10-Q/A 1 a13-4405_110qa.htm 10-Q/A

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q/A

 

(Mark One)

 

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

 

For the quarterly period ended September 29, 2012

 

OR

 

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

 

Commission file number 1-11735

 

99¢ ONLY STORES

(Exact Name of Registrant as Specified in Its Charter)

 

California

(State or Other Jurisdiction

of Incorporation or Organization)

 

95-2411605

(I.R.S. Employer Identification No.)

 

 

 

4000 Union Pacific Avenue,

City of Commerce, California

(Address of Principal Executive Offices)

 

 

90023

(Zip Code)

 

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

 

 

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

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

 

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

 

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

 

As of November 4, 2012, there were 100 shares of the registrant’s Class A Common Stock, par value $0.01 per share, outstanding and 100 shares of registrant’s Class B Common Stock, par value $0.01 per share, outstanding, none of which are publicly traded.

 

 

 



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EXPLANATORY NOTE

 

This Amendment No. 1 on Form 10-Q/A (“Form 10-Q/A”) amends the Quarterly Report on Form 10-Q of 99¢ Only Stores (the “Company”) for the quarterly period ended September 29, 2012 as originally filed with the Securities and Exchange Commission (the “SEC”) on November 13, 2012 (the “Original Filing”). This Form 10-Q/A amends the Original Filing to correct the Company’s accounting for the repricing of its seven-year term loan credit facility in the first quarter of fiscal 2013 ended June 30, 2012, as more fully described in Note 19 to the Consolidated Financial Statements contained in this Form 10-Q/A. For ease of reference, this Form 10-Q/A amends and restates the Original Filing in its entirety. Revisions to the Original Filing have been made to the following sections:

 

·      Part I, Item 1 — Financial Statements

·      Part I, Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

·      Part I, Item 3 — Quantitative and Qualitative Disclosures About Market Risk

·      Part I, Item 4 — Controls and Procedures

 

In addition, this Form 10-Q/A also includes, as exhibits, certifications from the Company’s principal executive officer and principal financial officer dated as of the date of this filing. Except as described above, no other amendments have been made to the Original Filing. This Form 10-Q/A continues to speak as of the date of the Original Filing, and the Company has not updated the disclosure contained herein to reflect information or events that have occurred since the November 13, 2012 filing date of the Original Filing, or modify or update disclosures set forth in the Original Filing, except to reflect the corrections discussed above. Accordingly, this Form 10-Q/A should be read in conjunction with the Company’s other filings made with the SEC subsequent to the filing of the Original Filing, including any amendments to those filings.

 

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Table of Contents

 

99¢ ONLY STORES

Form 10-Q

Table of Contents

 

 

 

Page

 

Part I - Financial Information

 

Item 1.

Financial Statements

5

 

Consolidated Balance Sheets as of September 29, 2012 (unaudited) (Restated) and March 31, 2012

5

 

Consolidated Statements of Comprehensive Income (Loss) for the second quarter and first half ended September 29, 2012 (Successor) (unaudited) (Restated) and October 1, 2011(Predecessor) (unaudited)

6

 

Consolidated Statements of Cash Flows for the first half ended September 29, 2012 (Successor) (unaudited) (Restated) and October 1, 2011 (Predecessor) (unaudited)

7

 

Notes to Consolidated Financial Statements

8

Item 2.

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

39

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

48

Item 4.

Controls and Procedures

49

 

Part II — Other Information

 

Item 1.

Legal Proceedings

50

Item 1A.

Risk Factors

50

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

50

Item 3.

Defaults Upon Senior Securities

50

Item 4.

Mine Safety Disclosures

50

Item 5.

Other Information

50

Item 6.

Exhibits

50

 

Signatures

52

 

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FORWARD-LOOKING INFORMATION

 

This Report on Form 10-Q contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words “expect,” “estimate,” “anticipate,” “predict,” “believe” and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief or current expectations of 99¢ Only Stores (the “Company”) and its directors or officers with respect to, among other things, (a) trends affecting the financial condition or results of operations of the Company, and (b) the business and growth strategies of the Company (including the Company’s store opening growth rate). Readers are cautioned not to put undue reliance on such forward-looking statements. Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in this Report, for the reasons, among others, discussed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections.  The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.  Readers should carefully review the risk factors described in other documents the Company files from time to time with the SEC or posts on the Company’s website, including the Company’s Registration Statement on Form S-4 (File No. 333-182582) declared effective on October 9, 2012 containing the Company’s most recent audited financial statements for the fiscal year ended March 31, 2012.

