Item 1. Business
With over 30 years of operating experience, we believe, based on our industry experience, that we are a leading operator of extreme value retail stores in the southwestern United States. As of January 27, 2017, we operated 390 stores located in the states of California (283 stores), Texas (48 stores), Arizona (38 stores) and Nevada (21 stores). Our stores offer everyday consumable products and other household items as well as seasonal items that are primarily priced at 99.99¢ or less. We carry a wide assortment of regularly available products as well as a broad variety of first-quality closeout merchandise. In addition, we carry domestic and imported fresh produce, deli, dairy and frozen and refrigerated food products, which we believe are generally of greater value than what consumers can find elsewhere. We believe that our differentiated merchandise mix, combined with outstanding value, enables us to appeal to a broad consumer demographic, increases our overall customer traffic and frequency of customer visits, as well as strengthens our customer loyalty. We believe that our stores are significantly larger than those of other U.S. publicly reporting dollar store chains, which enables us to offer a wider assortment of merchandise and provide our customers with a better shopping experience.
As of January 27, 2017, on a trailing 52-week period, our stores open for the full year averaged net sales of $5.2 million per store and $319 per estimated saleable square foot, which we believe, based on our industry experience, is the highest among U.S. publicly reporting dollar store chains. We opened five stores in California during fiscal 2017. We closed six underperforming stores in fiscal 2017 upon expiration of their leases, including five in California and one in Texas. In fiscal 2018, we currently intend to open three stores, all of which are expected to be opened in our existing markets.
We also sell merchandise through our Bargain Wholesale division to retailers, distributors and exporters. The Bargain Wholesale division complements our retail operations by exposing us to a broader selection of opportunistic buys and generating additional sales with relatively small incremental operating expenses. Bargain Wholesale represented 1.9% of our total sales in fiscal 2017.
Merger
On January 13, 2012, the Company was acquired through a merger (the “Merger”) with a subsidiary of Parent with the Company surviving. In connection with the Merger, the Company became a subsidiary of Parent, which is controlled by affiliates of Ares Management, L.P. (“Ares”) and Canada Pension Plan Investment Board (“CPPIB”) (together with Ares, the “Sponsors”). As a result of the Merger, the Company common stock was delisted from the New York Stock Exchange and we ceased to be a publicly held and traded equity company.
The total cash merger consideration paid was approximately $1.6 billion. In connection with the Merger, the Company obtained Credit Facilities (as defined below) provided by a syndicate of lenders arranged by Royal Bank of Canada as administrative agent, as well as other agents and lenders that are parties to the agreements governing these Credit Facilities. The Credit Facilities include (a) first lien based revolving credit facility (as amended, the “ABL Facility”), and (b) first lien term loan facility (as amended, the “First Lien Term Loan Facility” and together with the ABL Facility, the “Credit Facilities”). The Company also issued $250 million 11% senior unsecured notes due 2019 (the “Senior Notes”). See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources,” for more information about our indebtedness.
Conversion to LLC
On October 18, 2013, 99¢ Only Stores converted (the “Conversion”) from a California corporation to a California limited liability company, 99 Cents Only Stores LLC (“99 LLC”), that is managed by its sole member, Parent. In connection with the Conversion, each outstanding share of Class A common stock of 99¢ Only Stores, par value $0.01 per share, was converted into one membership unit of 99 LLC, and each outstanding share of Class B common stock of 99¢ Only Stores, par value $0.01 per share, was cancelled and forfeited. Pursuant to the laws of the State of California, all rights and property of 99¢ Only Stores were vested in 99 LLC and all debts, liabilities and obligations of 99¢ Only Stores continued as debts, liabilities and obligations of 99 LLC. 99 LLC has elected to be treated as a disregarded entity for United States federal income tax purposes. The Conversion did not have any effect on deferred tax assets or liabilities, and 99 LLC will continue to use the liability method of accounting for income taxes. 99 LLC computes its taxes on a separate return basis, but 99 LLC and Parent will continue to file consolidated or combined income tax returns with its subsidiaries in all jurisdictions. Parent is a holding company with no active business or operations and has no holdings in any business other than 99 LLC.
Our Competitive Strengths
Differentiated Retail Concept
We believe our stores offer consumers an extreme value shopping experience that is unique in our industry due to:
· Our current average store size of approximately 16,000 saleable square feet, which we believe are significantly larger than stores of other U.S. publicly reporting dollar store chains, enabling us to carry a wide assortment of consumable, general merchandise and seasonal products in a clean, attractive and comfortable shopping environment;
· Our large selection of food and grocery items, which is approximately 57% of gross sales, and includes many of the fresh produce, deli, dairy and refrigerated and frozen food items which we believe generally provide greater value than consumers can find elsewhere. We believe our extensive food and grocery offerings drive recurring traffic from customers who rely on us for their weekly household needs; and
· Our wide assortment of closeout merchandise, which helps create an atmosphere of treasure-hunt excitement within our stores. We believe that our wide assortment of closeout merchandise is a competitive advantage as many of our competitors lack the vendor relationships, management expertise or logistical capabilities to handle as large a percentage of sales as we do in closeout merchandise.
We believe, based on our industry experience, that these competitive strengths enable us to have the most productive stores among U.S. publicly reporting dollar store chains when ranked by sales per store and average sales per square foot.
Attractive Industry Fundamentals
The U.S. dollar store industry is large and growing, and we believe benefits from a number of attractive industry fundamentals which will continue to support our growth, including:
· Historical and projected growth in dollar store revenues driven by the addition of new dollar stores and the increasing acceptance of dollar stores among consumers;
· Same store sales growth among U.S. publicly reporting dollar store chains, which are outperforming many other retail channels, particularly U.S. publicly reporting traditional grocery stores;
· Within the dollar store industry, the opportunity for larger chains, including 99 Cents, to grow faster than the overall industry, the balance of which we believe consists primarily of independent store operators; and
· Strong historical performance by dollar stores throughout economic cycles.
We believe that these attractive industry fundamentals, when combined with the large population size and favorable income and demographic attributes within our existing markets, represent growth opportunities for 99 Cents.
Attractive Store Footprint
We have over 30 years of experience operating our stores. We currently operate a large network of extreme value retail stores in California and have a strong presence in three other southwestern states, Texas, Nevada and Arizona. Our stores are typically clustered in and around densely populated areas. We believe that many of our stores are more convenient than traditional “big box” retailers that typically occupy larger buildings located in less urban areas as a result of their store size requirements. We believe that the density of our store geographic coverage is a competitive advantage and would be difficult to replicate.
We believe that our southwestern geographic markets have attractive attributes that support our business model. Our markets generally have large, growing and ethnically diverse populations. Many of the markets we serve have high proportions of low-income consumers, as well as nearby middle and upper middle income consumers, who we believe are increasingly shopping dollar stores.
Strong Vendor Relationships and Sourcing Expertise Both Domestically and Globally
We believe that our sourcing expertise and our long-standing, mutually beneficial vendor relationships are competitive advantages. Many of our vendors have been supplying products to us for over 25 years. We are a trusted partner and a preferred buyer to our vendors, many of whom we believe contact us first when they are selling closeout inventory. We believe we are a preferred buyer due to our ability to, among other things:
· Make immediate buying decisions;
· Acquire large volumes of inventory and take possession of goods immediately;
· Pay cash or accept abbreviated credit terms; and
· Purchase goods that have a shorter than normal shelf life or are off-season or near the end of a selling season.
We believe our vendor relationships are also strengthened by our ability to minimize channel conflict for the manufacturer as well as our ability to quickly sell products through well-maintained, attractively merchandised stores.
Strong Historical Financial Performance and Compelling Store Unit Economics
Our store base has historically demonstrated strong and consistent sales and profitability growth potential as well as compelling unit economics. Our stores have posted positive same-stores sales growth in nine of the past ten years with the same-store sales growth of 2.1% in fiscal 2017. Our newly opened stores generally ramp up quickly and typically reach near full volumes within the first 12 to 24 months.
Historically, our stores have demonstrated relatively consistent profitability levels as a percentage of sales. Our stores have a low cost operating model with attractive margins, low maintenance capital expenditures and low ongoing working capital needs. Furthermore, despite headwinds in selling, general and administrative expenses, nearly all stores were 4-wall cash flow positive in fiscal 2017.
Our Business Strategy
We are focused on three key strategies designed to profitably scale our business while continuing to meet the needs of our customers.
Enhancing the Customer Shopping Experience
We aim to achieve a sustainable increase in sales by enhancing the customer shopping experience, which we believe will both increase basket size with our current customers and attract new customers, including those that historically have not shopped at extreme value retailers. Key elements of the strategy include:
Focus on fresh
We believe our fresh food offerings, including produce, deli and dairy products primarily priced at 99.99¢, represent a significant point of differentiation relative to our national dollar store and discount peers and are a key driver of sales growth. Customer research studies that were recently conducted by leading market research firms show that a significant portion of our customers view us as their first or primary destination when shopping for fresh perishable items. Despite the continuing food price deflation in fiscal 2017, we achieved meaningful growth of our fresh offerings through a combination of improved quality and in-stock levels on key SKUs. This was due in part to our successful partnerships with third-party produce providers, as well as improved product availability, relative to fiscal 2016, at our traditional price point of 99.99¢. We believe the overall strength in our fresh food offerings was a key driver of positive customer traffic in fiscal 2017. We are currently testing and intend to make additional targeted investments in our fresh food strategy which includes procurement, supply chain, in-store equipment and training to further improve quality and broaden our merchandise assortment. We are also exploring the possibility of expanding our partnerships with third-party produce providers to broaden assortment and cover additional store locations.
Provide a fun, exciting treasure hunt experience
We believe another important component of our differentiated shopping experience is our ability to create a fun and exciting treasure hunt experience that offers a “wow” factor for our customers. This is accomplished through two primary channels. First, our assortment has consistently included a significant portion of closeout merchandise, with a focus on national branded consumer packaged goods and high-value merchandise priced significantly below the typical retail prices of our peers in the discount retail industry. Independent customer research suggests that a sizable portion of our shoppers specifically visit our stores to hunt for these limited-time values, which in turn drives frequency, basket size and customer loyalty. Second, we have accelerated initiatives to broaden our general merchandise assortment priced above $1 as well as our seasonal assortment. Our over $1 general merchandise assortment is primarily comprised of high-value and high-recognition products for everyday household and recreational use, nearly always priced significantly below the everyday retail price of identical or comparable merchandise at peers in the discount retail industry. Our seasonal assortment includes a broad selection of popular and high-value décor, wearables and packaging materials, as well as consumables developed specifically for each season and primarily priced at $1. We believe the improvements in these assortments positively contributed towards our average ticket growth in fiscal 2017. We also believe that these assortments, and the fun and exciting shopping experience that they create on a consistent basis, will, over time, allow us to further improve our customer loyalty as well as acquire new customers.
Comprehensive market refresh program
Beginning in fourth quarter of fiscal 2016, we launched a comprehensive refresh program in one of our key markets, the city of San Diego, in order to accelerate our efforts to enhance the customer shopping experience. Key aspects of our market refresh program include:
1. Upgrading our store facilities and improving cleanliness;
2. Broadening our merchandise assortment, in-stock and fresh grocery offerings;
3. Elevating our customer service; and
4. Implementing targeted marketing campaigns to attract and retain new customers.
Since the completion of the San Diego refresh program in the second quarter of fiscal 2017, we have received positive customer feedback on the overall improvements and achieved strong sales momentum. The overall sales growth of San Diego has significantly exceeded our chain average.
We believe a systematic and comprehensive refresh program conducted on a market-by-market basis, when completed expeditiously and in a cost-effective manner, can meaningfully improve the operating performance of each market and generate positive returns on the initial investment. Accordingly, in the fourth quarter of fiscal 2017, we commenced our second refresh program in our Phoenix market. We expect to complete the Phoenix refresh program by early fiscal 2018. We intend to continue assessing the effectiveness of our market refresh programs in fiscal 2018 and evaluate additional potential target markets in a prudent and systematic fashion.
Improving Operational Efficiency and Effectiveness
We believe a number of opportunities exist to simplify and streamline our operational processes that will enable us to expand margins and improve profitability. In particular, we are focused on:
Reducing shrink and managing scrap
We intend to significantly reduce our current elevated levels of shrink and scrap through initiatives designed to address all potential areas of losses, including:
1. Effectively managing inventory allocation and sell-through of perishables items and establishing cold-chain management practices to minimize excess spoilage;
2. Maintaining supply chain integrity, such as pallet picking and shipping accuracy;
3. Improving execution of in-store merchandise receipts and product flow to ensure quality of store inventory and mitigate losses due to poor handling; and
4. Implementing preemptive loss prevention efforts to identify and eliminate theft.
In fiscal 2017, we achieved a meaningful reduction in our shrink and scrap expenses relative to fiscal 2016. We believe significant opportunities remain to further reduce our shrink and scrap expenses in fiscal 2018.
Improving merchandise flow
We have identified and are pursuing the following three key opportunities to simplify and streamline the flow of merchandise across our entire supply chain:
1. Apply greater discipline to buying by actively managing and optimizing on-hand levels of both re-orderable and closeout merchandise, to reduce warehouse and in-store inventories, improve merchandise sell-through and reduce shrink;
2. Reduce our reliance on a manual ordering process by implementing an automated merchandise ordering and replenishment system to ensure that the right product is replenished to the right store in the right quantities at the right time; and
3. Improve our distribution efficiencies by ensuring on-time deliveries to our warehouses and our stores, in order to minimize disruptions to the merchandise flow.
These initiatives are designed to achieve lower overall inventory levels and reduce our handling costs and warehousing space requirements, which we expect will contribute to reductions in working capital investments and improved operating margins. We also believe improving our merchandise flow will position us to achieve higher sales through a more robust allocations process, which will result in an improved in-stock position and fewer missed sales opportunities.
In fiscal 2017, improvements in our merchandise flow and clearance of excess inventory allowed us to significantly reduce our inventory levels, which in turn allowed us to rationalize multiple warehouse locations. The inventory reduction was accomplished even as we improved our overall in-stock levels of key, high-volume SKUs and positive same-store sales growth. Furthermore, we have made and plan to make additional investments in systems and infrastructure to support these merchandising flow improvements.
In addition, we believe opportunities remain to further improve the overall merchandise flow in our Texas market, which will be an area of emphasis in fiscal 2018 and beyond. We expect to accomplish this through a combination of improved inbound logistics to our Katy distribution center as well as refining the regional assortment through localized buying of key re-orderable and closeout merchandise. We believe these improvements will drive customer traffic and increase margins, which will allow us to achieve profitable growth in the Texas market.
Supporting a culture of safety
We remain committed to promoting a safe and friendly operating environment and are building a culture of safety by:
1. Engaging and empowering employees daily to develop a safe operating environment, through recurring huddles, hands-on training and constant communication to reinforce our safety message and instill accountability;
2. Expanding our comprehensive reporting and analytics to support problem identification and provide real-time visibility;
3. Investing in on-site treatment programs for better workplace care in the event of injuries; and
4. Consistently evaluating and adopting best practices in safety culture and safety initiatives through a joint corporate safety steering committee, which oversees the implementation of safety improvement measures.
We have made substantial progress in building a culture of safety in fiscal 2017, including an over 20% year-over-year reduction in total claims. The reduction in claims is one of the key drivers of a material reduction of our outstanding workers’ compensation liability reserve at the end of fiscal 2017.
In addition, we conduct regular evaluations of our real estate portfolio in the ordinary course of business. In fiscal 2017, as a part of the evaluation process, we closed six stores, including one in Texas and five in California. We believe a substantial portion of the volume will be absorbed into other nearby 99¢ Only stores, thereby minimizing the impact on overall sales. The relocation and closures occurred at stores with expiring leases, and did not result in any material termination charges. We may opportunistically close or relocate additional stores in the future to improve overall profitability.
Pursuing New Store Growth
We opened five new stores during fiscal 2017 and we currently intend to open three new stores in fiscal 2018. We plan to continue to pursue a disciplined store growth plan in our existing markets over the near term, and will accelerate our store growth in a manageable fashion over the longer term with continued improvement of cash flow and capital availability. We believe that this will strengthen our competitive advantage in our key geographic regions and enable us to take advantage of economies of scale in distribution, store logistics and marketing.
Retail Operations
Our stores offer customers a wide assortment of regularly available consumer goods, as well as a broad variety of quality, closeout merchandise. Merchandise sold in our 99¢ Only stores is priced primarily at or below 99.99¢ per item.
The following table sets forth certain relevant information with respect to our retail operations (dollar amounts in thousands, except percentages and sales per square footage):
(a) For fiscal 2015, each of annual net retail sales of $1,881.9 million and the annual net retail sales growth rate of 6.8% was calculated based on the net retail sales for the 52-week period ended January 31, 2014.
(b) For transition fiscal 2014, net retail sales of $1,486.7 million were based on a 44-week period and the annual net retail sales growth rate of 10.7% was calculated based on the net retail sales for the 43-week period ended January 26, 2013.
(c) Five stores in California and one store in Texas were closed in fiscal 2017 due to underperformance and the expiration of their respective leases.
(d) Stores open for 12 months.
(e) Average net sales per store and average net sales per estimated saleable square foot are based on trailing 52-week period.
(f) Change in comparable same-store sales for years ended January 27, 2017, January 29, 2016 and January 30, 2015 are based on stores open at least 14 months. For other periods presented change in comparable same-store sales is based on stores open at least 15 months. This change in definition of same-store sales, if applied retrospectively, would not have had a material impact on the comparability of same-store sales for the prior periods presented. See Item 6, “Selected Financial Data” for additional discussion.
(g) Comparable same-store sales for fiscal 2015 are calculated based on the 52-week period ended January 30, 2015 as compared to the 52-week period ended January 31, 2014.
(h) Comparable same-store sales for transition fiscal 2014 are calculated based on the 43-week period ended January 25, 2014 as compared to the 43-week period ended January 26, 2013.
Merchandising. All of our stores offer a broad variety of first-quality, name-brand and other closeout merchandise as well as a wide assortment of regularly available consumer goods, including a significant quantity of fresh and perishable food. We also carry private-label consumer products made for us. We believe that the success of our 99¢ Only stores concept arises in part from the value inherent in pricing consumable items primarily at 99.99¢ or less per item, many of which are name-brands, which generally provide greater value than consumers can find elsewhere. In addition, we offer selected items priced above 99.99¢ and we believe that we have additional opportunities to expand our selection of these items.
A significant amount of our gross sales are from products available for reorder, including many branded consumable items. The mix and the specific brands of merchandise frequently changes, depending primarily upon the availability of closeout merchandise at suitable prices. A significant amount of our sales are from closeout merchandise, which we believe represents a significantly larger share of closeout merchandise than those of other U.S. publicly reporting dollars stores chains, some of whom carry few or no closeouts. We currently expect to be able to obtain sufficient name-brand closeouts, as well as re-orderable merchandise, at attractive prices. We believe that the frequent changes in specific name-brands and products found in our stores encourage impulse and larger volume purchases, result in customers shopping more frequently, and help to create a sense of urgency, fun and treasure hunt excitement.
We believe that we differentiate ourselves from traditional dollar stores by offering a wider assortment of food and grocery items, including frozen, dairy, deli and produce, which collectively account for approximately 57% of our revenue. Substantially all of our stores have free-standing fresh and refrigerated produce displays as well as built-in refrigerated and frozen food wall units. We believe that many of our customers shop at our stores weekly for their groceries and frequently shop 99¢ Only stores first before supplementing these purchases at other food stores.
Over the past several years, we have expanded our assortment of seasonal and general merchandise. Consistent with our overall merchandising strategy, our seasonal and general merchandise categories offer high-value and high-recognition products, typically for special occasions, recreational and everyday household use. We believe the improved assortment has allowed us a capture a greater portion of our customers’ overall share of wallet.
Substantially all of our business is transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations have not historically had a significant impact on us.
Our major product categories at 99¢ Only stores consist of:
· Fresh merchandise, which includes deli, bakery, dairy, produce and frozen.
· Grocery merchandise, which includes beverages, candies, cookies, grocery-breakfast, grocery-canned and other snacks.
· Consumables products, which include baby products, food storage, health & beauty, household cleaning, pet supplies, picnic supplies and soft lines.
· General merchandise and seasonal, which includes bath & bedding, electronics, hardware & audio, home décor, kitchenware, party supplies, plastics, seasonal, stationery and toys & recreation.
Our retail sales by major product category for fiscal 2017, fiscal 2016 and fiscal 2015 are set forth below:
We target value-conscious consumers from a wide range of socio-economic backgrounds with diverse demographic characteristics. Purchases are by cash, credit card, debit card or EBT (electronic benefit transfers). Our stores currently do not accept checks or manufacturer’s coupons. Our stores’ operating hours are designed to meet the needs of families.
Store Size, Layout and Locations. We strive to provide stores that are attractively merchandised, brightly lit, clean, well-maintained, “destination” locations. Our stores are typically clustered around densely populated areas where it is convenient for our customers to do their weekly household shopping. The interior of each store is designed to reflect a generally uniform format, featuring consistent merchandise displays, bright lighting, customized check-out counters and a distinctive color scheme on its interior and exterior signage.
Marketing and Advertising. Our marketing strategy emphasizes a customer first approach through consumer research and data gathering. We have a strategic focus on communicating the magic of closeouts, our broad assortment, seasonal offering and fresh produce to drive incremental traffic and capture additional share of wallet. Our marketing includes multi-media campaigns that include print media, digital & social media, television and billboards as well as our store grand opening program. For example, we have recently launched a new marketing campaign on multiple media platforms titled “Do the 99!”, which uses specially designed graphics and visuals to highlight our assortment for a variety of everyday and special occasions. We are also continuously evaluating new and innovative methods to attract customers to our stores.
Purchasing
A primary component of our business model is our ability to identify and take advantage of opportunities to purchase merchandise with high customer appeal at prices lower than regular wholesale. We purchase most merchandise directly from the manufacturer. Other sources of merchandise include wholesalers, manufacturers’ representatives, importers, barter companies, auctions, professional finders and other retailers, varying on the season and closeout activity.
We continuously seek out buying opportunities from both our existing vendors and new sources. No single vendor accounted for more than 5% of our total purchases in fiscal 2017. During fiscal 2017, we purchased merchandise from more than 999 vendors, many of which have been supplying us product for over 25 years.
A significant portion of the merchandise purchased by us in fiscal 2017 was closeout merchandise. We have developed strong relationships with many vendors and distributors who recognize that our merchandise can be moved quickly through our retail and wholesale distribution channels. Our buyers continuously search for closeout opportunities.
Our experience and expertise in buying merchandise has enabled us to develop relationships with many manufacturers that often offer some or all of their closeout merchandise to us prior to attempting to sell it through other channels. The key elements to these vendor relationships include our (i) ability to make immediate buying decisions; (ii) experienced buying staff; (iii) willingness to take on large volume purchases and take possession of merchandise immediately; (iv) ability to pay cash or accept abbreviated credit terms; and (v) willingness to purchase goods close to a target season or out of season. We believe our relationships with our vendors are further enhanced by our ability to minimize channel conflict for a manufacturer.
Our strong relationships with many manufacturers and distributors, along with our ability to purchase in large volumes, also enable us to purchase re-orderable name-brand goods at prices that we believe are below general wholesale prices.
We utilize and develop private label consumer products to broaden the assortment of merchandise that is consistently available and to maintain attractive margins. We also import merchandise such as kitchen items, housewares, toys, seasonal products, party, pet-care and hardware.
Warehousing and Distribution
An important aspect of our purchasing strategy involves our ability to warehouse and distribute merchandise quickly and with flexibility. Our warehousing and distribution facilities are strategically located next to the Long Beach, California and Los Angeles, California port systems, the rail yards in the City of Commerce and the major California interstate arteries. This enables quick turnaround of time-sensitive products as well as provides long-term warehousing capabilities for one-time closeout purchases and seasonal or holiday items. Our distribution center in the Houston area has both dry and cold storage capacity, and services our Texas operations.
We utilize both our private fleet and owner operators for our store deliveries / backhauls and vendor pick-ups in Southern California. We have contracted with a dedicated carrier to service our Northern California, Arizona and Nevada stores. We use two dedicated operators to service our Texas stores.
Our primary distribution practice is to have the majority of the merchandise delivered from our vendors to our warehouses and then shipped to our store locations. We do, however, occasionally utilize direct store deliveries for select product categories.
In fiscal 2017, we established partnerships with multiple third-party produce distributors, who currently serve the majority of our store network and deliver a select number of high-volume fresh produce SKUs. We may expand our third-party produce distribution relationships in the future; however, retaining in-house expertise on cold chain distribution remains an integral part of our overall supply chain strategy.
Additional information pertaining to warehouse and distribution facilities is described under Item 2, “Properties.”
Information Systems
We currently operate all of our master data, price management, point-of-sale, merchandising, distribution center inventory, accounting and reporting systems on SAP. In fiscal 2017, we completed the migration of our human resources and payroll data processing to Ceridian DayForce HCM. We also operate several proprietary supply chain systems that are tightly coupled with HighJump’s warehouse management solutions. The proprietary systems include an IBM UNIX-based purchase order and inventory control system that supports store back office personal computer system the Bargain Wholesale business.
We are in the process of extending our SAP systems to support store inventory and perpetual management function that we plan to complete by the end of the first quarter of fiscal 2018. During fiscal 2017, we also integrated our proprietary store ordering and merchandising platform with an automated forecasting and replenishment package solution.
Competition
We face competition in both the acquisition of inventory and the sale of merchandise from other discount stores, single-price-point merchandisers, mass merchandisers, food markets, drug chains, club stores, wholesalers, and other retailers. Industry competition for acquiring closeout merchandise also includes a large number of retail and wholesale companies and individuals. In some instances, these competitors are also customers of our Bargain Wholesale division. There is increasing competition with other wholesalers and retailers, including other extreme value retailers, for the purchase of quality closeout merchandise. Some of these competitors have substantially greater financial resources and buying power than us. Our ability to compete will depend on many factors, including the success of our purchase and resale of such merchandise at lower prices than our competitors. In addition, we may face intense competition in the future from new entrants in the extreme value retail industry that could have an adverse effect on our business and results of operations.
We believe that we are able to compete effectively against other dollar stores as a result of our differentiated retail format, the larger size and more convenient location of our stores, our economies of scale in our operations and more than three decades of experience operating in the industry. For products where we compete with traditional grocery stores, such as fresh produce, deli, dairy and frozen food items, we believe that we offer greater value than our grocery competitors and our stores are often more convenient. For products where we compete with warehouse clubs and mass merchandisers, we believe we compete effectively on the basis of greater value, no membership fees, more convenient store locations and smaller, easier to navigate stores.
We believe we do not currently face significant competition from e-commerce retailers. We believe our low price points, significant mix of fresh food and perishables and relatively low e-commerce adoption rates of our core shoppers serve as barriers against direct competition with major e-commerce retailers.
Employees
As of January 27, 2017, we had approximately 17,200 employees. None of our employees are party to a collective bargaining agreement and none are represented by a labor union.
Trademarks
“99¢ Only Stores,” “Bargain Wholesale” and multiple other product trademarks are listed on the United States Patent and Trademark Office Principal Register. We believe that our trademarks are an important but not critical element of our merchandising strategy. We routinely undertake enforcement efforts against certain parties whom we believe are infringing upon our “99¢” family of marks and our other intellectual property rights, although we believe that simultaneous litigation against all persons everywhere whom we believe to be infringing upon these marks is not feasible.
Seasonality
For information regarding the seasonality of our business, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Seasonality and Quarterly Fluctuations,” which is incorporated by reference in this Item 1.
Environmental Matters
In the ordinary course of business, we handle or dispose of commonplace household products that are classified as hazardous materials under various environmental laws and regulations. Under various federal, state, and local environmental laws and regulations, current or previous owners or occupants of property may face liability associated with hazardous substances. These laws and regulations often impose liability without regard to fault. In the future we may be required to incur substantial costs for preventive or remedial measures associated with hazardous materials. We have several storage tanks at our distribution and warehouse facilities, including: an aboveground and underground diesel storage tank at one of our City of Commerce, California distribution centers, a compressed natural gas tank at one of our City of Commerce, California distribution centers; an aboveground propane storage tank at one of our City of Commerce, California distribution centers; an ammonia storage at our Texas warehouse; aboveground diesel storage tank at our Texas warehouse; an aboveground propane storage tank at our leased Slauson warehouse in City of Commerce, California; and an aboveground propane storage tank at our leased Los Palos warehouse in Los Angeles, California. Except as disclosed in Item 3, “Legal Proceedings,” we have not been notified of, and are not aware of, any potentially material current environmental liability, claim or non-compliance, concerning our owned or leased real estate.
Available Information
We make available free of charge our annual and transition reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports through a hyperlink from the “Investor Relations” portion of our website, www.99only.com, to the Securities and Exchange Commission’s website, www.sec.gov. Such reports are available on the same day that we electronically file them with or furnish them to the Securities and Exchange Commission. The reference to our website address does not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.
Copies of the reports and other information we file with the Securities and Exchange Commission may also be examined by the public without charge at 100 F Street, N.E., Room 1580, Washington D.C., 20549, or on the Internet at http://sec.gov. Copies of all or a portion of such materials can be obtained from the Securities and Exchange Commission upon payment of prescribed fees. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information.
Item 1A.
Item 1A. Risk Factors
Risks Related to Our Business
Improvement in our operating performance depends significantly on strategies and initiatives designed to increase sales and improve the efficiencies, costs and effectiveness of our operations. There can be no guarantee that the strategic initiatives we are implementing to improve our results will be successful.
Over the past several years, we implemented several strategic initiatives, including accelerating store growth, retrofitting our existing store base and enhancing our merchandising and replenishment systems. The accelerated timing in implementing these initiatives and the significant change they brought to our operations placed increased demands on our operating, managerial and administrative resources and also contributed to decreased profitability and other declines in our operating results during fiscal 2016. In response, we are continuing to implement corrective measures focusing on merchandising, supply chain and operational effectiveness that we believe will improve performance over the next several future periods. These measures are in various stages of testing, evaluation, and implementation, upon which we expect to rely to continue to improve our results of operations and financial condition and to achieve our financial plans. These initiatives are inherently risky and uncertain, even when tested successfully, in their application to our business in general. Successful system-wide implementation relies in part on consistency of training, stability of workforce, ease of execution, and the absence of offsetting factors that can influence results adversely. Failure to achieve successful implementation of our initiatives or the cost of these initiatives exceeding management’s estimates could adversely affect our business, results of operations and financial condition. Furthermore, there can be no assurance that these measures, even if successful, will improve our financial results and, if they do, there can be no guarantee as to the timing, sustainability or magnitude of any such improvement. In addition, implementation of these measures has required and may continue to require us to experience short-term cost increases or margin declines. For example, to clear inventory that had built up as a result of the “Go Taller” and global sourcing initiatives, during fiscal 2016, we undertook a range of promotional activities that adversely affected our margins. We were also required to undertake similar activities in fiscal 2017 to clear additional inventory. Poor operating performance could adversely affect our relationships with key vendors, our lenders and other business partners, who may seek to impose stricter credit or other terms on their arrangements with us. Any or all of the foregoing could restrict our operational flexibility and/or impair our liquidity position, which could further adversely affect our operating results and financial condition and cause the trading price of our debt securities to decline. This could also impair our ability to attract and retain qualified personnel, including members of management.
Inventory shrinkage could have a material adverse effect on our business, financial condition and results of operations.
We hold high volumes of inventory and are subject to the attendant risks of inventory loss, spoilage, shrink, scrap and theft (which we collectively refer to as “shrinkage”). Additionally, our strategic initiatives in merchandising and inventory allocation have in the past and may from time to time in the future exacerbate our inventory shrinkage rates. In transition fiscal 2014 and continuing into the first quarter of fiscal 2016, we implemented the “Go Taller” program to increase the length and height of shelving and displays at all retail locations. This remodeling program resulted in increased misplaced and damaged products as items were moved from the shelves to the floor, and increased shipment volumes of inventory to stores, all of which contributed to significant increases in inventory shrinkage. Although we have responded to recent inventory shrinkage charges by reinstating our in-house Loss Prevention department and implementing inventory procedures retraining, we cannot assure you that actual rates of inventory shrinkage will decline or that the measures we are taking will effectively reduce the problem of inventory shrinkage. Although some level of inventory shrinkage is an unavoidable cost of doing business, if we were to experience higher rates of inventory shrinkage or incur increased security costs to combat inventory theft, it could have a material adverse effect on our business, financial condition and results of operations.
We have potential risks regarding our store physical inventories and our inventory replenishment and forecasting systems.
We maintain a perpetual inventory system in our warehouses, and follow a cycle count program that is adhered to over the course of each year in order to ensure that inventories are accurately reported. We do not maintain a perpetual inventory system in our retail stores. Physical inventory counts are completed at each of the Company’s retail stores at least once a year by an outside inventory service company. Based on the results of annual inventory counts, we have made adjustments to inventory estimates, which at times have been significant. If our controls over inventory records are not appropriately designed or executed to validate the existence, completeness and accuracy of physical inventory quantities, or if our controls related to the validation of assumptions used in the calculation of reserves for excess and obsolete inventory, as well as the completeness and accuracy of the underlying data used in the calculation are insufficient or we do not otherwise continue to improve our inventory processes and procedures, we may fail to adequately reserve for shrinkage and excess and obsolete inventory. These failures could have a materially adverse effect on our store physical inventory results, shrinkage and margins. This in turn could materially affect our ability to timely complete our financial reporting obligations and our financial condition and results or operations.
Also, our success depends in part on management’s ability to effectively anticipate and respond to changing consumer preferences, product trends and store inventory needs and its ability to translate these preferences, trends and needs into marketable product offerings in advance of the actual time of sale to the customer. Even if we are successful in anticipating consumer demands, we must continue to be able to develop and introduce innovative, high-quality products in order to sustain consumer demand.
There can be no assurance that we will be able to successfully anticipate changing consumer preferences, product trends, store inventory needs or economic conditions and, as a result, we may not successfully manage inventory levels to meet our future order requirements. If we fail to accurately forecast these needs, we may experience excess inventory levels or a shortage of product required to meet the demand. Inventory levels in excess of consumer demand may result in inventory write-downs and the sale of excess inventory at discounted prices, which could have an adverse effect on the image and reputation of our brands and negatively impact profitability.
We purchase in large volumes and our inventory is highly concentrated. Our results of operations may be negatively affected if we are not successful in managing our inventory effectively.
Our profitability depends upon our ability to manage appropriate inventory levels and respond quickly to shifts in consumer demand patterns. To be successful, we must maintain sufficient inventory levels and an appropriate product mix to meet our customers’ demands without allowing those levels to increase to such an extent that the costs to store and hold the goods unduly impacts our financial results or that subjects us to the risk of increased inventory shrinkage. Our store and warehouse inventory, net of allowance, approximated $175.9 million and $196.7 million at January 27, 2017 and January 29, 2016, respectively. We periodically review the net realizable value of our inventory and make adjustments to our carrying value when appropriate. The current carrying value of inventory reflects our belief that we will realize the net values recorded on the balance sheet. However, we may not do so, and if we do not, this may result in overcrowding and supply chain difficulties. To obtain inventory at attractive prices, we take advantage of large volume purchases and closeouts. As a result, we carry high inventory levels relative to our sales. In recent periods, primarily as a result of network capacity changes and global sourcing initiatives, we experienced overcrowding in our warehouses, which placed stress on our distribution operations as well as the back rooms of our retail stores. This has also resulted in increased inventory shrinkage due to a variety of factors, including spoilage if merchandise could not be sold in the anticipated timeframes. In transition fiscal 2014, we implemented a new merchandising strategy that significantly increased global sourcing of merchandise from import suppliers, which in part required the purchase of seasonal merchandise up to nine months before its sale. These initiatives thus resulted in unanticipated inventory buildup that was particularly pronounced with respect to seasonal merchandise.
If we are unable to effectively manage inventory levels, we may have to sell large portions of inventory at amounts less than their carrying value or write down or otherwise dispose of a significant part of inventory, which could lead cost of sales, gross profit, operating income, and net income to decline significantly during the period in which such event or events occur. In response to the inventory buildup created by the global sourcing program, we implemented inventory liquidation initiatives including short-term promotional activities, which negatively impacted our gross margins and operating results. Margins could also be negatively affected should the grocery category sales become a larger percentage of total sales in the future, and by increases in shrinkage and spoilage from perishable products. In addition, we offer selected items priced above 99.99¢ and we believe that we have additional opportunities to expand our selection of these items. If we are unable to sell these items above 99.99¢ in the volumes that we expect this could further exacerbate the foregoing risks.
We are dependent on new store openings for future growth.
Our ability to generate growth in sales and operating income depends on increasing same-store sales of existing stores and on our ability to successfully open and operate new stores both within and outside of our existing markets and to manage future growth profitably. Our strategy depends on many factors, including our ability to identify suitable markets and sites for new stores, negotiate leases or purchases with acceptable terms, refurbish stores, successfully compete against local competition and the increasing presence of large and successful companies entering or expanding into the markets in which we operate, gain brand recognition and acceptance in new markets, and manage operating expenses and product costs. In addition, we must be able to hire, train, motivate, and retain competent managers and store personnel to support our growth. Many of these factors are beyond our control or are difficult to manage. As a result, we cannot assure that we will be able to achieve our goals with respect to growth. Any failure by us to achieve these goals on a timely basis, differentiate ourselves and obtain acceptance in markets in which we currently have limited or no presence, attract and retain management and other qualified personnel, and effectively manage operating expenses could adversely affect our future operating results and our ability to execute our business strategy.
A variety of factors, including store location, store size, local demographics, rental terms, competition, the level of store sales, availability of locally sourced merchandise, locally prevailing wages and labor pools, distance and time from existing distribution centers, local regulations, and the level of initial advertising, influence if and when a store becomes profitable. A portion of our new store base may include a portion of stores with relatively short operating histories. We also may not anticipate all of the challenges imposed by the expansion of our operations and, as a result, new stores may not achieve the sales per estimated saleable square foot and store-level operating margins historically achieved at existing stores. If new stores on average fail to achieve these results, planned expansion could decrease overall sales per estimated saleable square foot and store-level operating margins. Increases in the level of advertising and pre-opening expenses associated with the opening of new stores could also contribute to a decrease in operating margins. As we expand, differences in the available labor pool and potential customers could adversely impact us.
New stores opened in new markets have in the past been and may in the future be less profitable than existing stores. Some of our new stores may be located in areas where we have minimal operating experience or a lack of brand recognition. Those markets may have different competitive conditions, market conditions, consumer tastes and discretionary spending patterns than our existing markets, which may cause these new stores to be initially less successful than stores in our existing markets. In transition fiscal 2014, the Company initiated an accelerated store expansion program, along with other strategic initiatives, that placed pressure on our operational, managerial and administrative resources, and caused our operating results to decline. Consequently, in the third quarter of fiscal 2016, we decided to reduce the pace of future store openings to focus on stabilizing our operations and results. We cannot provide any assurance that we will resume accelerated growth in the future, which could adversely affect our operating results and competitive position. If we fail to successfully execute our growth strategy, including by opening new stores profitably and on schedule, our financial condition and operating results may be adversely affected.
Opening new stores in existing markets may negatively impact sales at our existing stores.
New stores opened in existing markets have in the past been and may in the future result in inadvertent oversaturation and temporarily or permanently divert customers and sales from our existing stores. Following the implementation of the Company’s accelerated store expansion program in transition fiscal 2014, the Company experienced cannibalization of sales at existing stores that contributed to a decline in profitability at our stores and of our same-store sales, and led to the Company’s decision to reduce the pace of future store openings. If in the future we expand our store base too aggressively, sales cannibalization between our stores may become significant and affect our sales growth, and we may experience a similar decline in financial condition and operating results.
Our operating results may fluctuate and may be affected by seasonal buying patterns.
