, as well as the rights to operate primary Play & Music centers in the PRC. GPPI receives a percentage of royalties and franchise fees earned by Gymboree Tianjin. Prior to the April 2014 Master Franchise Agreement, GPPI and Gymboree Tianjin had a Master Service Agreement (as amended in November 2012), whereby Gymboree Tianjin was allowed to enter into agreements directly with the unit franchises and issue tax invoices to the unit franchises. Gymboree Tianjin paid GPPI fees for consulting services provided under the Master Service Agreement. All intercompany revenues and expenses have been eliminated in consolidation.
In December 2011, we entered into a ten-year Retail Store Franchise Agreement with Gymboree China, an affiliate of the Company and indirect subsidiary of Gymboree Holding, Ltd., to develop, own and operate Gymboree branded retail stores and website(s) to market and sell Gymboree branded products in the PRC Territory under the Gymboree license and trademarks. Under the terms of the agreement, Gymboree China will purchase inventory from us and pay us royalties on retail sales within the PRC Territory. All intercompany revenues and charges have been eliminated in consolidation.
Other Transactions
During fiscal 2015, we purchased services from a company owned by funds associated with Bain Capital for $1.8 million.
The Audit Committee approved written procedures authorizing the Company’s General Counsel to review and approve or ratify related-person transactions involving the payment by the Company of amounts of $120,000 or less (unless involving the General Counsel). These procedures require the General Counsel to promptly report to the Audit Committee each such related-person transaction reviewed by her and her determination. Related-person transactions involving payments by the Company of amounts greater than $120,000 require the approval or ratification of the Audit Committee.
As discussed in Item 10 above, our Board has not determined whether any of our directors are independent. See “Item 10. Directors and Executive Officers of the Registrant.”
Item 14.
Item 14. Principal Accounting Fees and Services
Independent Registered Public Accounting Firm Fees and Services
The fees from Deloitte & Touche LLP for the indicated services performed during fiscal 2015 and fiscal 2014 were as follows:
(1) Audit Fees consist of fees for professional services rendered for the audit of the Company’s consolidated annual financial statements, review of the interim consolidated financial statements included in quarterly reports and services that are normally provided by the Company’s independent registered public accounting firm in connection with statutory and regulatory filings or engagements. Audit fees for fiscal 2014 were adjusted to include $205,250 of additional billings related to professional services rendered in connection with the fiscal 2014 audit of the Company’s consolidated annual financial statements.
(2) Audit-Related Fees consist of fees for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s consolidated financial statements and are not reported under Audit Fees. In fiscal 2015 and fiscal 2014, these fees were related to consents issued for the Company’s annual franchise disclosure document.
(3) Tax Fees consist of fees for professional services rendered for tax compliance, tax advice and tax planning. In fiscal 2015, these fees included $88,323 for tax consultation and $156,339 for tax compliance. In fiscal 2014, these fees included $110,056 for tax consultation and $256,158 for tax compliance.
(4) All Other Fees consist of license fees for an online technical research tool.
The Audit Committee has considered the non-audit services provided by Deloitte & Touche LLP as described above and believes that they are compatible with maintaining Deloitte & Touche LLP’s independence as the Company’s principal accountants.
The Audit Committee has established a policy requiring its pre-approval of the retention of the Company’s independent registered public accounting firm for all audit, review or attest engagements and all such non-audit services as the independent registered public accounting firm is permitted to provide the Company, as well as its approval of all fees, including those listed in the table above, for such services, other than de minimis non-audit services allowed by applicable law.
Our Board has determined that each member of the Audit Committee is financially literate and has sufficient business and financial expertise to effectively perform his duties as a member of the Audit Committee. As the Company is privately held and controlled by investment funds sponsored by Bain Capital, our Board has determined that it is not necessary to designate one or more of our Audit Committee members as an “audit committee financial expert” at this time. Our Board has not determined whether any of our Audit Committee members is an independent director.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(A)(1) Financial Statements
The following documents are filed as a part of this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Operations for the years ended January 30, 2016, January 31, 2015, and February 1, 2014
Consolidated Statements of Comprehensive Loss for the years ended January 30, 2016, January 31, 2015, and February 1, 2014
Consolidated Balance Sheets as of January 30, 2016 and January 31, 2015
Consolidated Statements of Cash Flows for the years ended January 30, 2016, January 31, 2015, and February 1, 2014
Consolidated Statements of Stockholders’ (Deficit) Equity for the years ended January 30, 2016, January 31, 2015, and February 1, 2014
Notes to Consolidated Financial Statements
(A)(2) Financial Statement Schedules
Financial statement schedules have been omitted because they are not required or are not applicable.
(A)(3) Exhibits required by Item 601 of Regulation S-K
(1) Incorporated by reference to the corresponding exhibits to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on November 23, 2010.
(2) Incorporated by reference to the corresponding exhibits to The Gymboree Corporation’s Registration Statement on Form S-4 filed with the SEC on May 16, 2011.
(3) Incorporated by reference to Exhibit 10.1 to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on March 24, 2015.
(4) Incorporated by reference to Exhibit 10.57 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended May 1, 2004 filed with the SEC on June 9, 2004.
(5) Incorporated by reference to Exhibit 10.1 to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on April 5, 2012.
(6) Incorporated by reference to Exhibit 10.1 to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on September 28, 2015.
(7) Incorporated by reference to the corresponding exhibits to The Gymboree Corporation’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012 filed with the SEC on April 26, 2012.
(8) Incorporated by reference to Exhibit 10.2 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended August 3, 2013 filed with the SEC on September 16, 2013.
(9) Incorporated by reference to Exhibit 10.3 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended August 3, 2013 filed with the SEC on September 16, 2013.
(10) Incorporated by reference to Exhibit 10.2 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2015 filed with the SEC on December 14, 2015.
(11) Incorporated by reference to Exhibit 21.1 to The Gymboree Corporation’s Annual Report on Form 10-K for the fiscal year ended February 2, 2013 filed with the SEC on May 2, 2013.
* Indicates management contracts or compensatory plans or arrangements required to be filed as exhibits to this report on Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
(1) Incorporated by reference to the corresponding exhibits to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on November 23, 2010.
(2) Incorporated by reference to the corresponding exhibits to The Gymboree Corporation’s Registration Statement on Form S-4 filed with the SEC on May 16, 2011.
(3) Incorporated by reference to Exhibit 10.1 to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on March 24, 2015.
(4) Incorporated by reference to Exhibit 10.57 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended May 1, 2004 filed with the SEC on June 9, 2004.
(5) Incorporated by reference to Exhibit 10.1 to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on April 5, 2012.
(6) Incorporated by reference to Exhibit 10.1 to The Gymboree Corporation’s Current Report on Form 8-K filed with the SEC on September 28, 2015.
(7) Incorporated by reference to the corresponding exhibits to The Gymboree Corporation’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012 filed with the SEC on April 26, 2012.
(8) Incorporated by reference to Exhibit 10.2 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended August 3, 2013 filed with the SEC on September 16, 2013.
(9) Incorporated by reference to Exhibit 10.3 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended August 3, 2013 filed with the SEC on September 16, 2013.
(10) Incorporated by reference to Exhibit 10.2 to The Gymboree Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2015 filed with the SEC on December 14, 2015.
(11) Incorporated by reference to Exhibit 21.1 to The Gymboree Corporation’s Annual Report on Form 10-K for the fiscal year ended February 2, 2013 filed with the SEC on May 2, 2013.
* Indicates management contracts or compensatory plans or arrangements required to be filed as exhibits to this report on Form 10-K.