 

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PART I.  FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

99¢ ONLY STORES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

September 29,
2012

 

March 31,
 2012

 

 

 

(Unaudited)
(Restated)

 

 

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash

 

$

42,067

 

$

27,766

 

Short-term investments

 

1,604

 

3,631

 

Accounts receivable, net of allowance for doubtful accounts of $425 and $280 at September 29, 2012 and March 31, 2012, respectively

 

1,420

 

2,999

 

Income taxes receivable

 

20,215

 

6,868

 

Deferred income taxes

 

25,843

 

25,843

 

Inventories, net

 

225,029

 

214,318

 

Assets held for sale

 

2,621

 

6,849

 

Other

 

14,674

 

11,297

 

Total current assets

 

333,473

 

299,571

 

Property and equipment, net

 

463,074

 

476,525

 

Deferred financing costs, net

 

22,435

 

30,400

 

Intangible assets, net

 

474,397

 

477,434

 

Goodwill

 

471,513

 

471,513

 

Deposits and other assets

 

13,862

 

12,598

 

Total assets

 

$

1,778,754

 

$

1,768,041

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

52,133

 

$

41,407

 

Payroll and payroll-related

 

17,515

 

15,580

 

Sales tax

 

5,780

 

6,128

 

Other accrued expenses

 

35,322

 

30,569

 

Workers’ compensation

 

37,838

 

39,024

 

Current portion of long-term debt

 

5,237

 

5,250

 

Current portion of capital lease obligation

 

80

 

77

 

Total current liabilities

 

153,905

 

138,035

 

Long-term debt, net of current portion

 

754,956

 

758,351

 

Unfavorable lease commitments, net

 

16,896

 

18,959

 

Deferred rent

 

3,160

 

798

 

Deferred compensation liability

 

5,195

 

5,136

 

Capital lease obligation, net of current portion

 

313

 

354

 

Long-term deferred income taxes

 

214,195

 

214,874

 

Other liabilities

 

3,473

 

767

 

Total liabilities

 

1,152,093

 

1,137,274

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

Preferred stock, no par value — authorized, 1,000 shares; no shares issued or outstanding

 

 

 

Common stock $0.01 par value — Class A authorized, 1,000 shares; issued and outstanding, 100 shares and Class B authorized, 1,000 shares; issued and outstanding, 100 shares at September 29, 2012 and March 31, 2012, respectively

 

 

 

Additional paid-in capital

 

637,630

 

636,037

 

Accumulated deficit

 

(9,974

)

(5,293

)

Other comprehensive (loss) income

 

(995

)

23

 

Total shareholders’ equity

 

626,661

 

630,767

 

Total liabilities and shareholders’ equity

 

$

1,778,754

 

$

1,768,041

 

 

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

 

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99¢ ONLY STORES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

September 29,
2012

 

 

October 1,
2011

 

September 29,
2012

 

 

October 1,
2011

 

 

 

(Successor)
(Restated)

 

 

(Predecessor)

 

(Successor)
(Restated)

 

 

(Predecessor)

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

99¢ Only Stores

 

$

382,073

 

 

$

352,220

 

$

771,029

 

 

$

709,764

 

Bargain Wholesale

 

11,290

 

 

10,818

 

23,284

 

 

21,614

 

Total sales

 

393,363

 

 

363,038

 

794,313

 

 

731,378

 

Cost of sales (excluding depreciation and amortization expense shown separately below)

 

242,699

 

 

217,264

 

486,601

 

 

436,784

 

Gross profit

 

150,664

 

 

145,774

 

307,712

 

 

294,594

 

Selling, general and administrative expenses:

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

120,362

 

 

114,367

 

239,133

 

 

227,933

 

Depreciation

 

13,931

 

 

6,985

 

27,683

 

 

13,694

 

Amortization of intangible assets

 

442

 

 

5

 

883

 

 

9

 

Total selling, general and administrative expenses

 

134,735

 

 

121,357

 

267,699

 

 

241,636

 

Operating income

 

15,929

 

 

24,417

 

40,013

 

 

52,958

 

Other (income) expense:

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

(35

)

 

(60

)

(259

)

 

(202

)

Interest expense

 

15,537

 

 

34

 

31,114

 

 

335

 

Other-than-temporary investment impairment due to credit losses

 

 

 

31

 

 

 

31

 

Loss on extinguishment of debt

 

 

 

 

16,346

 

 

 

Other

 

3

 

 

(19

)

67

 

 

(62

)

Total other expense (income), net

 

15,505

 

 

(14

)

47,268

 

 

102

 

Income (loss) before provision for income taxes

 

424

 

 

24,431

 

(7,255

)

 

52,856

 

Provision (benefit) for income taxes

 

214

 

 

9,317

 

(2,574

)

 

20,059

 

Net income (loss)

 

$

210

 

 

$

15,114

 

$

(4,681

)

 

$

32,797

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains on securities arising during period

 

4

 

 

(142

)

4

 

 

(138

)

Unrealized losses on interest rate cash flow hedge

 

(473

)

 

 