Historically, we have experienced higher volumes of net sales and higher levels of operating income during the quarters that have included the Halloween, Christmas and Easter selling seasons. If for any reason our net sales were to fall below historical levels during the Halloween, Christmas and/or Easter selling seasons, such a decline could have an adverse impact on profitability and impair the results of operations for the entire fiscal year. Transportation scheduling, warehouse capacity constraints, supply chain disruptions, adverse weather conditions, labor disruptions or other disruptions during peak holiday seasons could also affect net sales and profitability for the fiscal year.
In addition to seasonality, many other factors may cause the results of operations to vary significantly from quarter to quarter. These factors, some beyond our control, include the following:
· the number, size and location of new stores and timing of new store openings;
· the distance of new stores from existing stores and distribution sources;
· the level of advertising and pre-opening expenses associated with new stores;
· the integration of new stores into operations;
· the general economic health of the extreme value retail industry;
· changes in the mix of products sold;
· increases in fuel, shipping merchandise and energy costs;
· the ability to successfully manage inventory levels and product mix across our multiple distribution centers and our stores;
· changes in personnel;
· the expansion by competitors into geographic markets in which they have not historically had a strong presence;
· fluctuations in the amount of consumer spending;
· the amount and timing of operating costs and capital expenditures relating to the growth of the business and our ability to uniformly capture such costs; and
· the timing of certain holidays, such as Easter and Halloween.
Our ongoing implementation and testing of a new SAP software platform could interrupt operational transactions.
We depend on a variety of information systems for our operations, many of which are proprietary, which have historically supported many of our business operations such as inventory and order management, shipping, receiving, and accounting. Because most of our information systems consist of a number of internally developed applications, it can be more difficult to upgrade or adapt them compared to commercially available software solutions.
Although our new SAP system became operational at the beginning of the first quarter of fiscal 2016, we are still currently in the process of migrating our operations from our legacy proprietary system to SAP’s enterprise resource planning software, which includes integrated financial and inventory management systems. There are inherent risks associated with replacing and changing these core systems, including accurately capturing data and possible supply chain and vendor payment disruptions. In addition, this process is complex, time-consuming and expensive. Although we believe we are taking appropriate action to mitigate the risks through testing, training and staging implementation, we can make no assurances that we will not have disruptions, delays and/or negative business impacts from this forthcoming deployment. Any operational disruptions during the course of this migration process, delays or deficiencies in the design and implementation of the new SAP system, or in the performance of our legacy systems could materially and adversely affect our ability to effectively run and manage our business. Our success depends, in large part, on our ability to manage our inventory, pay our vendors and record and report financial and management information on a timely and accurate basis, which could be impaired while we are making these enhancements. Portions of our IT infrastructure also may experience interruptions, delays or cessations of service or produce errors in connection with systems integration or migration work that takes place from time to time. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive. Such disruptions could materially and adversely impact our ability to fulfill orders and interrupt other processes. If our information systems do not allow us to transmit accurate information, even for a short period of time, to key decision makers, the ability to manage our business could be disrupted and the results of operations and financial condition could be materially and adversely affected. Failure to properly or adequately address these issues could impact our ability to perform necessary business operations, which could materially and adversely affect our reputation, competitive position, business, results of operations and financial condition.
We could experience disruptions in or increased costs related to receiving and distribution or our transportation network.
Our success depends upon whether receiving and shipments are processed timely, accurately and efficiently. As we continue to grow, we may face increased or unexpected demands on warehouse operations, as well as unexpected demands on our transportation network. We distribute our products primarily by truck and rail. In addition, we rely on a variety of private fleet and common carriers for our store deliveries/backhauls and vendor pick-ups, and we route our products through various world ports, with the greatest reliance on California ports. In addition, new store locations receiving shipments from distribution centers that are increasingly further away will increase transportation costs and may create transportation scheduling strains. The very nature of our closeout business makes it uniquely susceptible to periodic interruptions and difficult to foresee warehouse/distribution center overcrowding caused by spikes in inventory resulting from opportunistic closeout purchases. Such demands could cause delays in delivery of merchandise to and from warehouses and/or to stores. We periodically evaluate new warehouse distribution and merchandising systems and could experience interruptions during implementations of new facilities and systems. A fire, earthquake, or other disaster at our warehouses or distribution centers could also hurt our business, financial condition and results of operations, particularly because much of our merchandise consists of closeouts and other irreplaceable products. We also face the possibility of reduced availability of trucks or rail cars due to adverse weather conditions, allocation of assets to other industries or geographies or otherwise, which could disrupt our receiving, processing, and shipment of merchandise.
In addition, our reliance upon ocean freight transportation for the delivery of our inventory exposes us to various inherent risks, including port workers’ union disputes and associated strikes, work slow-downs and work stoppages, severe weather conditions, natural disasters and terrorism, any of which could result in delivery delays and inefficiencies, increase our costs and disrupt our business. A severe and prolonged disruption to ocean freight transportation could cause delays in delivery of merchandise to our stores and in-stock inventory availability. Efficient and timely inventory deliveries and proper inventory management are important factors in our operations. Reduced product availability may diminish sales and brand loyalty. Severe and extended delays in the delivery of our inventory or our inability to effectively manage our inventory could have a material adverse effect on our business, financial condition, results of operations and liquidity.
We depend upon our relationships with vendors and the availability of closeout merchandise.
Our success depends in large part on our ability to locate and purchase quality closeout merchandise at attractive prices. This supports a changing mix of name-brand and other merchandise primarily at or below 99.99¢ price point. We cannot be certain that such merchandise will continue to be available in the future at wholesale prices consistent with our business plan and/or historical costs. Further, we may not be able to find and purchase merchandise in necessary quantities, particular as we grow, and therefore require a greater quantity of such merchandise at competitive prices. Additionally, vendors sometimes restrict the advertising, promotion and method of distribution of their merchandise. These restrictions in turn may make it more difficult for us to quickly sell these items from inventory. Although we believe we enjoy stable relationships with our vendors, we typically do not enter into long-term agreements or pricing commitments with any vendor. As a result, we must continuously seek out buying opportunities from existing vendors and from new sources. There is increasing competition for these opportunities with other wholesalers and retailers, discount and deep-discount stores, mass merchandisers, food markets, drug chains, club stores, and various other companies and individuals as the extreme value retail segment continues to expand outside and within existing retail channels. There is also a trend towards consolidation among vendors and vendors of merchandise targeted by us, and such larger consolidated entities may enjoy greater purchasing power than we do. A disruption in the availability of merchandise at attractive prices could impair our business.
We face risks associated with international sales and purchases.
International sales historically have not been important to our overall net sales. However, some of the inventory we purchase from domestic vendors is manufactured outside the United States. In particular, we will continue to purchase inventory from China, though plan to narrow our focus to sourcing general merchandise and seasonal inventory. If we directly import large volumes of merchandise from overseas vendors, we may be required to order these products further in advance than would be the case if these products were manufactured domestically. International transactions may be subject to risks such as:
· political or financial instability or disputes;
· lack of knowledge by foreign manufacturers of or compliance with applicable federal and state product, content, packaging, ethics and other laws, rules and regulations, such as the U.S. Foreign Corrupt Practices Act;
· foreign currency exchange rate fluctuations and local economic conditions, including inflation;
· uncertainty in dealing with foreign vendors and countries where the rule of law is less established;
· disruptions in the global transportation network, such as raw material shortages, factory consolidations, work stoppages, strikes or shutdowns of major ports or airports, or other political or labor unrest;
· risk of loss due to overseas transportation;
· import and customs review can delay delivery of products as could labor disruptions at ports;
· changes in import and export regulations, including “trade wars” and retaliatory responses;
· changes in tariff, import duties and freight rates; and
· testing and compliance.
The United States and other countries have at times proposed various forms of protectionist trade legislation. We are subject to trade restrictions in the form of tariffs or quotas, or both, applicable to the products we sell as well as to raw material imported to manufacture those products. We may also be subjected to additional duties, significant monetary penalties, the seizure and forfeiture of the products we are attempting to import, or the loss of import privileges if we or our vendors are found to be in violation of U.S. laws and regulations applicable to the importation of our products. Our and our vendors’ compliance with the regulations is subject to interpretation and review by applicable authorities. Any changes in current tariff structures or other trade policies or interpretations could result in increases in the cost of and/or store level reduction in the availability of certain merchandise and could adversely affect our ability to purchase such merchandise and our operations. The results of the recent United States elections may signal a change in trade policy between the United States and other countries. Because a large portion of our merchandise is sourced, directly or indirectly, from outside the United States, major changes in tax policy or trade relations, such as the disallowance of tax deductions for imported merchandise or the imposition of additional tariffs or duties on imported products, could adversely affect our business, results of operations, effective income tax rate, liquidity and net income. In addition, decreases in the value of the U.S. dollar against foreign currencies, particularly the Chinese renminbi, could increase the cost of products we purchase from overseas vendors. The pricing of our products in our stores may also be affected by changes in foreign currency rates and require us to make adjustments which would impact our revenue and profit.
Disruptions due to labor stoppages, strikes or slowdowns, shutdowns or major port or airport or other disruptions involving our vendors or the transportation and handling industries also may negatively affect our ability to receive merchandise and thus may negatively affect sales. Prolonged disruptions could also materially increase our labor costs both during and following the disruption. Significant increases in wages or wage taxes paid by contract facilities may increase the cost of goods manufactured, which could have a material adverse effect on our profit margins and profitability. For example, the costs of labor and wage taxes have increased in China, which means we are at risk of higher marginal costs associated with goods manufactured in China.
These and other factors affecting our vendors and our access to products, including the supply of our imported merchandise or the imposition of additional costs of purchasing or shipping imported merchandise, could have a material adverse effect on our business, financial condition and results of operations unless and until alternative supply arrangements are secured. Products from alternative sources may be of lesser quality or more expensive than those we currently purchase, resulting in a loss of sales or profit. As we increase our imports of merchandise from foreign vendors, the risks associated with foreign imports will increase.
Our success depends on our executive officers and key management individuals. If we lose any of these key individuals or are unable to hire additional qualified personnel in a timely fashion, our business may be adversely affected.
Our future success depends to a significant degree on the skills, experience and efforts of a limited number of key management personnel, including our executive management team. The unexpected loss of the services of any or a significant number of such individuals could result in a loss of management continuity and institutional knowledge and thus adversely affect our business. Other personnel may not have the experience and expertise to readily replace these individuals. As a result, our board of directors may have to search outside of the Company for qualified replacements. This search may be prolonged, and we cannot provide assurance that our executive succession planning, retention or hiring efforts will be successful. We do not maintain key person insurance on any of our executives or key management personnel. Further, the market for qualified executive candidates, who possess the desired talent and competencies, is highly competitive, and may subject us to increased labor costs during periods of low unemployment.
In recent periods, we have experienced significant management changes. Specifically, the positions of Chief Executive Officer, Chief Financial Officer and Chief Merchandising Officer each experienced turnover during the past two fiscal years, in some cases multiple times. After an extensive search with respect to each of these positions, we appointed Mr. Jack Sinclair as Chief Merchandising Officer in July 2015, Mr. Geoffrey J. Covert as President and Chief Executive Officer in September 2015, and Ms. Felicia Thornton as Chief Financial Officer and Treasurer in November 2015. We will continue to enhance our management team as necessary to strengthen our business for future growth. Although we do not anticipate additional significant management changes, these and other changes in management could result in changes to, or impact the execution of, our business strategy. Any such changes could be significant and could have a negative impact on our performance and results of operations. In addition, if we are unable to successfully transition members of management into their new positions, management resources could be constrained.
Failure to attract and retain qualified employees, particularly field, store and distribution center managers, while controlling labor costs, as well as other labor issues, could adversely affect our financial performance.
Our future growth and performance depends on our ability to attract, retain and motivate qualified employees, many of whom are in positions with historically high rates of turnover such as field managers and distribution center managers. Our ability to meet our labor needs, while controlling our labor costs, is subject to many external factors, including competition for and availability of qualified personnel in a given market, unemployment levels within those markets, prevailing wage rates, minimum wage laws, health and other insurance costs, and changes in employment and labor laws (including changes in the process for our employees to join a union) or other workplace regulation (including changes in “entitlement” programs such as health insurance and paid leave programs). To the extent a significant portion of our employee base unionizes, or attempts to unionize, our labor costs could increase. In addition, comprehensive healthcare reform legislation has caused our healthcare costs to increase. We anticipate future increases in the cost of health benefits, partly as a result of the implementation of the Patient Protection and Affordable Care Act (the “ACA”) enacted in 2010, as well as other healthcare reform legislation by Congress and state legislatures, including modification to or the repeal of the ACA. If the ACA is repealed or modified or if new legislation is passed, such action could significantly increase costs of the healthcare benefits provided to our employees, the ultimate costs of which and the potentially adverse impact to the Company and its employees cannot be quantified at this time. If we are unable to control healthcare and pension costs, we may experience increased operating costs, which may adversely affect our financial condition and operating results. Furthermore, our ability to pass along increases in labor costs to our customers is constrained by our low price model.
Increases in costs and other inflationary pressures may affect our ability to keep pricing almost all of our merchandise at 99.99¢ or less.
Our ability to provide quality merchandise for profitable resale primarily at a price point of 99.99¢ or less is subject to certain economic factors which are beyond our control. Future increases in costs for items such as merchandise, wages and benefits, shipping, freight, fuel and store occupancy, among others, may reduce our profitability. The minimum wage has increased or is scheduled to increase in multiple states and local jurisdictions and there is a possibility that Congress will increase the federal minimum wage. We can pass price increases on to customers to a certain extent, such as by selling smaller units for the same price and increasing the price of merchandise presently sold at less than 99.99¢, but there are limits to the ability to effectively increase prices on a sufficiently wide range of merchandise in this manner while rarely exceeding a dollar. In certain circumstances, we have discontinued and may continue to discontinue some items from our offerings due to vendor wholesale price increases or reduced availability, which may adversely affect our results of operations. In addition, inflation could have a material adverse effect on our business and results of operations, especially given the constraints on our ability to pass on incremental costs. While we currently offer selected quality merchandise priced above 99.99¢, and believe that there are additional opportunities to expand our selection of these items, an expanded offering of merchandise priced in excess of 99.99¢ may not gain customer acceptance, which could damage our brand name and harm our revenues and profitability. A sustained trend of increased costs and significant inflationary pressure could require us to abandon our customary practice of pricing quality merchandise primarily at a price point of 99.99¢ or less, which could have a material adverse effect on our business and results of operations.
Current economic conditions and other economic factors may adversely affect our financial performance and other aspects of our business by negatively impacting our customer’s disposable income or discretionary spending, increasing our costs of goods sold and selling, general and administrative expenses, and adversely affecting our sales or profitability.
We believe many of our customers are on fixed or low incomes and generally have limited discretionary spending dollars. Any factor that could adversely affect that disposable income would decrease our customer’s spending and could cause our customers to shift their spending to products other than those sold by us or to products sold by us that are less profitable than other product choices, all of which could result in lower net sales, decreases in inventory turnover, greater markdowns on inventory, and a reduction in profitability due to lower margins. Factors that could reduce our customers’ disposable income and over which we exercise no influence include but are not limited to a slowdown in the economy, a delayed economic recovery, or other economic conditions such as increased or sustained high unemployment or underemployment levels, reduction and/or cessation of unemployment benefit payments and government subsidized assistance programs, concerns over government mandated participation in health insurance programs and increasing healthcare costs, inflation, increases in fuel or other energy costs and interest rates, lack of available credit, consumer debt levels, higher tax rates and other changes in tax laws.
Many of the factors identified above that affect disposable income, as well as commodity rates, transportation costs (including the costs of diesel fuel), costs of labor, insurance and healthcare, foreign exchange rate fluctuations, lease costs, measures that create barriers to or increase the costs associated with international trade, changes in other laws and regulations and other economic factors, also affect our cost of goods sold and our selling, general and administrative expenses, which may adversely affect our sales or profitability. We have limited or no ability to control many of these factors.
In addition, many of the factors discussed above, along with current global economic conditions and uncertainties, the potential for additional failures or realignments of financial institutions, and the related impact on available credit may affect us and our vendors and other business partners, landlords and service providers in an adverse manner including, but not limited to, reducing access to liquid funds or credit, increasing the cost of credit, limiting our ability to manage interest rate risk, increasing the risk of bankruptcy of our vendors, landlords or counterparties to, or other financial institutions involved in, the Credit Facilities and other contracts, increasing the cost of goods to us, and other adverse consequences which we are unable to fully anticipate or control.
Material damage to, or interruptions to, our information systems as a result of external factors, staffing shortages and difficulties in updating our existing software or developing or implementing new software could have a material adverse effect on our business or results of operations.
We depend on a variety of information technology systems for the efficient functioning of many aspects of our business, including our inventory replenishment systems which are necessary to properly forecast, manage, analyze and record our inventory. We are continually evaluating our information processes and computer systems to better run our business, including through our migration to SAP. These technology improvements may not deliver desired results or may do so on a delayed schedule. Additionally, such systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, cybersecurity breaches, natural disasters and human error. Any material interruptions or the cost of replacements may require a significant investment to fix or replace them, and we may suffer interruptions in our operations in the interim, may experience loss or corruption of critical data and may receive negative publicity, all of which could have a material adverse effect on our business or results of operations.
We also rely heavily on our information technology staff. If we cannot meet our staffing needs in this area, we may not be able to maintain or improve our systems in the future. Further, we still have certain legacy systems that are not generally supportable by outside vendors, and should those of our information technology team who are conversant with such systems leave, these legacy systems could be without effective support.
We rely on certain software vendors to maintain and periodically upgrade many of these systems. The software programs supporting many of our systems are maintained and supported by independent software companies. The inability of these companies to continue to maintain and upgrade these information systems and software programs might disrupt or reduce the efficiency of our operations if we were unable to convert to alternate systems in an efficient and timely manner. In addition, costs and potential interruptions associated with the implementation of new or upgraded systems and technology could also disrupt or reduce the efficiency of our operations.
Impairment of our goodwill or our intangible assets could negatively impact our net income and stockholders’ equity. We recognized substantial goodwill impairment charges in the third quarter of fiscal 2016 and may be required to recognize additional goodwill and intangible asset impairment charges in the future.
A substantial portion of our total assets consists of goodwill and intangible assets. Goodwill and certain intangible assets are not amortized, but are tested for impairment at least annually and between annual tests if events or circumstances indicate that it is more likely than not that the fair value of our net assets might be impaired. Testing for impairment involves an estimation of the fair value of our net assets and other factors and involves a high degree of judgment and subjectivity. There are numerous risks that may cause the fair value of our net assets to fall below its carrying amount, including those described elsewhere in this Report. If we have an impairment of our goodwill or intangible assets, the amount of any impairment could be significant and could negatively impact our net income and stockholders’ equity for the period in which the impairment charge is recorded. During the third quarter of fiscal 2016, we determined that sufficient indicators of impairment existed to require an interim impairment analysis of goodwill and trade name, including (i) overall performance deterioration reflected in decreased comparable same-store sales and cannibalization from stores opened in fiscal 2015 under an accelerated expansion program, (ii) increases in inventory shrinkage and buildup of excess inventory, (iii) decreased margin due to disappointing results from sales promotions and (iv) a decision to delay the pace of future store openings. Our first step evaluation concluded that the fair value of the retail reporting unit was below its carrying value. We performed step two of the goodwill impairment test that requires the retail reporting unit’s fair value to be allocated to all of the assets and liabilities of the reporting unit, including any intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination, including consideration of the fair value of tangible property and intangible assets. As a result of the preliminary results of the impairment test, impairment of goodwill was required and based on our best estimate, we recorded a $120.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2016. The finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in a $20.9 million adjustment in goodwill, lowering the third quarter of fiscal 2016 goodwill impairment charge from $120.0 million to $99.1 million. If operating results continue to change versus our expectations, additional impairment charges may be recorded in the future. If we have an additional impairment of our goodwill or intangible assets, the amount of any impairment could be significant and could negatively impact our net income and members’ equity for the period in which the impairment charge is recorded.
Our operations are concentrated in California.
As of January 27, 2017, 283 of our 390 stores were located in California (with 48 stores in Texas, 38 stores in Arizona and 21 stores in Nevada). We expect that we will continue to open additional stores in as well as outside of California. For the foreseeable future, our results of operations will depend significantly on trends in the California economy and its legal/regulatory environment. Declines in retail spending on higher margin discretionary items and continuing trends of increasing demand for lower margin food products may negatively impact our profitability. California has also historically enacted minimum wages that exceed federal standards; the California minimum wage increased to $10.50 per hour effective January 1, 2017. Moreover, certain municipalities in which our stores are located have set minimum wages above the applicable state standards. Any further increases in the federal minimum wage or the enactment of additional state or local minimum wage increases could increase our labor costs. California typically has other factors making compliance, litigation and workers’ compensation claims more prevalent and costly. Additional local regulation in certain California jurisdictions may further pressure margins.
Natural disasters, unusually adverse weather conditions, pandemic outbreaks, terrorist acts, and global political events could cause temporary or permanent distribution center or store closures, impair our ability to purchase, receive or replenish inventory, or decrease customer traffic, all of which could result in lost sales and otherwise adversely affect our financial performance.
The occurrence of one or more natural disasters, such as earthquakes, hurricanes, fires, floods, tornadoes and earthquakes, unusually adverse weather conditions, pandemic outbreaks, terrorist acts or disruptive global political events, such as civil unrest in countries in which our vendors are located, or similar disruptions could adversely affect our operations and financial performance. To the extent these events result in the closure of one or more of our distribution centers or a significant number of stores, or impact one or more of our key local or overseas suppliers, our operations and financial performance could be materially adversely affected through an inability to make deliveries or provide other support functions to our stores and through lost sales. In addition, these events could result in increases in fuel (or other energy) prices or a fuel shortage, delays in opening new stores, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local and overseas vendors, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to our distribution centers or stores, the inability of customers to reach or have transportation to our stores directly affected by such events, the temporary reduction in the availability of products in our stores, and disruption of our utility services or to our information systems.
We could encounter risks related to transactions with affiliates.
Prior to the Merger, we leased 13 store locations and a parking lot associated with one of these stores from former members of management and their affiliates, of which 12 stores were leased on a month to month basis. In connection with the Merger, we entered into new lease agreements for these 13 stores and one parking lot. Although the terms negotiated were acceptable to us, we cannot be certain that terms negotiated are no less favorable than a negotiated arm’s length transaction with a third party.
Our current insurance program may expose us to unexpected costs and negatively affect our financial performance.
Our insurance coverage reflects deductibles, self-insured retentions, limits of liability and similar provisions that we believe are prudent. However, there are types of losses we may incur but against which we cannot be insured or which we believe are not economically reasonable to insure, such as losses due to employment practices, acts of war, employee, blackouts and certain other crime and some natural disasters, including earthquakes and tsunamis. If we incur these losses and they are material, our business could suffer. In addition, we self-insure a significant portion of expected losses under our workers’ compensation and general liability programs. Unanticipated changes in any applicable actuarial assumptions and management estimates underlying our recorded liabilities for these losses could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on our financial condition and results of operations. In the fourth quarter of fiscal 2016, we increased workers’ compensation accrual by $7.2 million as a result of higher incurred and projected expenses associated with fiscal 2016 workers’ compensation claims. We have designed and staffed a focused effort to build a culture of safety at 99 Cents designed to reduce the frequency and severity of workers’ compensation claims against us. In fiscal 2017, we experienced an improvement in frequency of claims and anticipation of severity of historical claims. However, we can provide no assurance that costs associated with workers’ compensation claims will continue to decline in the future. Future increases in workers’ compensation costs, if incurred, could have a material adverse effect on our business, financial condition, and results of operations. Although we continue to maintain property insurance for catastrophic events, we are effectively self-insured for property losses up to the amount of our deductibles. If we experience a greater number of these losses than we anticipate, our financial performance could be adversely affected.
We self-insure a portion of our health insurance program that may expose us to unexpected costs and negatively affect our financial performance.
We self-insure a portion of our employee medical benefit claims. The liability for the self-funded portion of our health insurance program is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported. We maintain stop loss insurance coverage to limit our exposure for the self-funded portion of our health insurance program. Liabilities associated with these losses include estimates of both claims filed and losses incurred but not yet reported. Unanticipated changes in any applicable actuarial assumptions and management estimates underlying our recorded liabilities for these losses could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on our financial condition and results of operations.
We face intense competition that could limit our growth opportunities and adversely impact our financial performance.
The retail business is highly competitive with respect to price, store location, merchandise quality, assortment and presentation, in-stock consistency, customer service, aggressive promotional activity, customers, and employees. We compete in both the acquisition of inventory and sale of merchandise with other wholesalers and retailers, discount and deep-discount stores, single price point merchandisers, mass merchandisers, food markets, drug chains, club stores and other retailers. We also compete for retail real estate sites. In the future, new companies may also enter the extreme value retail industry. It is also becoming more common for superstores to sell products competitive with our product offerings. Additionally, we currently face increasing competition for the purchase of quality closeout merchandise, and some of these competitors are entering or may enter our traditional markets. Also, companies like ours, due to customer demographics and other factors, may have limited ability to increase prices in response to increased costs without losing competitive position.
As we expand, we may enter new markets where our own brand is weaker and established brands are stronger, and where our own brand value may have been diluted by other retailers with similar names, appearances and/or business models. Some of our competitors have substantially greater financial resources and buying power than we do, as well as nationwide name-recognition and organization. Our ability to compete will depend on many factors including the ability to successfully purchase and resell merchandise at lower prices than competitors and the ability to differentiate ourselves from competitors that do not share our price and merchandise attributes, yet may appear similar to prospective customers. We also face competition from other retailers with similar names and/or appearances. We cannot assure that we will be able to compete successfully against current and future competitors in both the acquisition of inventory and the sale of merchandise.
We expect competition to continue to increase. Some of our large box competitors are or may be developing small box formats, and increasing the pace at which they will open the small box formats, which will produce more competition. We remain vulnerable to the marketing power and high level of consumer recognition of these larger competitors and to the risk that these competitors or others could venture into our industry in a significant way. Further, consolidation within the discount retail industry could significantly alter the competitive dynamics of the retail marketplace. This consolidation may result in competitors with greatly improved financial resources, improved access to merchandise, greater market penetration and other improvements in their competitive positions, as well as result in the provision of a wider variety of products and services at competitive prices by these consolidated companies, which could adversely affect our financial performance.
If we fail to protect our brand name, competitors may adopt trade names that dilute the value of our brand name.
We may be unable or unwilling to strictly enforce our trademark in each jurisdiction in which we do business. Also, we may not always be able to successfully enforce our trademarks against competitors or against challenges by others. Our failure to successfully protect our trademarks could diminish the value and efficacy of our brand recognition, and could cause customer confusion, which could, in turn, adversely affect our sales and profitability.
We are subject to governmental regulations, procedures and requirements. A significant change in, or noncompliance with, these regulations could have a material adverse effect on our financial performance.
Our business is subject to numerous federal, state and local laws and regulations. We routinely incur costs in complying with these regulations. New laws or regulations, particularly those dealing with healthcare reform, hazardous waste, product safety, and labor and employment, among others, or changes in existing laws and regulations, especially those governing the sale of products, may result in significant added expenses or may require extensive system and operating changes that may be difficult to implement and/or could materially increase our cost of doing business. In addition, such changes or new laws may require the write off and disposal of existing product inventory, resulting in significant adverse financial impact to us. Untimely compliance or noncompliance with applicable regulations or untimely or incomplete execution of a required product recall can result in the imposition of penalties, including loss of licenses or significant fines or monetary penalties, in addition to reputational damage.
We are subject to environmental regulations.
Under various federal, state and local environmental laws and regulations, current or previous owners or occupants of property may face liability associated with hazardous substances. These laws and regulations often impose liability without regard to fault. In the future, we may be required to incur substantial costs for preventive or remedial measures associated with hazardous materials. We have several storage tanks at our distribution and warehouse facilities, including: an aboveground and underground diesel storage tank at one of our City of Commerce, California distribution centers, a compressed natural gas tank at one of our City of Commerce, California distribution centers; an aboveground propane storage tank at one of our City of Commerce, California distribution centers; ammonia storage at our Texas warehouse; an aboveground diesel storage tank at our Texas warehouse; an aboveground propane storage tank at our leased Slauson warehouse in City of Commerce, California; and an aboveground propane storage tank at our leased Los Palos warehouse in Los Angeles, California. Except as disclosed in Item 3, “Legal Proceedings,” we have not been notified of, and are not aware of, any potentially material current environmental liability, claim or non-compliance. We could incur costs in the future related to owned properties, leased properties, storage tanks, or other business properties and/or activities. In the ordinary course of business, we handle or dispose of commonplace household products that are classified as hazardous materials under various environmental laws and regulations. We have adopted policies regarding the handling and disposal of these products, but we cannot be assured that our policies and training are comprehensive and/or are consistently followed, and we are still potentially subject to liability under, or violations of, these environmental laws and regulations in the future even if our policies are consistently followed.
Litigation may adversely affect our business, financial condition and results of operations.
Our business is subject to the risk of litigation by employees, consumers, vendors, competitors, shareholders, government agencies and others through private actions, class actions, administrative proceedings, regulatory actions or other litigation. The outcome of litigation, particularly class action lawsuits, regulatory actions and intellectual property claims, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to these lawsuits may remain unknown for substantial periods of time. In addition, certain of these lawsuits, if decided adversely to us or settled by us, may result in liability material to our financial statements as a whole or may negatively affect our operating results if changes to our business operation are required. The outcome of litigation is difficult to assess or quantify and the cost to defend current and future litigation may be significant. There also may be adverse publicity associated with litigation that could negatively affect customer perception of our business, regardless of whether the allegations are valid or whether we are ultimately found liable. Reserves are established based on our best estimates of our potential liability. However, we cannot accurately predict the ultimate outcome of any such proceedings due to the inherent uncertainties of litigation. Regardless of the outcome or whether the claims are meritorious, legal and regulatory proceedings may require that we devote substantial time and expense to defend our Company. As a result, litigation may adversely affect our business, financial condition and results of operations.
For a discussion of current legal matters, please see Item 3, “Legal Proceedings.” Resolution of these matters, if decided against the Company, could have a material adverse effect on our results of operations, accrued liabilities or cash flows.
We could be exposed to product liability, food safety claims or packaging violation claims.
We purchase many products on a closeout basis, some of which are manufactured or distributed by overseas entities, and some of which are purchased by us through brokers or other intermediaries as opposed to directly from their manufacturing or distribution sources. Many products are also sourced directly from manufacturers. The closeout nature of certain of these products and transactions may impact our opportunity to investigate all aspects of these products. We attempt to ensure compliance, and to test products when appropriate, but there can be no assurance that we will consistently succeed in these efforts. Despite our best efforts to ensure the quality, safety and freshness of the products that we sell in all of our stores, we may be subject to product liability claims from customers or actions required or penalties assessed by government agencies relating to products, including but not limited to food
products that are recalled, defective or otherwise alleged to be harmful. Even with adequate insurance and indemnification, such claims could significantly damage our reputation and consumer confidence in our products. We have or have had, and in the future could face, labeling, environmental, or other claims, from private litigants as well as from governmental agencies. Our litigation expenses could increase as well, which also could have a materially negative impact on our results of operations even if a product liability claim is unsuccessful or is not fully pursued.
We may be adversely impacted if our cybersecurity measures fail.
Our relationships with our customers may be adversely affected if the security measures that we use to protect their personal information, such as credit card numbers, are ineffective or perceived by consumers to be inadequate. We primarily rely on security and authentication technology that we license from other parties. With this technology, we perform real-time credit card authorization and verification with our banks and we are subject to the customer privacy standards of credit card companies and various consumer protection laws. We cannot predict whether there will be a compromise or breach of the technology we use to protect our customers’ personal information. If there is a compromise or breach of this nature, there is the potential that parties could seek damages from us, and we could lose the confidence of customers or be subject to lawsuits or significant fines or penalties from credit card companies or regulatory agencies.
Furthermore, our servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any such breaches.
We face risks related to protection of data related to our employees, customers, vendors and other parties.
As part of our normal business activities, we collect and store sensitive personal information, related to our employees, customers, vendors and other parties. We have certain procedures and technology in place to protect such data, but third parties may have the technology or know-how to breach the security of this information, and our security measures and those of our technology vendors may not effectively prohibit others from obtaining improper access to this information.
A security breach of any kind, which could be undetected for a period of time, or any failure by us to comply with the applicable privacy and information security laws, regulations and standards could expose us to risks of data loss, litigation, government enforcement actions and costly response measures (including, for example, credit monitoring services for affected customers, as well as further upgrades to our security measures) which may not be covered by our insurance policies, and could materially disrupt our operations. Any resulting negative media attention and publicity could significantly harm our reputation, which could cause us to lose market share as a result of customers discontinuing the use of debit or credit cards in our stores or not shopping in our stores altogether and could have a material adverse effect on our business and financial performance.
We need to comply with credit and debit card security regulations.
In connection with sales, we transmit confidential credit and debit card information. As a merchant who processes credit and debit card payments from customers, we are required to comply with the Payment Card Industry Data Security Standards (“PCI DSS”) and other requirements imposed on us for the protection and security of our customers’ credit and debit card information. PCI DSS contains compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing, and transmission of cardholder data. If we are unable to remain compliant with PCI DSS and other requirements, our business and operations could be adversely affected because we could incur significant fines or penalties from payment card companies or we could be prevented in the future from accepting customer payments by means of a credit or debit card. We also may need to expend significant management and financial resources to become or remain compliant with these requirements, which could divert these resources from other initiatives and adversely impact our results of operations, financial condition, business and prospects.
Changes to accounting rules or regulations may adversely affect our results of operations.
New accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. A change in accounting rules or regulations may even affect our reporting of transactions completed before the change is effective, and future changes to accounting rules or regulations or the questioning of current accounting practices may adversely affect our results of operations.
In February 2016, the Financial Accounting Standards Board (“FASB”) released a new lease standard, requiring companies to capitalize substantially all leases, including operating leases, in their financial statements. The new lease standard will be effective beginning after December 15, 2018. The new standard requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner that is largely similar to current accounting. The standard also eliminates real estate-specific provisions for all entities. Currently, substantially all of our leased properties are accounted for as operating leases with limited related assets and liabilities recorded on our balance sheet. The new accounting standard, as currently issued, is currently expected to result in significant changes to our current accounting and would treat each lease as creating an asset and a liability and require the
capitalization of such leases on the balance sheet. While this change would not impact the cash flow related to our store leases, we would expect our assets and liabilities to increase relative to the current presentation, which may impact our ability to raise additional financing from banks or other sources in the future. However, even if the new guidance is adopted as issued, certain incurrence ratios and other provisions under the indenture governing the Senior Notes (the “Indenture”) and under the Credit Facilities permit us to account for leases in accordance with the existing accounting requirements. As a result, our ability to incur additional debt or otherwise comply with such covenants may not directly correlate to our financial condition or results from operations as each would be reported under generally accepted accounting principles (“GAAP”) in the United States as so amended.
Our failure to implement and maintain effective internal control over financial reporting could result in material misstatements in our financial statements.
During fiscal 2016, management identified a material weakness in our internal control over financial reporting with respect to identifying items within our deferred tax balances that could be materially incorrect. Specifically, we did not provide appropriate oversight of our third-party tax preparer. A more complete description of this material weakness is included in Item 9A, “Controls and Procedures.” Although we have implemented certain measures that we believe will remediate this material weakness, we can provide no assurance that our remediation efforts will be effective or that additional material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties that may be encountered in their implementation, could result in additional material weaknesses, cause us to fail to meet our periodic or annual reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations regarding the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated under Section 404. The existence of material weaknesses could result in errors in our financial statements that could result in a restatement of those financial statements.
Risks Related to Our Substantial Indebtedness
We have substantial indebtedness and lease obligations, which could affect our ability to meet our obligations under our indebtedness and may otherwise restrict our activities.
Our total indebtedness as of January 27, 2017 was $883.2 million, consisting of gross borrowings under our First Lien Term Loan Facility of $593.9 million, borrowings under the ABL Facility of $39.3 million and $250.0 million of our Senior Notes. Availability under the ABL Facility (subject to the borrowing base) was $37.2 million as of January 27, 2017.
We also have, and will continue to have, significant lease obligations. As of January 27, 2017, our minimum annual rental obligations under long-term leases for fiscal 2018 are $84.8 million.
Our substantial indebtedness 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 under the Senior Notes and our Credit Facilities. Our substantial indebtedness could have important consequences, including:
· increasing our vulnerability to adverse economic, industry or competitive developments;
· requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;
· exposing us to the risk of increased interest rates because certain of our borrowings, including borrowings under our Credit Facilities, are at variable rates of interest;
· making it more difficult for us to satisfy our obligations with respect to our indebtedness, including the Senior Notes, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants and borrowing conditions, could result in an event of default under the Indenture and the agreements governing such other indebtedness;
· restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;
· imposing restrictions on the operation of our business that may hinder our ability to take advantage of strategic opportunities or to grow our business;
· limiting our ability to obtain additional financing for working capital, capital expenditures (including real estate acquisitions and store expansion), debt service requirements and general corporate or other purposes, which could be exacerbated by further volatility in the credit markets; and
· limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to any of our competitors who are less leveraged and who therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting.
We and our subsidiaries are still able to incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial indebtedness.
We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The Indenture and our Credit Facilities each contain restrictions on the incurrence of additional indebtedness. However, these restrictions are subject to a number of significant qualifications and exceptions, and under certain circumstances, the amount of indebtedness that could be incurred in compliance with these restrictions could be substantial. Accordingly, we and our subsidiaries may be able to incur substantial additional indebtedness in the future. We have additional availability under our ABL Facility subject to the borrowing base of $37.2 million as of January 27, 2017.
Subject to certain limitations and the satisfaction of certain conditions, including the receipt of commitments for additional borrowings, we were also permitted to incur up to an aggregate of $50.0 million of additional borrowings pursuant to incremental facilities under the First Lien Term Loan Facility and up to an aggregate of $25.0 million of additional revolving commitments (subject to the borrowing base) pursuant to the ABL Facility. If new debt is added to our and our subsidiaries’ current debt levels, the risks that we now face as a result of our leverage would intensify and could have a negative impact on our credit rating.
We may not be able to generate sufficient cash to service all of our indebtedness or repay such indebtedness when due, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal of, and premium, if any, and additional interest, if any, on, our indebtedness, including the Senior Notes.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness, including the Senior Notes. Our First Lien Term Loan Facility matures on January 13, 2019, and our Senior Notes mature on December 15, 2019. While the maturity date of our ABL Facility has been conditionally extended to April 8, 2021 in connection with the Fourth Amendment, such extension resulted in higher interest rates and, if our First Lien Term Loan Facility and Senior Notes are not refinanced or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021, our ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of our First Lien Term Loan Facility and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of the Indenture and our Credit Facilities or any future debt instruments that we may enter into may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Perceived liquidity issues resulting from any such failure to make payments of interest or principal or restructure or refinance our existing debt could adversely affect our relationships with key vendors, our lenders and other business partners, who may seek to impose stricter credit or other terms on their arrangements with us, including by requiring us to post collateral to secure our obligations, which could in turn materially and adversely affect our business and operations.
Failure to comply with the financial requirements under our ABL Facility could result in decreased credit availability and reduced distributions.
Additional borrowing under our ABL Facility is dependent on the maintenance of certain liquidity levels, compliance with financial ratio covenants, the borrowing base and other provisions set forth in the ABL Facility. Our ABL Facility contains additional restrictive provisions that are imposed if “excess availability” falls below the greater of (x) 15% of the maximum credit under the ABL Facility and (y) $25.0 million for five (5) consecutive Business Days. Operating under “cash dominion” would increase our reporting requirements, operational complexities for the Company and permit the administrative agent to invoke control rights over certain of our accounts. Further, under the ABL Facility, we could in the future be required to maintain a fixed charge coverage ratio of 1.00 to 1.00 when “excess availability” falls below the greater of (i) 12.5% of the maximum credit under the ABL Facility and (y) $20.0 million. As of January 27, 2017, our fixed charge coverage ratio was less than 1.00 to 1.00. A decrease in excess availability as a result of decreases in inventory, increases in outstanding debt (including letters of credit) or otherwise, could cause our excess availability to fall below the “cash dominion” trigger, which would subject us to additional requirements and restrict access to borrowings under the ABL Facility, which would adversely affect our liquidity and our ability to execute our strategic plan.