(1,017

)

 

 

Less: reclassification adjustment included in net income

 

 

 

7

 

(5

)

 

(18

)

Other comprehensive loss, net of tax

 

(469

)

 

(135

)

(1,018

)

 

(156

)

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive (loss) income

 

$

(259

)

 

$

14,979

 

$

(5,699

)

 

$

32,641

 

 

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

 

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99¢ ONLY STORES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

 

First Half Ended

 

 

 

September 29,
2012

 

 

October 1,
2011

 

 

 

(Successor)

 

 

(Predecessor)

 

 

 

(Restated)

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

(4,681

)

 

$

32,797

 

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

 

 

 

 

 

 

Depreciation

 

27,683

 

 

13,694

 

Amortization of deferred financing costs and accretion of OID

 

2,059

 

 

 

Amortization of intangible assets

 

883

 

 

9

 

Amortization of favorable/unfavorable leases, net

 

91

 

 

 

Loss on extinguishment of debt

 

16,346

 

 

 

Loss on disposal of fixed assets

 

403

 

 

80

 

Loss on interest rate hedge

 

665

 

 

 

Investments impairment

 

 

 

31

 

Excess tax benefit from share-based payment arrangements

 

 

 

(584

)

Deferred income taxes

 

 

 

(105

)

Stock-based compensation expense

 

1,593

 

 

1,313

 

 

 

 

 

 

 

 

Changes in assets and liabilities associated with operating activities:

 

 

 

 

 

 

Accounts receivable

 

1,586

 

 

(836

)

Inventories

 

(11,437

)

 

(42,641

)

Deposits and other assets

 

(3,874

)

 

165

 

Accounts payable

 

9,047

 

 

8,498

 

Accrued expenses

 

6,358

 

 

7,600

 

Accrued workers’ compensation

 

(1,186

)

 

(2,169

)

Income taxes

 

(13,347

)

 

12,495

 

Deferred rent

 

2,362

 

 

1,114

 

Other long-term liabilities

 

(73

)

 

 

Net cash provided by operating activities

 

34,478

 

 

31,461

 

Cash flows from investing activities:

 

 

 

 

 

 

Purchases of property and equipment

 

(19,861

)

 

(23,553

)

Proceeds from sale of property and fixed assets

 

11,549

 

 

2

 

Purchases of investments

 

(449

)

 

(50,389

)

Proceeds from sale of investments

 

2,470

 

 

48,174

 

Net cash used in investing activities

 

(6,291

)

 

(25,766

)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Payment of debt

 

(2,618

)

 

 

Payment of debt issuance costs

 

(11,230

)

 

 

Payments of capital lease obligation

 

(38

)

 

(35

)

Repurchases of common stock related to issuance of Performance Stock Units

 

 

 

(753

)

Proceeds from exercise of stock options

 

 

 

2,470

 

Excess tax benefit from share-based payment arrangements

 

 

 

584

 

Net cash (used in) provided by financing activities

 

(13,886

)

 

2,266

 

Net increase in cash

 

14,301

 

 

7,961

 

Cash - beginning of period

 

27,766

 

 

16,723

 

Cash - end of period

 

$

42,067

 

 

$

24,684

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

Income taxes paid

 

$

10,772

 

 

$

5,679

 

Interest paid

 

$

26,125

 

 

$

29

 

Non-cash investing activities for purchases of property and equipment

 

$

(1,679

)

 

$

837

 

 

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

 

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99¢ ONLY STORES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.                                      Basis of Presentation and Summary of Significant Accounting Policies

 

Nature of Business

 

On January 13, 2012, pursuant to the Agreement and Plan of Merger (the “Merger”), dated as of October 11, 2011, by and among 99¢ Only Stores (the “Company”), Number Holdings, Inc., a Delaware corporation (“Parent”), and Number Merger Sub, Inc. (“Merger Sub”) a subsidiary of Parent, the Merger was consummated.  Merger Sub merged with and into 99¢ Only Stores, with 99¢ Only Stores being the surviving corporation.  As a result of the Merger, the Company became a subsidiary of Parent.  Parent is controlled by affiliates of Ares Management LLC, Canada Pension Plan Investment Board (together, the “Sponsors”) and Eric Schiffer, the Company’s Chief Executive Officer, Jeff Gold, the Company’s President and Chief Administrative Officer, Howard Gold, the Company’s Executive Vice President, Karen Schiffer and The Gold Revocable Trust dated October 26, 2005 (collectively, the “Rollover Investors”). 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 or traded corporation. See Note 2 for more information regarding the Merger.

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  However, certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been omitted or condensed pursuant to the rules and regulations of the Securities and Exchange Commission.  These statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Registration Statement on Form S-4 (File No. 333-182582) declared effective on October 9, 2012 (the “Registration Statement”).  In the opinion of the Company’s management, these interim consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the consolidated financial position and results of operations for each of the periods presented.  The results of operations and cash flows for such periods are not necessarily indicative of results to be expected for the full fiscal year ending March 30, 2013 (“fiscal 2013”).