Our debt agreements contain restrictions that limit our flexibility in operating our business.
Our Credit Facilities and the Indenture contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our Parent’s (solely with respect to our Credit Facilities) and our restricted subsidiaries’ ability to, among other things:
· incur additional indebtedness or issue certain preferred shares;
· pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;
· make certain investments;
· transfer or sell certain assets;
· create or incur liens;
· consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and
· enter into certain transactions with our affiliates.
A breach of any of these covenants could result in a default under one or more of these agreements, including as a result of cross default provisions, and, in the case of our Credit Facilities, permit the lenders to cease making loans to us. Upon the occurrence of an event of default under our Credit Facilities, the lenders could elect to declare all amounts outstanding under our Credit Facilities to be immediately due and payable and terminate all commitments to extend further credit under the ABL Facility. Such actions by those lenders could cause cross defaults under our other indebtedness. If we were unable to repay those amounts, the lenders under our Credit Facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of our assets as collateral under our Credit Facilities. If the lenders under our Credit Facilities accelerate the repayment of borrowings, we may not have sufficient assets to repay our Credit Facilities as well as our other indebtedness, including the Senior Notes.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under our Credit Facilities are at variable rates of interest and expose us to interest rate risk. If interest rates continue to increase, our debt service obligations on our variable rate indebtedness will increase even though the amount borrowed would remain the same, and our net income and cash flow, including cash available for servicing our indebtedness, will correspondingly decrease.
Changes in our credit ratings may limit our access to capital markets and adversely affect our liquidity.
The credit rating agencies periodically review our capital structure and the quality and stability of our earnings. Any future downgrades to our long-term credit ratings could result in reduced access to the credit and capital markets and higher interest costs on future financings. The future availability of financing will depend on a variety of factors such as economic and market conditions, the availability of credit and our credit ratings, as well as the possibility that lenders could develop a negative perception of us. There is no assurance that we will be able to obtain additional financing on favorable terms or at all.
Certain investment funds affiliated with Ares and CPPIB own substantially all the equity of Parent, and their interests may not be aligned with those of the holders of the Senior Notes.
We are controlled by Ares and CPPIB. Ares and CPPIB control the election of a majority of our directors and thereby have the power to control our affairs and policies, including the appointment of management, the issuance of additional stock and the declaration and payment of dividends. Ares and CPPIB do not have any liability for any obligations under the Senior Notes and their interests may be in conflict with yours. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, Ares and CPPIB may pursue strategies that favor equity investors over debt investors. In addition, our equity holders may have an interest in pursuing acquisitions, divestitures, financing or other transactions that, in their judgment, could enhance their equity investments, even though such transactions may involve risk to the holders of the Senior Notes. Additionally, Ares and CPPIB may make investments in businesses that directly or indirectly compete with us, or may pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. For information concerning our arrangements with Ares and CPPIB, see Item 13, “Certain Relationships and Related Transactions” for more information.
Investment funds advised by entities affiliated with Ares and CPPIB have in the past and may in the future buy or sell portions of our debt in open market transactions at any time.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of January 27, 2017, we owned 66 stores and leased 324 of our 390 store locations. Additionally, as of January 27, 2017, we owned four parcels of land for potential store sites.
Our leases generally provide for a fixed minimum rental, and some leases require additional rental based on a percentage of sales once a minimum sales level has been reached. Management believes that our stable operating history and ability to generate substantial customer traffic give us leverage when negotiating lease terms. Certain leases include cash reimbursements from landlords for leasehold improvements and other cash payments received from landlords as lease incentives. A large majority of our store leases were entered into with multiple renewal periods, which are typically five to ten years and occasionally longer.
The large majority of our store leases were entered into with multiple renewal options of typically five years per option. Historically, we have exercised the large majority of the lease renewal options as they arise, and anticipate continuing to do so for the majority of leases for the foreseeable future.
The following table sets forth, as of January 27, 2017, information relating to the calendar year expiration dates for our current store leases:
We own our main distribution center and executive office facility, located in the City of Commerce, California. We lease two warehouse facilities located in City of Commerce, California that expire in March 2018 and January 2030, respectively. We also lease a cold warehouse facility located in Los Angeles, California that expires in February 2029.
In calendar 2016, we exited two leased warehouse facilities to reduce our warehouse footprint in Southern California. In July 2016, we sold and concurrently licensed (through March 31, 2017) a warehouse facility in the City of Commerce, California. See Note 10 to the Consolidated Financial Statements for additional information.
We own a distribution center in the Houston area to service our Texas operations.
As our needs change, we may relocate, expand, and/or otherwise increase or decrease the size and/or costs of our distribution or warehouse facilities.
Item 3.
Item 3. Legal Proceedings
Information for this item is included in Note 10 to our Consolidated Financial Statements included in this Report, and incorporated herein by reference.
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
Market Information
Subsequent to the Merger, our membership units are privately held and there is no established public trading market for such units.
Dividends
We do not expect to make any dividends, distributions or other similar payments to Parent in the foreseeable future.
Item 6.
Item 6. Selected Financial Data
The selected consolidated financial data presented below as of January 27, 2017 and January 29, 2016 and for the years ended January 27, 2017, January 29, 2016 and January 30, 2015 have been derived from our Consolidated Financial Statements and notes thereto included in this Report. The selected consolidated financial data as of January 30, 2015, January 31, 2014 and March 30, 2013, and for the ten months ended January 31, 2014 and the year ended March 30, 2013 have been derived from our audited consolidated financial statements that are not included in this Report.
Fiscal years ended January 27, 2017, January 29, 2016 and January 30, 2015 are each comprised of 52 weeks. The period for the ten months ended January 31, 2014 is comprised of 44 weeks. The fiscal year ended March 30, 2013 is comprised of 52 weeks.
In the first quarter of fiscal 2015, we modified our definition of same-store sales. Previously, we defined same-store sales as sales at stores that have been open at least 15 months. In situations in which the store was relocated, or closed and later reopened in the same location, the affected store was considered a new store for any same-store sales analysis. A store would only be included in the same-store sales analysis once it had been open, or reopened, for 15 months. Under the new definition, same-store sales are sales at stores that have been open at least 14 months, including stores that have been remodeled, expanded or relocated during that period. Since we do not have e-commerce sales, such sales are not part of our same-store sales calculation. This change in definition of same-store sales was a prospective change and was made in order to be in line with our peers in the retail industry. This change in definition of same-store sales, if applied retrospectively, would not have had a material impact on the comparability of same-store sales for the prior periods presented.
Certain amounts as of and for the year ended January 29, 2016 have been revised to correct for immaterial errors as described in Note 1 to our Consolidated Financial Statements.
The historical results presented below are not necessarily indicative of the results to be expected for any future period. The information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and notes thereto included in this Report.
(a) Includes retail operating data solely for our 99¢ Only stores. For comparability purposes, average net sales per store and average net sales per estimated saleable square foot are based on a trailing 52-week period for all periods presented. Comparable same-store sales is based on a comparable 52-week period for all periods presented, except for the ten months ended January 31, 2014, which is based on a comparable 43-week period of the prior year.
(b) Change in comparable same-store sales compares net sales for all stores open at least 14 months.
(c) Change in comparable same-store sales compares net sales for all stores open at least 15 months.
(d) Computed based upon estimated total saleable square footage of stores open for at least 12 months.
(e) Certain prior year balance sheet amounts have been reclassified to conform to the current year’s presentation. Specifically, in fiscal 2017, we adopted an accounting standard that requires us to present debt issuance costs related to a recognized debt liability on the balance sheet as a direct deduction from the debt liability, similar to the presentation of original issue discounts (“OID”). The adoption of this accounting standard resulted in the reclassification of $11.5 million, $14.3 million, $16.7 million, $18.7 million of debt issuance costs (net of accumulated amortization) from deferred financing costs, net to long-term debt, net of current portion on our consolidated balance sheets at January 29, 2016, January 30, 2015, January 31, 2014 and March 31, 2013, respectively. We also early adopted a new accounting standard in fiscal 2017, which requires that all deferred tax assets and liabilities be classified as long-term on the balance sheet. The adoption of this accounting standard resulted in the reclassification of $16.6 million, $41.6 million, $47.0 million and $33.1 million of deferred income tax from current assets to long-term deferred income taxes liability on our consolidated balance sheets at January 29, 2016, January 30, 2015, January 31, 2014 and March 31, 2013, respectively. For additional information, see Note 2 to our Consolidated Financial Statements.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in connection with Item 1, “Business”, Item 6, “Selected Financial Data” and Item 8, “Financial Statements and Supplementary Data” of this Report.
Overview
On January 13, 2012, we were acquired through the Merger. See Item 1, “Business-Merger” for more information about the Merger.
We follow a fiscal calendar consisting of four quarters with 91 days, each ending on the Friday closest to the last day of April, July, October or January, as applicable, and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. Fiscal year 2017 consisted of 52 weeks beginning January 30, 2016 and ending January 27, 2017. Fiscal 2016 thus consisted of 52 weeks beginning January 31, 2015 and ending January 29, 2016. Fiscal 2015 consisted of 52 weeks beginning February 1, 2014 and ending January 30, 2015. Our fiscal 2018 will consist of 53 weeks beginning January 28, 2017 and ending February 2, 2018.
During fiscal 2017, we had net sales of $2,062.0 million, operating loss of $53.1 million and net loss of $118.2 million. Sales increased by 2.9% in fiscal 2017 over fiscal 2016 primarily due to increase in same-store sales of 2.1%, the full year effect of new stores opened in fiscal 2016 and the effect of five new stores opened in fiscal 2017. Average sales per store open at least 12 months, on a trailing 52-week period, were $5.2 million in fiscal 2017 compared to $5.1 million in in fiscal 2016. Average net sales per estimated saleable square foot (computed for stores open at least 12 months) on a trailing 52-week period were $319 per square foot for fiscal 2017 compared to $314 per square foot for fiscal 2016. Existing stores at January 27, 2017 averaged approximately 16,000 saleable square feet. Fiscal 2017 results were positively impacted by decrease in shrinkage compared to fiscal 2016 as further discussed under “Results of Operations- Fiscal Year Ended January 29, 2016 Compared to Fiscal Year Ended January 30, 2015-Gross Profit” and negatively impacted by higher payroll-related expenses as further discussed under “Results of Operations- Fiscal Year Ended January 27, 2017 Compared to Fiscal Year Ended January 29, 2016 - Selling, General and Administrative Expenses”.
The senior leadership team continues to focus on key strategies designed to enable us to profitably scale our business while continuing to meet the needs of our customers. These areas are discussed in detail under Item 1, “Business-Our Business Strategy”. A number of factors could prevent us from achieving our key strategies. See Item 1A, “Risk Factors,” for more information on such factors.
In fiscal 2016, we decided to reduce the pace of store openings to focus on stabilizing our operations and results. In fiscal 2017, we opened five stores in California and closed six stores upon the expiration of their leases, including five in California and one in Texas. The six closed stores were underperforming our overall chain average and, in a majority of the cases, we believe a substantial portion of the volume will be absorbed into other nearby 99¢ Only stores, thereby minimizing the impact on overall sales. The relocation and closures occurred at stores with expiring leases, and did not result in any material termination charges.
In fiscal 2018, we currently intend to open three new stores, all of which are expected to be opened in our existing markets. We believe that our near term growth in fiscal 2018 will primarily result from new store openings in our existing territories and increases in same-store sales.
Critical Accounting Policies and Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect reported earnings. These estimates and assumptions are evaluated on an on-going basis and are based on historical experience and other factors that management believes are reasonable. Estimates and assumptions include, but are not limited to, the areas of inventories, long-lived asset impairment, goodwill and other intangibles, legal reserves, self-insurance reserves, leases, taxes and stock-based compensation.
We believe that the following items represent the areas where more critical estimates and assumptions are used in the preparation of our financial statements:
Inventory valuation. Inventories are valued at the lower of cost or market. Inventory costs are established using a methodology that approximates first in, first out, which for store inventories is based on a retail inventory method. Valuation allowances for shrinkage, as well as excess and obsolete inventory are also recorded. We include spoilage, scrap and shrink in our definition of shrinkage. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. Physical inventory counts are taken at each of our retail stores at least once a year by an outside inventory service company. We perform inventory cycle counts at our warehouses throughout the year. We also perform inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory. The valuation allowances for excess and obsolete inventory are based on the age of the inventory, sales trends and future merchandising plans. The valuation
allowances for excess and obsolete inventory require management judgment and estimates that may impact the ending inventory valuation and valuation allowances that may have a material effect on the reported gross margin for the period. These estimates are subject to change based on management’s evaluation of, and response to, a variety of factors and trends, including, but not limited to, consumer preferences and buying patterns, age of inventory, increased competition, inventory management, merchandising strategies and historical sell through trends. Our ability to adequately evaluate the impact of inventory management and merchandising strategies executed in response to such factors and trends in future periods could have a material impact on such estimates.
In the fourth quarter of fiscal 2015, we recorded a charge for additional inventory shrinkage based upon the results of annual physical inventory counts completed during the quarter. This resulted in a net charge to cost of sales and a corresponding reduction in inventory of approximately $10.0 million, which was primarily related to the implementation of certain strategic initiatives, including the “Go Taller” store remodeling program. The “Go Taller” store remodeling program increased the amount of shelving space at our stores by raising the height of store shelves. During the remodeling and startup phase of the program, our retail stores remained open and many products were moved from the shelves to the floor to accommodate the remodeling, which we believe led to an increase in misplaced and damaged products. In anticipation of the extra shelf space, more inventory was shipped to our stores, which we believe also increased shrinkage. A reduction in workforce during transition fiscal 2014 resulted in the outsourcing of our Loss Prevention department, which was not reinstated in-house until the third quarter of fiscal 2016. These initiatives collectively disrupted our store operations, resulting in increased loss due to theft and misplaced and damaged inventory.
Considerable management judgment is necessary to estimate these inventory valuation reserves. As an indicator of the sensitivity of this estimate, a 10% increase in shrinkage and the excess and obsolete inventory provisions at January 27, 2017, would have increased these reserves by approximately $2.6 million and $0.2 million, respectively, and increased pre-tax loss in fiscal 2017 by the same amounts.
In order to obtain inventory at attractive prices, we take advantage of large volume purchases, closeouts and other similar purchase opportunities. Consequently, our inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities. Our inventory was $175.9 million as of January 27, 2017 and $196.7 million as of January 29, 2016. Inventory turnover, which we calculate by dividing cost of sales by ending inventory, was 8.3 times as of January 27, 2017 and 7.3 times as of January 29, 2016.
Long-lived asset impairment. We assess the impairment of depreciable long-lived assets when events or changes in circumstances indicate that the carrying value may not be recoverable. We group and evaluate long-lived assets for impairment at the individual store level, which is the lowest level at which individual identifiable cash flows are available. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. Factors that we consider important which could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner we use of the acquired assets or the strategy for our overall business; and (3) significant changes in our business strategies and/or negative industry or economic trends. On a quarterly basis, we assess whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable. Considerable management judgment is necessary to estimate projected future operating cash flows. Accordingly, if actual results fall short of such estimates, significant future impairments could result.
During the third quarter of fiscal 2017, we decided to close five retail stores in California by the end of fiscal 2017 upon the expiration of their respective lease terms. As a result of this decision, we recognized an impairment charge of approximately $0.1 million related to the closure of three of these stores and recorded an impairment charge of $0.1 million related to fixtures that will be disposed of and for which we concluded the fair value was zero. During fiscal 2017, we also reduced the carrying value of a held for sale property to the estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.2 million. During fiscal 2016, due to the underperformance of two stores in Texas and one store in California, we concluded that the carrying value of the long-lived assets relating to such stores were not recoverable and accordingly recorded an asset impairment charge of $0.8 million. During fiscal 2016, we also recorded impairment charges of $0.2 million related to equipment and fixtures that will be disposed of and for which we concluded the fair value was zero. During fiscal 2015, we wrote down the carrying value of a held for sale property to the estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.1 million. We have not made any material changes to our long-lived asset impairment methodology during fiscal 2017.
Goodwill and other intangible assets. The Merger was accounted for as a purchase business combination, whereby the purchase price paid was allocated to recognize the acquired assets and liabilities at their fair value. In connection with the purchase price allocation, certain intangible assets were established or revalued. The purchase price in excess of the fair value of assets and liabilities was recorded as goodwill. Management has determined that the Company has two reporting units, the wholesale reporting unit and the retail reporting unit.
Intangible assets with a definite life are amortized on a straight line basis over their useful lives. Amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on undiscounted cash flows, and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows used in the impairment tests.
Goodwill and indefinite-lived intangible assets, such as the 99¢ Only Stores trade name, are not amortized but are instead tested annually for impairment or more frequently when events or changes in circumstances indicate that the assets might be impaired. Goodwill is tested for impairment by comparing the carrying amount of the reporting unit to the fair value of the reporting unit to which the goodwill is assigned. We determine fair value based on a combination of the income approach and the market approach prepared by an independent third party valuation firm. Fair value of a trade name is determined using a relief from royalty method under the income approach, which uses projected revenue allocable to the trade name and an assumed royalty rate. These approaches involve making key assumptions about future cash flows, discount rates and asset lives using then best available information. These assumptions are subject to a high degree of complexity and judgment and are subject to change.
Our judgments are based on historical experience, current market trends and other information. Key assumptions used in the income approach include growth in net sales, new store openings and same-store sales, trends in cost of sales and selling, general and administrative expense, and changes in working capital. Future cash flow estimates are based on management’s knowledge of the current operating environment and expectations for the future, discount rates are based on an industry- and investment market- centered weighted average cost of capital for the expected target capital structure and asset lives are based on industry norms and management’s knowledge of our operating history. The market approach is based upon a review of comparable companies and transactions in our industry, including review of earnings and sales multiples.
In each case, these estimates and assumptions could be materially affected by factors such as unforeseen events or changes in general economic conditions, a decline in comparable company market multiples, changes to discount rates, increased competitive forces, our inability to maintain our pricing structure, deterioration of our vendor relationships, failure to adequately manage and improve our inventory processes and procedures and changes in customer behavior which could result in changes to management’s strategies. Such changes could affect the fair value of our retail reporting unit and ultimately result in an impairment charge.
During the third quarter of fiscal 2016, we determined that indicators of impairment existed to require an interim impairment analysis of goodwill and trade name, including (i) overall performance deterioration reflected in decreased comparable same-store sales and cannibalization from stores opened in fiscal 2015 under an accelerated expansion program, (ii) increases in inventory shrinkage and buildup of excess inventory, (iii) decreased margin due to disappointing results from sales promotions and (iv) a decision to delay the pace of future store openings. Our first step evaluation concluded that the fair value of the retail reporting unit was below its carrying value. We performed step two of the goodwill impairment test that requires the retail reporting unit’s fair value to be allocated to all of the assets and liabilities of the reporting unit, including any intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination, including consideration of the fair value of tangible property and intangible assets. As a result of this preliminary analysis and based on our best estimate, we recorded a $120.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2016, which was reflected as goodwill impairment in the consolidated statements of comprehensive income (loss). The finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in a $20.9 million adjustment in goodwill, lowering the third quarter of fiscal 2016 goodwill impairment charge from $120.0 million to $99.1 million.
During the fourth quarter of fiscal 2016, we completed step one of our annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of our reporting units exceeded their carrying amounts. The results of this test showed that the fair values of our retail reporting unit and wholesale reporting unit exceeded their carrying values by substantial amounts.
The remaining amount of goodwill allocated to the retail reporting unit and wholesale reporting unit was $368.1 and $12.5 million, respectively, as of January 29, 2016.
During the fourth quarter of fiscal 2017, we completed step one of our annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of our reporting units exceeded their carrying amounts. The results of this test showed that the fair value of our retail reporting unit exceeded its carrying value by a substantial amount. The fair value of our wholesale reporting unit exceeded carrying value by approximately 18%. As discussed above, considerable management judgment is necessary in estimating future cash flows, market interest rates, discount rates and other factors affecting the valuation of goodwill. The forecasts used in our fiscal 2017 annual impairment test include growth in net sales, new store openings and same-store sales, positive trends in cost of sales and selling, general and administrative expense. As described above, these estimates and assumptions could be materially affected by factors such as unforeseen events or changes in general economic conditions, a decline in comparable company market multiples, changes to discount rates, increased competitive forces, our inability to maintain our pricing structure, deterioration of our vendor relationships, failure to adequately manage and improve our inventory processes and procedures and changes in customer behavior which could result in changes to management’s strategies. If operating results continue to change versus our expectations, additional impairment charges may be recorded in the future. See Note 1 to our Consolidated Financial Statements.
Additionally, during the fourth quarter of fiscal 2017, we completed our annual indefinite-lived intangible asset impairment test and determined there was no impairment to the trade name since the fair value of the trade name exceeded its carrying amount. The results of this test showed that the fair value of trade name exceeded carrying value by approximately 18%. Fair value of the trade name was determined using the relief from royalty method that estimates our theoretical royalty savings from ownership of the intangible asset. Key assumptions used in this model included sales projections, discount rates and royalty rates, and considerable management judgment is necessary in developing and evaluating such assumptions. If future results are not consistent with our current estimates and assumptions, impairment charges maybe recorded in future.
Legal reserves. We are subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of business. A number of these lawsuits, proceedings and claims may exist at any given time. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business are expected to have a material adverse effect on our financial position, results of operations, or overall liquidity. Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our reports pursuant to the Securities Exchange Act of 1934, as amended. We record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.
There were no material changes in the estimates or assumptions used to determine legal reserves during fiscal 2017 and a 10% change in legal reserves would not be material to our consolidated financial position or results of operations.
Self-insured workers’ compensation liability. We self-insure for workers’ compensation claims in California and Texas. We have established a liability for losses from both estimated known and incurred but not reported insurance claims based on reported claims and actuarial valuations of estimated future costs of known and incurred but not yet reported claims. Should an amount of claims greater than anticipated occur, the liability recorded may not be sufficient and additional workers’ compensation costs, which may be significant, could be incurred. We do not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing our workers’ compensation liability. In fiscal 2016, we increased worker’s compensation liability reserve by $7.2 million primarily as a result of higher incurred and projected expenses associated with fiscal 2016 workers’ compensation claims. We implemented initiatives designed to create a culture of safety and to reduce the frequency and severity of workers’ compensation injuries. In the fourth quarter of fiscal 2017, we decreased workers’ compensation liability reserve by $5.6 million, primarily as a result of lower incurred and projected expenses associated with fiscal 2017 workers’ compensation claims. As an indicator of the sensitivity of this estimate, at January 27, 2017, a 10% increase in our estimate of expected losses from workers’ compensation claims would have increased this reserve by approximately $6.9 million and increased fiscal 2017 pre-tax loss by the same amount.
Self-insured health insurance liability. We self-insure for a portion of our employee medical benefit claims. The liability for the self-funded portion of our health insurance program is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported. We maintain stop loss insurance coverage to limit our exposure for the self-funded portion of our health insurance program. At January 27, 2017, a 10% change in self-insured health liability would not have been material to our consolidated financial position or results of operations.
Operating leases. We recognize rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred tenant improvements. Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.
In certain lease arrangements, we can be involved with the construction of the building. If it is determined that we have substantially all of the risks of ownership during construction of the leased property and therefore are deemed to be the owner of the construction project, we record an asset for the amount of the total project costs and an amount related to the value attributed to the pre-existing leased building in property and equipment, net and the related financing obligation as part of current and non-current liabilities. Once construction is complete, if it is determined that the asset does not qualify for sale-leaseback accounting treatment, we amortize the obligation over the lease term and depreciate the asset over the life of the lease. We do not report rent expense for the portion of the rent payment determined to be related to the assets which are owned for accounting purposes. Rather, this portion of the rent payment under the lease is recognized as a reduction of the financing obligation and interest expense.
For store closures where a lease obligation still exists, we record the estimated future liability associated with the rental obligation on the cease use date (when the store is closed). Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs. Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimation of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from our estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.
Tax Valuation Allowances and Contingencies. We recognize deferred tax assets and liabilities using the enacted tax rates for the effect of temporary differences between the financial reporting basis and tax basis of recorded assets and liabilities. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized.
We assess our ability to realize deferred tax assets throughout the fiscal year. As a result of this assessment during the second quarter of fiscal 2016, we concluded that it was more likely than not that we would not realize our deferred tax assets. In the quarters prior to the recording of a valuation allowance in the second quarter of fiscal 2016, we weighed all available positive and negative evidence and determined that it was more likely than not that the deferred tax assets were fully realizable. In fiscal 2016, management had begun to take meaningful steps to focus on the operational execution of the initiatives launched in fiscal 2015, which were expected to drive performance improvements over the second and third quarters of fiscal 2016. However, in the second quarter of fiscal 2016, we experienced (i) margin declines due to short-term sales promotions, (ii) delays in sales growth due to cannibalization from new store openings, (iii) increased inventory shrinkage from a buildup of inventory levels, and (iv) increases in support costs as a percentage of sales. As a result of these second quarter of fiscal 2016 events, we decided to adjust merchandise pricing strategies, delay the pace of future store openings for the remainder of fiscal 2016, revise inventory shrinkage processes and establish selling, general and administrative cost control measures. We concluded that until the performance issues identified in the second quarter of fiscal 2016 showed improvement, it was more likely than not that we would not realize our net deferred tax assets, and therefore we recorded a $31.7 million increase to provision for income taxes in order to establish a valuation allowance against such net deferred tax assets. See Note 5 to our Consolidated Financial Statements.
We had approximately $163.0 million of net deferred tax liabilities as of January 29, 2016, which was comprised of approximately $57.2 million of net deferred tax assets and $220.2 million of deferred tax liabilities, net of tax valuation allowance of $88.3 million. The increase in the valuation allowance was primarily related to an increase in losses incurred during fiscal 2016. We had approximately $161.5 million of net deferred tax liabilities as of January 27, 2017, which was comprised of approximately $32.0 million of net deferred tax assets and $193.5 million of deferred tax liabilities, net of tax valuation allowance of $137.7 million. Management re-evaluated the available evidence in assessing our ability to realize the benefits of our deferred tax assets at January 27, 2017 and concluded it was more likely than not that we would not realize our net deferred tax assets. Significant management judgment is required in accounting for income tax contingencies as the outcomes are often difficult to predict. There are no uncertain tax positions at January 27, 2017.
Stock-Based Compensation. Subsequent to the Merger, Parent issued options to acquire shares of common stock of our Parent to certain of our executive officers and employees. We account for stock-based payment awards based on their fair values. Stock options have a term of ten years. For awards classified as equity, we estimate the fair value for each option award as of the date of grant using the Black-Scholes option pricing model or other appropriate valuation models. Assumptions utilized to value options include estimating the fair value of Parent’s common stock (which is not publicly traded), the term that the options are expected to be outstanding, an estimate of the volatility of Parent’s stock price (which is based on a peer group of publicly traded companies), applicable interest rates and the expected dividend yield of Parent’s common stock. Other factors involving judgments that affect the expensing of stock-based payments include estimated forfeiture rates of stock-based awards. All of the outstanding options that we have granted to our executive officers and employees (with the exception of options granted to our current Chief Financial Officer and certain directors that contain less restrictive repurchase rights) give the Parent repurchase rights as described in more detail in Note 11 to our Consolidated Financial Statements. In accordance with accounting guidance, we have not recorded any stock-based compensation expense for these grants. For all other time-based options, the value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods, which is generally a vesting term of four or five years. For options that vest based on achievement of performance targets, compensation expense will be recognized only when it is probable that applicable performance criteria will be met. As described in Note 11 to our Consolidated Financial Statements, we granted options to our current Chief Executive Officer that are valued using binomial model and a Monte Carlo simulation method. For the reasons set forth above, the Company has deferred recognition of the stock-based compensation expense for these stock options.
Results of Operations
The following discussion defines the components of the statement of income and should be read in conjunction with Item 6, “Selected Financial Data.”
Net Sales: Revenue is recognized at the point of sale in our stores (“retail sales”). Bargain Wholesale sales revenue is recognized in accordance with the shipping terms agreed upon on the purchase order. Bargain Wholesale sales are typically recognized free on board origin, where title and risk of loss pass to the buyer when the merchandise leaves our distribution facility.
Cost of Sales: Cost of sales includes the cost of inventory, freight in, obsolescence, spoilage, scrap and inventory shrinkage, and is net of discounts and allowances. Cost of sales also includes receiving, warehouse costs and distribution costs (which include payroll and associated costs, occupancy, transportation to and from stores and depreciation expense). Cash discounts for satisfying early payment terms are recognized when payment is made, and allowances and rebates based upon milestone achievements such as reaching a certain volume of purchases of a vendor’s products, are included as a reduction of cost of sales when such contractual milestones are reached or based on other systematic and rational approaches where possible.
Selling, General, and Administrative Expenses: Selling, general and administrative expenses include the costs of selling merchandise in stores (which include payroll and associated costs, occupancy and other store-level costs) and corporate costs (which include payroll and associated costs, occupancy, advertising, professional fees and other corporate administrative costs). Selling, general and administrative expenses also include depreciation and amortization expense relating to these costs.
Goodwill Impairment: Represents the goodwill impairment charge measured by comparing the implied fair value of goodwill (determined as a result of our third quarter of fiscal 2016 interim impairment analysis) with the carrying amount of goodwill. See “Critical Accounting Policies and Estimates-Goodwill and other intangible assets.”
Other Expense (Income): Other expense relates primarily to loss on extinguishment of debt, interest expense on our debt, capitalized and financing leases and other interest.
Certain amounts as of and for the year ended January 29, 2016 have been revised to correct immaterial errors as described in Note 1 to our Consolidated Financial Statements.
The following table sets forth, for the periods indicated, certain selected income statement data, including such data as a percentage of net sales. The years ended January 27, 2017, January 29, 2016, and January 30, 2015 each consist of 52 weeks (the percentages may not add up due to rounding):
Fiscal Year Ended January 27, 2017 (52 Weeks) Compared to Fiscal Year Ended January 29, 2016 (52 Weeks)
Net sales. Total net sales increased $58.0 million, or 2.9%, to $2,062.0 million in fiscal 2017, a 52-week period, from $2,004.0 million in fiscal 2016, also a 52-week period. Net retail sales increased $61.9 million, or 3.2%, to $2,023.0 million in fiscal 2017, from $1,961.1 million in fiscal 2016. Bargain Wholesale net sales decreased by approximately $3.9 million, or 9.2%, to $39.0 million in fiscal 2017, from $42.9 million in fiscal 2016. Of the $61.9 million increase in net retail sales, $41.1 million was due to a 2.1% increase in same-store sales for all stores open at least 14 months, the effect of new stores opened in fiscal 2017 was $15.8 million and the full year effect of new stores opened in or prior to fiscal 2016 was $12.1 million. The increase in retail sales was partially offset by a decrease in sales of approximately $7.1 million due the impact of closed stores. Same-store sales increased 2.1% compared to fiscal 2016, with higher average ticket of 1.7% and higher customer traffic of 0.4%. The increase in same-store sales was primarily driven by higher sales from fresh offerings as a result of better product availability, improved in-stock levels and the expansion of our third party distributor partnership, as well as improved sales from general merchandise driven by better product assortment and higher seasonal sales achieved in part through improved store execution. These improvements were partially offset by the ongoing deflationary environment in milk and eggs, which persisted throughout fiscal 2017.
During fiscal 2017, we opened five stores in California and closed six stores in fiscal 2017 upon expiration of their leases, including five in California and one in Texas. At the end of fiscal 2017, we had 390 stores compared to 391 stores at the end fiscal 2016. Estimated saleable retail square footage as of January 27, 2017 and January 29, 2016 was 6.31 million and 6.30 million, respectively. For 99¢ Only stores open all of fiscal 2017, the average net sales per estimated saleable square foot was $5.2 million per store and $319 per estimated saleable square foot.
Gross profit. Gross profit increased $39.0 million, or 6.9% to $601.4 million in fiscal 2017, compared to $562.4 million in fiscal 2016. As a percentage of net sales, overall gross margin increased to 29.2% in fiscal 2017, from 28.1% in fiscal 2016. Among the gross profit components, shrinkage improved by 60 basis points compared to fiscal 2016 as a result of positive trends in recent physical counts that we believe were driven by ongoing initiatives that identify and reduce shrinkage, including loss prevention efforts and adherence to disciplined inventory management processes. Product margin was flat compared to fiscal 2016 as lower inbound freight and duty costs were offset by our efforts to reduce excess inventory through clearance initiatives as well as an unfavorable product mix shift. Distribution and transportation expenses decreased by 10 basis points primarily due to lower distribution costs. The remaining improvements in gross profit were attributable to other less significant items included in costs of sales.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by $40.5 million, or 6.6%, to $654.5 million in fiscal 2017, from $614.0 million in fiscal 2016. As a percentage of net sales, selling, general and administrative expenses increased to 31.7% for fiscal 2017 from 30.6% for fiscal 2016. The 110 basis point increase in selling, general and administrative expenses as a percentage of net sales was driven by a number of factors. Payroll-related expenses increased by 120 basis points, primarily due to an increase in the California minimum wage, which went into effect in January 2016, and higher performance compensation expenses. In addition selling, general and administrative expenses were negatively impacted by the anniversary of a $5.4 million gain realized on the sale of a cold storage facility during the third quarter of fiscal 2016 as well as higher outside services expenses. These increases were partially offset by a 50 basis points decrease in workers’ compensation accrual, primarily driven by lower incurred and projected expenses associated with workers’ compensation claims in fiscal 2017 and prior years.
Goodwill impairment. During the third quarter of fiscal 2016, we recorded a best estimate of $120.0 million non-cash goodwill impairment charge relating to the retail reporting unit. The finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in $20.9 million adjustment in goodwill, lowering the third quarter of fiscal 2016 goodwill impairment charge to $99.1 million. Significant changes in assumptions that led to the goodwill impairment included decreases in new store expansion for all future years, slower sales growth from new store additions and gross margin compression. The goodwill impairment charge did not adversely affect our debt position, cash flow, liquidity or compliance with financial covenants. See Note 1 to the Consolidated Financial Statements.
Operating loss. Operating loss was $53.1 million for fiscal 2017, compared to operating loss of $150.8 million for fiscal 2016. Operating loss as a percentage of net sales was (2.6)% in fiscal 2017 compared to operating loss as a percentage of sales of (7.5)% in fiscal 2016. The decrease in operating loss as a percentage of net sales was primarily due to favorable comparison to prior year that included a goodwill impairment charge as well as changes in gross margin and selling, general, and administrative expenses, as discussed above.
Interest expense and loss on extinguishment of debt. Interest expense was $68.8 million in fiscal 2017, compared to $65.6 million in in fiscal 2016. Interest expense was higher primarily due to amortization of debt issuance costs, interest expense on financing leases and interest on estimated sales tax liability. Loss on extinguishment of debt was $0.3 million relating to the amendment of the ABL Facility in April 2016.
(Benefit) provision for income taxes. The provision for income taxes was a benefit of $4.0 million in fiscal 2017, compared to an income tax provision of $31.9 million in fiscal 2016, primarily due to the establishment of a valuation allowance of $31.7 million in the second quarter of fiscal 2016 against deferred income tax assets (as described in Note 5 to our Consolidated Financial Statements). The effective tax rate for fiscal 2017 was a benefit rate of 3.3% compared to an effective tax rate of 14.8% for fiscal 2016. The effective combined federal and state income tax rates for fiscal 2017 differ from the statutory rates primarily due to recording of additional valuation allowance for losses sustained in fiscal 2017 (as described in Note 5 to our Consolidated Financial Statements) and the benefit of a tax credit carryback for fiscal 2017. The effective combined federal and state income tax rates for fiscal 2016 differ from the statutory rates primarily due to the non-deductible goodwill impairment charge and the establishment of a valuation allowance in fiscal 2016 (as described in Note 5 to our Consolidated Financial Statements).
Net loss. As a result of the items discussed above, net loss for fiscal 2017 was $118.2 million, compared to net loss for fiscal 2016 of $248.4 million. Net loss as a percentage of net sales was (5.7)% in fiscal 2017 compared to net loss as a percentage of net sales of (12.4)% in fiscal 2016.
Fiscal Year Ended January 29, 2016 (52 Weeks) Compared to Fiscal Year Ended January 30, 2015 (52 Weeks)
Net sales. Total net sales increased $77.1 million, or 4.0%, to $2,004.0 million in fiscal 2016, a 52-week period, from $1,926.9 million in fiscal 2015, also a 52-week period. Net retail sales increased $79.2 million, or 4.2%, to $1,961.1 million in fiscal 2016, from $1,881.9 million in fiscal 2015. Bargain Wholesale net sales decreased by approximately $2.1 million, or 4.7%, to $42.9 million in fiscal 2016, from $45.1 million in fiscal 2015. Of the $79.2 million increase in net retail sales, the full year effect of new stores opened in or prior to fiscal 2015 was $112.3 million, and the effect of new stores opened in fiscal 2016 was $17.3 million. Net retail sales for stores that were open at least 14 months in fiscal 2016 decreased $50.4 million, representing a 2.7% decrease in same-store sales over a comparable 52-week period of the prior year. The 2.7% decrease in same-store sales was due to a 4.5% decrease in customer traffic, partially offset by higher average ticket of 1.9%. Same-store sales were affected by a number of factors, including challenges in produce and consumables sales caused, in part, by elevated out-of-stock levels as a result of the unsuccessful implementation of a new allocation and replenishment system as well as the disruptions stemming from the transition back to the legacy allocation and replenishment system and poor product availability, the cannibalization impact of recent new store openings, and the implementation of ongoing initiatives meant to clear on-hand seasonal inventory through promotions and mark-downs. These challenges were partially offset by higher sales in general merchandise departments caused, in part, by introduction of new product assortments.
During fiscal 2016, we added eight new stores: six in California and two in Arizona. At the end of fiscal 2016, we had 391 stores compared to 383 stores at the end fiscal 2015. Estimated saleable retail square footage as of January 29, 2016 and January 30, 2015 was 6.30 million and 6.19 million, respectively. For 99¢ Only stores open all of fiscal 2016, the average net sales per estimated saleable square foot was $5.1 million per store and $314 per estimated saleable square foot.
Gross profit. Gross profit was $562.4 million in fiscal 2016, compared to $618.1 million in fiscal 2015. As a percentage of net sales, overall gross margin decreased to 28.1% in fiscal 2016, from 32.1% in fiscal 2015. Among the gross profit components, cost of products sold increased by 180 basis points compared to fiscal 2015, which was primarily due to a combination of higher inbound freight and duty costs that negatively impacted gross margin by approximately 90 basis points and lower product margin which also negatively impacted gross margin by approximately 90 basis points. The lower product margin was primarily driven by margin compression in our fresh, grocery and consumables offerings, which negatively impacted margin by approximately 70 basis points and our efforts to reduce seasonal inventory through accelerated implementation of inventory clearance initiatives, which negatively impacted margin by approximately 30 basis points. These negative impacts were partially offset by a shift in product mix toward higher margin general merchandise products, which improved margin by approximately 30 basis points. This shift to higher margin general merchandise products was not part of a specific Company strategy but rather due to opportunistic purchases made by us during the period, which are inconsistent in nature, as well as other external economic factors outside our control that lowered product costs generally. We do not expect this shift to have a continuing impact on gross profit. Based on the results of physical inventory counts completed during the year, inventory shrinkage increased 130 basis points compared to fiscal 2015. Distribution and transportation expenses increased 40 basis points primarily due to higher transportation costs. The remaining change was attributable to other less significant items included in costs of sales.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by $67.8 million, or 12.4%, to $614.0 million in fiscal 2016, from $546.3 million in fiscal 2015. As a percentage of net sales, selling, general and administrative expenses increased to 30.6% for fiscal 2016 from 28.3% for fiscal 2015. The 230 basis point increase in selling, general and administrative expenses as a percentage of net sales was primarily driven by increases in store level payroll, workers’ compensation accrual and occupancy expenses, together accounting for 130 basis points, as well as higher depreciation and amortization and outside professional fees. Selling, general and administrative expenses as a percentage of sales were negatively impacted by the opening of new stores in the prior fiscal year and an increase in the minimum wage in California, as well as negative operating leverage as a result of the decline in same-store sales during the second half of fiscal 2016. Depreciation and amortization
expense was 40 basis points higher due to the information system implementation, new store openings and the implementation of the “Go Taller” store remodeling program. In the fourth quarter of fiscal 2016, selling, general and administrative expense included an increase in workers’ compensation accrual of $6.6 million, representing 30 basis points, which was primarily the result of higher incurred and projected expenses associated with fiscal 2016 workers’ compensation claims. Outside professional fees were higher primarily due to charges relating to previously capitalized store and distribution center real estate development costs expensed in the second quarter of fiscal 2016 as a result of cancelled projects, as well as costs relating to executive transitions. These increases were partially offset by a gain of $5.4 million realized on the sale of a cold storage facility during the third quarter of fiscal 2016.
Goodwill impairment. During the third quarter of fiscal 2016, we recorded a best estimate of $120.0 million non-cash goodwill impairment charge relating to the retail reporting unit. The finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in $20.9 million adjustment in goodwill, lowering the third quarter of fiscal 2016 goodwill impairment charge to $99.1 million. Significant changes in assumptions that led to the goodwill impairment included decreases in new store expansion for all future years, slower sales growth from new store additions and gross margin compression. The goodwill impairment charge did not adversely affect our debt position, cash flow, liquidity or compliance with financial covenants. See Note 1 to the Consolidated Financial Statements.
Operating (loss) income. Operating loss was $150.8 million for fiscal 2016, compared to operating income of $71.8 million for fiscal 2015. Operating loss as a percentage of net sales was (7.5)% in fiscal 2016 compared to operating income of 3.7% in fiscal 2015. The decrease in operating income as a percentage of net sales was primarily due to the recording of a goodwill impairment charge, changes in gross margin and selling, general, and administrative expenses, each as discussed above.
Interest expense. Interest expense was $65.6 million in fiscal 2016, compared to $62.7 million in in fiscal 2015. Interest expense was higher primarily due to interest expense on financing leases and higher average borrowings under the ABL Facility (as discussed below).
Provision for income taxes. The provision for income taxes was $31.9 million in fiscal 2016, compared to an income tax provision of $3.6 million in fiscal 2015, primarily due to the establishment of a valuation allowance of $31.7 million in the second quarter of fiscal 2016 against deferred income tax assets (as described in Note 5 to our Consolidated Financial Statements). The effective tax rate for fiscal 2016 was a provision rate of 14.8% compared to an effective tax rate of 39.6% for fiscal 2015. The effective combined federal and state income tax rates for fiscal 2016 differ from the statutory rates primarily due to the non-deductible goodwill impairment charge and the establishment of a valuation allowance in fiscal 2016 (as described in Note 5 to our Consolidated Financial Statements). The effective combined federal and state income tax rates for fiscal 2015 differ from the statutory rates primarily due to the non-deductibility of certain costs.
Net (loss) income. As a result of the items discussed above, net loss for fiscal 2016 was $248.4 million, compared to net income for fiscal 2015 of $5.5 million. Net loss as a percentage of net sales was (12.4)% in fiscal 2016 compared to net income as a percentage of net sales of 0.3% in fiscal 2015.
Effects of Inflation
During fiscal 2017, fiscal 2016 and fiscal 2015, inflation did not have a material impact on our overall operations. Increases in various costs due to future inflation may impact our operating results to the extent that such increases cannot be passed along to our customers. See Item 1A, “Risk Factors-Risks Related to Our Business- Increases in costs and other inflationary pressures may affect our ability to keep pricing almost all of our merchandise at 99.99¢ or less.”
Liquidity and Capital Resources
Our capital requirements consist primarily of purchases of inventory, expenditures related to new store openings, investments in information technology and supply chain infrastructure, working capital requirements for new and existing stores, including lease obligations, and debt service requirements. Our primary sources of liquidity are the net cash flow from operations and availability under our ABL Facility, which we believe will be sufficient to fund our regular operating needs and principal and interest payments on our indebtedness, for at least the next 12 months. Availability under our ABL Facility is not expected to materially affect our ability to make immediate buying decisions, willingness to take on large volume purchases or ability to pay cash or accept abbreviated credit terms.
As of January 27, 2017, we held $2.4 million in cash, and our total indebtedness was $883.2 million, consisting of gross borrowings under the First Lien Term Loan Facility of $593.9 million, borrowings under the ABL Facility of $39.3 million and $250.0 million of our Senior Notes. As of January 27, 2017, availability under the ABL Facility (subject to the borrowing base) was $37.2 million and, subject to certain limitations and the satisfaction of certain conditions, including the receipt of commitments for additional borrowings, we were also permitted to incur up to an aggregate of $50.0 million of additional borrowings pursuant to incremental facilities under the First Lien Term Loan Facility and up to an aggregate of $25.0 million of additional revolving commitments (subject to the borrowing base) pursuant to the ABL Facility. The First Lien Term Loan Facility matures on January 13, 2019, and our Senior Notes mature on December 15, 2019. While the maturity date of our ABL Facility has been conditionally extended to April 8, 2021 in connection with the Fourth Amendment, such extension resulted in higher interest rates and, if our First Lien Term Loan Facility and Senior Notes are not refinanced or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021, our ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of our First Lien Term Loan Facility and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes. We may pursue a refinancing of our other long-term obligations, but potential volatility and challenges in the then-current capital markets, including conditions affecting borrowing costs, could limit our ability to refinance at favorable terms, and could have a material adverse impact on our future financial condition. We also have, and will continue to have, significant lease obligations. As of January 27, 2017, our minimum annual rental obligations under long-term leases for fiscal 2018 are $84.8 million. These obligations are significant and could affect our ability to pursue significant growth initiatives, such as strategic acquisitions, in the future. However, we expect to be able to service these obligations from our net cash flow from operations and availability under our ABL Facility, and we do not expect these obligations to negatively affect our expansion plans for the foreseeable future, including our plans to increase our store count, planned upgrades to our information technology systems and other planned capital expenditures.
Credit Facilities and Senior Notes
On January 13, 2012 (the “Original Closing Date”), in connection with the Merger, we obtained Credit Facilities provided by a syndicate of lenders arranged by Royal Bank of Canada as administrative agent, as well as other agents and lenders that are parties to these Credit Facilities. The Credit Facilities include our ABL Facility and our First Lien Term Loan Facility.
First Lien Term Loan Facility
Under the First Lien Term Loan Facility, (i) $525.0 million of term loans were incurred on the Original Closing Date and (ii) $100.0 million of additional term loans were incurred pursuant to an incremental facility effected through an amendment entered into on October 8, 2013 (the “Second Amendment”) (all such term loans, collectively, the “Term Loans”). The First Lien Term Loan Facility has a term of seven years with a maturity date of January 13, 2019. All obligations under the First Lien Term Loan Facility are guaranteed by Parent and our direct or indirect 100% owned domestic subsidiaries (with customary exceptions, including immaterial subsidiaries) (collectively, the “Credit Facilities Guarantors”). In addition, the First Lien Term Loan Facility is secured by pledges of certain of our equity interests and the equity interests of the Credit Facilities Guarantors.
We are required to make scheduled quarterly payments each equal to 0.25% of the principal amount of the Term Loans, with the balance due on the maturity date. Borrowings under the First Lien Term Loan Facility bear interest at an annual rate equal to an applicable margin plus, at the Company’s option, either (i) a base rate (the “Base Rate”) determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as the “Prime Rate” (3.75% as of January 27, 2017), (b) the federal funds effective rate plus 0.50% and (c) an adjusted Eurocurrency rate for one month (determined by reference to the greater of the
Eurocurrency rate for the interest period subject to certain adjustments) plus 1.00%, or (ii) a Eurocurrency rate determined by reference to the London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserve requirements, for the interest period relevant to such borrowing.
On April 4, 2012, we amended the terms of the First Lien Term Loan Facility (the “First Amendment”) and incurred related refinancing costs of $11.2 million. The First Amendment, among other things, (i) decreased the applicable margin from LIBOR plus 5.50% (or Base Rate plus 4.50%) to LIBOR plus 4.00% (or Base Rate plus 3.00%) and (ii) decreased the LIBOR floor from 1.50% to 1.25%.
On October 8, 2013, we entered into the Second Amendment which among other things, (i) provided $100.0 million of additional term loans as described above, (ii) decreased the applicable margin from LIBOR plus 4.00% (or Base Rate plus 3.00%) to LIBOR plus 3.50% (or Base Rate plus 2.50%) and (iii) decreased the LIBOR floor from 1.25% to 1.00%. The Second Amendment required scheduled quarterly payments each equal to 0.25% of the amended principal amount of the Term Loans (approximately $1.5 million).
In addition, the Second Amendment (i) amended certain restricted payment provisions, (ii) removed the maximum capital expenditures covenant from the agreement governing the First Lien Term Loan Facility, (iii) modified the existing provision restricting our ability to make dividend and other payments so that from and after March 31, 2013, the permitted payment amount represents the sum of (a) a calculation based on 50% of Consolidated Net Income (as defined in the First Lien Term Loan Facility agreement), if positive, or a deficit of 100% of Consolidated Net Income, if negative, and (b) $20 million, and (iv) permitted proceeds of any sale leasebacks of any assets acquired after January 13, 2012, to be reinvested in our business without restriction.
As of January 27, 2017 and January 29, 2016, the interest rate on the First Lien Term Loan Facility was 4.50% (1.00% Eurocurrency rate, plus the Eurocurrency loan margin of 3.50%). As of January 27, 2017 and January 29, 2016, the gross amount outstanding under the First Lien Term Loan Facility was $593.9 million and $600.0 million, respectively.
Following the end of each fiscal year, we are required to make prepayments on the First Lien Term Loan Facility in an amount equal to (i) 50% of Excess Cash Flow (as defined in the agreement governing the First Lien Term Loan Facility), with the ability to step down to 25% and 0% upon achievement of specified total leverage ratios, minus (ii) the amount of certain voluntary prepayments made on the First Lien Term Loan Facility and/or the ABL Facility during such fiscal year. There was no Excess Cash Flow payment required for fiscal 2017, fiscal 2016 and fiscal 2015.
The First Lien Term Loan Facility includes certain customary restrictions, among other things, on our ability and the ability of Parent, the Credit Facilities Guarantors (including our subsidiary 99 Cents Only Stores Texas Inc. (“99 Cents Texas”)) and certain future subsidiaries of ours to incur or guarantee additional indebtedness, make certain restricted payments, acquisitions or investments, materially change our business, incur or permit to exist certain liens, enter into transactions with affiliates, sell assets, make capital expenditures or merge or consolidate with or into, another company. As of January 27, 2017, we were in compliance with the terms of the First Lien Term Loan Facility.
As of January 27, 2017, various funds affiliated with Ares and CPPIB held approximately $130.5 million of term loans under the First Lien Term Loan Facility. From time to time, these or other affiliated funds may hold additional term loans. The terms of these term loans are the same as those held by unaffiliated third party lenders under the First Lien Term Loan Facility.
ABL Facility
The ABL Facility initially provided for up to $175.0 million of borrowings, subject to certain borrowing base limitations. Subject to certain conditions, we could increase the commitments under the ABL Facility by up to $50.0 million. All obligations under the ABL Facility are guaranteed by Parent and the other Credit Facilities Guarantors. The ABL Facility is secured by substantially all of our assets and the assets of the Credit Facilities Guarantors, including a first priority security interest in certain current assets, and a second priority pledge of all of our equity interests and the equity interests of the Credit Facilities Guarantors and second priority security interest in certain other fixed assets.
Borrowings under the ABL Facility bear interest at a rate based, at our option, on (i) LIBOR plus an applicable margin to be determined (3.00% as of January 27, 2017) or (ii) the determined base rate (Prime Rate) plus an applicable margin to be determined (2.00% at January 27, 2017), in each case based on a pricing grid depending on average daily excess availability for the most recently ended quarter. The weighted average interest rate for borrowings under the ABL Facility was 4.18% as of January 27, 2017 and 2.53% as of January 29, 2016.
In addition to paying interest on outstanding principal under the Credit Facilities, we are required to pay a commitment fee to the lenders under the ABL Facility on unused commitments. The commitment fee is adjusted at the beginning of each quarter based upon the average historical excess availability of the prior quarter (0.50% for the quarter ended January 27, 2017 and January 29, 2016). We must also pay customary letter of credit fees and agency fees.
As of January 27, 2017, borrowings under the ABL Facility were $39.3 million, outstanding letters of credit were $31.6 million and availability under the ABL Facility subject to the borrowing base, was $37.2 million. As of January 29, 2016, borrowings under the ABL Facility were $47.8 million, outstanding letters of credit were $2.5 million and availability under the ABL Facility subject to the borrowing base, was $90.9 million, prior to giving effect to a subsequent amendment to the ABL Facility on April 8, 2016 that decreased commitments available under the ABL Facility by $25.0 million.
The ABL Facility includes restrictions on our ability and the ability of Parent and certain of our subsidiaries to incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, its capital stock, make certain acquisitions or investments, materially change its business, incur or permit to exist certain liens, enter into transactions with affiliates, sell assets or merge or consolidate with or into another company.
On October 8, 2013, we amended the ABL Facility to, among other things, modify the provision restricting our ability to make dividend and other payments. Such payments are subject to achievement of Excess Availability (as defined in the agreement governing the ABL Facility) and a ratio of EBITDA (as defined in the agreement governing the ABL Facility) to fixed charges.
On August 24, 2015, we amended the ABL Facility to increase commitments available under ABL Facility by $10.0 million, resulting in an aggregate ABL Facility size of $185.0 million. The additional commitments implemented pursuant to the amendment have terms identical to the existing commitments under the ABL Facility, including as to interest rate and other pricing terms. We paid amendment fees of $0.5 million to lenders under the ABL Facility.
In addition, the amendment to the ABL Facility (i) modified certain springing covenants triggered by reference to excess availability under the ABL Facility agreement so that, from August 24, 2015 to April 30, 2016, the occurrence of any such excess availability trigger is determined solely by reference to the available borrowing base under the ABL Facility rather than by reference to the lesser of the available borrowing base and the available aggregate commitments under the ABL Facility, (ii) increased the inventory advance rate during such period for purposes of calculating the borrowing base from 90% to 92.5%, (iii) provided for certain additional inspection rights by the administrative agent if there is a material increase in the amount of inventory that is not eligible inventory for purposes of the borrowing base and (iv) provided for certain additional technical waivers and amendments in order to effect the foregoing.
On April 8, 2016, we amended the ABL Facility to, among other things, decrease the commitments available under the ABL Facility by $25.0 million, resulting in an aggregate facility size of $160.0 million, and extend the maturity date of the ABL Facility to April 8, 2021; provided however, the ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of the First Lien Term Loan Facility and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes, unless the First Lien Term Loan Facility and Senior Notes have been repaid or refinanced in full or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021 (the date of such repayment or refinancing, the “Term/Notes Refinancing Date” (such amendment, the “Fourth Amendment”). The Fourth Amendment also modified the interest rate margins payable under the ABL Facility. The initial applicable margin for borrowings under the ABL Facility is 2.0% with respect to base rate borrowings and 3.0% with respect to Eurocurrency rate borrowings. Commencing with the first day of the first fiscal quarter commencing after the closing of the Fourth Amendment, the applicable margin for borrowings thereunder is subject to adjustment each fiscal quarter, based on average historical excess availability during the preceding fiscal quarter. Furthermore, the applicable margin will be reduced by 0.50% after the Term/Notes Refinancing Date.
In addition, the Fourth Amendment (i) reduced the incremental revolving commitment capacity from $50.0 million to $25.0 million, but provides that any such incremental revolving commitment may take the form of a “last-out” term loan, (ii) added restrictions on certain negative covenants in respect of investments, restricted payments and prepayments of indebtedness, including the First Lien Term Loan Facility and the Senior Notes, in each case, until the occurrence of Term/Notes Refinancing Date, (iii) reduced the letter of credit sublimit from $50.0 million to $45.0 million and (iv) provided for certain additional technical waivers and amendments in order to effect the foregoing.
In connection with the Fourth Amendment and in the first quarter of fiscal 2017, we recognized a loss on debt extinguishment of approximately $0.3 million related to a portion of the unamortized debt issuance costs. We recorded $4.7 million of debt issuance costs in connection with the Fourth Amendment in the first quarter of fiscal 2017 as part of non-current deferred financing costs.
As of January 27, 2017, we were in compliance with the terms of the ABL Facility.
Senior Notes
On December 29, 2011, we issued the Senior Notes that mature on December 15, 2019. The Senior Notes are guaranteed by the same subsidiaries that guarantee the Credit Facilities.
Pursuant to the terms of the Indenture, we may redeem all or a part of the Senior Notes at certain redemption prices that vary based on the date of redemption. We are not required to make any mandatory redemptions or sinking fund payments, and may at any time or from time to time purchase notes in the open market.
The Indenture contains covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to incur or guarantee additional indebtedness, create or incur certain liens, pay dividends or make other restricted payments and investments, incur restrictions on the payment of dividends or other distributions from restricted subsidiaries, sell assets, engage in transactions with affiliates, or merge or consolidate with other companies. As of January 27, 2017, we were in compliance with the terms of the Indenture.
As of January 27, 2017, various funds affiliated with Ares and CPPIB have collectively acquired $102.1 million aggregate principal amount of our Senior Notes in open market transactions. From time to time, these or other affiliated funds may acquire additional Senior Notes.
Cash Flows
Operating Activities
Cash provided by operating activities in fiscal 2017 was $16.6 million and consisted of (i) net loss of $118.2 million; (ii) net loss adjustments for depreciation and other non-cash items of $80.7 million; (iii) an increase in working capital activities of $46.1 million; and (iv) an increase in other activities of $7.9 million, primarily due to an increase in other long-term liabilities. The increase in working capital activities was primarily due to a decrease in inventory and increase in accrued expenses and accounts payable, partially offset by decrease in accrued workers’ compensation. Inventory decreased primarily as a result of a focused effort on inventory and supply chain efficiencies.
Cash provided by operating activities in fiscal 2016 was $31.7 million and consisted of (i) net loss of $248.4 million; (ii) net income adjustments for depreciation, deferred taxes, goodwill impairment and other non-cash items of $206.9 million; (iii) an increase in working capital activities of $67.4 million; and (iv) an increase in other activities of $5.8 million, primarily due to increased deferred rent and other long-term liabilities. The increase in working capital activities was primarily due to a decrease in inventory and income taxes receivable, partially offset by decreases in accounts payable. Inventory decreased primarily as a result of a Company-wide strategy to reduce inventory.
Cash provided by operating activities in fiscal 2015 was $38.3 million and consisted of (i) net income of $5.5 million; (ii) net income adjustments for depreciation and other non-cash items of $69.4 million; (iii) a decrease in working capital activities of $40.5 million; and (iv) an increase in other activities of $3.9 million, primarily due to an increase in deferred rent, partially offset by a decrease in other long-term liabilities, and an increase in other long-term assets. The decrease in working capital activities was primarily due to an increase in inventories and income taxes receivable, partially offset by increases in accounts payable and accrued expenses. Inventory increased as a result of several factors, including the opening of new stores, an expansion of our seasonal merchandise programs, higher volume of purchases sourced directly from international vendors, and the “Go Taller” store remodeling program which increased shelf height (and consequently, merchandising space) across our stores.
Investing Activities
Capital expenditures in fiscal 2017 consisted of property acquisition, leasehold improvements, fixtures and equipment for new store openings, information technology projects and other capital projects, totaling $45.8 million. Proceeds from sale of property and fixed assets primarily relate to a sale-leaseback transaction completed during fiscal 2017 (see Note 1 to our Consolidated Financial Statements).
Capital expenditures in fiscal 2016 consisted of leasehold improvements, fixtures and equipment for new store openings, information technology projects and other capital projects of $66.0 million. Proceeds from sale of fixed assets primarily relate to sale of held for sale properties and sale-leaseback transactions completed during the year (see Note 1 to our Consolidated Financial Statements).
Capital expenditures in fiscal 2015 consisted of property acquisitions, leasehold improvements, fixtures and equipment for new store openings, information technology projects and other capital projects, totaling $111.4 million.
We estimate that total capital expenditures over the next twelve months will be approximately $53 million to $58 million, comprised of approximately $36 million to $41 million for leasehold improvements and fixtures and equipment for new and existing stores, and approximately $17 million primarily related to information technology upgrades and supply chain infrastructure upgrades and maintenance. We expect to fund a portion of the capital expenditures through divestitures of surplus assets and sale-leaseback transactions. Our estimated capital expenditures exclude anticipated expenditures associated with the rebuild of one of our stores in the Los Angeles area that was impacted by a fire in May 2016, a substantial portion of which we expect to recover through insurance reimbursements.
Financing Activities
Net cash provided by financing activities in fiscal 2017 was primarily comprised of proceeds from financing lease obligations associated with sale-leaseback transactions, partially offset by net repayments under the ABL Facility, repayment of debt under the First Lien Term Loan Facility and payments of debt issuance costs associated with the amendment of the ABL Facility. In the second quarter of fiscal 2017, we sold and concurrently licensed (through March 31, 2017) a warehouse facility in the City of Commerce, California with a carrying value of $12.1 million and received net proceeds from this transaction of $28.5 million. Additional information regarding the sale of the warehouse facility is contained in Note 10 to our Consolidated Financial Statements. Additional information regarding sale-leaseback transactions is contained in Note 1 to our Consolidated Financial Statements.
Net cash provided by financing activities in fiscal 2016 was comprised primarily of net repayments of borrowings under the ABL Facility and the First Lien Term Loan Facility, partially offset by proceeds from the financing lease obligations associated with sale-leaseback transactions (see Note 1 to our Consolidated Financial Statements).
Net cash provided by financing activities in fiscal 2015 was comprised primarily of net borrowings under the ABL Facility, partially offset by repayments of borrowings on the First Lien Term Loan Facility.
Off-Balance Sheet Arrangements
As of January 27, 2017, we had no off-balance sheet arrangements.
Contractual Obligations
The following table summarizes our consolidated contractual obligations (in thousands) as of January 27, 2017.
(a) Assumes planned maturity of $39.3 million under the ABL Facility on April 8, 2021; provided however, the ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of the First Lien Term Loan Facility and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes, unless the First Lien Term Loan Facility and Senior Notes have been repaid or refinanced in full or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021. See Note 6 to our Consolidated Financial Statements.
(b) Includes interest expense on fixed and variable debt, using fiscal 2017 year end rates and balance. See Note 6 to our Consolidated Financial Statements.
(c) Includes capital and financing lease obligations and related interest.
(d) Purchase obligations include legally binding agreements that primarily consist of construction contracts of new stores. Amounts committed under open purchase orders for merchandise are not included if cancelable without penalty prior to a date that precedes the vendors’ scheduled shipment date.
We do not have any liabilities related to uncertain tax positions as of January 27, 2017. See Note 5 to our Consolidated Financial Statements.
Lease Commitments
We lease various facilities under operating leases (except for one location classified as a capital lease and seven locations classified as financing leases), which will expire at various dates through fiscal year 2035. Most of the lease agreements contain renewal options and/or provide for fixed rent escalations or increases based on the Consumer Price Index. Total minimum lease payments under each of these lease agreements, including scheduled increases, are charged to expenses on a straight-line basis over the term of each respective lease. Most leases require us to pay property taxes, maintenance and insurance. Rental expenses (including property taxes, maintenance and insurance) charged to expenses in fiscal 2017 were approximately $102.5 million. Rental expenses (including property taxes, maintenance and insurance) charged to expenses in fiscal 2016 were approximately $97.3 million. Rental expenses (including property taxes, maintenance and insurance) charged to expenses in fiscal 2015 were approximately $85.5 million. We typically seek leases with a five-year to ten-year term and with multiple five-year renewal options. See Item 2, “Properties.” The large majority of our store leases were entered into with multiple renewal periods, which are typically five years and occasionally longer.
Variable Interest Entities
As of January 27, 2017 and January 29, 2016, we did not have any variable interest entities.
Seasonality and Quarterly Fluctuations
We have historically experienced and expect to continue to experience some seasonal fluctuations in our net sales, operating income, and net income. During the quarters that have included the Halloween, Christmas and Easter selling seasons, we have historically experienced higher net sales and higher operating income. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of certain these holidays, the timing of new store openings and the merchandise mix.
New Authoritative Standards
Information regarding new authoritative standards is contained in Note 2 to our Consolidated Financial Statements which is incorporated herein by this reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate risk for our debt borrowings.
Our primary interest rate exposure relates to outstanding amounts under our Credit Facilities. As of January 27, 2017, we had variable rate borrowings of $593.9 million under our First Lien Term Loan Facility and $39.3 million under our ABL Facility. The Credit Facilities provide interest rate options based on certain indices as described in Note 6 to our Consolidated Financial Statements.
We may manage interest rate risk through the use of interest swap agreements or interest cap agreements to limit the effect of interest rate fluctuations from time to time. We were previously a party to an interest rate swap agreement that limited our interest exposure on a notional value of $261.8 million to 1.36% plus an applicable margin of 3.50%. We are currently not using an interest swap agreement or interest cap agreement to limit such interest rate fluctuations.
A change in interest rates on our variable rate debt impacts our pre-tax earnings and cash flows. Based on our variable rate borrowing levels and interest rate derivatives outstanding as of January 27, 2017 and January 29, 2016, respectively, the annualized effect of a 1% increase in applicable interest rates would have resulted in an increase of our pre-tax loss and a decrease in cash flows of approximately $6.3 million for fiscal 2017 and $1.9 million for fiscal 2016.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
99 Cents Only Stores LLC
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of January 27, 2017 and January 29, 2016
Consolidated Statements of Comprehensive Income (Loss) for the years ended January 27, 2017, January 29, 2016 and January 30, 2015
Consolidated Statements of Member’s Equity for the years ended January 27, 2017, January 29, 2016 and January 30, 2015
Consolidated Statements of Cash Flows for the years ended January 27, 2017, January 29, 2016 and January 30, 2015
Notes to Consolidated Financial Statements
Schedule II - Valuation and Qualifying Accounts
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Member of 99 Cents Only Stores LLC
We have audited the accompanying consolidated balance sheets of 99 Cents Only Stores LLC and subsidiaries as of January 27, 2017 and January 29, 2016, and the related consolidated statements of comprehensive income (loss), member’s equity and cash flows for the years ended January 27, 2017, January 29, 2016, and January 30, 2015. Our audits also included the financial statement schedule listed in the Index at Item 15(b) for the years ended January 27, 2017, January 29, 2016, and January 30, 2015. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit 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, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of 99 Cents Only Stores LLC and subsidiaries at January 27, 2017 and January 29, 2016, and the consolidated results of its operations and its cash flows for the years ended January 27, 2017, January 29, 2016, and January 30, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Los Angeles, California
April 26, 2017
99 Cents Only Stores LLC
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
99 Cents Only Stores LLC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
99 Cents Only Stores LLC
CONSOLIDATED STATEMENTS OF MEMBER’S EQUITY
(Amounts in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
99 Cents Only Stores LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
99 Cents Only Stores LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Years Ended January 27, 2017, January 29, 2016 and January 30, 2015
1. Basis of Presentation and Summary of Significant Accounting Policies
Nature of Business
The Company is organized under the laws of the State of California. Effective October 18, 2013, 99¢ Only Stores converted from a California corporation to a California limited liability company, 99 Cents Only Stores LLC, that is managed by its sole member, Number Holdings, Inc., a Delaware corporation (“Parent”). The term “Company” refers to 99¢ Only Stores and its consolidated subsidiaries prior to the Conversion (as defined below) and to 99 Cents Only Stores LLC and its consolidated subsidiaries at the time of or after the Conversion. The Company is an extreme value retailer of consumable and general merchandise and seasonal products. As of January 27, 2017, the Company operated 390 retail stores with 283 in California, 48 in Texas, 38 in Arizona, and 21 in Nevada. The Company is also a wholesale distributor of various products.
Merger
On January 13, 2012, the Company was acquired through a merger (the “Merger”) with a subsidiary of Parent with the Company surviving. In connection with the Merger, the Company became a subsidiary of Parent, which is controlled by affiliates of Ares Management, L.P. (“Ares”) and Canada Pension Plan Investment Board (“CPPIB”) (together, the “Sponsors”). As a result of the Merger, the Company’s common stock was delisted from the New York Stock Exchange and the Company ceased to be a publicly held and traded equity company.
Conversion to LLC
On October 18, 2013, 99¢ Only Stores converted (the “Conversion”) from a California corporation to a California limited liability company, 99 Cents Only Stores LLC (“99 LLC”), that is managed by its sole member, Parent. In connection with the Conversion, each outstanding share of Class A common stock of 99¢ Only Stores, par value $0.01 per share, was converted into one membership unit of 99 LLC, and each outstanding share of Class B common stock of 99¢ Only Stores, par value $0.01 per share, was cancelled and forfeited. Pursuant to the laws of the State of California, all rights and property of 99¢ Only Stores were vested in 99 LLC and all debts, liabilities and obligations of 99¢ Only Stores continued as debts, liabilities and obligations of 99 LLC. 99 LLC has elected to be treated as a disregarded entity for United States federal income tax purposes. The Conversion did not have any effect on deferred tax assets or liabilities, and 99 LLC will continue to use the liability method of accounting for income taxes. 99 LLC computes its taxes on a separate return basis, but 99 LLC and Parent will continue to file consolidated or combined income tax returns with its subsidiaries in all jurisdictions. Parent is a holding company with no active business or operations and has no holdings in any business other than 99 LLC.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries required to be consolidated in accordance with accounting principles generally accepted in the United States (“GAAP”). Intercompany accounts and transactions between the consolidated companies have been eliminated in consolidation.
Fiscal Year
The Company follows a fiscal calendar consisting of four quarters with 91 days, with a 98 day quarter every five to six years each ending on the Friday closest to the last day of April, July, October or January, as applicable, and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. The Company’s fiscal year 2017 (“fiscal 2017”) began on January 30, 2016, and ended on January 27, 2017 and consisted of 52 weeks. The Company’s fiscal year 2016 (“fiscal 2016”) began on January 31, 2015, and ended on January 29, 2016 and consisted of 52 weeks. The Company’s fiscal year 2015 (“fiscal 2015”) began on February 1, 2014, and ended on January 30, 2015 and consisted of 52 weeks.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassification
Certain prior year amounts have been reclassified to conform to the current year’s presentation. Specifically, the Company adopted Accounting Standard Update (“ASU”) No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs” in the first quarter of fiscal 2017, which requires the Company to present debt issuance costs related to a recognized debt liability on the balance sheet as a direct deduction from the debt liability, similar to the presentation of original issue discounts (“OID”). The adoption of this accounting standard resulted in the reclassification of $11.5 million of debt issuance costs (net of accumulated amortization) from deferred financing costs, net to long-term debt, net of current portion on the Company’s consolidated balance sheet at January 29, 2016. The Company also early adopted ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes” in the first quarter of fiscal 2017, which requires that all deferred tax assets and liabilities be classified as long-term on the balance sheet. The adoption of this accounting standard resulted in the reclassification of $16.6 million of deferred income tax from current assets to long-term deferred income taxes liability on the Company’s consolidated balance sheet at January 29, 2016.
Immaterial Error Correction
During the fourth quarter of fiscal 2017, the Company determined that deferred tax liabilities as of January 29, 2016 were overstated by $6.5 million and the deferred tax valuation allowance was understated by $6.5 million. The total net deferred tax balances as of January 29, 2016 and tax provision for fiscal 2017 were not affected by this error. The Company analyzed the impact of the $6.5 million deferred tax liability overstatement on the goodwill impairment charge recorded in fiscal 2016 and determined that the charge was understated by $7.1 million.
Management evaluated the materiality of these errors quantitatively and qualitatively, and concluded that they were not material, to the financial statements of any period presented, but has elected to correct them in the accompanying fiscal 2016 consolidated financial statements.
Certain of the as previously reported balances include the adoption of ASU 2015-03 related to debt issuance costs and ASU 2015-17 related to deferred income tax (see Note 2).The following table sets forth the effect this correction had on the Company’s prior period reported balance sheet as of January 29, 2016 (in thousands):
The following table sets forth the effect this correction had on the Company’s prior statement of comprehensive loss for fiscal 2016 (in thousands):
The correction discussed above also resulted in changes to previously reported amounts in the Company’s consolidated statements of cash flows. The correction had no impact on net cash provided by operating activities. The following table sets forth the effect this correction had on the Company’s prior statement of cash flows for fiscal 2016 (in thousands):
Certain amounts disclosed in Notes 1, 3, 5, 8 and 16 for fiscal 2016 have been revised to reflect the correction.
Cash
For purposes of reporting cash flows, cash includes cash on hand, cash at the stores and cash in financial institutions. The majority of payments due from financial institutions for the settlement of debit card and credit card transactions are processed within three business days and therefore are also classified as cash. Cash balances held at financial institutions are generally in excess of federally insured limits. These accounts are only insured by the Federal Deposit Insurance Corporation up to $250,000. The Company’s cash balances held at financial institutions and exceeding FDIC insurance totaled $4.4 million and $3.9 million as of January 27, 2017 and January 29, 2016, respectively. The Company historically has not experienced any losses in such accounts. The Company places its temporary cash investments with what it believes to be high credit, quality financial institutions. Under the Company’s cash management system, checks issued but not presented to the bank may result in book cash overdraft balances for accounting purposes. The Company reclassifies book overdrafts to accounts payable, which are reflected as an operating activity in its consolidated statements of cash flows. Book overdrafts included in accounts payable were $7.0 million and $7.9 million as of January 27, 2017 and January 29, 2016, respectively.
Allowance for Doubtful Accounts
In connection with its wholesale business, the Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer’s or tenant’s ability to meet its financial obligations subsequent to the original sale, the Company will record an allowance against amounts due and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers and tenants, the Company recognizes allowances for doubtful accounts based on the length of time the receivables are past due, industry and geographic concentrations, the current business environment and the Company’s historical experiences.
Inventories
Inventories are valued at the lower of cost or market. Inventory costs are established using a methodology that approximates first in, first out, which for store inventories is based on a retail inventory method. Valuation allowances for shrinkage as well as excess and obsolete inventory are also recorded. The Company includes spoilage, scrap and shrink in its definition of shrinkage. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. Physical inventory counts are completed at each of the Company’s retail stores at least once a year by an outside inventory service company. The Company performs inventory cycle counts at its warehouses throughout the year. The Company also performs inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory. The valuation allowances for excess and obsolete inventory are based on the age of the inventory, sales trends and future merchandising plans. The valuation allowances for excess and obsolete inventory require management judgment and estimates that may impact the ending
inventory valuation and valuation allowances that may have a material effect on the reported gross margin for the period. These estimates are subject to change based on management’s evaluation of, and response to, a variety of factors and trends, including, but not limited to, consumer preferences and buying patterns, age of inventory, increased competition, inventory management, merchandising strategies and historical sell through trends. The Company’s ability to adequately evaluate the impact of inventory management and merchandising strategies executed in response to such factors and trends in future periods could have a material impact on such estimates.
In the fourth quarter of fiscal 2015, the Company recorded a charge for additional inventory shrinkage based upon the results of annual physical inventory counts completed during the quarter. This resulted in a net charge to cost of sales and a corresponding reduction in inventory of approximately $10.0 million, which was primarily related to the implementation of certain strategic initiatives, including the “Go Taller” store remodeling program. The “Go Taller” store remodeling program increased the amount of shelving space at the stores by raising the height of store shelves. During the remodeling and startup phase of the program, retail stores remained open and many products were moved from the shelves to the floor to accommodate the remodeling, which the Company believes led to an increase in misplaced and damaged products. In anticipation of the extra shelf space, more inventory was shipped to stores, which we believe also increased shrinkage. A reduction in workforce during fiscal year ended January 31, 2014 resulted in the outsourcing of the Company’s Loss Prevention department, which was not reinstated in-house until the third quarter of fiscal 2016. These initiatives collectively disrupted store operations, resulting in increased loss due to theft and misplaced and damaged inventory.
In order to obtain inventory at attractive prices, the Company takes advantage of large volume purchases, closeouts and other similar purchase opportunities. Consequently, the Company’s inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities.
Property and Equipment
Property and equipment are carried at cost and are depreciated or amortized on a straight-line basis over the following useful lives:
Owned buildings and improvements
Lesser of 30 years or the estimated useful life of the improvement
Leasehold improvements
Lesser of the estimated useful life of the improvement or remaining lease term
Fixtures and equipment
3-5 years
Transportation equipment
3-5 years
Information technology systems
For major corporate systems, estimated useful life up to 7 years; for functional standalone systems, estimated useful life up to 5 years
The Company’s policy is to capitalize expenditures that materially increase asset lives and expense ordinary repairs and maintenance as incurred.
Long-Lived Assets
The Company assesses the impairment of depreciable long-lived assets when events or changes in circumstances indicate that the carrying value may not be recoverable. The Company groups and evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual identifiable cash flows are available. Recoverability is measured by comparing the carrying amount of an asset to expected future net cash flows generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. Factors that the Company considers important that could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business; and (3) significant changes in the Company’s business strategies and/or negative industry or economic trends. On a quarterly basis, the Company assesses whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable (Level 3 measurement, see Note 8, “Fair Value of Financial Instruments”). Considerable management judgment is necessary to estimate projected future operating cash flows. Accordingly, if actual results fall short of such estimates, significant future impairments could result.
During the third quarter of fiscal 2017, the Company decided to close five retail stores in California by the end of fiscal 2017 upon the expiration of their respective lease terms. As a result of this decision, the Company recognized an impairment charge of approximately $0.1 million related to the closure of three of these stores and recorded an impairment charge of $0.1 million related to fixtures that will be disposed of and for which the Company concluded the fair value was zero. During fiscal 2017, the Company also reduced the carrying value of a held for sale property to the estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.2 million.
During fiscal 2016, due to the underperformance of two stores in Texas and one store in California, the Company concluded that the carrying value of the long-lived assets relating to such stores were not recoverable and accordingly recorded an asset impairment charge of $0.8 million. During fiscal 2016, the Company also recorded impairment charges of $0.2 million related to equipment and fixtures that will be disposed of and for which the Company concluded the fair value was zero.
During fiscal 2015, the Company wrote down the carrying value of a held for sale property to the estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.1 million.
Goodwill and Other Intangible Assets
In connection with the Merger purchase price allocation, the fair values of long-lived and intangible assets were determined based upon assumptions related to the future cash flows, discount rates and asset lives using then available information, and in some cases were obtained from independent professional valuation experts. The Company amortizes intangible assets over their estimated useful lives unless such lives are deemed indefinite.
Amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on undiscounted cash flows, and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows used in the impairment tests (Level 3 measurement, see Note 8, “Fair Value of Financial Instruments”).
Goodwill and indefinite-lived intangible assets are not amortized but instead tested annually for impairment or more frequently when events or changes in circumstances indicate that the assets might be impaired. Goodwill is tested for impairment by comparing the carrying amount of the reporting unit to the fair value of the reporting unit to which the goodwill is assigned. The Company has the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step zero of the goodwill impairment test). If the Company does not perform a qualitative assessment, or determines, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of goodwill. Management has determined that the Company has two reporting units, the retail reporting unit and the wholesale reporting unit.
The Company, assisted by an independent third party valuation firm, performs the annual test for impairment in January of the fiscal year and determines fair value based on a combination of the income approach and the market approach. The income approach is based on discounted cash flows to determine fair value. The market approach uses a selection of comparable companies and transactions in determining fair value. The fair value of the trade name is also tested for impairment in the fourth quarter by comparing the carrying value to the fair value. Fair value of a trade name is determined using a relief from royalty method under the income approach, which uses projected revenue allocable to the trade name and an assumed royalty rate (Level 3 measurement, see Note 8, “Fair Value of Financial Instruments”). These approaches involve making key assumptions about future cash flows, discount rates and asset lives using then best available information. These assumptions are subject to a high degree of complexity and judgment and are subject to change.