 

The Company is incorporated in the State of California. The Company is an extreme value retailer of primarily consumable and general merchandise with an emphasis on name-brand products.  As of September 29, 2012, the Company operated 303 retail stores with 222 in California, 37 in Texas, 29 in Arizona, and 15 in Nevada.  The Company is also a wholesale distributor of various products.

 

Fiscal Periods

 

The Company follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Saturday closest to the calendar quarter-end, 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.   On January 13, 2012, the Company completed the Merger.  The accompanying consolidated financial statements are presented for the “Predecessor” and “Successor” relating to the periods preceding and succeeding the Merger, respectively. Fiscal 2013 began on April 1, 2012 and will end on March 30, 2013 and will consist of 52 weeks. The Company’s fiscal year ending March 31, 2012 (“fiscal 2012”) consisted of the Successor period from January 15, 2012 to March 31, 2012 and the Predecessor period from April 3, 2011 to January 14, 2012, for a total of 52 weeks. The second quarter ended September 29, 2012 (“second quarter of fiscal 2013”) and second quarter ended October 1, 2011 (“second quarter of fiscal 2012”) were each comprised of 91 days.  The period ended September 29, 2012 (“first half of fiscal 2013”) and the period ended October 1, 2012 (“first half of fiscal 2012”) were each comprised of 182 days.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year presentation.

 

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Cash

 

For purposes of reporting cash flows, cash includes cash on hand and at the stores and cash in financial institutions.  Cash balance held at financial institutions, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. All non-interest bearing cash balances were fully insured at September 29, 2012 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning in calendar 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and non-interest bearing cash balances may again exceed federally insured limits. The Company’s interest-bearing amounts on deposit are not insured by the Federal Deposit Insurance Corporation. The Company places its temporary cash investments with what it believes to be high credit, quality financial institutions.

 

Allowance for Doubtful Accounts

 

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

 

Investments

 

The Company’s investments in debt and equity securities are classified as available-for-sale and are comprised primarily of money market funds and auction rate securities.

 

Investment securities are recorded as required by Accounting Standard Codification (“ASC”) 320, “Investments-Debt and Equity Securities.”   These investments are carried at fair value, based on quoted market prices or other readily available market information. Investments are adjusted for the amortization of premiums or discounts to maturity and such amortization is included in interest income. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is a separate component of shareholders’ equity in the Company’s Consolidated Balance Sheets. Gains and losses are recognized when realized in the Company’s Consolidated Statements of Comprehensive Income. When it is determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in earnings.

 

Inventories

 

Inventories are valued at the lower of cost (first in, first out) or market. Valuation allowances for shrinkage as well as excess and obsolete inventory are also recorded. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. Physical inventories are taken at each of the Company’s retail stores at least once a year by an independent inventory service company.  Additional store-level physical inventories are taken by the service companies from time to time based on a particular store’s performance and/or book inventory balance.  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 Company’s policy is to analyze all items held in inventory that would not be sold through at current sales rates over a 24 month period to determine what merchandise should be reserved for as excess and obsolete. The valuation allowances for excess and obsolete inventory in many locations (including various warehouses, store backrooms, and sales floors of its stores), require management judgment and estimates that may impact the ending inventory valuation and valuation allowances that may affect the reported gross margin for the period.

 

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

 

At times, the Company also makes large block purchases of inventory that it plans to sell over a period of longer than twelve months.  As of September 29, 2012 and March 31, 2012, the Company held inventory of specific products identified as expected to sell over a period that exceeds twelve months in the amounts of approximately $7.2 million and $6.4 million, respectively, which is included in deposits and other assets in the consolidated financial statements.

 

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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

 

5 years

Transportation equipment

 

3-5 years

Information technology systems

 

For major corporate systems, estimated useful life up to 7 years; for functional stand alone 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

 

In accordance with ASC 360, “Property, Plant and Equipment,” the Company assesses the impairment of long-lived assets quarterly or when events or changes in circumstances indicate that the carrying value may not be recoverable. 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. Considerable management judgment is necessary to estimate projected future operating cash flows.  Accordingly, if actual results fall short of such estimates, significant future impairments could result.  During each of second quarter and first half of fiscal 2013 and fiscal 2012, the Company did not record any asset impairment charges. During the second quarter and first half of fiscal 2012, the Company did not record any asset impairment charges.

 

Goodwill and Other Intangible Assets

 

In connection with the Merger purchase price allocation, the fair values of long-lived and intangible assets have been determined based upon assumptions related to the future cash flows, discount rates and asset lives utilizing currently available information, and in some cases were obtained from independent professional valuation experts.  Under ASC 350, “Intangibles — Goodwill and Other” the Company amortizes intangible assets over their estimated useful lives unless such lives are deemed indefinite.