The amount of goodwill allocated to the retail reporting unit and wholesale reporting unit was $467.2 million and $12.5 million, respectively, as of January 30, 2015.
During the third quarter of fiscal 2016, the Company determined that indicators of impairment existed to require an interim impairment analysis of goodwill and trade name, including (i) overall performance deterioration reflected in decreased comparable same-store sales and cannibalization from stores opened in fiscal 2015 under an accelerated expansion program, (ii) increases in inventory shrinkage and buildup of excess inventory, (iii) decreased margin due to disappointing results from sales promotions and (iv) a decision to delay the pace of future store openings. The first step evaluation concluded that the fair value of the retail reporting unit was below its carrying value. The Company performed step two of the goodwill impairment test that requires the retail reporting unit’s fair value to be allocated to all of the assets and liabilities of the reporting unit, including any intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination, including consideration of the fair value of tangible property and intangible assets. As a result of this preliminary analysis and based on best estimate, the Company recorded a $120.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2016, which was reflected as goodwill impairment in the consolidated statements of comprehensive income (loss). The finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in a $20.9 million adjustment in goodwill, lowering the estimated third quarter of fiscal 2016 goodwill impairment charge from $120.0 million to $99.1 million.
During the fourth quarter of fiscal 2016, the Company completed step one of its annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of the Company’s reporting units exceeded their carrying amounts.
The remaining amount of goodwill allocated to the retail reporting unit and wholesale reporting unit was $368.1 million and $12.5 million, respectively, as of January 29, 2016.
During the fourth quarter of fiscal 2017, the Company completed step one of its annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of the Company’s reporting units exceeded their carrying amounts. The results of this test showed that the fair value of our retail reporting unit exceeded its carrying value by a substantial amount. The results of this test showed that the fair value of wholesale reporting unit exceeded carrying value by approximately 18%. As discussed above, considerable management judgment is necessary in estimating future cash flows, market interest rates, discount rates and other factors affecting the valuation of goodwill. The Company’s forecasts used in its fiscal 2017 annual impairment test include growth in net sales, new store openings and same-store sales, positive trends in cost of sales and selling, general and administrative expense. In each case, these estimates and assumptions could be materially affected by factors such as unforeseen events or changes in general economic conditions, a decline in comparable company market multiples, changes to discount rates, increased competitive forces, inability to maintain pricing structure, deterioration of vendor relationships, failure to adequately manage and improve inventory processes and procedures and changes in customer behavior which could result in changes to management’s strategies. If operating results continue to change versus the Company’s expectations, additional impairment charges may be recorded in the future.
Additionally, during the fourth quarter of fiscal 2017, the Company completed its annual indefinite-lived intangible asset impairment test and determined there was no impairment to the trade name since the fair value of the trade name exceeded its carrying amount. The results of this test showed that the fair value of trade name exceeded carrying value by approximately 18%. The relief from royalty method estimates our theoretical royalty savings from ownership of the intangible asset. Key assumptions used in this model included sales projections, discount rates and royalty rates, and considerable management judgment is necessary in developing and evaluating such assumptions. If future results are not consistent with current estimates and assumptions, impairment charges maybe recorded in future.
Derivatives
The Company accounts for derivative financial instruments in accordance with authoritative guidance for derivative instrument and hedging activities. Financial instrument positions taken by the Company are primarily intended to be used to manage risks associated with interest rate exposures.
The Company’s derivative financial instruments are recorded on the balance sheet at fair value, and are recorded in either current or noncurrent assets or liabilities based on their maturity. Changes in the fair values of derivatives are recorded in net earnings or other comprehensive income (“OCI”), based on whether the instrument is designated and effective as a hedge transaction and, if so, the type of hedge transaction. Gains or losses on derivative instruments reported in accumulated other comprehensive income (“AOCI”) are reclassified to earnings in the period the hedged item affects earnings. Any ineffectiveness is recognized in earnings in the period incurred.
Income Taxes
The Company uses the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The Company’s ability to realize deferred tax assets is assessed throughout the year and a valuation allowance is established accordingly. The Company recognizes the impact of a tax position only if it is more likely than not to be sustained upon examination based on the technical merits of the position. The Company recognizes potential interest and penalties related to uncertain tax positions in income tax expense. Refer to Note 5, “Income Tax Provision” for further discussion of income taxes.
Stock-Based Compensation
The Company accounts for stock-based payment awards based on their fair value. The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods. For awards classified as equity, the Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model or other appropriate valuation models. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the stock price. Stock options are generally granted to employees at exercise prices equal to or greater than the fair market value of the stock at the dates of grant. The fair value of options granted to the current Chief Executive Officer were valued using a binomial model and the Monte Carlo simulation method. Refer to Note 11, “Stock-Based Compensation Plans” for further discussion of the Company’s stock-based compensation.
Revenue Recognition
The Company recognizes retail sales in its retail stores at the time the customer takes possession of merchandise. All sales are net of discounts and returns and exclude sales tax. Wholesale sales are recognized in accordance with the shipping terms agreed upon on the purchase order. Wholesale sales are typically recognized free on board origin, where title and risk of loss pass to the buyer when the merchandise leaves the Company’s distribution facility.
The Company has a gift card program. The Company does not charge administrative fees on gift cards and the Company’s gift cards do not have expiration dates. The Company records the sale of gift cards as a current liability and recognizes a sale when a customer redeems a gift card. The liability for outstanding gift cards is recorded in accrued expenses.
Cost of Sales
Cost of sales includes the cost of inventory, freight in, obsolescence, spoilage, scrap and inventory shrink, and is net of discounts and allowances. Cost of sales also includes receiving, warehouse costs and distribution costs (which include payroll and associated costs, occupancy, transportation to and from stores and depreciation expense). Cash discounts for satisfying early payment terms are recognized when payment is made, and allowances and rebates based upon milestone achievements such as reaching a certain volume of purchases of a vendor’s products are included as a reduction of cost of sales when such contractual milestones are reached or based on other systematic and rational approaches where possible.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include the costs of selling merchandise in stores (which include payroll and associated costs, occupancy and other store-level costs) and corporate costs (which include payroll and associated costs, occupancy, advertising, professional fees and other corporate administrative costs). Selling, general and administrative expenses also include depreciation and amortization expense relating to these costs.
Leases
The Company follows the policy of capitalizing allowable expenditures that relate to the acquisition and signing of its retail store leases. These costs are amortized on a straight-line basis over the applicable lease term.
The Company recognizes rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred rent. Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.
In certain lease arrangements, the Company can be involved with the construction of the building. If it is determined that the Company has substantially all of the risks of ownership during construction of the leased property and therefore is deemed to be the owner of the construction project, the Company records an asset for the amount of the total project costs and an amount related to the value attributed to the pre-existing leased building in property and equipment, net and the related financing obligation as part of current and non-current liabilities. Once construction is complete, if it is determined that the asset does not qualify for sale-leaseback accounting treatment, the Company amortizes the obligation over the lease term and depreciates the asset over the life of the lease. The Company does not report rent expense for the portion of the rent payment determined to be related to the assets which are owned for accounting purposes. Rather, this portion of the rent payment under the lease is recognized as a reduction of the financing obligation and interest expense.
For store closures where a lease obligation still exists, the Company records the estimated future liability associated with the rental obligation on the cease use date (when the store is closed). Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs. Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimates of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from the Company’s estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.
During the third quarter of fiscal 2017, the Company sold and concurrently leased back two stores with an aggregate carrying value of $7.6 million and received net proceeds from these transactions of $10.5 million. The Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. The resulting leases are accounted for as financing leases and the Company has recorded a corresponding financing lease obligation of $10.5 million (as a component of current and non-current liabilities). The Company will amortize the financing lease obligation over the lease term and depreciate the assets over their remaining useful lives. During the fourth quarter of fiscal 2017, the Company sold and concurrently leased back a store with a carrying value of $2.7 million and received net proceeds from this transaction of $5.6 million. The resulting lease qualifies as and is accounted for as an operating lease. The Company recorded a gain on the sale of $0.9 million as part of selling, general and administrative expenses and will amortize deferred gain of $2.0 million relating to the sale-leaseback transaction over the lease term.
During the second quarter of fiscal 2016, the Company sold and concurrently leased back two retail stores with a carrying value of $7.9 million and received net proceeds from these transactions of $8.7 million. The Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. The resulting leases are accounted for as financing leases and the Company has recorded a corresponding financing lease obligation of $8.7 million (as a component of current and non-current liabilities). The Company will amortize the financing lease obligation over the lease term and depreciate the assets over their remaining useful lives. During the third quarter of fiscal 2016, the Company sold and concurrently leased back one store, and the resulting lease qualifies as and is accounted for as an operating lease. The net proceeds from the sale-leaseback transaction amounted to $9.0 million. The Company will amortize deferred gains of $2.6 million relating to the sale-leaseback transaction over the lease term. During the fourth quarter of fiscal 2016, the Company sold and concurrently leased back two stores, and the resulting leases qualify and are accounted for as operating leases. The net proceeds from these sale-leaseback transactions amounted to $9.1 million. The Company will amortize deferred gains of $1.5 million relating to the sale-leaseback transactions over the lease term.
Self-Insured Workers’ Compensation Liability
The Company self-insures for workers’ compensation claims in California and Texas. The Company establishes a liability for losses from both estimated known and incurred but not reported insurance claims based on reported claims and actuarial valuations of estimated future costs of known and incurred but not yet reported claims. Should an amount of claims greater than anticipated occur, the liability recorded may not be sufficient and additional workers’ compensation costs, which may be significant, could be incurred. The Company has not discounted the projected future cash outlays for the time value of money for claims and claim-related costs when establishing its workers’ compensation liability in its financial reports for January 27, 2017 and January 29, 2016.
Self-Insured Health Insurance Liability
The Company self-insures for a portion of its employee medical benefit claims. The liability for the self-funded portion of the Company health insurance program is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported. The Company maintains stop loss insurance coverage to limit its exposure for the self-funded portion of its health insurance program.
Pre-Opening Costs
The Company expenses, as incurred, pre-opening costs such as payroll, rent and marketing related to the opening of new retail stores.
Advertising
The Company expenses advertising costs as incurred. Advertising expenses were $8.3 million, $8.2 million and $6.2 million in fiscal 2017, fiscal 2016 and fiscal 2015, respectively.
Fair Value of Financial Instruments
The Company’s financial instruments consist principally of cash, accounts receivable, interest rate and other derivatives, accounts payable, accruals, debt, and other liabilities. Cash and derivatives are measured and recorded at fair value. Accounts receivable and other receivables are financial assets with carrying values that approximate fair value. Accounts payable and other accrued expenses are financial liabilities with carrying values that approximate fair value. Refer to Note 8, “Fair Value of Financial Instruments” for further discussion of the fair value of debt.
The Company uses the authoritative guidance for fair value, which includes the definition of fair value, the framework for measuring fair value, and disclosures about fair value measurements. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. Fair value measurements reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model.
Comprehensive Income (Loss)
OCI includes unrealized gains or losses on investments and interest rate derivatives designated as cash flow hedges. The following table sets forth the calculation of comprehensive income (loss), net of tax effects, for the periods indicated (in thousands):
Amounts in accumulated other comprehensive loss as of January 29, 2016 consisted of unrealized losses on interest rate cash flow hedges. Reclassifications out of AOCI in fiscal 2017, fiscal 2016 and fiscal 2015 are presented in Note 7, “Derivative Financial Instruments.”
2. New Authoritative Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. The ASU also requires expanded disclosures about revenue recognition. In adopting ASU 2014-09, companies may use either a full retrospective or a modified retrospective approach. ASU 2014-09 was to be effective for the first interim period within annual reporting periods beginning after December 15, 2016, and early adoption was not permitted. In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date”, which defers the effective date of ASU 2014-09 for all entities by one year, while allowing early adoption as of the original public entity date. In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing,” which amends the revenue recognition guidance on accounting for licenses of intellectual property and identifying performance obligations as well as clarifies when a promised good or service is separately identifiable. In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients,” which provides clarifying guidance in certain narrow areas such as an assessment of collectibility, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition as well as adds some practical expedients. In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” to clarify or to correct unintended application of the Topic 606, including disclosure requirements related to performance obligations. The effective date and transition of these amendments is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers,” as amended by the one-year deferral and early adoption provisions in ASU 2015-14. The Company is primarily engaged in the business of selling consumable and general merchandise and seasonal products. Revenues from the sale of such products are recognized at the point of sale. To date, the Company has performed a preliminary detailed review of key contracts and compared historical accounting policies and practices to the new standard. While the Company is still evaluating this standard, it is not expected that this standard will have a material impact on our consolidated financial statements. The Company will continue to evaluate ASU 2014-09 and other amendments and related interpretive guidance through the date of adoption. The expected adoption method of ASU 2014-09 is being evaluated by the Company.
In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This ASU requires management to assess whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued. If substantial doubt exists, additional disclosures are required. This ASU is effective for annual periods ending after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company adopted this standard as of January 27, 2017 and such adoption did not have an impact on the Company or its consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This ASU requires companies to present debt issuance costs related to a recognized debt liability on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts. Debt issuance costs will continue to be amortized to interest expense using the effective interest method. In August 2015, FASB issued ASU No. 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangement.” ASU 2015-15 clarifies the presentation and measurement of debt issuance costs incurred in connection with line-of-credit arrangements given the lack of guidance on this topic in ASU 2015-03. For line-of-credit arrangements, an entity can continue to present debt issuance costs as an asset and amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. These standards are effective for public companies for annual periods beginning after December 15, 2015 as well as interim periods within those annual periods using the retrospective approach. The Company adopted this guidance retrospectively in the first quarter of fiscal 2017. As a result, the presentation of $11.5 million of debt issuance costs (net of accumulated amortization) have been reclassified from deferred financing costs, net to long-term debt, net of current portion as of January 29, 2016.
In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.” This ASU simplifies the subsequent measurement of inventories by replacing the lower of cost or market test with a lower of cost or net realizable value test. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The guidance is effective for reporting periods beginning after December 15, 2016 and interim periods within those fiscal years, with early adoption permitted. This ASU should be applied prospectively. The Company will adopt ASU 2015-11 in the first quarter of fiscal 2018 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.
In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes.” This ASU simplifies the presentation of deferred income taxes by requiring that all deferred tax liabilities and assets be classified as long-term on the balance sheet. This guidance is effective for fiscal years beginning after December 15, 2017, and allows for either prospective or retrospective adoption, with early adoption permitted. The Company adopted this guidance retrospectively in the first quarter of fiscal 2017. As a result, the presentation of $16.6 million of deferred income taxes was reclassified from current assets to long-term deferred income tax liabilities as of January 29, 2016.
In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU revises an entity’s accounting on the classification and measurement of financial instruments. Although the ASU retains many current requirements, it significantly revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments. This ASU becomes effective for public entities in the fiscal year beginning after December 15, 2017. Early adoption is not permitted except for the provisions related to the presentation of certain fair value changes for financial liabilities measured at fair value. The Company will adopt ASU 2016-01 in the first quarter of fiscal 2019 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which requires lessees to recognize right-of-use assets and lease liabilities, for all leases, with the exception of short-term leases, at the commencement date of each lease. This ASU requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. This ASU is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods. Early adoption is permitted. The amendments of this update should be applied using a modified retrospective approach, which requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements and is anticipating a material impact on its consolidated financial statements because the Company is party to a significant number of lease contracts.
In March 2016, the FASB issued ASU 2016-04, “Recognition of Breakage for Certain Prepaid Stored-Value Products,” which is designed to provide guidance and eliminate diversity in the accounting for the de-recognition of financial liabilities related to certain prepaid stored-value products using a revenue-like breakage model. Breakage should be recognized in proportion to the pattern of rights expected to be exercised by the product holder to the extent that it is probable a significant reversal of the recognized breakage amount will not subsequently occur. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted, and is to be applied retrospectively or using a modified retrospective approach. The Company will adopt ASU 2016-04 in the first quarter of fiscal 2019 and such adoption is not expected to have a material impact on the Company or its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting”. This ASU will require companies to recognize the income tax effects of awards in the income statement when the awards vest or are settled. The guidance requires companies to present excess tax benefits as an operating activity and cash paid to a taxing authority to satisfy statutory withholding as a financing activity on the statement of cash flows. The guidance will also allow entities to make an alternative policy election to account for forfeitures as they occur. This ASU is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period. The Company will adopt this standard in the first quarter of fiscal 2018. The Company will make a policy election to account for forfeitures of share-based payments as they occur and will implement this provision using a modified retrospective transition method. The Company expects to adopt other provisions of ASU 2016-09 on a prospective basis, and the adoption of these provisions is not expected to have a material impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments”. This ASU replaces the current incurred loss impairment methodology of recognizing credit losses when a loss is probable, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to assess credit loss estimates. The standard will be effective for fiscal years beginning after December 15, 2019, with early adoption permitted for periods after December 15, 2018. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments”, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted, and is to be applied retrospectively. The adoption is not expected to have a material impact on the Company or its consolidated financial statements.
In October 2016, the FASB has issued ASU No. 2016-17, “Interest Held through Related Parties that are under Common Control”, which provides guidance on the evaluation of whether a reporting entity is the primary beneficiary of a variable interest entity (“VIE”) by amending how a reporting entity, that is a single decision maker of a VIE, treats indirect interests in that entity held through related parties that are under common control. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. The adoption is not expected to have a material impact on the Company or its consolidated financial statements.
In October 2016 the FASB has issued ASU No. 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory”, which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted as of the beginning of a fiscal year. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, “Restricted Cash,” which requires a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this ASU do not provide a definition of restricted cash or restricted cash equivalents. The guidance is effective for periods beginning after December 15, 2017 on a retrospective basis, with early adoption permitted. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.
On December 2016, FASB issued ASU 2016-19, “Technical Corrections and Improvements”, which includes amendments related to differences between original guidance and the Accounting Standards Codification, guidance clarification and reference corrections, simplifications to the Accounting Standards Codification, and minor improvements to the guidance. The amendments of the standard that require transition guidance are effective for annual and interim reporting periods beginning after December 15, 2016, and early adoption is permitted. All other amendments were effective immediately. The Company is currently evaluating the impact of the amendments to the standard that have not yet been adopted by the Company on its consolidated financial statements.
In January 2017 the FASB issued ASU No. 2017-01 “Business Combinations: Clarifying the Definition of a Business”, revises the definition of a business and may affect acquisitions, disposals, goodwill impairment and consolidation. The new guidance specifies that when substantially all of the fair value of gross assets acquired is concentrated in a single asset (or a group of similar assets), the assets acquired would not represent a business. The changes to the definition of a business in this guidance will likely result in more acquisitions being accounted for as asset acquisitions and would also affect the accounting for disposal transactions. This guidance is effective for annual periods beginning after December 15, 2017, with early adoption permitted. The adoption is not expected to have a material impact on the Company or its consolidated financial statements.
In January 2017, the FASB issued 2017-03, “Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings”. The amendments in this ASU add language to the SEC Staff Guidance in relation to new FASB guidance on revenue, leases and credit losses. This ASU provides the SEC Staff view that a registrant should consider additional quantitative and qualitative disclosures related to the previously mentioned ASUs in connection with the status and impact of their adoption. The Company adopted this ASU during the fourth quarter of fiscal 2017. Since this update is intended to add disclosures related to certain ASUs, the adoption of this standard did not have a material impact on our financial statements.
In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment”, which simplifies the goodwill impairment testing by eliminating Step 2 from the goodwill impairment testing required, should an impairment be discovered during its annual or interim assessment. The new standard is effective for annual or interim impairment tests beginning after December 15, 2019, with early adoption permitted. The Company is currently in the process of evaluating the impact of this standard on its consolidated financial statements.
3. Goodwill and Other Intangible Assets and Liabilities
As a result of the Merger, the Company recognized goodwill, and other intangible assets and liabilities. The following table sets forth the value of the goodwill and other intangible assets and liabilities, and the amortization of finite lived intangible assets and liabilities (in thousands):
(a) Amortization of trademarks and Bargain Wholesale customer relationships is recognized in selling, general and administrative expenses on the Consolidated Statement of Comprehensive Income (Loss).
(b) Amortization of favorable and unfavorable leases is recognized in rent expense, as a component of selling, general and administrative expenses on the Consolidated Statement of Comprehensive Income (Loss).
The Company recorded a goodwill impairment charge of $99.1 million in fiscal 2016. See Note 1, “Basis of Presentation and Summary of Significant Accounting Policies”. In fiscal 2016, the Company recorded a favorable lease impairment charge of $0.6 million relating one store as part of selling, general and administrative expenses. In fiscal 2016, the Company recorded an impairment charge of $0.6 million relating to its trademarks as part of selling, general and administrative expenses.
4. Property and Equipment, net
The following table provides details of property and equipment (in thousands):
As of January 27, 2017 and January 29, 2016, buildings include $24.6 million that represents the estimated fair market value of a building under a build-to-suit lease in which the Company is the deemed owner for accounting purposes. See Note 10, “Commitments and Contingencies.” As of January 27, 2017, land, buildings and building improvements include $30.2 million relating to five sale-leaseback transactions completed in fiscal 2017 and fiscal 2016 in which the Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. As of January 29, 2016, land, buildings and building improvements include $8.8 million relating to two sale-leaseback transactions completed in fiscal 2016 in which the Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. See Note 1, “Basis of Presentation and Summary of Significant Accounting Policies” and Note 10, “Commitments and Contingencies.”
5. Income Tax Provision
The provision (benefit) for income taxes consists of the following (in thousands):
Differences between the provision (benefit) for income taxes and income taxes at the statutory federal income tax rate are as follows (in thousands):
The difference between the statutory rate of 35% and the effective tax rate for fiscal 2017 was driven primarily by the impact of recording additional valuation allowance against deferred tax assets due to additional losses sustained in fiscal 2017 as discussed below.
The difference between the statutory rate of 35% and the effective tax rate for fiscal 2016 was driven primarily due to the tax effect of the non-deductible goodwill impairment charge and the establishment of a valuation allowance against deferred tax assets as discussed below.
The difference between the statutory rate of 35% and the effective tax rate for fiscal 2015 was driven primarily by the impact of state income taxes and the non-deductibility of certain costs.
The components of deferred tax assets and liabilities were as follows (in thousands):
The Company assesses its ability to realize deferred tax assets throughout the fiscal year. As a result of this assessment during the second quarter of fiscal 2016, the Company concluded that it was more likely than not that the Company would not realize its deferred tax assets. In the quarters prior to the recording of a valuation allowance in the second quarter of fiscal 2016, the Company weighed all available positive and negative evidence and determined that it was more likely than not that the deferred tax assets were fully realizable. In fiscal 2016, the Company’s management had begun to take meaningful steps to focus on the operational execution of the initiatives launched in fiscal 2015, which were expected to drive performance improvements over the second and third quarters of fiscal 2016. However, in the second quarter of fiscal 2016, the Company’s experienced (i) margin declines due to short-term sales promotions, (ii) delays in sales growth due to cannibalization from new store openings, (iii) increased inventory shrinkage from a buildup of inventory levels, and (iv) increases in support costs as a percentage of sales. As a result of these second quarter of fiscal 2016 events, the Company decided to adjust merchandise pricing strategies, delay the pace of future store openings for the remainder of fiscal 2016, revise inventory shrinkage processes and establish selling, general and administrative cost control measures. The Company concluded that until the performance issues identified in the second quarter of fiscal 2016 showed improvement, it was more likely than not that the Company would not realize its net deferred tax assets, and therefore the Company recorded a $31.7 million increase to provision for income taxes in order to establish a valuation allowance against such net deferred tax assets.
As of January 29, 2016, the valuation allowance increased to $88.3 million, which was primarily related to an increase in losses incurred during fiscal 2016. As of January 27, 2017, the valuation allowance increased to $137.7 million, which was primarily related to an increase in losses incurred during fiscal 2017.
The Company will continue to evaluate all of the positive and negative evidence in future periods and will make a determination as to whether it is more likely than not that all or a portion of its deferred tax assets will be realized in such future periods. At such time as the Company determines that it is more likely than not that all or a portion of its deferred tax assets are realizable, the valuation allowance will be reduced or released in its entirety, and the corresponding benefit will be reflected in the Company’s tax provision. Deferred tax liabilities associated with indefinite-lived intangibles cannot be considered a source of taxable income to support the realization of deferred tax assets because these deferred tax liabilities will not reverse until some indefinite future period when these assets are either sold or impaired for book purposes. The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from using its loss carryforwards or utilizing other deferred tax assets in the future.
As of January 27, 2017, the Company had federal and state net operating loss (“NOL”), which will expire between fiscal 2019 and fiscal 2037. The Company’s credit carryforwards will expire between fiscal 2025 and fiscal 2037. As of January 27, 2017 and January 29, 2016, the Company had not accrued any liabilities related to unrecognized tax benefits, and had also not accrued any interest and penalties related to uncertain tax positions for the relevant periods. The Company files income tax returns in the U.S. federal jurisdiction and in various states. The Company is subject to examinations by the major tax jurisdictions in which it files for the tax years 2011 forward.
6. Debt
Short and long-term debt consists of the following (in thousands):
As of January 27, 2017 the scheduled maturities of debt for each of the five succeeding fiscal years are as follows (in thousands):
(a) Assumes planned maturity of $39.3 million under the ABL Facility on April 8, 2021; provided however, the ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of the First Lien Term Loan Facility (as defined below) and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes (as defined below), unless the First Lien Term Loan Facility and Senior Notes have been repaid or refinanced in full or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021.
As of January 27, 2017 and January 29, 2016 the current and non-current net deferred financing costs are as follows (in thousands):
On January 13, 2012 (the “Original Closing Date”), in connection with the Merger, the Company obtained Credit Facilities (as defined below) provided by a syndicate of lenders arranged by Royal Bank of Canada as administrative agent, as well as other agents and lenders that are parties to the agreements governing these Credit Facilities. The Credit Facilities include (a) a first lien based revolving credit facility (as amended, the “ABL Facility”), and (b) a first lien term loan facility (as amended, the “First Lien Term Loan Facility” and together with the ABL Facility, the “Credit Facilities”).
First Lien Term Loan Facility
Under the First Lien Term Loan Facility, (i) $525.0 million of term loans were incurred on the Original Closing Date and (ii) $100.0 million of additional term loans were incurred pursuant to an incremental facility effected through an amendment entered into on October 8, 2013 (the “Second Amendment”) (all such term loans, collectively, the “Term Loans”). The First Lien Term Loan Facility has a maturity date of January 13, 2019. All obligations under the First Lien Term Loan Facility are guaranteed by Parent and the Company’s direct or indirect 100% owned domestic subsidiaries (with customary exceptions, including immaterial subsidiaries) (collectively, the “Credit Facilities Guarantors”). In addition, the First Lien Term Loan Facility is secured by substantially all of the Company’s assets and the assets of the Credit Facilities Guarantors, including a first priority pledge of all of the Company’s equity interests and the equity interests of the Credit Facilities Guarantors and a first priority security interest in certain other fixed assets, and a second priority security interest in certain current assets.
The Company is required to make scheduled quarterly payments each equal to 0.25% of the principal amount of the Term Loans, with the balance due on the maturity date. Borrowings under the First Lien Term Loan Facility bear interest at an annual rate equal to an applicable margin plus, at the Company’s option, either (i) a base rate (the “Base Rate”) determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as the “Prime Rate” (3.75% as of January 27, 2017), (b) the federal funds effective rate plus 0.50% and (c) an adjusted Eurocurrency rate for one month (determined by reference to the greater of the Eurocurrency rate for the interest period subject to certain adjustments) plus 1.00%, or (ii) a Eurocurrency rate determined by reference to the London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserve requirements, for the interest period relevant to such borrowing.
On April 4, 2012, the Company amended the terms of the First Lien Term Loan Facility (the “First Amendment”) and incurred related refinancing costs of $11.2 million. The First Amendment, among other things, (i) decreased the applicable margin from LIBOR plus 5.50% (or Base Rate plus 4.50%) to LIBOR plus 4.00% (or Base Rate plus 3.00%) and (ii) decreased the LIBOR floor from 1.50% to 1.25%.
On October 8, 2013, the Company entered into the Second Amendment, which among other things, (i) provided $100.0 million of additional term loans as described above, (ii) decreased the applicable margin from LIBOR plus 4.00% (or Base Rate plus 3.00%) to LIBOR plus 3.50% (or Base Rate plus 2.50%) and (iii) decreased the LIBOR floor from 1.25% to 1.00%. Upon the occurrence of the Second Amendment, the Company’s obligation to make scheduled quarterly payments on the Term Loans was increased to require the Company to make scheduled quarterly payments each equal to 0.25% of the amended principal amount of the Term Loans (approximately $1.5 million).
In addition, the Second Amendment (i) amended certain restricted payment provisions, (ii) removed the maximum capital expenditures covenant from the agreement governing the First Lien Term Loan Facility, (iii) modified the existing provision restricting the Company’s ability to make dividend and other payments so that from and after March 31, 2013, the permitted payment amount represents the sum of (a) a calculation based on 50% of Consolidated Net Income (as defined in the First Lien Term Loan Facility agreement), if positive, or a deficit of 100% of Consolidated Net Income, if negative, and (b) $20.0 million, and (iv) permitted proceeds of any sale leasebacks of any assets acquired after January 13, 2012, to be reinvested in the Company’s business without restriction.
As of January 27, 2017 and January 29, 2016, the interest rate charged on the First Lien Term Loan Facility was 4.50% (1.00% Eurocurrency rate, plus the Eurocurrency loan margin of 3.50%). As of January 27, 2017 and January 29, 2016, the gross amount outstanding under the First Lien Term Loan Facility was $593.9 million and $600.0 million, respectively.
Following the end of each fiscal year, the Company is required to make prepayments on the First Lien Term Loan Facility in an amount equal to (i) 50% of Excess Cash Flow (as defined in the agreement governing the First Lien Term Loan Facility), with the ability to step down to 25% and 0% upon achievement of specified total leverage ratios, minus (ii) the amount of certain voluntary prepayments made on the First Lien Term Loan Facility and/or the ABL Facility during such fiscal year. There was no Excess Cash Flow payment required for fiscal 2017, fiscal 2016 or fiscal 2015.
The First Lien Term Loan Facility includes certain customary restrictions, among other things, on the Company’s ability and the ability of Parent, the Credit Facilities Guarantors (including the Company’s subsidiary 99 Cents Only Stores Texas Inc.) and certain future subsidiaries of the Company to incur or guarantee additional indebtedness, make certain restricted payments, acquisitions or investments, materially change the Company’s business, incur or permit to exist certain liens, enter into transactions with affiliates, sell assets, make capital expenditures or merge or consolidate with or into, another company. As of January 27, 2017, the Company was in compliance with the terms of the First Lien Term Loan Facility.
ABL Facility
The ABL Facility initially was to mature on January 13, 2017 and provided for up to $175.0 million of borrowings, subject to certain borrowing base limitations. Subject to certain conditions, the Company could increase the commitments under the ABL Facility by up to $50.0 million. All obligations under the ABL Facility are guaranteed by Parent and the other Credit Facilities Guarantors.
The ABL Facility is secured by substantially all of the Company’s assets and the assets of the Credit Facilities Guarantors, including a first priority security interest in certain current assets, and a second priority pledge of all of the Company’s equity interests and the equity interest of the Credit Facilities Guarantors and a second priority security interest in certain other fixed assets.
Borrowings under the ABL Facility bear interest at a rate based, at the Company’s option, on (i) LIBOR plus an applicable margin to be determined (3.00% as of January 27, 2017) or (ii) the determined Base Rate plus an applicable margin to be determined (2.00% at January 27, 2017), in each case based on a pricing grid depending on average daily excess availability for the most recently ended quarter. The weighted average interest rate for borrowings under the ABL Facility was 4.18% as of January 27, 2017 and 2.53% as of January 29, 2016.
In addition to paying interest on outstanding principal under the Credit Facilities, the Company is required to pay a commitment fee to the lenders under the ABL Facility on unused commitments. The commitment fee is adjusted at the beginning of each quarter based upon the average historical excess availability of the prior quarter (0.50% for the quarter ended January 27, 2017 and January 29, 2016). The Company must also pay customary letter of credit fees and agency fees.
As of January 27, 2017, borrowings under the ABL Facility were $39.3 million, outstanding letters of credit were $31.6 million and availability under the ABL Facility subject to the borrowing base, was $37.2 million. As of January 29, 2016, borrowings under the ABL Facility were $47.8 million, outstanding letters of credit were $2.5 million and availability under the ABL Facility subject to the borrowing base, was $90.9 million, prior to giving effect to a subsequent amendment to the ABL Facility on April 8, 2016 that decreased commitments available under the ABL Facility by $25.0 million.
The ABL Facility includes restrictions on the Company’s ability, and the ability of Parent and certain of the Company’s restricted subsidiaries to incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, its capital stock, make certain acquisitions or investments, materially change its business, incur or permit to exist certain liens, enter into transactions with affiliates, sell assets or merge or consolidate with or into another company.
On October 8, 2013, the ABL Facility was amended to, among other things, modify the provision restricting the Company’s ability to make dividend and other payments. Such payments are subject to achievement of Excess Availability (as defined in the agreement governing the ABL Facility) and a ratio of EBITDA (as defined in the agreement governing the ABL Facility) to fixed charges.
On August 24, 2015, the Company amended its ABL Facility to increase commitments available under the ABL Facility by $10.0 million, resulting in an aggregate ABL Facility size of $185.0 million. The additional commitments implemented pursuant to the amendment have terms identical to the existing commitments under the ABL Facility, including as to interest rate and other pricing terms. The Company paid amendment fees of $0.5 million to lenders under the ABL Facility.
In addition, the amendment to the ABL Facility (i) modified certain springing covenants triggered by reference to excess availability under the ABL Facility agreement so that, from August 24, 2015 to April 30, 2016, the occurrence of any such excess availability trigger is determined solely by reference to the available borrowing base under the ABL Facility rather than by reference to the lesser of the available borrowing base and the available aggregate commitments under the ABL Facility, (ii) increased the inventory advance rate during such period for purposes of calculating the borrowing base from 90% to 92.5%, (iii) provided for certain additional inspection rights by the administrative agent if there is a material increase in the amount of inventory that is not eligible inventory for purposes of the borrowing base and (iv) provided for certain additional technical waivers and amendments in order to effect the foregoing.
On April 8, 2016, the Company amended its ABL Facility to, among other things, decrease the commitments available under the ABL Facility by $25.0 million, resulting in an aggregate facility size of $160.0 million, and extend the maturity date of the ABL Facility to April 8, 2021; provided however, the ABL Facility will mature on the earlier of (i) the date that is 90 days prior to the stated maturity date in respect of the First Lien Term Loan Facility and (ii) the date that is 90 days prior to the stated maturity date in respect of the Senior Notes (as defined below), unless the First Lien Term Loan Facility and Senior Notes have been repaid or refinanced in full or amended to extend the final maturity dates thereof to a date that is at least 180 days after April 8, 2021 (the date of such repayment or refinancing, the “Term/Notes Refinancing Date”) (such amendment, the “Fourth Amendment”). The Fourth Amendment also modified the interest rate margins payable under the ABL Facility. The initial applicable margin for borrowings under the ABL Facility is 2.0% with respect to base rate borrowings and 3.0% with respect to Eurocurrency rate borrowings. Commencing with the first day of the first fiscal quarter commencing after the closing of the Fourth Amendment, the applicable margin for borrowings thereunder is subject to adjustment each fiscal quarter, based on average historical excess availability during the preceding fiscal quarter. Furthermore, the applicable margin will be reduced by 0.50% after the Term/Notes Refinancing Date.
In addition, the Fourth Amendment (i) reduced the incremental revolving commitment capacity from $50.0 million to $25.0 million, but provides that any such incremental revolving commitment may take the form of a “last-out” term loan, (ii) added restrictions on certain negative covenants in respect of investments, restricted payments and prepayments of indebtedness, including the
First Lien Term Loan Facility and the Senior Notes, in each case, until the occurrence of Term/Notes Refinancing Date, (iii) reduced the letter of credit sublimit from $50.0 million to $45.0 million and (iv) provided for certain additional technical waivers and amendments in order to effect the foregoing.
In connection with the Fourth Amendment and in the first quarter of fiscal 2017, the Company recognized a loss on debt extinguishment of approximately $0.3 million related to a portion of the unamortized debt issuance costs. The Company recorded $4.7 million of debt issuance costs in connection with the Fourth Amendment in the first quarter of fiscal 2017 as part of non-current deferred financing costs.
As of January 27, 2017, the Company was in compliance with the terms of the ABL Facility.
Senior Notes
On December 29, 2011, the Company issued $250.0 million aggregate principal amount of 11% Senior Notes that mature on December 15, 2019 (the “Senior Notes”). The Senior Notes are guaranteed by the same subsidiaries that guarantee the Credit Facilities (the “Subsidiary Guarantors”).
Pursuant to the terms of the indenture governing the Senior Notes (the “Indenture”), the Company may redeem all or a part of the Senior Notes at certain redemption prices that vary based on the date of redemption. The Company is not required to make any mandatory redemptions or sinking fund payments, and may at any time or from time to time purchase notes in the open market.
The Indenture contains covenants that, among other things, limit the Company’s ability and the ability of certain of its subsidiaries to incur or guarantee additional indebtedness, create or incur certain liens, pay dividends or make other restricted payments and investments, incur restrictions on the payment of dividends or other distributions from restricted subsidiaries, sell assets, engage in transactions with affiliates, or merge or consolidate with other companies. As of January 27, 2017, the Company was in compliance with the terms of the Indenture.
The significant components of interest expense are as follows (in thousands):
7. Derivative Financial Instruments
The Company entered into derivative instruments for risk management purposes and uses these derivatives to manage exposure to fluctuation in interest rates.
Interest Rate Swap
In May 2012, the Company entered into a floating-to-fixed interest rate swap agreement for an initial aggregate notional amount of $261.8 million to limit exposure to interest rate increases related to a portion of the Company’s floating rate indebtedness once the Company’s interest rate cap agreement expires. The swap agreement that expired in May 2016, hedged a portion of contractual floating rate interest commitments through its expiration. As a result of the agreement, the Company’s effective fixed interest rate on the notional amount of floating rate indebtedness was 1.36% plus an applicable margin of 3.50%.
The Company designated the interest rate swap agreement as a cash flow hedge. The interest rate swap agreement was highly correlated to the changes in interest rates to which the Company is exposed. Unrealized gains and losses on the interest rate swap were designated as effective or ineffective. The effective portion of such gains or losses was recorded as a component of AOCI or loss, while the ineffective portion of such gains or losses was recorded as a component of interest expense. Realized gains and losses in connection with each required interest payment were reclassified from AOCI or loss to interest expense.
Covert Transition Payments
In September 2015, the Company entered into an employment agreement with Geoffrey J. Covert as the President and Chief Executive Officer of each of the Company and Parent. In connection with this agreement, Mr. Covert is entitled to receive amounts under a transition program based on the value of certain equity awards from his former employer that he forfeited in connection with his previous employment. The maximum amount of payments due under this agreement is approximately $5.0 million, payable over a period of four years. The Company accounts for these transition payments as derivatives that are not designated as hedging instruments and has measured the obligation at fair value at January 27, 2017 and January 29, 2016. The Company recognizes the expense associated with these payments over the requisite service period.
Fair Value
The fair value of the interest rate swap agreement was estimated using industry standard valuation models using market-based observable inputs, including interest rate curves (Level 2, as defined in Note 8, “Fair Value of Financial Instruments”). The fair value of Mr. Covert’s transition payments is estimated using a valuation model that includes unobservable inputs (Level 3, as defined in Note 8, “Fair Value of Financial Instruments”). A summary of the recorded amounts included in the consolidated balance sheet is as follows (in thousands):
A summary of recorded amounts included in the consolidated statements of comprehensive income (loss) is as follows (in thousands):
8. Fair Value of Financial Instruments
The Company complies with authoritative guidance for fair value measurement and disclosures which establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1: Defined as observable inputs such as quoted prices in active markets for identical assets or liabilities.
Level 2: Defined as observable inputs other than Level 1 prices. These include quoted prices for similar assets or liabilities in an active market, quoted prices for identical assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The Company uses the best available information in measuring fair value. The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis (in thousands) as of January 27, 2017:
Level 1 measurements include $0.8 million of deferred compensation assets that fund the liabilities related to the Company’s deferred compensation, including investments in trust funds. The fair values of these funds are based on quoted market prices in an active market.
There were no Level 2 assets or liabilities as of January 27, 2017.
Level 3 measurements include transition payments to Mr. Covert (See Note 7, “Derivative Financial Instruments”) estimated using a valuation model that includes Level 3 unobservable inputs. Significant assumptions used in the analysis include projected stock prices, stock volatility and the Company’s credit spread.
The Company did not have any transfers of investments in and out of Levels 1 and 2 during fiscal 2017.
The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis (in thousands) as of January 29, 2016:
Level 1 measurements include $0.7 million of deferred compensation assets that fund the liabilities related to the Company’s deferred compensation plan, including investments in trust funds. The fair values of these funds are based on quoted market prices in an active market.
Level 2 measurements include interest rate swap agreement estimated using industry standard valuation models using market-based observable inputs, including interest rate curves.
Level 3 measurements include transition payments to Mr. Covert estimated using a valuation model that includes Level 3 unobservable inputs. Significant assumptions used in the analysis include projected stock prices, stock volatility and the Company’s credit spread.
The Company did not have any transfers of investments in and out of Levels 1 and 2 during fiscal 2016.
The following table summarizes the activity for the period of changes in fair value of the Company’s Level 3 instruments (in thousands):
(1)Losses are included in selling, general and administrative expenses.
The outstanding debt under the Credit Facilities and the Senior Notes is recorded in the financial statements at historical cost, net of applicable unamortized discounts and deferred financings costs.
The fair value of the First Lien Term Loan Facility was estimated at $516.7 million, or $77.2 million lower than its carrying value, as of January 27, 2017, based on quoted market prices of the debt (Level 1 inputs). The fair value of the First Lien Term Loan Facility was estimated at $393.0 million, or $207.0 million lower than its carrying value, as of January 29, 2016, based on quoted market prices of the debt (Level 1 inputs).
The fair value of the Senior Notes was estimated at $166.9 million, or $83.1 million lower than the carrying value, as of January 27, 2017, based on quoted market prices of the debt (Level 1 inputs). The fair value of the Senior Notes was estimated at $103.1 million, or $146.9 million lower than the carrying value, as of January 29, 2016, based on quoted market prices of the debt (Level 1 inputs).
See Note 6, “Debt” for more information on the Company’s debt.
Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis
During the fourth quarter of fiscal 2017, the Company reduced the carrying value of certain transferable liquor licenses to their fair value of $0.1 million from $0.4 million, resulting in an impairment charge of $0.3 million. Fair value measurements used in these impairment evaluations were based on prices of liquor licenses in the open market in same or similar jurisdictions (Level 2).
During the third quarter of fiscal 2017, the Company recognized an impairment charge of approximately $0.1 million relating to the anticipated closure of three stores. The remaining net book value of assets measured at fair value was $0.1 million. During the third quarter of fiscal 2017, the Company also recorded impairment charges of $0.1 million related to fixtures that will be disposed of and for which the Company concluded the fair value was zero. The fair value measurements used in these impairment evaluations were based on discounted cash flow estimates using unobservable inputs (Level 3).
During the third quarter of fiscal 2017, the Company also reduced the carrying value of a held for sale property to its fair value of $1.5 million from $1.7 million, resulting in an impairment charge of $0.2 million. Fair value was determined on the basis of a broker quote, less estimated cost to sell (Level 2).
In fiscal 2016, the Company recorded a goodwill impairment charge of $99.1 million. The valuation methodologies incorporate unobservable inputs reflecting significant estimates and assumptions made by management (Level 3 inputs). See Note 1, “Basis of Presentation and Summary of Significant Accounting Policies.” In fiscal 2016, the Company recorded an impairment charge of $0.6 million relating to its trademarks, primarily as a result of change in merchandising strategy and resulting lower projected cash flows than previously estimated. The fair value measurements used in these impairment evaluations were based on relief from royalty method using unobservable inputs (Level 3). See Note 3, “Goodwill and Other Intangible Assets and Liabilities.”
During fiscal 2016, due to the underperformance of two stores in Texas and one store in California, the Company concluded that the carrying value of the long-lived assets relating to such stores were not recoverable and accordingly recorded an asset impairment charge of $0.8 million. The remaining net book value of assets measured at fair value was $0.3 million. During fiscal 2016, the Company also recorded impairment charges of $0.2 million related to equipment and fixtures that will be disposed of and for which the Company concluded the fair value was zero. The fair value measurements used in these impairment evaluations were based on discounted cash flow estimates using unobservable inputs (Level 3).
9. Related-Party Transactions
Stockholders Agreement
Upon completion of the Merger, Parent entered into a stockholders agreement with each of its stockholders, which included certain of the Company’s former directors, employees and members of management and the Company’s principal stockholders. The stockholders agreement gives (i) Ares the right to designate four members of the board of directors of Parent (the “Parent Board”), (ii) Ares the right to designate up to three independent members of the Parent Board, which directors shall be approved by CPPIB, and (iii) CPPIB the right to designate two members of the Parent Board, in each case for so long as they or their respective affiliates beneficially own at least 15% of the then outstanding shares of Class A Common Stock. The stockholders agreement provides for the election of the current Chief Executive Officer of Parent to the Parent Board. Under the terms of the stockholders agreement, certain significant corporate actions require the approval of a majority of directors on the board of directors, including at least one director designated by Ares and one director designated by CPPIB. These actions include the incurrence of additional indebtedness over $20 million in the aggregate outstanding at any time, the issuance or sale of any of our capital stock over $20 million in the aggregate, the sale, transfer or acquisition of any assets with a fair market value of over $20 million, the declaration or payment of any dividends, entering into any merger, reorganization or recapitalization, amendments to our charter or bylaws, approval of our annual budget and other similar actions.
The stockholders agreement contains significant transfer restrictions and certain rights of first offer, tag-along, and drag-along rights. In addition, the stockholders agreement contains registration rights that, among other things, require Parent to register common stock held by the stockholders who are parties to the stockholders agreement in the event Parent registers for sale, either for its own account or for the account of others, shares of its common stock.
Under the stockholders agreement, certain affiliate transactions, including certain affiliate transactions between Parent, on the one hand, and Ares, CPPIB or any of their respective affiliates, on the other hand, require the approval of a majority of disinterested directors.
Management Services Agreements
Upon completion of the Merger, the Company and Parent entered into management services agreements with affiliates of the Sponsors (the “Management Services Agreements”). Under each of the Management Services Agreements, the Company and Parent agreed to, among other things, retain and reimburse affiliates of the Sponsors for certain expenses incurred in connection with the provision by Sponsors of certain management and financial services and provide customary indemnification to the Sponsors and their affiliates. The affiliates of the Sponsors provided no services to the Company in fiscal 2015. In fiscal 2016, the Company reimbursed affiliates of the Sponsors their expenses in the amount of $0.4 million. In fiscal 2017, the Company reimbursed affiliates of the Sponsors their expenses in the amount of less than $0.1 million.
First Lien Term Loan Facility
As of January 27, 2017, funds affiliated with Ares and CPPIB held approximately $130.5 million of term loans under the First Lien Term Loan Facility. The terms of the term loans are the same as those held by unaffiliated third party lenders under the First Lien Term Loan Facility. No amounts were held by these affiliates as of January 29, 2016.
Senior Notes
As of January 27, 2017 and January 29, 2016 various funds affiliated with Ares and CPPIB have collectively acquired $102.1 million aggregate principal amount of the Company’s Senior Notes in open market transactions. From time to time, these or other affiliated funds may acquire additional Senior Notes.
10. Commitments and Contingencies
Credit Facilities
The Company’s Credit Facilities and commitments are discussed in detail in Note 6, “Debt”.
Lease Commitments
The Company leases various facilities under operating leases (except for one location which is classified as a capital lease and seven locations classified as financing leases) expiring at various dates through fiscal year 2035. Most of the lease agreements contain renewal options and/or provide for fixed rent escalations or increases based on the Consumer Price Index. Total minimum lease payments under each of these lease agreements, including scheduled increases, are charged to expenses on a straight-line basis over the term of each respective lease. Certain leases require the payment of property taxes, maintenance and insurance. Rental expenses (including property taxes, maintenance and insurance) charged to expense in fiscal 2017 were $102.5 million, of which $0.3 million was paid as percentage rent, based on sales volume for fiscal 2017. Rental expenses (including property taxes, maintenance and insurance) charged to expense in fiscal 2016 were $97.3 million, of which $0.3 million was paid as percentage rent, based on sales volume for fiscal 2016. Rental expenses (including property taxes, maintenance and insurance) charged to expense in fiscal 2015 were $85.5 million, of which $0.3 million was paid as percentage rent, based on sales volume for fiscal 2015. Sub-lease income earned in fiscal 2017, fiscal 2016 and fiscal 2015 was $0.9 million, $0.4 million and $0.5 million, respectively.
As of January 27, 2017, the minimum annual rentals payable and future minimum sub-lease income under all non-cancelable leases was as follows (amounts in thousands):
The capital leases relate to a building for one of the Company’s retail stores and vehicles. The gross asset amount recorded under the capital lease was $0.4 million as of January 27, 2017 and $0.3 million as of January 29, 2016. Accumulated depreciation was $0.3 million at each of January 27, 2017 and January 29, 2016.
Five of the financing leases relate to sale-leaseback transactions in fiscal 2017 and fiscal 2016 in which the Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed with the financing obligations equal to the amount of proceeds received. See Note 1, “Basis of Presentation and Summary of Significant Accounting Policies.” As of January 27, 2017, the Company has also recorded a financing lease obligation related to the sale of a warehouse facility as described below.
As of January 29, 2016, the Company had also recorded a financing lease obligation and related construction in progress for one store. The Company had concluded that it was the “deemed owner” of the construction project (for accounting purposes) during the construction period. As of January 29, 2016, the Company had recorded an asset of $1.0 million, representing the amount of construction in progress, and a financing lease obligation of $0.6 million recorded as a component of non-current liabilities. Upon completion of the construction, the Company evaluated the de-recognition of the asset and liability under sale-leaseback accounting guidance. The Company concluded that it had “continuing involvement,” which precluded the de-recognition of the asset and the financing obligations from the consolidated balance sheet when construction was completed. As of January 27, 2017, the Company has recorded an asset of $2.7 million and a financing lease obligation of $2.3 million recorded as a component of current and non-current liabilities.
In May 2014, the Company entered into a lease agreement for office and warehouse space in the City of Commerce, California that expires in February 2030. In order for the leased space to meet the Company’s operating specifications, both the landlord and the Company would make structural changes to the property, and as a result, the Company concluded that it was the “deemed owner” of the construction project (for accounting purposes) during the construction period. Accordingly, the Company recorded an asset
representing the estimated fair market value of the building (a Level 2 measurement) and a corresponding construction financing obligation. Upon completion of construction, the Company evaluated the de-recognition of the asset and liability under sale-leaseback accounting guidance. The Company was deemed to have “continuing involvement,” which precluded the de-recognition of the asset from the consolidated balance sheet when construction was complete.
Accordingly, as of January 30, 2015, the Company had recorded an asset of $24.6 million, representing the estimated fair market value of the building, and a financing lease obligation of $24.9 million (including accrued interest), recorded as a component of current and non-current liabilities.
Sale of Warehouse Facility
On July 6, 2016, the Company sold and concurrently licensed (through March 31, 2017) a warehouse facility in the City of Commerce, California with a carrying value of $12.1 million and received net proceeds from this transaction of $28.5 million. In addition to the proceeds, $1.0 million purchase price consideration had been held in escrow for the buyer to make certain repairs, and any amount not used for such repairs would be paid to the Company. The repairs were completed in January 2017 and the Company received $0.6 million from amounts held in escrow. The Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. The resulting lease is accounted for as a financing lease and the Company has recorded a financing lease obligation of $30.1 million (as a component of current liabilities) as of January 27, 2017. The Company will de-recognize the assets and financing lease obligation at the earlier of when the lease term ends or when the Company no longer has continuing involvement. The Company exited the warehouse facility in March 2017, and expects to record a gain on sale of $18.5 million in the first quarter of fiscal 2018.
Mid-Term Cash Incentive Plan and Special Bonus Letters
On July 26, 2016, the Compensation Committee of the Board (the “Compensation Committee”) adopted the 99 Cents Only Stores LLC 2016 Mid-Term Cash Incentive Plan (the “Mid-Term Cash Incentive Plan”). The Mid-Term Cash Incentive Plan is intended to promote the success of the Company by rewarding certain employees for their service to the Company and to provide incentives for such employees to remain in the employ or other service of the Company and to contribute to the performance of the Company. Under the Mid-Term Cash Incentive Plan, if the Company achieves an initial Adjusted EBITDA (as defined in the Mid-Term Cash Incentive Plan) goal for either fiscal 2017 or fiscal 2018 (the “Initial Mid-Term Plan Goal”), 50% of a participant’s award will be eligible for payment. No amounts will be paid under the Mid-Term Cash Incentive Plan if the Initial Mid-Term Plan Goal is not achieved. If the Company achieves the Initial Mid-Term Plan Goal and then achieves the same Adjusted EBITDA goal for the fiscal year immediately following the year in which the Initial Mid-Term Plan Goal was achieved, the remaining 50% of the participant’s award will be eligible for payment. Payment of eligible awards will only be made to the extent the Company’s Free Cash Flow (as defined in the Mid-Term Cash Incentive Plan) exceeds the amount eligible for payment, as measured at the end of each second quarter and fourth quarter of each fiscal year after an amount becomes eligible for payment until the end of the fiscal year ending January 31, 2020. The Company does not expect to maintain the Mid-Term Cash Incentive Plan for periods after the fiscal year ending July 31, 2020. The maximum payout under the Mid-Term Cash Incentive Plan is $22.5 million. The Company recognizes the expense associated with this Mid-Term Cash Incentive Plan over the requisite service periods and has accrued $6.0 million as January 27, 2017.
On July 26, 2016, the Compensation Committee approved special bonus letters for three executives. Pursuant to the terms thereof, if a Refinancing Transaction (as defined in the special bonus letters) occurs prior to October 1, 2018, each of the applicable executives will be eligible to receive a special bonus payable within 30 days of such transaction. The special bonuses to be earned by the applicable executives total $4.0 million. No amounts have been accrued as of January 27, 2017.
Workers’ Compensation
The Company self-insures its workers’ compensation claims in California and Texas and provides for losses of estimated known and incurred but not reported insurance claims. The Company does not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing its workers’ compensation liability.
In the fourth quarter of fiscal 2016, the Company increased worker’s compensation liability reserve by $7.2 million, primarily as a result of higher incurred and projected expenses associated with fiscal 2016 workers’ compensation claims. The Company implemented initiatives designed to create a culture of safety and to reduce the frequency and severity of workers’ compensation injuries. In the fourth quarter of fiscal 2017, the Company decreased workers’ compensation liability reserve by $5.6 million, primarily as a result of lower incurred and projected expenses associated with fiscal 2017 workers’ compensation claims. As of January 27, 2017 and January 29, 2016, the Company had recorded a liability of $69.1 million and $76.3 million, respectively, for estimated workers’ compensation claims in California. The Company has limited self-insurance exposure in Texas and had recorded a liability of less than $0.1 million as of each of January 27, 2017 and January 29, 2016 for workers’ compensation claims in Texas. The Company purchases workers’ compensation insurance coverage in Arizona and Nevada and is not self-insured in those states.
Self-Insured Health Insurance Liability
The Company self-insures for a portion of its employee medical benefit claims. At January 27, 2017 and January 29, 2016, the Company had recorded a liability of $0.9 million and $0.4 million, respectively, for estimated health insurance claims. The Company maintains stop loss insurance coverage to limit its exposure for the self-funded portion of its health insurance program.
The following table summarizes the changes in the reserves for self-insurance for the periods indicated (in thousands):
Legal Matters
Wage and Hour Matters
Shelley Pickett v. 99¢ Only Stores. Plaintiff Shelley Pickett, a former cashier for the Company, filed a representative action complaint against the Company on November 4, 2011 in the Superior Court of the State of California, County of Los Angeles alleging a Private Attorneys General Act of 2004 (“PAGA”) claim that the Company violated section 14 of Wage Order 7-2001 by failing to provide seats for its cashiers behind checkout counters. Pickett seeks civil penalties of $100 to $200 per violation, per each pay period for each affected employee, and attorney’s fees. The court denied the Company’s motion to compel arbitration of Pickett’s individual claims or, in the alternative, to strike the representative action allegations in the complaint, and the Court of Appeals affirmed the trial court’s ruling. On June 27, 2013, Pickett entered into a settlement agreement and release with the Company in another matter. Payment has been made to the plaintiff under that agreement and the other action has been dismissed. The Company’s position is that the release Pickett executed in that matter waives the claims she asserts in this action, waives her right to proceed on a class or representative basis or as a private attorney general and requires her to dismiss this action with prejudice as to her individual claims. The Company notified Pickett of its position by a letter dated as of July 30, 2013, but she refused to dismiss the lawsuit. On February 11, 2014, the Company answered the complaint, denying all material allegations, and filed a cross-complaint against Pickett seeking to enforce her agreement to dismiss this action. Through the cross-complaint, the Company seeks declaratory relief, specific performance and damages. Pickett has answered the cross-complaint, asserting a general denial of all material allegations and various affirmative defenses. On September 30, 2014, the court denied the Company’s motion for judgment on the pleadings as to its cross-complaint and granted leave to Pickett to amend her complaint to add another representative plaintiff, Tracy Humphrey. Plaintiffs filed their amended complaint on October 8, 2014, and the Company answered on October 10, 2014, denying all material allegations. On April 4, 2016, in an unrelated matter involving similar claims against a different employer, the California Supreme Court issued a ruling that provides guidance to lower courts as to California’s employee seating requirement, which is a largely untested area of law. The instant action had been stayed pending the issuance of the California Supreme Court ruling. The stay has been lifted and the parties mediated this matter on October 19, 2016. The mediation did not result in a settlement, and a bench trial has been scheduled for May 31, 2017. The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, that could result from such lawsuit.
Sofia Wilton Barriga v. 99¢ Only Stores. Plaintiff, a former store associate, filed an action against the Company on August 5, 2013, in the Superior Court of the State of California, County of Riverside alleging on behalf of the plaintiff and all others allegedly similarly situated under the California Labor Code that the Company failed to pay wages for all hours worked, provide meal periods, pay wages timely upon termination, and provide accurate wage statements. The plaintiff also asserted a derivative claim for unfair competition under the California Business and Professions Code. The plaintiff seeks to represent a class of all non-exempt employees who were employed in California in the Company’s retail stores who worked the graveyard shift at any time from January 1, 2012, through the date of trial or settlement. Although the class period as originally pled would extend back to August 5, 2009, the parties have agreed that any class period would run beginning January 1, 2012, because of the preclusive effect of a judgment in a previous matter. The plaintiff seeks to recover alleged unpaid wages, statutory penalties, interest, attorney’s fees and costs, and restitution. On September 23, 2013, the Company filed an answer denying all material allegations. A case management conference was held on October 4, 2013, at which the court ordered that discovery may proceed as to class certification issues only. After discovery commenced, a mediation was held on March 12, 2015, resulting in a confidential mediator’s proposal, which the parties verbally
accepted. The parties were unable to negotiate and finalize a written settlement agreement. Subsequent settlement discussions directly and through the mediator, as well as a court-ordered settlement conference, were unsuccessful. Discovery resumed and plaintiff’s motion for class certification has been fully briefed. Plaintiff has also brought a motion to strike the evidence submitted in support of the Company’s opposition to class certification. At the Court’s request the parties agreed to mediate this matter prior to any ruling on the class certification motion and the motion to strike. That mediation took place on March 2, 2017, and did not result in a settlement. The motion for class certification and motion to strike were heard on April 20, 2017, and taken under submission by the Court. On October 26, 2015, plaintiffs’ counsel filed another action in Los Angeles Superior Court, entitled Ivan Guerra v. 99 Cents Only Stores LLC (Case No. BC599119), which asserts PAGA claims based in part on the allegations at issue in the Barriga action. By stipulation of the parties, the Guerra action has been transferred to Riverside Superior Court and was mediated along with the Barriga action on March 2, 2017. The Company cannot predict the outcome of these lawsuits or the amount of potential loss, if any, that could result from such lawsuits.
Phillip Clavel v. 99 Cents Only Stores LLC, et al. Former warehouse worker Phillip Clavel filed an action against the Company on March 30, 2016, on behalf of himself and all other alleged aggrieved employees, seeking civil penalties under the PAGA for the following alleged Labor Code violations: failure to pay regular, overtime and minimum wages for all hours worked, failure to provide proper meal and rest periods, failure to pay wages timely during employment and upon termination, failure to provide proper wage statements, failure to reimburse business expenses, and failure to provide notice of the material terms of employment under the Wage Theft Prevention Act. Mr. Clavel alleges that his claims arose during two periods of employment-one from March 2015 through mid-October 2015, during which he was employed by the Company as a forklift operator in the Commerce Distribution Center, and a second period from late October 2015 through February 2016, when he was similarly employed (through a staffing agency, BaronHR) at the Company’s Washington Boulevard warehouse. On June 9, 2016, Plaintiff filed a First Amended Complaint. The Company answered the First Amended Complaint on June 14, 2016, generally denying the allegations in the complaint and asserting a number of affirmative defenses. BaronHR has also answered the First Amended Complaint. Trial has been set to commence on July 18, 2017. A mediation took place on January 19, 2017, and at the conclusion of the mediation, the parties executed a term sheet settlement agreement to resolve the alleged PAGA claims. The parties are in the process of drafting a long-form settlement agreement reflecting the final terms and the settlement is contingent on court approval. The Company has accrued in an immaterial amount related to this matter in fiscal 2017. If the proposed settlement is not finalized or not approved by the Court, the Company will not be able to predict the outcome of this lawsuit or the amount of potential loss, if any, that could result from such lawsuit.
Jimmy Mejia, et al. v. 99 Cents Only Stores LLC. Former store associates Jimmy Mejia and Yamilet Serrano filed an action against the Company on September 16, 2016, on behalf of themselves and all other alleged aggrieved employees, seeking civil penalties under the PAGA for the following alleged Labor Code violations: failure to pay overtime and minimum wages for all hours worked, failure to provide proper meal and rest periods, failure to pay timely wages during employment and upon termination, and failure to provide proper wage statements. On November 14, 2016, the Company answered the complaint, generally denying the allegations in the complaint and asserting a number of affirmative defenses. Trial has been scheduled for January 8, 2018. The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, that could result from such lawsuit.
Environmental Matters
People of the State of California v. 99 Cents Only Stores LLC. This action was brought by the San Joaquin District Attorney and a number of other public prosecutors against the Company alleging that the Company had violated hazardous waste statutory and regulatory requirements at its retail stores in California. The Company settled this case through the entry of a stipulated judgment in December 2014 which contained injunctive relief requiring the Company to comply with applicable hazardous waste requirements at these stores. On June 29, 2015, the District Attorney informed the Company of alleged hazardous waste violations identified during a March 2015 inspection of a recently-opened store in Sonora, Tuolumne County and requested a meeting with the Company. Since that time, the Company has been cooperating with the District Attorney to provide information regarding the alleged violations. The District Attorney has demanded that the Company pay $187,500 to resolve this matter and to agree to additional injunctive relief in the existing settlement. In May 2016, the discussions with the District Attorney were extended to include non-compliance issues identified at an existing store in San Jose during an inspection on March 16, 2016. In connection with this matter, the Company has accrued an immaterial amount. Although any monetary damages ultimately paid by the Company may exceed the accrued amount, it is not currently possible to estimate the amount of any such excess or the impact that any injunctive relief may have on the Company’s business, financial condition and results of operations.
Other Matters
The Company is also subject to other private lawsuits, administrative proceedings and claims that arise in its ordinary course of business. A number of these lawsuits, proceedings and claims may exist at any given time. While the resolution of such a lawsuit, proceeding or claim may have an impact on the Company’s financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business is expected to have a material adverse effect on the Company’s financial position, results of operations or overall liquidity.
11. Stock-Based Compensation Plans
Number Holdings, Inc. 2012 Equity Incentive Plan
On February 27, 2012, the board of directors of Parent (the “Board”) adopted the Number Holdings, Inc. 2012 Stock Incentive Plan (the “2012 Plan”). On July 26, 2016, the 2012 Plan was amended to increase the aggregate number of shares authorized for issuance under the 2012 Plan to 87,500 shares of Class A Common Stock of Parent and 87,500 shares of Class B Common Stock of Parent. Prior to the increase, the 2012 Plan authorized equity awards to be granted for up to 85,000 shares of Class A Common Stock of Parent and 85,000 shares of Class B Common Stock of Parent. As of January 27, 2017, options for 82,140 shares of each of Class A Common Stock and Class B Common Stock were outstanding and held by employees, members of management and directors. Options upon vesting may be exercised only for units consisting of an equal number of Class A Common Stock and Class B Common Stock. Class B Common Stock has de minimis economic rights and the right to vote solely for election of directors.
Employee Option Grants
Options subject to time-vesting conditions granted to employees generally become exercisable over a four or five year service period and have terms of ten years from the date of grant. Options with performance-vesting conditions granted to employees generally become exercisable based on the achievement of certain performance targets and have terms of ten years from the date of grant.
Under the standard form of option award agreement for the 2012 Plan, Parent has a right to repurchase from the participant all or a portion of (i) Class A and Class B Common Stock issued upon the exercise of the options awarded to a participant and (ii) fully vested but unexercised options. The repurchase price for the shares of Class A and Class B Common Stock is the fair market value of such shares as of the date of such termination, and, for the fully vested but unexercised options, the repurchase price is the difference between the fair market value of the Class A and Class B Common Stock as of the date of termination of employment and the exercise price of the option. However, upon (i) a termination of employment for cause, (ii) a voluntary resignation without good reason, or (iii) upon discovery that the participant engaged in detrimental activity, the repurchase price is the lesser of the exercise price paid by the participant to exercise the option or the fair market value of the Class A and Class B Common Stock. If Parent elects to exercise its repurchase right for any shares acquired pursuant to the exercise of an option, it must do so no later than 180 days after the date of participant’s termination of employment, or (ii) for any unexercised option no later than 90 days from the latest date that such option can be exercised. The options also contain transfer restrictions that lapse upon registration of an offering of Parent common stock under the Securities Act of 1933 (a “liquidity event”).
The Company defers recognition of substantially all of the stock-based compensation expense related to these stock options. The nature of repurchase rights and transfer restrictions create a performance condition that is not considered probable of being achieved until a liquidity event or certain employment termination events are probable of occurrence. Additionally, the Company has deferred recognition of the stock-based compensation expense for performance-based options until it is probable that the performance targets will be achieved. These options are accounted for as equity-based awards. The fair value of these stock options was estimated at the date of grant using the Black-Scholes pricing model. There were 21,925 time-based and 17,965 performance-based employee options outstanding (for individuals other than board members, Mr. Covert and Ms. Thornton) as of January 27, 2017.
During the second quarter of fiscal 2017, Parent provided certain employee option holders an opportunity to exchange their outstanding non-qualified stock options for options with an exercise price of $757 per share. On July 26, 2016, the Compensation Committee of Parent canceled 15,555 of the outstanding options with an exercise price higher than $757 per share and granted new options to holders of the canceled options with an exercise price of $757 per share. In the third quarter of fiscal 2017, the Compensation Committee of Parent canceled an additional 260 of the outstanding options with an exercise price higher than $757 per share and granted new options to holders of the canceled options with an exercise price of $757 per share. The new options are generally vested to the same extent as the canceled options and have terms of ten years. New options subject to time-vesting conditions vest over a five-year service period and performance-vested options vest upon achievement of certain performance targets. The exchanges were treated as a modification of stock options for accounting purposes and had no impact on compensation expense. The fair value of new time-vested and performance-vested options was estimated at the date of modification using the Black-Scholes pricing model.
In the fourth quarter of fiscal 2016, 5,000 options were granted to the new Chief Merchandising Officer of the Company and Parent, which will vest based on the achievement of certain performance targets. The Company has deferred recognition of the stock-based compensation expense for these performance-based stock options due to repurchase rights and transfer restrictions included in the terms of the award. The nature of the repurchase rights and transfer restrictions create a performance condition that is not considered probable of being achieved until a liquidity event or certain employment termination events are probable of occurrence. Additionally, the Company has deferred recognition of the stock-based compensation expense for these performance-based options until it is probable that the performance targets will be achieved. The fair value of these performance-based options was estimated at the date of grant using the Black-Scholes pricing model. On July 26, 2016, the Compensation Committee of Parent amended these
options to conform the vesting conditions for the performance-vested options with those granted to other employees. The amendment of the performance hurdles was treated as a modification of stock options for accounting purposes and had no impact on compensation expense. The Company has continued to defer recognition of the stock-based compensation expense for the amended performance-based options. The fair value of these performance-based options was estimated at the date of modification using the Black-Scholes pricing model.
Director Option Grants
Options granted to board members generally become exercisable over a three, four or five year service period and have terms of ten years from the date of grant. Options granted to board members do not contain repurchase rights that would allow the Parent to repurchase these options at less than fair value. The Company recognizes stock-based compensation expense for these option grants over the service period. These options are accounted for as equity awards. The fair value of these stock options was estimated at the date of grant using the Black-Scholes pricing model. On July 26, 2016, the Compensation Committee of Parent amended 1,000 previously granted board member options with exercise prices in excess of $757 per share to lower the exercise price to $757 per share. The reduction in the exercise price was treated as a modification of stock options for accounting purposes. The modification, based on the fair value of the options both immediately before and after such modification, resulted in a total incremental compensation expense of less than $0.1 million in the second quarter of fiscal 2017.
Chief Financial Officer Equity Awards
In October 2015, the Company entered into an employment agreement with Felicia Thornton as the Chief Financial Officer and Treasurer of each of the Company and Parent. In connection with this agreement, Ms. Thornton was granted options to purchase 10,000 shares of Class A and Class B Common Stock of Parent. One-half of the options vest on each of the first four anniversaries of Ms. Thornton’s start date, and the other half of the options vest based on the achievement of certain performance targets. Options granted to Ms. Thornton contain repurchase rights as described above that would allow the Parent to repurchase these options at less than fair value, except that repurchase rights at less than fair value in the case of voluntary resignation without good reason lapse after November 2, 2017.
The Company records stock-based compensation for the time-based options in accordance with the four year vesting period. The Company has deferred recognition of the stock-based compensation expense for the performance-based options until it is probable that the performance targets will be achieved. The time-based and performance-based options are accounted for as equity awards. The fair value of these time-based and performance-based options was estimated at the date of grant using the Black-Scholes pricing model.
On July 26, 2016, the Compensation Committee of Parent amended Ms. Thornton’s performance-based options to conform the vesting conditions for the performance-vested options with those granted to other employees. The amendment of the performance targets was treated as a modification of stock options for accounting purposes and had no impact on compensation expense. The Company has continued to defer recognition of the stock-based compensation expense for the amended performance-based options. The fair value of these amended performance-based options was estimated at the date of modification using the Black-Scholes pricing model.
Chief Executive Officer Equity Awards
In September 2015, the Company entered into an employment agreement with Geoffrey J. Covert as the President and Chief Executive Officer of each of the Company and Parent. In connection with this agreement, Mr. Covert was granted two options, each to purchase 15,500 shares of Class A and Class B Common Stock of Parent. One of the grants has an exercise price of $1,000 per share. The other grant has an exercise price equal to $750 per share plus the amount by which the fair market value of the underlying share exceeds $1,000 on the date of exercise. One-half of each grant vests on each of the first four installments of the grant date, and the other half of each grant vests based on the achievement of certain performance targets. The vesting of the options is subject to Mr. Covert’s continued employment through the applicable vesting date. The options are subject to the terms of the 2012 Plan and the award agreements under which they were granted.
The Company has deferred recognition of the stock-based compensation expense for these time-based and performance-based stock options due to repurchase rights and transfer restrictions included in the terms of the award. The nature of the repurchase rights and transfer restrictions create a performance condition that is not considered probable of being achieved until a liquidity event or certain employment termination events are probable of occurrence. Additionally, the Company has deferred recognition of the stock-based compensation expense for performance-based options until it is probable that the performance targets will be achieved. The fair value of the grant with an exercise price of $1,000 per share was estimated at the date of grant using a binomial model. The fair value of the other grant was estimated at the date of grant using a Monte Carlo simulation method.
On July 26, 2016, the Compensation Committee of Parent amended Mr. Covert’s performance-based options to conform the vesting conditions for the performance-vested options with those granted to other employees. The amendment of the performance
hurdles was treated as a modification of stock options for accounting purposes and had no impact on compensation expense. The Company has continued to defer recognition of the stock-based compensation expense for the amended performance-based options. The fair value of the grant with an exercise price of $1,000 per share was estimated at the date of modification using a binomial model. The fair value of the other grant was estimated at the date of modification using a Monte Carlo simulation method.
Accounting for stock-based compensation
Determining the fair value of options at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise and the associated volatility. At the grant date, the Company estimates an amount of forfeitures that will occur prior to vesting. During fiscal 2017, the Company recorded stock-based compensation expense of $0.7 million related to time-based options. The income tax benefit was $0.3 million for fiscal 2017. During fiscal 2016, the Company recorded stock-based compensation expense of $1.5 million related to time-based options. The income tax benefit was $0.2 million for fiscal 2016. During fiscal 2015, the Company recorded stock-based compensation expense of $2.8 million related to time-based options. The income tax benefit was $1.1 million for fiscal 2015.
The fair value of stock options was estimated at the date of grant using the Black-Scholes pricing model with the following assumptions:
The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant with an equivalent remaining term. Expected life represents the estimated period of time until exercise and is calculated by using “simplified method.” Expected stock price volatility is based on average historical volatility of stock prices of companies in a peer group analysis. The Company currently does not anticipate the payment of any cash dividends. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on the Company’s historical experience and future expectations.
The fair value of the grant to the current President and Chief Executive Officer of the Company and Parent that have an exercise price equal to $750 per share plus the amount by which the fair market value of the underlying share exceeds $1,000 on the date of exercise was valued using a third-party valuation firm that used a binomial model to capture early exercise behaviors. The binomial model captures the optimal exercise timing as a function of the future stock price over the full contractual life of the options. Other key assumptions used include those described above for determining the fair value of options with service-based conditions. The Company also has to assume a time horizon to when the performance conditions of the options will be met. The fair value of the grant to the current President and Chief Executive Officer of the Company and Parent that have an exercise price equal to $1,000 per share was valued by a third-party valuation firm using a Monte Carlo simulation method. Key assumptions used include those described above for determining the fair value of options with service-based conditions and in addition the simulation utilizes a range of possible future stock values to construct a distribution of where future stock prices might be relative to the assumed exercise threshold. The simulations and resulting distributions will give a statistically acceptable range of future stock prices. The expected life of an option is derived from the Monte Carlo simulation model, and is based on several factors, including the contract life, exercise factor and volatility. The Company also has to assume a time horizon to when the performance targets of the options will be met.
As of January 27, 2017, there were $20.9 million of total unrecognized compensation costs related to non-vested options and options subject to repurchase rights for which no compensation has been recorded. During fiscal 2017, 9,093 options vested and the fair value of these vested options was $2.7 million. During fiscal 2016, 8,623 options vested and the fair value of these vested options was $4.0 million. During fiscal 2015, 8,226 options vested and the fair value of these vested options was $3.8 million. No options were exercised in fiscal 2017. The aggregate pre-tax intrinsic value of options exercised in fiscal 2016 was $0.1 million. The aggregate pre-tax intrinsic value of options exercised in fiscal 2015 was less than $0.1 million. The following summarizes stock option activity during the year ended January 27, 2017:
(a) Includes 13,266 options granted to employees that vest based on the achievement of certain performance targets.
(b) Includes cancellation of 15,815 options in exchange for options with new terms.
The following table summarizes the stock awards available for grant under the 2012 Plan as of January 27, 2017:
12. Operating Segments
The Company manages its business on the basis of one reportable segment. The Company’s sales through Bargain Wholesale are not material to the Company’s consolidated financial statements; therefore, Bargain Wholesale is not presented as a separate segment.
The Company had no customers representing more than ten percent of net sales. Substantially all of the Company’s net sales were to customers located in the United States. All of the Company’s operations are located in the United States with the exception of certain sourcing entities located in Asia. The foreign operations solely support domestic operations and are not material.
13. Employee Benefit Plans
401(k) Plan
In 1998, the Company adopted a 401(k) Plan (the “Plan”). All full-time employees are eligible to participate in the Plan after 30 days of service and are eligible to receive matching contributions from the Company after one year of service. The Company contributed $2.1 million, $2.0 million and $1.9 million during fiscal year 2017, fiscal year 2016 and fiscal year 2015. The Company matches 100% of the first 3% of compensation that an employee contributes and 50% of the next 2% of compensation that the employee contributes with immediate vesting.
Deferred Compensation Plan
The Company has a deferred compensation plan to provide certain key management employees the ability to defer a portion of their base compensation and/or bonuses. The plan is an unfunded nonqualified plan. The deferred amounts and earnings thereon are payable to participants, or designated beneficiaries, at specified future dates, upon retirement or death. The Company does not make contributions to this plan or guarantee earnings. The assets and liabilities of a rabbi trust are accounted for as if they are assets and liabilities of the Company. The assets held in the rabbi trust are not available for general corporate purposes. The rabbi trust is subject to creditor claims in the event of insolvency. The deferred compensation liability and related long-term assets were $0.8 million as of January 27, 2017 and $0.7 million as of January 29, 2016.
14. Assets Held for Sale
Assets held for sale as of January 27, 2017 consisted of vacant land in Rancho Mirage and Los Angeles, California and land in Bullhead, Arizona with an aggregate carrying value of $4.9 million. Assets held for sale as of January 29, 2016 consisted of vacant land in Rancho Mirage, California and land in Bullhead, Arizona with an aggregate carrying value of $2.3 million.
In September 2015, the Company completed the sale of a cold storage distribution center in City of Commerce, California and received net proceeds of $11.8 million. The carrying value of the cold storage distribution center was $6.5 million. The gain on the sale is recorded as part of selling, general and administrative expenses.
15. Other Current Assets and Other Accrued Expenses
Other current assets as of January 27, 2017 and January 29, 2016 are as follows (in thousands):
Other accrued expenses as of January 27, 2017 and January 29, 2016 are as follows (in thousands):
16. Financial Guarantees
On December 29, 2011, the Company (the “Issuer”) issued $250 million principal amount of the Senior Notes. The Senior Notes are irrevocably and unconditionally guaranteed, jointly and severally, by each of the Company’s existing and future restricted subsidiaries that are guarantors under the Credit Facilities and certain other indebtedness.
As of January 27, 2017 and January 29, 2016, the Senior Notes are fully and unconditionally guaranteed by the Subsidiary Guarantors.
The tables in the following pages present the condensed consolidating financial information for the Company and the Subsidiary Guarantors together with consolidating entries, as of and for the periods indicated. The subsidiaries that are not Subsidiary Guarantors are minor. The condensed consolidating financial information may not necessarily be indicative of the financial position, results of operations or cash flows had the Company, and the Subsidiary Guarantors operated as independent entities.