 

Goodwill and indefinite-lived intangible assets are not amortized but instead tested annually for impairment or more frequently when events or changes in circumstances indicate that the assets might be impaired. Goodwill is tested for impairment by comparing the carrying amount of the reporting unit to the fair value of the reporting unit to which the goodwill is assigned.  Under Accounting Standards Update (“ASU”) 2011-8 (effective December 15, 2011), which amends the guidance in ASC 350-20 on testing goodwill for impairment, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step one of the goodwill impairment test). If entities determine, 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 ASU does not change how goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test goodwill annually for impairment. In addition, the ASU does not amend the requirement to test goodwill for impairment between annual tests if events or circumstances warrant; however, it does revise the examples of events and circumstances that an entity should consider.

 

The Company will perform the qualitative assessment for impairment in January 2013, during the fourth quarter of fiscal 2013, and annually thereafter. In the event that the qualitative assessment indicates that goodwill has been impaired, then the two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. 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’s has two reporting units, the wholesale reporting unit and the retail reporting unit.

 

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Table of Contents

 

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.

 

Derivatives

 

The Company accounts for derivative financial instruments in accordance with accounting ASC 815, “Derivatives and Hedging.” All financial instrument positions taken by the Company are 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, 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 are reclassified to earnings in the period the hedged item affects earnings. Any ineffectiveness is recognized in earnings in the current period.

 

Purchase Accounting

 

Under ASC 805, “Business Combinations” (“ASC 805”), the Company’s assets and liabilities have been accounted for at their estimated fair values as of the date of the Merger.  The aggregate purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based upon an assessment of their relative fair value as of the Merger date.  These estimates of fair values, the allocation of the purchase price and other factors related to the accounting for the Merger are subject to significant judgments and the use of estimates.

 

Income Taxes

 

The Company utilizes the liability method of accounting for income taxes as set forth in ASC 740, “Income Taxes” (“ASC 740”).  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.  ASC 740 also requires that deferred tax assets be 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. ASC 740 requires the Company to recognize in the consolidated financial statements 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.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation expense under the fair value recognition provisions of ASC 718, “Compensation-Stock Compensation” (“ASC 718”). ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.  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.  The Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model.  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 the fair market value of the stock at the dates of grant.

 

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. The Company has not recorded any breakage income related to its gift card program.

 

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Table of Contents

 

Cost of Sales

 

Cost of sales includes the cost of inventory, freight in, inter-state warehouse transportation costs, obsolescence, spoilage, scrap and inventory shrinkage, and is net of discounts and allowances.  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 in accordance with ASC 605-50-25, “Revenue Recognition-Customer Payments and Incentives-Recognition.”  In addition, the Company analyzes its inventory levels and the related cash discounts received to arrive at a value for cash discounts to be included in the inventory balance.  The Company does not include purchasing, receiving and distribution warehouse costs in its cost of sales. Due to this classification, the Company’s gross profit rates may not be comparable to those of other retailers that include costs related to their distribution network in cost of sales.

 

Operating Expenses

 

Selling, general and administrative expenses include purchasing, receiving, inspection and warehouse costs, the costs of selling merchandise in stores (payroll and associated costs, occupancy and other store-level costs), distribution costs (payroll and associated costs, occupancy, transportation to and from stores and other distribution-related costs) and corporate costs (payroll and associated costs, occupancy, advertising, professional fees and other corporate administrative 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.

 

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) in accordance with ASC 420, “Exit or Disposal Cost Obligations” (“ASC 420”).  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, as prescribed by ASC 420.  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 first half of fiscal 2013, the Company sold and leased back three stores and the resulting leases qualify and are accounted for as operating leases.  The net proceeds from the sale-leaseback transactions amounted to $5.3 million.  Gains of $0.4 million were deferred and are being amortized over the lease terms (12-15 years).

 

Self-Insured Workers’ Compensation Liability

 

The Company self-insures for workers’ compensation claims in California and Texas. The Company establishes a liability for losses of 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 September 29, 2012 and March 31, 2012.

 

Self-Insured Health Insurance Liability

 

During the second quarter of fiscal 2012, the Company began self-insuring for a portion of its employee medical benefit claims.  The liability for the self-funded portion of the Company health insurance program is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported. The Company maintains stop loss insurance coverage to limit its exposure for the self-funded portion of its health insurance program.

 

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Table of Contents

 

Pre-Opening Costs

 

The Company expenses, as incurred, all pre-opening costs related to the opening of new retail stores.

 

Advertising

 

The Company expenses advertising costs as incurred except the costs associated with television advertising, which are expensed the first time the advertising takes place.  Advertising expenses were $1.3 million and $1.4 million for the second quarter of fiscal 2013 and 2012, respectively.  Advertising expenses were $2.6 million and $2.7 million for the first half of fiscal 2013 and 2012, respectively.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist principally of cash, short-term marketable securities, accounts receivable, interest rate derivatives, accounts payable, accruals, debt, and other liabilities.  Cash, short-term marketable securities and interest rate 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.   See Note 9 for further discussion of the fair value of debt.

 

The Company complies with the provisions of ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”).  ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. ASC 820-10-35, “Subsequent Measurement” (“ASC 820-10-35”), clarifies that 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. ASC 820-10-35 also requires that a fair value measurement 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.  The Company also follows ASC 825, “Financial Instruments,” to expand required disclosures.

 

Comprehensive Income

 

ASC 220, “Comprehensive Income,” establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Accumulated other comprehensive income includes unrealized gains or losses on investments and interest rate derivatives designated as cash flow hedges.

 

2.                                      The Merger

 

As discussed in Note 1, the Merger was completed on January 13, 2012 and was financed by:

 

·                  Borrowings consisting of (i) a $175 million, 5-year asset-based revolving credit facility (as amended, the “ABL Facility”), of which $10 million was drawn at closing of the Merger and was fully repaid in February 2012 and (ii) a $525 million, 7-year term loan credit facility (as amended, the “First Lien Term Loan Facility” and, together with the ABL Facility, the “Credit Facilities”);

·                  Issuance of $250 million principal amount of 11% senior notes due 2019 (the “Senior Notes”); and

·                  Equity contributions of $635.9 million from the Sponsors and the Rollover Investors.

 

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The Merger was accounted for as a business combination in accordance with ASC 805 whereby the purchase price paid to effect the Merger was allocated to recognize the acquired assets and liabilities at fair value.  The Merger and the allocation of the purchase price of $1.6 billion have been recorded as of January 14, 2012.  The sources and uses of funds in connection with the Merger are summarized in the following table (in thousands):

 

Sources:

 

 

 

Proceeds from First Lien Term Loan Facility

 

$

525,000

 

Proceeds from Senior Notes

 

250,000

 

Proceeds from ABL Facility

 

10,000

 

Proceeds from equity contributions

 

535,900

 

Rollover equity from the Rollover Investors

 

100,000

 

Cash on hand

 

212,575

 

Total sources

 

$

1,633,475

 

 

 

 

 

Uses:

 

 

 

Equity purchase price

 

$

1,577,563

 

OID and other debt issuance costs

 

41,911

 

Cash to balance sheet

 

14,001

 

Total uses

 

$

1,633,475

 

 

Acquisition Accounting

 

In connection with the purchase price allocation, estimates of the fair values of long-lived and intangible assets have been determined based upon assumptions related to the future cash flows, discount rates and asset lives utilizing currently available information, and in some cases, preliminary valuation results from independent valuation specialists.  Purchase accounting adjustments have been recorded to: (i) increase the carrying value of property and equipment, (ii) establish intangible assets for trade names, vendor relations and favorable lease commitments, and (iii) revalue lease-related liabilities.

 

The allocation of purchase price was as follows (in thousands):

 

Purchase price

 

$

1,577,563

 

Less: net assets acquired

 

741,254

 

Preliminary excess of purchase price over book value of net assets acquired

 

$

836,309

 

 

 

 

 

Write up (down) of tangible assets:

 

 

 

Property and equipment

 

$

87,863

 

Land and buildings

 

63,549

 

Assets held for sale

 

(933

)

Deferred rent

 

(425

)

Leasing commission

 

(5,224

)

 

 

 

 

Acquisition-related intangible assets:

 

 

 

Trade name (indefinite life)

 

$

410,000

 

Trademarks (20 year life)

 

1,822

 

Bargain Wholesale customer relationships

 

20,000

 

Fair market value of favorable leases

 

46,723

 

Acquisition-related intangibles

 

478,545

 

 

 

 

 

Write down/(up) of liabilities:

 

 

 

Deferred rent and lease incentive revaluation

 

10,742

 

Fair market value of unfavorable leases

 

(19,836

)

 

 

 

 

Deferred income taxes:

 

 

 

Long-term deferred tax asset

 

$

(249,485

)

 

 

 

 

Residual goodwill (1)

 

$

471,513

 

Total allocated excess purchase price

 

$

836,309

 

 


(1)         The Company does not expect any of the residual goodwill to be tax deductible. Goodwill is considered to have an indefinite life and is not amortized, but rather reviewed annually for impairment or more frequently if indicators of impairment exist.

 

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Table of Contents

 

As a result of the Merger, the Company recognized one-time legal, financial advisory, accounting, and other merger related costs of $10.6 million for the period January 15, 2012 to March 31, 2012 and $15.2 million for the period April 3, 2011 to January 14, 2012.