CONDENSED CONSOLIDATING BALANCE SHEETS
As of January 27, 2017
(In thousands)
CONDENSED CONSOLIDATING BALANCE SHEETS
As of January 29, 2016
(In thousands)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended January 27, 2017
(Amounts in thousands)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended January 29, 2016
(Amounts in thousands)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended January 30, 2015
(Amounts in thousands)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended January 27, 2017
(In thousands)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended January 29, 2016
(In thousands)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended January 30, 2015
(Amounts in thousands)
17. Subsequent Events
On July 6, 2016, the Company sold and concurrently licensed (through March 31, 2017) a warehouse facility in the City of Commerce, California with a carrying value of $12.1 million and received net proceeds from this transaction of $28.5 million. In addition to the proceeds, $1.0 million purchase price consideration had been held in escrow for the buyer to make certain repairs, and any amount not used for such repairs would be paid to the Company. The repairs were completed in January 2017 and the Company received $0.6 million from amounts held in escrow. The Company was deemed to have “continuing involvement,” which precluded the de-recognition of the assets from the consolidated balance sheet when the transactions closed. The resulting lease is accounted for as a financing lease and the Company has recorded a financing lease obligation of $30.1 million (as a component of current liabilities) as of January 27, 2017. The Company will de-recognize the assets and financing lease obligation at the earlier of when the lease term ends or when the Company no longer has continuing involvement. The Company exited the warehouse facility in March 2017, and expects to record a gain on sale of $18.5 million in the first quarter of fiscal 2018.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this Report. Disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, has been appropriately recorded, processed, summarized and reported on a timely basis and are effective in ensuring that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as a result of the material weakness in internal control over financial reporting related to the accounting for deferred income taxes described below, our controls and procedures were not effective as of January 27, 2017.
Material Weakness in Internal Control Over Financial Reporting; Remediation Plan
Deferred Income Taxes
During the fourth quarter of fiscal 2016, we identified a material weakness in our internal controls over financial reporting related to our accounting for deferred income taxes. Specifically, we did not design and maintain effective controls to identify items within the deferred tax balances that could be materially incorrect. We did not provide appropriate oversight of our third-party preparer. This material weakness resulted in various adjustments to our deferred tax accounts for fiscal 2016.
In order to remediate this material weakness and further strengthen the overall controls surrounding the Company’s accounting for income taxes, we have taken, and are taking, several steps to improve the overall processes and controls in our tax function. We have supplemented our accounting and tax professionals with additional personnel with expertise in accounting for deferred taxes; and are continuing to redesign and enhance our income tax review procedures to include a more robust reconciliation of the deferred tax balances. As part of this remediation process, during the fourth quarter of fiscal 2017 (as more fully described in Note 1 to our Consolidated Financial Statements), we revised certain amounts as of and for the year ended January 29, 2016. We evaluated the effect of these errors and concluded that they arose as a result of a material weakness over internal controls over financial reporting relating to our accounting for deferred income taxes that existed as of January 29, 2016. In addition, during the fourth quarter of fiscal 2017, we identified certain other adjustments relating to our deferred tax accounts for fiscal 2017 that led management to conclude that the material weakness in our internal controls over financial reporting was not fully remediated as of January 27, 2017.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness in our internal control over financial reporting was a result of not designing effective controls over the assessment of accounting for deferred income taxes as described above. Notwithstanding this material weakness, management has concluded that the consolidated financial statements in this Annual Report on Form 10-K for the year ended January 27, 2017 and year ended January 29, 2016 fairly present, in all material respects, our financial position, results of operations and cash flows for all periods and dates presented. In addition, while the material weakness resulted in the audit adjustments described above during our fourth quarter ended January 29, 2016 and other adjustments in the fourth quarter of fiscal 2017, it did not result in any material misstatements of our consolidated financial statements or disclosures for any interim periods during, or for the annual periods of, fiscal 2017, fiscal 2016 or fiscal 2015.
Based on the foregoing processes and remediation measures, management believes that the above mentioned control deficiencies will be remediated, but the material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. Management may take additional measures over time to address this material weakness or modify the remediation plan described above.
We are committed to a strong internal control environment and will continue to review the effectiveness of our internal controls over financial reporting and other disclosure controls and procedures.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining an adequate system of internal control over financial reporting, (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended), pursuant to Rule 13a-15(c) of the Securities Exchange Act of 1934, as amended. This system is intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
A company’s internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, uses the framework and criteria established in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework), for evaluating the effectiveness of our internal control over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, and 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 policies or procedures may deteriorate.
Based on this evaluation and testing, management concluded that there was a material weakness in deferred income tax accounting as described more fully above. Due to this material weakness, management concluded that the Company’s internal control over financial reporting was not effective as of January 27, 2017. While the material weakness resulted in the audit adjustments described above during our fourth quarter ended January 29, 2016 and other adjustments identified in the fourth quarter of fiscal 2017, it did not result in any material misstatements of our consolidated financial statements or disclosures for any interim periods during, or for the annual periods of, fiscal 2017, fiscal 2016 or fiscal 2015.
Changes in Internal Control Over Financial Reporting
Except as described above, we did not make any changes that materially affected or are reasonably likely to materially affect our 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
The following table sets forth certain information regarding the Company’s executive officers and members of the board of directors (the “Parent Board”) of Number Holdings, Inc., the Company’s sole member, as of March 31, 2017:
Geoffrey Covert joined the Company as President and Chief Executive Officer and as a member of the Parent Board in September 2015. Mr. Covert was previously the Senior Vice President of Retail Divisions for The Kroger Company, a global retail corporation, operating grocery, multi-department, discount, convenience and jewelry stores (“Kroger”), a position he held since 2012. Mr. Covert joined Kroger in 1996 serving in positions of increased responsibility, starting as Vice President of the Grocery Products Group and later being promoted to Senior Officer, Retail Operations at Kroger. Before joining Kroger, Mr. Covert worked for 22 years in a number of management positions with The Procter & Gamble Co., a multinational consumer goods company. Mr. Covert holds a Bachelor’s degree in chemical engineering from Case Western Reserve University. Mr. Covert brings significant senior leadership and both operational and industry experience to the Parent Board, along with extensive knowledge of the grocery retail industry.
Felicia Thornton joined the Company in November 2015 as Chief Financial Officer and Treasurer. Ms. Thornton’s appointment was part of a broader operating advisor agreement with Ares Management. Ms. Thornton has extensive executive experience in retail, and particularly in the grocery store industry, having served in senior leadership positions at DeMoulas Super Market, Inc. (“DSM”), a supermarket chain, Albertsons, a grocery and drugstore company, and The Kroger Company, a global retail corporation, operating grocery, multi-department, discount, convenience and jewelry stores. Most recently at DSM, she served as Co-Chief Executive Officer, President and Chief Operating Officer of the supermarket chain, and prior to that, she was Chief Executive Officer of Knowledge Universe U.S., one of the largest private childhood education companies. At Albertsons, she served as Chief Financial Officer and led overall strategy for the company for almost five years. For eight years prior to that, Ms. Thornton served in a variety of executive strategic and financial roles at Ralphs, a grocery store based in Southern California, and Fred Meyer, a retail supermarket company, both of which eventually became part of The Kroger Company, where she continued as Group Vice President responsible for retail operations. Ms. Thornton has served as a member of the boards of directors for both public and private companies, including Nordstrom, Inc. and Knowledge Universe Education, Inc.
Jack Sinclair joined the Company in July 2015 as Chief Merchandising Officer. Mr. Sinclair served as Executive Vice President of Food for Walmart U.S. Grocery Division from December 2007 until April 2015, where he integrated planning, category management and store experience into the grocery business unit. Prior to joining Walmart, Mr. Sinclair served as the European Development Director at SB Capital and was a Director of McCurrach UK from 2004 to 2007. He started his career as a trainee at Shoppers’ Paradise in the United Kingdom (UK) as part of the Fine Fare Group. He then joined Tesco Food Division in 1986. Mr. Sinclair joined Safeway Plc in 1990, where he held a number of senior positions, including Managing Director of Operations from 2001 to 2002 and Group Marketing and Trading Director from May 2002 to 2004, during which time he led the merger of Safeway and Morrison. Mr. Sinclair was a Director of the Food Marketing Institute from January 2005 to 2007. Mr. Sinclair holds a Bachelor of Arts degree in Economics and Marketing from the University of Strathclyde, Glasgow, Scotland.
Norman Axelrod joined the Company as a director in January 2012. Beginning in 1988, he served as Chief Executive Officer and a member of the board of directors of Linens ‘n Things, Inc., a retailer of home textiles, housewares and decorative home accessories, was appointed as Chairman of its board of directors in 1997, and served in such capacities until its acquisition in February 2006. Mr. Axelrod is also the Chairman of the boards of directors of the parent entities of Guitar Center, Inc., a musical instruments retailer, and Floor and Decor Outlets of America, Inc., a specialty retailer of hard surface flooring and related accessories, and serves on the boards of directors of the parent entities of Jaclyn, Inc., a handbags and apparel company, and The Neiman Marcus Group LLC, a luxury retailer. He also serves on the board of directors of Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer. Mr. Axelrod has also previously served as the Chairman of the board of directors of GNC Holdings, Inc., a
specialty retailer of health and wellness products, National Bedding Company LLC, a mattress and bedding product manufacturer, and Simmons Company, a mattress and bedding product manufacturer, and as a member of the board of directors of Reebok International Ltd., a leading worldwide designer and marketer of sports, fitness and casual footwear, apparel and equipment, and Maidenform Brands, Inc., an intimate apparel retailer. Mr. Axelrod has provided consulting services to certain Ares Management entities. Mr. Axelrod received a B.S. in Management and Marketing from Lehigh University and an M.B.A. from New York University. Mr. Axelrod’s vast experience in the retail industry led to the conclusion that he should serve as a member of the Parent Board.
Michael Fung joined the Company as a director in December 2013 and served as the Company’s Interim Chief Financial Officer and Treasurer from June 2015 until November 2015 and Interim Executive Vice President and Chief Administrative Officer from January 2013 until September 2013. Mr. Fung currently serves as Interim Chief Operating Officer and Chief Financial Officer of The Neiman Marcus Group LLC, a luxury retailer. Mr. Fung served as Senior Vice President and Chief Financial Officer at Walmart U.S., a multinational retailer, from 2006 until his retirement in February 2012. At Walmart U.S., Mr. Fung also served as Senior Vice President, Internal Audit Services between 2003 and 2006, and as Vice President, Finance and Administration of Global Procurement between 2001 and 2003. Before joining Walmart, Mr. Fung spent five years as Vice President and Chief Financial Officer of Sensient Technologies Corporation, a global manufacturer and marketer of colors, flavors and fragrances, three years as Senior Vice President and Chief Financial Officer of Vanstar Corporation, a developer of information technology and networking solutions, and four years as Vice President and Chief Financial Officer of Bass Pro Shops, Inc., a hunting, fishing and outdoor gear retailer. Mr. Fung is currently a member of the Board of Directors of Franklin Covey Co. Mr. Fung is a Certified Public Accountant (Inactive) in the State of Illinois. He received his M.B.A from the University of Chicago and his B.S. in Accounting from the University of Illinois at Chicago. Mr. Fung brings valuable financial knowledge and experience to the Parent Board.
Andrew Giancamilli joined the Company as a director in May 2012 and served as the Company’s Interim President and Chief Executive Officer from May 2015 to September 2015. Mr. Giancamilli served as President and Chief Executive Officer of Katz Group Canada Ltd., the Canadian subsidiary of the Katz Group of Companies, operators of over 1,800 traditional drug stores in Canada, from October 2003 to February 2012. Prior to joining Katz Group Canada, Mr. Giancamilli was with Canadian Tire Corporation Ltd., a Canadian retail conglomerate, from 2001 to 2003. Mr. Giancamilli also held several positions, including President and Chief Operating Officer, at Kmart Corporation, a discount retailer, from 1995 to 2001. From 1993 to 1995 he served as President and Chief Operating Officer of Perry Drug Stores, Inc., a U.S. based drug store chain. He began his career at Perry Drug Stores in 1975. Mr. Giancamilli currently serves as a director of Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer. Mr. Giancamilli is currently a member of the Wayne State University School of Business Board of Visitors, and has also served as a member of the board of GS1 Canada, and as a member of the board of directors, and Chairman of the National Association of Chain Drug Stores (NACDS), the Canadian Association of Chain Drug Stores and Sacred Heart Rehabilitation Center, and has served as a Trustee of the Detroit Opera House and the Canadian Opera Company. With his more than 30 years of experience and strong record of performance in the retail industry, Mr. Giancamilli brings to the Parent Board extensive knowledge and expertise in the industries in which the Company operates.
Dennis Gies joined the Company as a director in January 2012. Mr. Gies is a Partner in the Private Equity Group of Ares Management. Mr. Gies joined Ares Management in 2006 from UBS Investment Bank where he participated in the execution of a variety of transactions including leveraged buyouts, mergers and acquisitions, dividend recapitalizations and debt and equity financings. He currently serves on the boards of directors of Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer and the parent entity of The Neiman Marcus Group LLC, a luxury retailer. Mr. Gies also serves on the Board of Trustees of the Center for Early Education. Mr. Gies graduated with a M.S. in Electrical Engineering from University of California, Los Angeles and magna cum laude with a B.S. in Electrical Engineering from Virginia Tech. Mr. Gies brings to the Parent Board financial expertise, as well as experience as a private equity investor evaluating and managing investments in companies across various industries.
David Kaplan joined the Company as a director in January 2012. He is a Co-Founder of Ares Management and a Director and Partner of Ares Management GP LLC, Ares Management’s general partner. He is a Partner of Ares Management, Co-Head of its Private Equity Group and a member of its Management Committee. He additionally serves on several of the investment committees for certain funds managed by the Ares Management Private Equity Group. Mr. Kaplan joined Ares Management in 2003 from Shelter Capital Partners, LLC, where he was a Senior Principal from June 2000 to April 2003. From 1991 through 2000, Mr. Kaplan was affiliated with, and a Senior Partner of, Apollo Management, L.P. and its affiliates, during which time he completed multiple private equity investments from origination through exit. Prior to Apollo Management, L.P., Mr. Kaplan was a member of the Investment Banking Department at Donaldson, Lufkin & Jenrette Securities Corp. Mr. Kaplan currently serves as Chairman of the boards of directors of the parent entity of The Neiman Marcus Group LLC, a luxury retailer, and of Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer, and as a member of the boards of directors of ATD Corporation, a replacement tire distributor, and the parent entities of Floor and Decor Outlets of America, Inc., a hard surface flooring and related accessories retailer, and Guitar Center, Inc., a musical instruments retailer. Mr. Kaplan’s previous public company board of directors experience includes Maidenform Brands, Inc., an intimate apparel retailer, where he served as the company’s Chairman, GNC Holdings, Inc., a specialty retailer of health and wellness products, Dominick’s Supermarkets, Inc., a grocery store retailer, Stream Global Services, Inc., a business process outsourcing provider, Orchard Supply Hardware Stores Corporation, a home improvement retailer, and Allied Waste
Industries Inc., a waste services company. Mr. Kaplan also serves on the board of directors of Cedars-Sinai Medical Center, is a Trustee of the Center for Early Education and serves on the President’s Advisory Group of the University of Michigan. Mr. Kaplan graduated with High Distinction, Beta Gamma Sigma, from the University of Michigan, School of Business Administration with a B.B.A. concentrating in Finance. Mr. Kaplan brings to the Parent Board over 20 years of experience managing investments in, and serving on the boards of directors of, companies operating in various industries, including in the retail and consumer products industries.
Scott Nishi joined the Company as a director in January 2012. He is a Senior Principal in the Direct Private Equity Group of CPPIB Equity. Mr. Nishi joined CPPIB Equity in 2007 from Oliver Wyman, a management consultancy where he advised consumer, healthcare and technology companies. Previously, Mr. Nishi was at Launchworks, a venture capital firm that invested in early stage technology companies. Mr. Nishi also serves on the board of directors of the parent entity of The Neiman Marcus Group LLC, a luxury retailer and Petco Animal Supplies, Inc, a pet supplies retailer. Mr. Nishi holds an M.B.A from the Richard Ivey School of Business at the University of Western Ontario and a B.Sc. from the University of British Columbia. Mr. Nishi brings to the Parent Board financial expertise, as well as experience as a private equity investor evaluating and managing investments in companies across various industries.
Allyson Satin joined the Company as a director in August 2016. Ms. Satin is a Principal in the Private Equity Group of Ares Management. Prior to joining Ares Management in 2009, Ms. Satin was an investment banking Analyst in the Global Financial Sponsors Group at Barclays Capital (formerly Lehman Brothers). Ms. Satin graduated from the University of California, Berkeley Haas School of Business where she received a B.S. in Business Administration. Ms. Satin brings to the Parent Board experience as a private equity investor evaluating and managing investments in companies across various industries.
Conversion
Effective upon and following the Conversion, we are managed by our sole member, Parent, rather than directly by a board of directors. The Parent Board serves in the capacity of the board of directors for us.
Board Composition and Terms
As of March 31, 2017, the Parent Board was composed of eight directors. Each director serves for annual terms or until his or her successor is duly elected and qualified. Pursuant to the stockholders agreement of our Parent, one of our Parent’s two principal stockholders has the right to designate four members of the Parent Board and two independent members of the Parent Board, which independent directors shall be approved by the other principal stockholder, and the other principal stockholder has the right to designate two members of the Parent Board, in each case for so long as they or their respective affiliates beneficially own at least 15% of the then outstanding shares of Class A Common Stock. The stockholders agreement provides for the election of the current chief executive officer of Parent to the Parent Board. For more details of the stockholders agreement of our Parent, see Item 13, “Certain Relationships and Related Transactions, and Director Independence-Stockholders Agreement” in this Report.
Board Committees
The Parent Board has established an audit committee (the “Audit Committee”) and a compensation committee (the “Compensation Committee”).
Audit Committee
The Audit Committee has the authority to supervise the auditing of us and Parent and to act as liaison between us and our independent registered public accounting firm. The members of the Audit Committee are Michael Fung (Chair), Dennis Gies and Scott Nishi. Adam Stein was a member of the Audit Committee until his resignation on August 23, 2016. The Parent Board has determined that Messrs. Fung, Gies and Nishi are “audit committee financial experts” as defined by Item 407(d)(5)(ii) of Regulation S-K and have the attributes set forth in such section.
Compensation Committee
The Compensation Committee has the authority to review and approve the compensation of the officers of us and Parent and all of our other officers, key employees and directors, as well as our compensation philosophy, strategy, program design, and administrative practices. The members of the Compensation Committee are Norman Axelrod (Chair), Scott Nishi and Dennis Gies. Mr. Gies was appointed to the Compensation Committee only July 21, 2016 upon Adam Stein’s resignation from the Compensation Committee.
Code of Ethics
The Company has adopted a Code of Business Conduct and Ethics applicable to all of our directors, officers and employees. A copy of the Code of Business Conduct and Ethics is available on our website at www.99only.com.
Section 16(a) Beneficial Ownership Reporting Compliance
In light of our status as a privately held company, Section 16(a) of the Securities Exchange Act of 1934, as amended, does not apply to our directors, executive officers and significant stockholders.
Item 11.
Item 11. Executive Compensation
Compensation Discussion & Analysis
There were no changes to our named executive officers (“Named Executive Officers,” “NEOs” or “executives”) in fiscal 2017.
Accordingly, our NEOs for fiscal 2017 are (i) the individual who served as our principal executive officer (Mr. Covert), (ii) the individual who served as our principal financial officer (Ms. Thornton) and (iii) the other individual who was serving as an executive officer (Mr. Sinclair):
· Geoffrey J. Covert - President and Chief Executive Officer
· Felicia Thornton - Chief Financial Officer and Treasurer
· Jack Sinclair - Chief Merchandising Officer
Compensation Objectives
Our compensation program with respect to our executives is designed to:
· attract, motivate and retain individuals of outstanding abilities and experience who are capable of achieving our strategic business goals;
· align total compensation with the short-term, mid-term and long-term performance of our Company;
· recognize outstanding contributions; and
· provide more at-risk compensation opportunities to encourage dedication to the Company’s exceptional performance, profitability and growth.
We provide ongoing income and security in the form of salary and benefits to our executives that are intended to be both attractive and competitive. We also provide our executives with short-term incentives in the form of an annual cash bonus to reward the achievement of annual goals that support our business objectives. Executives also receive long-term incentive compensation, which promotes retention and provides a link between executive compensation and value creation for the Company’s shareholders over a multi-year period. Our long-term incentive compensation consists of stock options. The stock options provide compensation tied to the fair market value of Parent’s common stock and provide no compensation if the fair market value of Parent’s common stock decreases below the fair market value on the grant date.
In fiscal 2017 we implemented additional programs to align the interests of executives and shareholders. We established two mid-term incentive programs, the Mid-Term Cash Incentive Plan and the special Refinancing Bonus Letters, each designed to promote the success of the Company by rewarding certain employees (including NEOs) for their service to the Company and to provide incentives for such employees to remain in the employ or other service of the Company and to contribute to the performance of the Company. Awards under the Mid-Term Cash Incentive Plan are payable if certain EBITDA targets are met in fiscal 2017 or fiscal 2018. Similarly, in order to provide incentive for obtaining a refinancing for the Company, bonuses under the Refinancing Bonus Letters are payable if the Company obtains refinancing by October 1, 2018.
Assessment of Risk
We have periodically reviewed our compensation policies and practices for all employees and concluded that such policies and practices are not reasonably likely to have a material adverse effect on our Company.
Elements of Compensation
Our executive compensation program consists of five main elements:
· base salary;
· annual cash bonus;
· mid-term cash incentive bonus;
· special refinancing bonus; and
· long-term incentives consisting of stock options.
We have chosen these primary elements because each supports achievement of one or more of our compensation objectives, and each has an integral role in our total compensation program.
The Company did not benchmark levels of executive compensation for fiscal 2017. The Compensation Committee used general industry data to obtain a general understanding of the market trends in compensation practices in setting compensation levels for fiscal 2017.
Base Salary. The base salaries of our executives are generally intended to reflect the position, duties and responsibilities of each executive. They are designed to provide competitive compensation and attract individuals who are capable of achieving our business goals. Accordingly, Mr. Covert receives an annual base salary of $900,000 and Ms. Thornton receives an annual base salary of $650,000. Mr. Sinclair’s annual base salary was increased from $575,000 to $650,000 in fiscal 2017, in order to bring his salary into range with the salaries of the other executives.
Annual Cash Bonuses. By providing incentives based on Company performance, our annual cash bonuses reward outstanding contributions to the Company and encourage exceptional Company performance. Pursuant to Mr. Covert’s employment agreement, he was eligible to receive an annual cash bonus, with a target bonus of 100% of his base salary and a maximum bonus of 200% of his base salary. Pursuant to Ms. Thornton’s employment agreement, she was eligible to receive an annual cash bonus with a target bonus of 75% of her base salary and a maximum bonus of 150% of her base salary. Pursuant to Mr. Sinclair’s employment agreement, he was eligible to receive an annual cash bonus with a target bonus of 75% of his base salary and a maximum bonus of 150% of his base salary. Cash bonuses are payable based on the achievement of certain Adjusted EBITDA (as defined under our annual cash bonus plan) goals. For fiscal 2017, target Adjusted EBITDA was $66.6 million. Adjusted EBITDA is based on audited consolidated net income, taxes based on income or profits, net interest expense, depreciation and amortization expense, the expense or income effect of certain items (including stock-based compensation, non-cash lease expense, discontinued operations and closed store costs), severance, termination and non-capitalized consulting expenses, and certain other adjustments as determined to be appropriate by the Compensation Committee. With adjustments for improvements in workers’ compensation, reduction in shrink and management of scrap, as approved by the Compensation Committee, the Company achieved an Adjusted EBITDA of $65.4 million for fiscal 2017. Based on this achievement, pursuant to our annual cash bonus plan, Mr. Covert received a cash bonus of $832,500, Ms. Thornton received a cash bonus of $450,938, and Mr. Sinclair received a cash bonus of $450,938 for fiscal 2017.
Onboarding Payments. In connection with Ms. Thornton’s hiring, she was granted a one-time signing bonus of $500,000 in fiscal 2016. If Ms. Thornton’s employment is terminated by the Company for Cause or by Ms. Thornton without Good Reason and not due to her Disability (as each is defined below under “Potential Payments Upon Termination or Change in Control - Felicia Thornton”) on or prior to November 2, 2017, then her net signing bonus will be subject to repayment.
Transition Program. In connection with Mr. Covert’s hiring in fiscal 2016, he became eligible to receive cash amounts under a transition program based on the value of certain equity awards from his former employer that he forfeited in connection with his employment at the Company. The maximum amount of such cash payments is approximately $4.87 million (based on the value of his prior equity awards), payable over a period of four years, such that the actual amounts paid in each of fiscal 2016 and 2017 are $240,000 and $2.34 million, respectively, and the approximate maximum amounts payable in the following three fiscal years are: $1.31 million, $710,000 and $265,000, respectively. If Mr. Covert is terminated for Cause or he resigns without Good Reason (each as defined below under “Potential Payments Upon Termination or Change in Control - Geoffrey Covert”), payment of such amounts will cease. If Mr. Covert resigns without Good Reason on or prior to September 11, 2017, then he must repay to the Company all the amounts paid to him pursuant to the transition program. Upon a Change in Control (as defined below under “Potential Payments Upon Termination or Change in Control - Geoffrey Covert”), all payments pursuant to the transition program shall accelerate, vest and become immediately payable.
Long-Term Incentives. We provide our executives with long-term incentive compensation through stock option awards granted under the 2012 Plan. We believe that awarding stock options creates a culture of ownership among our executives and aligns the interests of our executives with those of our shareholders. We did not grant any stock option awards in fiscal 2017 to our NEOs.
The options that are subject to time-based vesting requirements vest in equal installments over four years, subject to continued employment. For the options that are subject to performance-based vesting requirements, vesting will occur upon, and subject to, the Company’s and Parent’s achievement of certain performance conditions. During fiscal 2017, we approved the amendment and restatement of the terms of options with performance-based vesting requirements. These new terms provide that, with respect to Mr. Covert, Ms. Thornton and Mr. Sinclair, if on any date following the date of grant, (i) the Company’s LTM EBITDA (as defined below) equals or exceeds $99 million on the last day of each of the 12 consecutive calendar months ending prior to such date, 50% of the options subject to performance-based vesting requirements will vest, and (ii) the Company’s LTM EBITDA equals or exceeds $150 million on the last day of each of the 12 consecutive calendar months ending prior to such date, 100% of the options subject to performance-based vesting requirements will vest. Prior to the amendment and restatement of the option terms, Mr. Covert’s performance-vesting options required that LTM EBITDA equal or exceed $175 million for 50% vesting and $225 million for 100% vesting, and Ms. Thornton’s and Mr. Sinclair’s performance-vesting options required that LTM EBITDA equal or exceed $150 million for 50% vesting and $225 million for 100% vesting.
“LTM EBITDA,” as defined in the option agreements, means, on any date, the Adjusted EBITDA (as defined below) of the Company, as determined by the Compensation Committee, for the most recent 12 fiscal month period for which financial statements are available on such date.
“Adjusted EBITDA,” as defined in the option agreements, generally means audited consolidated net income, determined in accordance with generally accepted accounting principles, plus (without duplication) to the extent deducted in calculating such consolidated net income, the sum of (a) the provision for taxes based on income or profits; plus (b) consolidated net interest expense; plus (c) consolidated depreciation and amortization expense; plus (d) the expense or income effect of certain items, including stock-based compensation, non-cash lease expense, discontinued operations and closed store costs (including termination expenses), severance, termination and other one-time personnel-related expenses, and non-capitalized consulting expenses; plus (e) certain other adjustments as determined to be appropriate by the Compensation Committee, in each case as determined by the Compensation Committee, as such sum may be adjusted by the Committee.
Options are generally subject to the right of Parent to repurchase (i) the shares received from exercise of the options at fair market value of such shares upon termination and (ii) the vested but unexercised options at the excess of the fair market value on the date of termination over the exercise price of such options. However, if either Messrs. Covert’s or Sinclair’s employment with the Company is terminated for Cause (as defined in the 2012 Plan), or either voluntarily resigns employment with the Company without Good Reason (as defined in the 2012 Plan) or is found to have engaged in Detrimental Activity (as defined in the 2012 Plan), Parent may repurchase the shares received from exercise of the options for the lesser of the exercise price of the options or the fair market value of the options on the date of such termination of employment. If Ms. Thornton’s employment with the Company is terminated for Cause, she voluntarily resigns employment with the Company without Good Reason prior to the second anniversary of her start date (November 2, 2017) or she is found to have engaged in Detrimental Activity, Parent may repurchase the shares received from exercise of the options for the lesser of the exercise price of the options or the fair market value of the options on the date of such termination of employment. See Note 11 to our Consolidated Financial Statements for further discussion on the repurchase rights available under the option awards.
All of the foregoing options are subject to the terms of the 2012 Plan and the award agreement under which they were granted. For further details regarding option grants made in fiscal 2017, see below under “Compensation Tables - Grants of Plan-Based Awards for Fiscal 2017.”
Option Exchange and Option Amendments. On July 26, 2016, the shareholders of Holdings approved an increase in the number shares of common stock of Holdings authorized for issuance under the Number Holdings, Inc. 2012 Stock Incentive Plan (the “2012 Plan”). The 2012 Plan now authorizes equity awards to be granted for up to 87,500 shares of Class A Common Stock of Holdings and 87,500 shares of Class B Common Stock of Holdings (such Class A Common Stock and Class B Common Stock, collectively “Common Stock”). Prior to the increase, the 2012 Plan authorized equity awards to be granted for up to 85,000 shares of Common Stock.
In addition, Holdings provided most employee option holders (excluding Messrs. Covert and Sinclair and Ms. Thornton) an opportunity to exchange their outstanding nonqualified stock options (“Options”) for Options with an exercise price of $757 per share. Specifically, the Committee canceled the outstanding Options with an exercise prices per share higher than $757 and granted new Options to holders of the canceled Options with an exercise price of $757 per share. The purpose of allowing the exchange of options for options with lower exercise prices is to ensure option holders remain incentivized by their options, and to promote share ownership so as to align option holder and shareholder interests. The new Options are vested to the same extent as the canceled options and are otherwise generally subject to time-vesting and performance-vesting conditions.
The Committee approved the amendment and restatement of the terms of the outstanding Options held by Messrs. Covert and Sinclair and Ms. Thornton (the “Option Agreements”). The Option Agreements, each of which consists of 50% time-vested Options (vesting over 4 years from the grant date) and 50% performance-vested Options, were amended to conform the vesting hurdles for the performance-vested options with those granted to other employees. Mr. Covert has two Options to purchase 15,500 shares of Common Stock each, and Ms. Thornton and Mr. Sinclair each have an Option to purchase 10,000 shares of Common Stock.
Mid-Term Cash Incentive Plan. In fiscal 2017, the Compensation Committee adopted the 99 Cents Only Stores LLC 2016 Mid-Term Cash Incentive Plan (the “Mid-Term Cash Incentive Plan”). The Mid-Term Cash Incentive Plan is intended to promote the success of the Company by rewarding certain employees (including NEOs) for their service to the Company and to provide incentives for such employees to remain in the employ or other service of the Company and to contribute to the performance of the Company. Under the Mid-Term Cash Incentive Plan, if the Company achieves an initial Adjusted EBITDA (as defined in the Mid-Term Cash Incentive Plan) of $75,000,000 for either fiscal 2017 or fiscal 2018 (the “Initial Mid-Term Plan Goal”), 50% of a participant’s target award amount under the Mid-Term Cash Incentive Plan will be eligible for payment. No amounts will be paid under the Mid-Term Cash Incentive Plan if the Initial Mid-Term Plan Goal is not achieved. If the Company achieves the Initial Mid-Term Plan Goal and then achieves the same Adjusted EBITDA goal for the fiscal year immediately following the year in which the Initial Mid-Term Plan Goal was achieved, the remaining 50% of the participant’s target award amount will be eligible for payment. Payment of eligible awards will only be made to the extent the Company’s Free Cash Flow (as defined in the Mid-Term Cash Incentive Plan) exceeds the amount eligible for payment, as measured at the end of each second quarter and fourth quarter of each fiscal year after an amount becomes eligible for payment until the end of the fiscal year ending January 31, 2020. The Company does not expect to maintain the Mid-Term Cash Incentive Plan for periods after the fiscal year ending January 31, 2020.
Generally, if a participant experiences a termination of employment with the Company prior to payment, the unpaid portion of the participant’s award is forfeited. However, if (i) Mr. Covert, Ms. Thornton or Mr. Sinclair is terminated by us without Cause (as defined in their respective employment agreements with the Company) or (ii) Mr. Covert or Ms. Thornton terminates his or her employment for Good Reason (as defined in their respective employment agreements with the Company), the applicable executive will remain eligible to receive a pro rata portion of their respective award, if any, for a limited period following termination. The awards eligible to be earned by Messrs. Covert and Sinclair and Ms. Thornton are $7.0 million, $5.0 million and $5.0 million, respectively.
The Company did not achieve the Initial Mid-Term Plan Goal for fiscal 2017, so no awards were paid or became eligible for payment under the Mid-Term Cash Incentive Plan with respect to fiscal 2017.
Special Refinancing Bonus Letters. In fiscal 2017, the Compensation Committee approved special bonus letters for Messrs. Covert and Sinclair and Ms. Thornton (the “Refinancing Bonus Letters”). The Refinancing Bonus Letters are designed to promote the success of the Company by providing incentives and rewarding executives for obtaining refinancing for the Company in fiscal 2017 or fiscal 2018. Pursuant to the terms of the Refinancing Bonus Letters, if a Refinancing Transaction (as defined in the Refinancing Bonus Letters) occurs prior to October 1, 2018, each of the applicable executives will be eligible to receive a special bonus payable within 30 days of such transaction (the “Refinancing Bonus”). The Refinancing Bonuses eligible to be earned by the applicable executives total $4.0 million. If, within 45 days prior to such transaction, (i) Mr. Covert, Ms. Thornton or Mr. Sinclair experiences a termination of employment by the Company without Cause or (ii) Mr. Covert or Ms. Thornton terminates his or her employment for Good Reason, the applicable executive will receive the Refinancing Bonus. The Refinancing Bonuses to be earned by Messrs. Covert and Sinclair and Ms. Thornton are $2.0 million, $1.0 million and $1.0 million, respectively.
A Refinancing Transaction did not occur in fiscal 2017, so no Refinancing Bonuses were paid or became eligible for payment during fiscal 2017.
Perquisites. Our executives are provided with certain limited perquisites in connection with the performance of their respective duties, in part to attract and retain such executives with a competitive compensation package as compared to the compensation packages for executives of similar positions and levels of responsibility in similar industries. During fiscal 2017, Messrs. Covert, Sinclair and Ms. Thornton were provided with Company-paid life insurance premiums and other Company-paid insurance premiums. Additionally, Mr. Covert and Ms. Thornton received reimbursements for relocation expenses during fiscal 2017. For further detail regarding perquisites provided to our executives, see below under “Summary Compensation Table.”
401(k) Plan. All full-time employees are eligible to participate in our 401(k) plan after 30 days of service and are eligible to receive matching contributions from the Company after one year of service. The Company matches employee contributions in cash at a rate of 100% of the first 3% of base compensation that an employee contributes, and 50% of the next 2% of base compensation that an employee contributes, with immediate vesting. Our executives are also eligible for these Company matches, subject to regulatory limits on contributions to 401(k) plans.
Post-Termination Arrangements. The employment agreements with Mr. Covert, Ms. Thornton and Mr. Sinclair contain severance provisions. The terms of these agreements related to post-termination compensation are described in detail under “Potential Payments Upon Termination or Change in Control.”
COMPENSATION COMMITTEE REPORT
The Compensation Committee has reviewed and discussed with management the above Compensation Discussion and Analysis. Based on our review and discussions with management, the Compensation Committee recommended to the Parent Board that the Compensation Discussion and Analysis be included in this Report.
COMPENSATION COMMITTEE
Norman Axelrod
Scott Nishi
Dennis Gies
COMPENSATION TABLES
Summary Compensation Table for Fiscal 2017
The following table sets forth information concerning all compensation paid to or earned by our NEOs for services to the Company in all capacities during fiscal 2017:
(a) For Mr. Covert, the amount in the Bonus column for fiscal 2017 reflects the transition payments of $2,339,286, paid to Mr. Covert during fiscal 2017, see above under “Elements of Compensation - Transition Program”. For Mr. Covert, the amount in the Bonus column for fiscal 2016 reflects the transition payments of $239,995 paid to Mr. Covert during fiscal 2016 and the prorated guaranteed bonus paid to Mr. Covert in respect of fiscal 2016 of $346,154. For Ms. Thornton, the amount in the Bonus column for fiscal 2016 reflects a one-time signing bonus of $500,000. For Mr. Sinclair, the amount in the Bonus column for fiscal 2016 ($500,000) reflects (i) a one-time bonus upon commencement of employment of $250,000 and (ii) a discretionary bonus paid with the respect to fiscal 2016 of $250,000.
(b) In accordance with SEC regulations, this column sets forth the aggregate grant date fair value of stock options computed in accordance with FASB ASC Topic 718. Amounts shown in this column may not correspond to the actual value that will be realized by the Named Executive Officers. The options granted are options to purchase the common stock of Parent. See Note 11 to our Consolidated Financial Statements for the assumptions used to calculate grant date fair value.
(c) Messrs. Covert and Sinclair were granted 31,000 and 10,000 stock options, respectively, in fiscal 2016. If either of Messrs. Covert’s or Sinclair’s employment with the Company is terminated for Cause, or either voluntarily resigns employment with the Company without Good Reason, Parent may repurchase the options for the lesser of the exercise price of the option or the fair market value of the option on the date of termination of employment, see above under “Long-Term Incentives.” Accordingly, we have not recorded any stock-based compensation expense on the options for Messrs. Covert and Sinclair pursuant to FASB ASC Topic 718. If not for this repurchase feature, the grant date fair value of the options granted in fiscal 2016 would have been $6,255,839 for Mr. Covert and $3,296,975 for Mr. Sinclair.
(d) For Mr. Covert, the amount in the Non-Equity Incentive Plan Compensation column for fiscal 2017 reflects an annual cash bonus paid in respect of fiscal 2017 of $832,500. For Ms. Thornton, the amount in the Non-Equity Incentive Plan Compensation column for fiscal 2017 reflects an annual cash bonus paid in respect of fiscal 2017 of $450,938. For Mr. Sinclair, the amount in the Non-Equity Incentive Plan Compensation column for fiscal 2017 reflects an annual cash bonus paid in respect of fiscal 2017 of $450,938.
(e) The amounts reported in the All Other Compensation column reflect, for each executive, as applicable (i) the amount of our matching contribution under our 401(k) plan, (ii) dollar value of life insurance premiums we paid for each executive, (iii) relocation expenses and (iv) other Company-paid insurance premiums. Specifically, the All Other Compensation column above includes:
Grants of Plan-Based Awards for Fiscal 2017
The following table sets forth information concerning the annual bonus plan, mid-term cash incentive plan and special bonus letters granted to the NEOs during fiscal 2017. There were no options granted to the Named Executive Officers under Parent’s 2012 Stock Incentive Plan during fiscal 2017:
(a) The amounts represent the threshold, target and maximum payout amounts under the Company’s annual cash bonus plan. See “Components of Executive Compensation - Annual Cash Bonuses” above for more information regarding the annual cash bonuses.
(b) The amounts represent the target payout amounts under the Company’s Mid-Term Cash Incentive Plan. No threshold or maximum amounts were established. See “Components of Executive Compensation - Mid-Term Cash Incentive Plan” above for more information.
(c) The amounts represent the target payout amounts under the special bonus letters. No threshold or maximum amounts were established. See “Components of Executive Compensation - Special Bonus Letters” above for more information.
Outstanding Equity Awards at Fiscal Year End 2017
The following table sets forth information on stock options held by the Named Executive Officers as of January 27, 2017:
(a) All options have a term of ten years from the grant date. One-half of each grant for Mr. Covert, Ms. Thornton and Mr. Sinclair vests on each of the first four installments of the grant date, and the other half of each grant vests based on the achievement of certain performance targets.