 

3.                                      Goodwill and Other Intangibles

 

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 as of September 29, 2012 and March 31, 2012 (in thousands):

 

 

 

As of September 29, 2012

 

As of March 31, 2012

 

 

 

Amortization
Period
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Amortization
Period
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Indefinite lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

 

 

$

471,513

 

$

 

$

471,513

 

 

 

$

471,513

 

$

 

$

471,513

 

Trade name

 

 

 

410,000

 

 

410,000

 

 

 

410,000

 

 

410,000

 

Total indefinite lived intangible assets

 

 

 

$

881,513

 

$

 

$

881,513

 

 

 

$

881,513

 

$

 

$

881,513

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finite lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks

 

20

 

$

2,000

 

$

(71

)

$

1,929

 

20

 

$

2,000

 

$

(21

)

$

1,979

 

Bargain Wholesale customer relationships

 

12

 

20,000

 

(1,186

)

18,814

 

12

 

20,000

 

(353

)

19,647

 

Favorable leases

 

2 to 17

 

46,723

 

(3,069

)

43,654

 

2 to 17

 

46,723

 

(915

)

45,808

 

Total finite lived intangible assets

 

 

 

68,723

 

(4,326

)

64,397

 

 

 

68,723

 

(1,289

)

67,434

 

Total goodwill and other intangible assets

 

 

 

$

950,236

 

$

(4,326

)

$

945,910

 

 

 

$

950,236

 

$

(1,289

)

$

948,947

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trade name

 

 

 

$

410,000

 

$

 

$

410,000

 

 

 

$

410,000

 

$

 

$

410,000

 

Trademarks

 

 

 

2,000

 

(71

)

1,929

 

 

 

2,000

 

(21

)

1,979

 

Bargain Wholesale customer relationships

 

 

 

20,000

 

(1,186

)

18,814

 

 

 

20,000

 

(353

)

19,647

 

Favorable leases

 

 

 

46,723

 

(3,069

)

43,654

 

 

 

46,723

 

(915

)

45,808

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total intangible assets

 

 

 

$

478,723

 

$

(4,326

)

$

474,397

 

 

 

$

478,723

 

$

(1,289

)

$

477,434

 

 

 

 

As of September 29, 2012

 

As of March 31, 2012

 

 

 

Amortization

Period
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Amortization
Period
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unfavorable leases

 

2 to 18

 

$

19,835

 

$

(2,939

)

$

16,896

 

2 to 18

 

$

19,835

 

$

(876

)

$

18,959

 

 

4.                                      Property and Equipment, net

 

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

 

 

 

September 29, 2012

 

March 31, 2012

 

Land

 

$

157,353

 

$

156,137

 

Buildings

 

88,881

 

89,110

 

Buildings improvements

 

61,698

 

59,375

 

Leasehold improvements

 

97,815

 

92,909

 

Fixtures and equipment

 

65,662

 

54,659

 

Transportation equipment

 

6,998

 

6,489

 

Construction in progress

 

23,695

 

29,271

 

Total property and equipment

 

502,102

 

487,950

 

Less: accumulated depreciation and amortization

 

(39,028

)

(11,425

)

Property and equipment, net

 

$

463,074

 

$

476,525

 

 

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5.                                      Investments

 

The following tables summarize the investments in marketable securities (in thousands):

 

 

 

September 29, 2012

 

 

 

Cost or
Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

Available for sale:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

1

 

$

 

$

 

$

1

 

Auction rate securities

 

1,566

 

37

 

 

1,603

 

Total

 

$

1,567

 

$

37

 

$

 

$

1,604

 

 

 

 

 

 

 

 

 

 

 

Reported as:

 

 

 

 

 

 

 

 

 

Short-term investments

 

 

 

 

 

 

 

$

1,604

 

Long-term investments in marketable securities

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

$

1,604

 

 

 

 

March 31, 2012

 

 

 

Cost or
Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

Available for sale:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

1,627

 

$

 

$

 

$

1,627

 

Auction rate securities

 

1,965

 

39

 

 

2,004

 

Total

 

$

3,592

 

$

39

 

$

 

$

3,631

 

 

 

 

 

 

 

 

 

 

 

Reported as:

 

 

 

 

 

 

 

 

 

Short-term investments

 

 

 

 

 

 

 

$

3,631

 

Long-term investments in marketable securities

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

$

3,631

 

 

The auction rate securities the Company holds have historically been considered short-term debt instruments that provided liquidity through a Dutch auction process in which interest rates reset every 7 to 35 days.  Beginning in February 2008, auctions of the Company’s auction rate securities failed to sell all securities offered for sale.  Consequently, the principal associated with these failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuers redeem the securities, the issuers establish a different form of financing to replace these securities or final payments come due to long-term contractual maturities.  For each unsuccessful auction, the interest rate moves to a rate defined for each security.  Currently, the Company intends to liquidate its remaining auction rate securities within one year.  Accordingly, the Company has included $1.6 million and $2.0 million of its auction rate securities in current assets on the Company’s balance sheets as of September 29, 2012 and March 31, 2012, respectively.