(b) For Mr. Covert, one of the option grants has an exercise price equal to $750 per share plus the amount by which the fair market value of the underlying share exceeds $1,000 on the date of exercise.
Option Exercises and Stock Vested
During fiscal 2017, our Named Executive Officers did not acquire shares pursuant to the exercise of option grants or the vesting of equity-based awards.
Potential Payments Upon Termination or Change in Control
This section describes the benefits that may become payable to our Named Executive Officers in connection with certain terminations of their employment with the Company and/or a change in control of the Company.
Geoffrey Covert
We entered into an employment agreement with Mr. Covert effective September 11, 2015. The agreement provides that if Mr. Covert’s employment is terminated without “Cause” (as defined below) or if Mr. Covert resigns for “Good Reason” (as defined below), Mr. Covert will be entitled to receive the following severance payments, contingent upon Mr. Covert executing a general release in favor of the Company and Mr. Covert’s continued compliance with all applicable post-termination restrictive covenants:
(i) a payment equal to his base salary;
(ii) if the termination is during the last six months of the applicable fiscal year, a pro-rated share of the bonus for the year of termination (based on the period of actual employment) to which Mr. Covert would have been entitled had he worked for the full fiscal year during which the termination occurred, based on the actual level of achievement of the applicable goals for such fiscal year (a “pro-rata bonus”).
If Mr. Covert’s employment is terminated as a result of his death or “Disability,” which is defined as a “total disability” (as defined in the Company’s Long Term Disability Plan, or if none is in effect, as disability is defined in Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”)), Mr. Covert (or his estate) is entitled to receive, in addition to his accrued benefits, a pro-rata bonus (as defined above).
For purposes of the employment agreement, “Cause” means Mr. Covert’s (i) (a) being indicted for, or charged with, a felony under Federal or state law or (b) conviction of, or plea of guilty or nolo contendere to, a misdemeanor where imprisonment is imposed (other than traffic-related offenses); (ii) perpetration of an illegal act, dishonesty, or fraud that that could cause economic injury to Parent, the Company or any of their subsidiaries; (iii) insubordination or refusal to perform his duties or responsibilities for the Company, Parent or any of their subsidiaries for any reason other than illness or incapacity; (iv) unsatisfactory performance of his material duties for the Company, Parent or any of their subsidiaries, after written notice thereof (if such a breach is capable of correction), unless he fully corrects his unsatisfactory performance within 30 days following receipt of such notice, as determined by the Parent Board or a duly authorized committee thereof; (v) willful and deliberate failure to perform his duties after he has been given notice and an opportunity to effectuate a cure as determined by the Company; (vi) willful misconduct or gross negligence with regard to the Company, Parent or any of their subsidiaries; (vii) unlawful appropriation of a material corporate opportunity; (viii) breach of (a) any confidentiality or other restrictive covenant entered into between Mr. Covert and the Company or any of its affiliates, including the fair competition agreement or (b) any other agreement with the Company or any of its affiliates; or (ix) failure to start providing services to the Company on September 11, 2015 in accordance with his employment agreement for any reason.
For purposes of the employment agreement, “Good Reason” means a material breach of Mr. Covert’s employment agreement by the Company without Mr. Covert’s written consent. In each instance, in order to constitute Good Reason, Mr. Covert must provide the Company with written notice within 60 days following the circumstances constituting Good Reason, the Company must fail to cure the event within 30 days following the notice, and Mr. Covert must then resign within 15 days following the expiration of the Company’s cure period without the Company curing such circumstances.
Upon a Change in Control (as defined in the 2012 Plan, that otherwise qualifies as a change in control under Section 409A), all payments pursuant to the transition program, as described above under “Transition Program,” will accelerate, vest and become immediately payable. Payments under the transition program are subject to forfeiture only upon Mr. Covert’s resignation without Good Reason.
Felicia Thornton
We entered into an employment agreement with Ms. Thornton effective November 2, 2015. The agreement provides that if Ms. Thornton’s employment is terminated without “Cause” (as defined below) or if Ms. Thornton resigns for “Good Reason” (as defined below), Ms. Thornton will be entitled to receive the following severance payments, contingent upon Ms. Thornton executing a general release in favor of the Company and her continued compliance with all applicable post-termination restrictive covenants.
(i) if such termination is prior to November 2, 2017: (a) in addition to Ms. Thornton’s accrued benefits, she will be entitled to receive an amount equal to one and one-half times her base salary; (b) an amount equal to the Company portion of her health care premiums (including for her spouse and eligible dependents) for 18 months following her termination date; and (c) any unpaid annual bonus for the fiscal year completed prior to the year of such termination based on actual performance; or
(ii) if such termination is on or after November 2, 2017: (a) in addition to Ms. Thornton’s accrued benefits, she will be entitled to receive from the Company an amount equal to her base salary; (b) an amount equal to the Company portion of her health care premiums (including for her spouse and eligible dependents) for 12 months following her termination date; and (c) any unpaid annual bonus for the fiscal year completed prior to the year of such termination based on actual performance.
Additionally, in the event that, prior to a Change in Control (as defined in the 2012 Plan), Ms. Thornton’s employment is terminated without Cause or if Ms. Thornton resigns for Good Reason, the portion of Ms. Thornton’s options which will become vested and exercisable are (i) a pro-rata portion of her unvested time-vested options, based on the ratio of the number of days employed since the immediately preceding vesting date (or the grant date, if applicable) through the date of termination, up to 365; and (ii) a pro-rata portion of her performance-vested options (including any previously vested portion), based on the ratio of the number of days employed since the grant date through the date of termination, up to 1,460, subject to the attainment of the applicable performance requirements at any time through the last day of the fiscal year in which such termination occurs.
In the event of a Change in Control in which Ms. Thornton’s options survive such Change in Control and where Ms. Thornton’s employment is terminated without Cause or where Ms. Thornton resigns for Good Reason, the unvested portion of Ms. Thornton’s options will become fully vested and exercisable.
If Ms. Thornton’s employment is terminated as a result of her death or “Disability,” which is defined as a “total disability” (as defined in the Company’s Long Term Disability Plan, or if none is in effect, as disability is defined in Section 409A of the Internal Revenue Code of 1986, as amended), Ms. Thornton (or her estate) is entitled to receive, in addition to the accrued benefits, any unpaid annual bonus for the fiscal year completed prior to the year of such termination based on actual performance.
For purposes of the employment agreement, “Cause” means Ms. Thornton’s (i) (a) being indicted for, or charged with, a felony under Federal or state law or (b) conviction of, or plea of guilty or nolo contendere to, a misdemeanor where imprisonment is imposed (other than traffic-related offenses); (ii) perpetration of an illegal act, dishonesty, or fraud that that could cause economic injury to Parent, the Company or any of their subsidiaries or any act of moral turpitude by Ms. Thornton, (iii) insubordination, or willful failure to perform her duties or responsibilities for the Company, Parent or any of their subsidiaries for any reason other than illness or incapacity; (iv) willful misconduct or gross negligence with regard to the Company, Parent or any of their subsidiaries; (v) unlawful appropriation of a material corporate opportunity; or (vi) material breach of agreement with the Company or any of its
affiliates, or breach (which will be deemed “material”) of such an agreement respecting any confidentiality or other restrictive covenant including the fair competition agreement, entered into between Ms. Thornton and the Company or any of its affiliates. No termination of Ms. Thornton’s employment by the Company for “Cause” under clause (iii) or (vi) above will be effective unless (i) the Company provides Ms. Thornton (a) written notice of the circumstances constituting “Cause” and (b) 30 days to cure such circumstances (if curable) and (ii) such circumstances have not been cured upon the expiration of such 30-day cure period. No act or omission to act by Ms. Thornton will be “willful” if conducted in good faith or with a reasonable belief that such act or omission was in the best interests of the Company.
For purposes of the employment agreement, “Good Reason” means the occurrence of any of the following without Ms. Thornton’s consent: (i) a material reduction in Ms. Thornton’s titles, duties or authorities (including reporting responsibilities); (ii) a material reduction in Ms. Thornton’s annual base salary or target bonus, other than an across-the-board reduction applicable to all senior executives of the Company; (iii) any relocation of Ms. Thornton’s principal office by more than 50 miles; or (iv) a material breach of her employment agreement by the Company without her written consent. In each instance, in order to constitute Good Reason, Ms. Thornton must provide the Company with written notice within 60 days following the first occurrence of the circumstances constituting Good Reason, the Company must fail to cure the event within 30 days following the notice, and Ms. Thornton must then resign within 15 days following the expiration of the Company’s cure period without the Company curing such circumstances.
Jack Sinclair
We entered into an employment agreement with Mr. Sinclair effective August 24, 2016. The agreement provides that if Mr. Sinclair’s employment is terminated without “Cause” (as defined below), Mr. Sinclair will be entitled to receive the following severance payments, contingent upon Mr. Sinclair executing a general release in favor of the Company and his continued compliance with all applicable post-termination restrictive covenants.
(i) if such termination is prior to March 11, 2017, in addition to Mr. Sinclair’s accrued benefits, he will be entitled to receive an amount equal to one and one-half times his base salary paid over 18 months following his termination date.
(ii) if such termination is on or after March 11, 2017, in addition to Mr. Sinclair’s accrued benefits, he will be entitled to receive from the Company an amount equal to his base salary paid over 12 months following his termination date.
For purposes of the employment agreement, “Cause” means Mr. Sinclair’s (i) (a) being indicted for, or charged with, a felony under Federal or state law or (b) conviction of, or plea of guilty or nolo contendere to, a misdemeanor where imprisonment is imposed (other than traffic-related offenses); (ii) perpetration of an illegal act, dishonesty, or fraud that could cause economic injury to Parent, the Company or any of their subsidiaries or any act of moral turpitude by Mr. Sinclair; (iii) insubordination, refusal to perform his duties or responsibilities for any reason other than illness or incapacity or unsatisfactory performance of his duties for the Company, Parent or any of their subsidiaries; (iv) willful and deliberate failure to perform his duties after he has been given notice and an opportunity to effectuate a cure as determined by the Company; (v) willful misconduct or gross negligence with regard to the Company, Parent or any of their subsidiaries; (vi) unlawful appropriation of a material corporate opportunity; or (vii) material breach of agreement with the Company or any of its affiliates, including any confidentiality or other restrictive covenant entered into between Mr. Sinclair and the Company or any of its affiliates, including the fair competition agreement.
Mid-Term Cash Incentive Plan and Special Refinancing Bonus Letters
Generally under the Mid-Term Cash Incentive Plan, if a participant experiences a termination of employment with the Company prior to payment, the unpaid portion of the participant’s Mid-Term Cash Bonus award is forfeited. However, if (i) Mr. Covert, Ms. Thornton or Mr. Sinclair is terminated by us without Cause (as defined in their respective employment agreements with the Company) or (ii) Mr. Covert or Ms. Thornton terminates his or her employment for Good Reason (as defined in their respective employment agreements with the Company), the applicable executive will remain eligible to receive a pro rata portion of their respective award, if any, for a limited period following termination. The awards eligible to be earned by Messrs. Covert and Sinclair and Ms. Thornton are $7.0 million, $5.0 million and $5.0 million, respectively. The Company did not achieve the Initial Mid-Term Plan Goal for fiscal 2017, so no awards were paid or became eligible for payment under the Mid-Term Cash Incentive Plan with respect to fiscal 2017.
Under the Special Refinancing Bonus Letters, if, within 45 days prior to a Refinancing Transaction (as defined in the Refinancing Bonus Letters), (i) Mr. Covert, Ms. Thornton or Mr. Sinclair experiences a termination of employment by the Company without Cause or (ii) Mr. Covert or Ms. Thornton terminates his or her employment for Good Reason, the applicable executive will receive the Refinancing Bonus. The Refinancing Bonuses to be earned by Messrs. Covert and Sinclair and Ms. Thornton are $2.0 million, $1.0 million and $1.0 million, respectively. A Refinancing Transaction did not occur in fiscal 2017, so no Refinancing Bonuses were paid or became eligible for payment during fiscal 2017.
The following table sets forth information on the potential payments to Mr. Covert, Ms. Thornton and Mr. Sinclair upon certain terminations or upon a change in control, assuming such termination or change in control occurred on January 27, 2017:
(a) Cash payment for Mr. Covert represents 12 months of base salary continuation ($900,000), annual cash bonus ($832,500) and the value of the unpaid payments under his transition program ($2,289,248).
(b) Cash payment for Mr. Covert represents the value of the unpaid payments under his transition program ($2,289,248).
(c) Cash payment for Mr. Covert represents annual cash bonus ($832,500).
(d) Cash payment for Ms. Thornton represents 18 months of base salary continuation ($975,000) and annual cash bonus ($450,938).
(e) The fair market value of Parent’s common stock underlying the options held by Ms. Thornton as of January 27, 2017, the date of her separation, was lower than the exercise price of such options.
(f) Cash payment for Ms. Thornton represents annual cash bonus ($450,938).
(g) Cash payment for Mr. Sinclair represents 18 months of base salary continuation ($975,000).
Compensation of Directors During Fiscal 2017
The Parent Board sets the compensation for each director who is not an officer of or otherwise employed by us (a “non-executive director”) based on recommendations from the Compensation Committee. Non-executive directors who are employed by Ares or CPPIB do not receive compensation for their services as directors. Messrs. Axelrod, Fung and Giancamilli are not employed by Ares or CPPIB, and accordingly, they are the only directors who earned compensation for services as a director for fiscal 2017 (the “non-sponsor directors”).
Mr. Axelrod, as the longest tenured non-sponsor director, earned $50,000 in cash fees for his service on the Parent Board in fiscal 2017.
Mr. Giancamilli currently serves as the Chairman of the Parent Board. For his service as member of the Parent Board, Mr. Giancamilli earned an annualized fee of $35,000. For his service as Chairman of the Parent Board, he received an additional fee for such Chairman services at an annualized rate of $115,000, which resulted in Mr. Giancamilli earning an annualized fee of $150,000 in fiscal 2017.
Mr. Fung currently serves as the Chairman of the Audit Committee and member of the Parent Board. For his service as member of the Parent Board, Mr. Fung earned an annualized fee of $35,000. For his service as Chairman of the Audit Committee, he received an additional fee for such Chairman services at an annualized rate of $10,000, which resulted in Mr. Fung earning an annualized fee of $45,000 with respect to such period. In addition, the outstanding Options with exercise prices in excess of $757 per
share previously granted to Norman Axelrod, Andrew Giancamilli and Michael Fung, members of the Board, were amended to lower the exercise price to $757 per share. The purpose of amending these options to lower their exercise prices is to ensure directors remain incentivized by their options, and to promote share ownership by directors so as to align director and shareholder interests.
The following table provides information regarding the compensation earned by or awarded to our non-executive directors who did not serve as named executive officers during fiscal 2017:
Compensation Committee Interlocks and Insider Participation
The Compensation Committee consists of Messrs. Axelrod, Nishi and Gies. To our knowledge, there were no interrelationships involving members of the Compensation Committee or other directors requiring disclosure.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Security Ownership of Certain Beneficial Owners and Management
All of the outstanding membership units of 99 Cents Only Stores LLC are held directly by Parent.
The following table sets forth, as of March 31, 2017, certain information relating to the ownership of the common stock of Parent by (i) each person or group known by us to own beneficially more than 5% of the outstanding shares of our Parent’s common stock, (ii) each of our directors, (iii) each of our Named Executive Officers, and (iv) all of our current executive officers and directors as a group. Shares issuable upon the exercise of options exercisable on March 31, 2017 or within 60 days thereafter are considered outstanding and to be beneficially owned by the person holding such options for the purpose of computing such person’s percentage beneficial ownership, but are not deemed outstanding for the purposes of computing the percentage of beneficial ownership of any other person. Except as may be indicated in the footnotes to the table and subject to applicable community property laws, each such person has the sole voting and investment power with respect to the shares owned. The percentages of shares outstanding provided in the table below are based upon 542,720 shares of Class A Common Stock and 542,720 shares of Class B Common Stock outstanding as of March 31, 2017.
* Less than 1% of the outstanding shares.
(1) Except as otherwise noted, the address of each beneficial owner is c/o 99 Cents Only Stores LLC, 4000 Union Pacific Avenue, City of Commerce, CA 90023.
(2) Through a voting agreement within the stockholders agreement, (i) Ares has the right to designate four members of the Parent Board and, subject to the approval of CPPIB, two independent members of the Parent Board, and (ii) CPPIB has the right to designate two members of the Parent Board, in each case, for so long as such Sponsor and its affiliates and permitted transferees own at least 15% of outstanding shares of Class A Common Stock. Under the terms of the stockholders agreement, each of the Sponsors has agreed to vote in favor of the other’s director designees. See Item 13, “Certain Relationships and Related Transactions, and Director Independence-Stockholders Agreement.” As a result, each of the Sponsors may be deemed to be the beneficial owner of the shares of Class A Common Stock of Parent owned by the other. Each of Ares and CPPIB expressly disclaims beneficial ownership of the shares of Class A Common Stock of Parent not directly held by it, and such shares have not been included in the table above for purposes of calculating the number of shares beneficially owned by Ares or CPPIB.
(3) Consists of 15,500 shares of each of Class A Common Stock and Class B Common Stock issuable to Mr. Covert upon the exercise of performance-based options which may become exercisable within 60 days of March 31, 2017 and 3,875 shares of each of Class A Common Stock and Class B Common stock issuable to Mr. Covert upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of March 31, 2017.
(4) Consists of 5,000 shares of each of Class A Common Stock and Class B Common Stock issuable to Ms. Thornton upon the exercise of performance-based options which may become exercisable within 60 days of March 31, 2017 and 1,250 shares of each of Class A Common Stock and Class B Common stock issuable to Ms. Thornton upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of March 31, 2017.
(5) Consists of 5,000 shares of each of Class A Common Stock and Class B Common Stock issuable to Mr. Sinclair upon the exercise of performance-based options which may become exercisable within 60 days of March 31, 2017 and 1,250 shares of each of Class A Common Stock and Class B Common stock issuable to Mr. Sinclair upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of March 31, 2017.
(6) Consists of (i) (a) 500 shares of each of Class A Common Stock and Class B Common Stock directly held by Mr. Axelrod and (b) 250 shares of each of Class A Common Stock and Class B Common Stock directly held by AS Skip, LLC, a Delaware limited liability company of which Mr. Axelrod is the managing member; such shares were purchased in connection with a Stock Purchase Agreement, dated as of June 11, 2012, for an aggregate purchase price of $750,000, and (ii) 500 shares of each of Class A Common Stock and Class B Common Stock issuable to Mr. Axelrod upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of March 31, 2017.
(7) Consists of (i) 310 shares of each of Class A Common Stock and Class B Common Stock directly held by Mr. Fung; such shares were purchased in connection with a Stock Purchase Agreement, dated as of April 11, 2014, for an aggregate purchase price of $398,970 and (ii) 150 shares of each of Class A Common Stock and Class B Common Stock issuable to Mr. Fung upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of March 31, 2017.
(8) Consists of (i) 410 shares of each of Class A Common Stock and Class B Common Stock directly held by Mr. Giancamilli; such shares were purchased in connection with a Stock Purchase Agreement, dated as of October 8, 2013, for an aggregate purchase price of $499,790, and (ii) 388 shares of each of Class A Common Stock and Class B Common Stock issuable to Mr. Giancamilli upon the exercise of options which are currently exercisable or which will become exercisable within 60 days of March 31, 2017.
(9) The address of Mr. Gies is c/o Ares Management LLC, 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067. Mr. Gies is a Principal in the Private Equity Group of Ares Management. Mr. Gies expressly disclaims beneficial ownership of the shares owned by Ares.
(10) The address of Mr. Kaplan is c/o Ares Management LLC, 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067. Mr. Kaplan is a Partner in the Private Equity Group of Ares Management and Partner of Ares Management GP LLC, the general partner of Ares Management, L.P. (“Ares L.P.”), both of which indirectly control Ares. Mr. Kaplan expressly disclaims beneficial ownership of the shares owned by Ares.
(11) The address of Mr. Nishi is c/o Canada Pension Plan Investment Board, One Queen Street East, Suite 2500, Toronto, ON, M5C 2W5. Mr. Nishi is a Senior Principal in the Direct Private Equity Group of CPPIB.
(12) The address of Ms. Satin is c/o Ares Management LLC, 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067. Ms. Satin is a Principal in the Private Equity Group of Ares Management. Ms. Satin expressly disclaims beneficial ownership of the shares owned by Ares.
(13) Refers to shares owned by Ares acquired in connection with the Merger. The manager of Ares is ACOF Operating Manager III, LLC (“ACOF Operating Manager III”), and the sole member of ACOF Operating Manager III is Ares Management. The sole member of Ares Management is Ares Management Holdings L.P. (“Ares Management Holdings”) and the general partner of Ares Management Holdings is Ares Holdco LLC (“Ares Holdco”), whose sole member is Ares Holdings Inc. (“Ares Holdings”), whose sole stockholder is Ares L.P. The general partner of Ares L.P. is Ares Management GP LLC (“Ares Management GP”) and the sole member of Ares Management GP is Ares Partners Holdco LLC (“Ares Partners” and, together with Ares, ACOF Operating Manager III, Ares Management, Ares Management Holdings, Ares Holdco, Ares Holdings, Ares L.P., and Ares Management GP, the “Ares Entities”). Ares Partners is managed by a board of managers, which is composed of Michael Arougheti, Mr. Kaplan, John Kissick, Antony Ressler and Bennett Rosenthal. Decisions by Ares Partners’ board of managers generally are made by a majority of the members, which majority, subject to certain conditions, must include Mr. Ressler. Each of the Ares Entities (other than Ares with respect to the shares held directly by it) and the members of Ares Partners’ board of managers and the other directors, officers, partners, stockholders, members and managers of the Ares Entities expressly disclaims beneficial ownership of the shares of common stock owned by Ares. The address of each Ares Entity is 2000 Avenue of the Stars, 12th Floor, Los Angeles, California 90067.
(14) 38,000 of these shares of Class B Common Stock are subject to (i) a call right that allows CPP Investment Board (USRE II) Inc. (“CPP”) to repurchase such stock at any time for de minimis consideration and (ii) a proxy by which Ares is to take certain actions requested by CPP to elect or remove the directors of Parent or certain other matters.
(15) Refers to shares owned by CPP acquired in connection with the Merger. CPP is a wholly owned subsidiary of CPPIB. CPPIB is managed by a board of directors. Because the board of directors acts by consensus/majority approval, none of the directors has sole voting or dispositive power with respect to the shares of stock of Parent owned by CPP. Mr. Nishi expressly disclaims beneficial ownership of such shares. The address of each of CPP and CPPIB is c/o Canada Pension Plan Investment Board, One Queen Street East, Suite 2500, Toronto, ON, M5C 2W5.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Stockholders Agreement
Upon completion of the Merger, Parent entered into a stockholders agreement with each of its stockholders, which included certain of our former directors, employees and members of management and our principal stockholders. The stockholders agreement, as amended, gives (i) Ares the right to designate four members of the Parent Board, (ii) Ares the right to designate up to three independent members of the Parent Board, which directors shall be approved by CPPIB, and (iii) CPPIB the right to designate two members of the Parent Board, in each case for so long as they or their respective affiliates beneficially own at least 15% of the then outstanding shares of Class A Common Stock. The stockholders agreement provides for the election of the current chief executive officer of Parent to the Parent Board. Under the terms of the stockholders agreement, certain significant corporate actions require the approval of a majority of directors on the board of directors, including at least one director designated by Ares and one director designated by CPPIB. These actions include the incurrence of additional indebtedness over $20 million in the aggregate outstanding at any time, the issuance or sale of any of our capital stock over $20 million in the aggregate, the sale, transfer or acquisition of any assets with a fair market value of over $20 million, the declaration or payment of any dividends, entering into any merger, reorganization or recapitalization, amendments to our charter or bylaws, approval of our annual budget and other similar actions.
The stockholders agreement contains significant transfer restrictions and certain rights of first offer, tag-along, and drag-along rights. In addition, the stockholders agreement contains registration rights that, among other things, require Parent to register common stock held by the stockholders who are parties to the stockholders agreement in the event Parent registers for sale, either for its own account or for the account of others, shares of its common stock.
Under the stockholders agreement, certain affiliate transactions, including certain affiliate transactions between Parent, on the one hand, and Ares, CPPIB or any of their respective affiliates, on the other hand, require the approval of a majority of disinterested directors.
Management Services Agreements
Upon completion of the Merger, the Company and Parent entered into management services agreements with affiliates of the Sponsors (the “Management Services Agreements”). Under each of the Management Services Agreements, the Company and Parent agreed to, among other things, retain and reimburse affiliates of the Sponsors for certain expenses incurred in connection with the provision by Sponsors of certain management and financial services and provide customary indemnification to the Sponsors and their affiliates. In fiscal 2015, the Company did not reimburse affiliates of the Sponsors for any expenses. The Sponsors provided no services to us during fiscal 2015. In fiscal 2016, the Company reimbursed affiliates of the Sponsors their expenses in the amount of $0.4 million. In fiscal 2017, the Company reimbursed affiliates of the Sponsors their expenses in the amount of less than $0.1 million.
Credit Facility
In connection with the Merger, the Company entered into the First Lien Term Loan Facility, under which various funds affiliated with Ares were lenders. As of January 29, 2016, these affiliates no longer held any term loans under the First Lien Term Loan Facility. As of January 27, 2017, funds affiliated with Ares and CPPIB held approximately $130.5 million of term loans under the First Lien Term Loan Facility. The terms of the term loans are the same as those held by unaffiliated third party lenders under the First Lien Term Loan Facility.
Senior Notes
As of January 27, 2017 and January 29, 2016 various funds affiliated with Ares and CPPIB have collectively acquired $102.1 million aggregate principal amount of the Company’s Senior Notes in open market transactions. From time to time, these or other affiliated funds may acquire additional Senior Notes.
Director Independence
As of March 31, 2017, the Parent Board was comprised of Norman Axelrod, Michael Fung, Andrew Giancamilli, Dennis Gies, Geoffrey Covert, David Kaplan, Scott Nishi and Allyson Satin. Pursuant to the stockholders agreement of Parent, Messrs. Axelrod, Gies, Kaplan and Satin were designated by Ares and Mr. Nishi was designated by CPPIB. Messrs. , Fung and Giancamilli were designated and approved by the Sponsors. Mr. Covert, as chief executive officer, was elected pursuant to the stockholders agreement of Parent. We have no securities listed for trading on a national securities exchange or in an automated inter-dealer quotation system of a national securities association which has requirements that a majority of our board of directors or other governing body be independent.
Review, Approval or Ratification of Transactions with Related Persons
Although we have not adopted formal procedures for the review, approval or ratification of transactions with related persons, the Parent Board reviews potential transactions with those parties we have identified as related parties prior to the consummation of the transaction, and we adhere to the general policy that such transactions should only be entered into if they are approved by the Parent Board, in accordance with applicable law, and on terms that, on the whole, are no more or less favorable than those available from unaffiliated third parties.
Item 14.
Item 14. Principal Accountant Fees and Services
Ernst & Young LLP (“EY”) served as our independent registered public accounting firm and reported on our Consolidated Financial Statements for fiscal 2017 and fiscal 2016.
Services provided by EY and related fees for fiscal 2017 and fiscal 2016 were as follows:
(a) Includes fees necessary to perform an audit or quarterly review in accordance with generally accepted auditing standards and services that generally only the independent registered public accounting firm can reasonably provide, such as attest services, consents and assistance with, and review of, documents filed with the Securities and Exchange Commission.
(b) Includes fees for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements.
(c) Includes fees for tax compliance services and other on-call tax advisory services.
The Audit Committee has considered whether the provision of non-audit services by our principal registered public accounting firm is compatible with maintaining auditor independence and determined that it is. Pursuant to the rules of the Securities and Exchange Commission, before our independent registered accounting firm is engaged to render audit or non-audit services, the engagement must be approved by the Audit Committee or entered into pursuant to the Audit Committee’s pre-approval policies and procedures. The Audit Committee has a practice of granting pre-approval to certain specific audit and audit-related services and other services. The Audit Committee pre-approved 100% of the audit and tax services provided by EY during fiscal 2017 and fiscal 2016.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedule
a) Financial Statements. Reference is made to the Index to the Financial Statements set forth in Item 8 on page 50 of this Report.
Financial Statement Schedules. All Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are included herein.
b) Exhibits. The exhibits listed on the accompanying Index to Exhibits are filed as part of, or incorporated by reference into, this Report.
Item 16. Form 10-K Summary
None.
99 Cents Only Stores LLC
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Amounts in thousands)
INDEX TO EXHIBITS
Exhibit No.
Exhibit Description
2.1
Agreement and Plan of Merger among Number Holdings, Inc., Number Merger Sub, Inc. and Registrant, dated October 11, 2011.(1)
3.1
Limited Liability Company Articles of Organization - Conversion of 99 Cents Only Stores LLC, dated as of October 18, 2013.(2)
3.2
Limited Liability Company Agreement of 99 Cents Only Stores LLC, dated as of October 18, 2013.(2)
3.5
Certificate of Incorporation of 99 Cents Only Stores Texas, Inc.(5)
3.6
Bylaws of 99 Cents Only Stores Texas, Inc.(5)
4.1
Indenture, dated as of December 29, 2011, between Number Merger Sub, Inc. and Wilmington Trust, National Association, as trustee.(3)
4.2
Supplemental Indenture, dated as of January 13, 2012, among the Registrant, 99 Cents Only Stores Texas, Inc., 99 Cents Only Stores and Wilmington Trust, National Association, as trustee.(3)
4.3
Registration Rights Agreement, dated as of December 29, 2011, between Number Merger Sub, Inc. and RBC Capital Markets, LLC, as representative of the Initial Purchasers (as defined therein).(3)
10.1
$175,000,000 Credit Agreement, dated as of January 13, 2012, among the Registrant, Number Holdings, Inc., the lenders party thereto, Royal Bank of Canada, as administrative agent and Issuer (as defined therein), BMO Harris Bank N.A. and Deutsche Bank Securities Inc., as co-syndication agents, and the other agents named therein (the ‘‘ABL Credit Agreement’’).(3)
10.2
$525,000,000 Credit Agreement, dated as of January 13, 2012, among the Registrant, Number Holdings, Inc., the lenders party thereto, Royal Bank of Canada, as administrative agent, BMO Capital Markets and Deutsche Bank Securities Inc., as co-syndication agents, and the other agents named therein (the ‘‘Term Credit Agreement’’).(3)
10.3
Security Agreement, dated as of January 13, 2012, among Number Holdings, Inc., the Registrant, the Subsidiary Guarantors (as defined therein), and Royal Bank of Canada, as collateral agent for the Secured Parties (as defined therein).(3)
10.4
Security Agreement, dated as of January 13, 2012, among Number Holdings, Inc., the Registrant, the Subsidiary Guarantors (as defined therein), and Royal Bank of Canada, as collateral agent for the Secured Parties (as defined therein).(3)
10.5
Guaranty, dated as of January 13, 2012, among Number Holdings, Inc, the other Guarantors (as defined therein) and the Royal Bank of Canada, as administrative agent and collateral agent.(3)
10.6
Guaranty, dated as of January 13, 2012, among Number Holdings, Inc, the other Guarantors (as defined therein) and the Royal Bank of Canada, as administrative agent and collateral agent.(3)
10.7
Intercreditor Agreement, dated as of January 13, 2012, between the Royal Bank of Canada, as administrative agent under the ABL Facility (as defined herein), and the Royal Bank of Canada, as administrative agent under the Term Loan Facility (as defined herein).(3)
10.8
2012 Stock Incentive Plan of Number Holdings, Inc.(5)
10.9
Form of Non-Qualified Stock Option Agreement pursuant to the 2012 Stock Incentive Plan.(5)
10.10
Management Services Agreement, dated as of January 13, 2012, by and among Number Holdings, Inc., the Registrant and ACOF Operating Manager III, LLC.(6)
10.11
Management Services Agreement, dated as of January 13, 2012, by and among Number Holdings, Inc., the Registrant and CPPIB Equity Investments Inc.(6)
10.12
Amendment No. 1 to the ABL Credit Agreement, dated as of April 4, 2012, among the Registrant, Number Holdings, Inc., each other Loan Party thereto and Royal Bank of Canada, as administrative agent.(7)
10.13
Amendment No. 1 to the Term Credit Agreement, dated as of April 4, 2012, among the Registrant, Number Holdings, Inc., each other Loan Party thereto, each Participating Lender Party thereto and Royal Bank of Canada, as administrative agent.(7)
10.14
First Amendment to the 2012 Stock Incentive Plan of Number Holdings, Inc., dated as of September 27, 2013.(2)
10.15
Amendment No. 2 to the ABL Credit Agreement, dated as of October 8, 2013, among the Registrant, Number Holdings, Inc., each other Loan Party thereto, each Lender party thereto and Royal Bank of Canada, as administrative agent.(2)
10.16
Amendment No. 2 to the Term Credit Agreement, dated as of October 8, 2013, among the Registrant, Number Holdings, Inc., each other Loan Party thereto, each Lender party thereto and Royal Bank of Canada, as administrative agent.(2)
10.17
Purchase Agreement, dated as of October 15, 2013, by and among Number Holdings, Inc., Sherry Gold, individually and in her capacity as Trustee of The Gold Revocable Trust dated 10/26/2005, Jeff Gold, Howard Gold, Karen Schiffer and Eric Schiffer.(8)
10.18
Stockholders Agreement, dated as of January 13, 2012, among Number Holdings, Inc., Ares Corporate Opportunities Fund III, L.P., Canada Pension Plan Investment Board and the Other Stockholders party thereto.(5)
10.19
First Amendment to Stockholders Agreement, dated as of December 16, 2013, by and between Ares Corporate Opportunities Fund III, L.P. and CPP Investment Board (USRE II) Inc.(4)
10.20
Severance Agreement, dated as of April 17, 2013, among the Registrant and Mike Kvitko.(9)
10.21
Non-Qualified Stock Option Agreement pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of February 5, 2015, among Number Holdings, Inc. and Bradley Lukow.(9)
10.22
Consulting Agreement, dated July 6, 2015, among the Registrant and Bradley Lukow.(10)
10.23
Consulting Agreement, dated May 26, 2015, among the Registrant and Stéphane Gonthier.(11)
10.24
Consulting Agreement, dated May 26, 2015, among the Registrant and Andrew Giancamilli.(11)
10.25
Consulting Agreement, dated August 24, 2015, among the Registrant and Michael Fung.(12)
10.26
Amendment No. 3 to the ABL Credit Agreement, dated August 24, 2015, among the Company, Number Holdings, Inc., each other Loan Party thereto, each Lender party thereto and Royal Bank of Canada, as administrative agent.(12)
10.27
Employment Agreement, dated September 11, 2015, among the Registrant and Geoffrey J. Covert.(14)
10.28
Non-Qualified Stock Option Agreement ($750) pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of September 21, 2015, between Number Holdings, Inc. and Geoffrey J. Covert.(14)
10.29
Non-Qualified Stock Option Agreement ($1000) pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of September 21, 2015, between Number Holdings, Inc. and Geoffrey J. Covert.(14)
10.30
Employment Agreement, dated October 31, 2015, among the Registrant and Felicia Thornton.(13)
10.31
Non-Qualified Stock Option Agreement, pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of November 13, 2015, between Number Holdings, Inc. and Felicia Thornton.(14)
10.32
Non-Qualified Stock Option Agreement, pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of December 2, 2015, between Number Holdings, Inc. and Jack Sinclair.(15)
10.33
Amendment No. 4 to the ABL Credit Agreement, dated April 8, 2016, among the Company, Number Holdings, Inc., each other Loan Party thereto, each Lender party thereto and Royal Bank of Canada, as administrative agent.(16)
10.34
Second Amendment to the 2012 Stock Incentive Plan of Number Holdings, Inc., dated as of July 26, 2016. (17)
10.35
2016 Mid-Term Cash Incentive Plan.(17)
10.36
Form of Mid-Term Cash Incentive Plan Letter Agreement.(17)
10.37
Form of Refinancing Bonus Letter Agreement.(17)
10.38
Form of Non-Qualified Employee Stock Option Agreement, pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan.(17)
10.39
Non-Qualified Amended and Restated Stock Option Agreement ($750), pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of September 21, 2015, between Number Holdings, Inc. and Geoffrey J. Covert.(17)
10.40
Non-Qualified Amended and Restated Stock Option Agreement ($1000), pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of September 21, 2015, between Number Holdings, Inc. and Geoffrey J. Covert.(17)
10.41
Non-Qualified Amended and Restated Stock Option Agreement, pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of November 13, 2015, between Number Holdings, Inc. and Felicia Thornton.(17)
10.42
Non-Qualified Amended and Restated Stock Option Agreement, pursuant to the Number Holdings, Inc. 2012 Stock Incentive Plan, dated as of December 2, 2015, between Number Holdings, Inc. and Jack Sinclair.(17)
10.43
Employment Agreement, dated August 24, 2016, among the Registrant and Jack Sinclair.(18)
21.0
Subsidiaries*
31(a)
Certification of Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.*
31(b)
Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.*
32(a)
Certification of Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.**
32(b)
Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.**
101.INS
XBRL Instance Document*
101.SCH
XBRL Taxonomy Extension Schema*
101.CAL
XBRL Taxonomy Extension Calculation Linkbase*
101.DEF
XBRL Taxonomy Extension Definition Linkbase*
101.LAB
XBRL Taxonomy Extension Label Linkbase*
101.PRE
XBRL Taxonomy Extension Presentation Linkbase*
*
Filed herewith
**
Furnished herewith.
(1) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on October 11, 2011.
(2) Incorporated by reference from the Registrant’s Form 10-Q as filed with the Securities and Exchange Commission on November 8, 2013.
(3) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on January 13, 2012.
(4) Incorporated by reference from the Registrant’s 2014 Transition Report on Form 10-KT as filed with the Securities and Exchange Commission on April 22, 2014.
(5) Incorporated by reference from the Registrant’s Registration Statement on Form S-4 as filed with the Securities and Exchange Commission on July 9, 2012.
(6) Incorporated by reference from the Registrant’s Amendment No. 1 to Registration Statement on Form S-4/A as filed with the Securities and Exchange Commission on August 29, 2012.
(7) Incorporated by reference from the Registrant’s Amendment No. 2 to Registration Statement on Form S-4/A as filed with the Securities and Exchange Commission on September 21, 2012.
(8) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on October 16, 2013.
(9) Incorporated by reference from the Registrant’s 2015 Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 22, 2015
(10) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on July 9, 2015
(11) Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on September 11, 2015.
(12) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on August 25, 2015.
(13) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on November 3, 2015.
(14) Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on December 14, 2015.
(15) Incorporated by reference from the Registrant’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 28, 2016
(16) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on April 11, 2016.
(17) Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on September 9, 2016.
(18) Incorporated by reference from the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on August 29, 2016.
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.
99 CENTS ONLY STORES LLC
/s/ Geoffrey J. Covert
Date: April 26, 2017
By:
Geoffrey J. Covert
President and Chief Executive Officer
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.
Signature
Title
Date
/s/ Geoffrey J. Covert
Geoffrey J. Covert
President, Chief Executive Officer and Director (principal executive officer)
April 26, 2017
/s/ Felicia Thornton
Felicia Thornton
Chief Financial Officer and Treasurer (principal financial officer and principal accounting officer)
April 26, 2017
/s/ Norman Axelrod
Norman Axelrod
Director
April 26, 2017
/s/ Michael Fung
Michael Fung
Director
April 26, 2017
/s/Andrew Giancamilli
Andrew Giancamilli
Chairman of the Board
April 26, 2017
/s/ Dennis Gies
Dennis Gies
Director
April 26, 2017
/s/ Scott Nishi
Scott Nishi
Director
April 26, 2017
/s/ Allyson Satin
Allyson Satin
Director
April 26, 2017
/s/ David Kaplan
David Kaplan
Director
April 26, 2017