 

The following table summarizes the maturities of marketable fixed-income securities classified as available for sale as of September 29, 2012 (in thousands):

 

 

 

September 29, 2012

 

 

 

Amortized
Cost

 

Estimated Fair
Value

 

Due within one year

 

$

1,566

 

$

1,603

 

 

 

$

1,566

 

$

1,603

 

 

There was no realized gain or losses from the sale of marketable securities for the second quarter of fiscal 2013 and there were less than $0.1 million realized losses from the sale of marketable securities for the first half of fiscal 2013.  Realized gains from the sale of marketable securities for the second quarter and the first half of fiscal 2012 were less than $0.1 million.  There were no impairment charges related to credit losses in the second quarter and the first half of fiscal 2013.  The Company recorded an impairment charge related to credit losses on its auction rate securities of less than $0.1 million during the second quarter and first half of fiscal 2012.

 

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Proceeds from the sales of marketable securities were $1.1 million and $2.5 million for the second quarter and first half of fiscal 2013, respectively.  Proceeds from the sales of marketable securities were $2.3 million and $48.2 million for the second quarter and first half of fiscal 2012, respectively.

 

The Company did not have any available-for-sale securities with unrealized losses as of September 29, 2012 and March 31, 2012.

 

During the second quarter and first half of fiscal 2013, the Company did not have any non-credit related other-than-temporary losses on any of its securities.  Accordingly, the Company’s other comprehensive income does not include any charges related to the other-than-temporary non-credit portion of its securities.

 

6.                                      Comprehensive Income

 

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

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

September 29,
 2012

 

 

October 1,
2011

 

September 29,
 2012

 

 

October 1,
2011

 

 

 

(Successor)

 

 

(Predecessor)

 

(Successor)

 

 

(Predecessor)

 

Net income (loss)

 

$

210

 

 

$

15,114

 

$

(4,681

)

 

$

32,797

 

Unrealized holding gains (losses) on marketable securities, net of tax effects of $3, $(94), $3 and $(92) for the second quarter and first half of fiscal 2013 and 2012, respectively

 

4

 

 

(142

)

4

 

 

(138

)

Unrealized losses on interest rate cash flow hedge, net of tax effects of $(315), $0, $(678) and $0 for the second quarter and first half of fiscal 2013 and 2012, respectively

 

(473

)

 

 

(1,017

)

 

 

Reclassification adjustment, net of tax effects of $0, $5, $(3) and $(12) for the second quarter and first half of fiscal 2013 and 2012, respectively

 

 

 

7

 

(5

)

 

(18

)

 

 

 

 

 

 

 

 

 

 

 

 

Total unrealized losses, net

 

(469

)

 

(135

)

(1,018

)

 

(156

)

Total comprehensive (loss) income

 

$

(259

)

 

$

14,979

 

$

(5,699

)

 

$

32,641

 

 

7.                                      Debt

 

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

 

 

 

September 29,
2012

 

March 31,
2012

 

 

 

 

 

 

 

ABL Facility agreement, maturing January 13, 2017, with available borrowing up to $175,000, interest due quarterly, with unpaid principal and accrued interest due January 13, 2017

 

$

 

$

 

First Lien Term Loan Facility agreement, maturing on January 13, 2019, payable in quarterly installments of $1,309, plus interest, commencing March 31, 2012 through December 31, 2019, with unpaid principal and accrued interest due January 13, 2019, net of unamortized OID of $10,876 and $10,086 as of September 29, 2012 and March 31, 2012, respectively

 

510,193

 

513,601

 

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

 

250,000

 

250,000

 

 

 

 

 

 

 

Total long-term debt

 

760,193

 

763,601

 

Less: current portion of long-term debt

 

5,237

 

5,250

 

Long-term debt, net of current portion

 

$

754,956

 

$

758,351

 

 

As of September 29, 2012 and March 31, 2012, the deferred financing costs are as follows (in thousands):

 

 

 

September 29, 2012

 

March 31, 2012

 

Deferred financing costs

 

Gross Carrying
Amount

 

Accumulated Amortization

 

Net
Amount

 

Gross Carrying Amount

 

Accumulated Amortization

 

Net
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ABL Facility

 

$

3,078

 

$

(438

)

$

2,640

 

$

3,078

 

$

(130

)

$

2,948

 

First Lien Term Loan Facility

 

9,308

 

(577

)

8,731

 

16,572

 

(653

)

15,919

 

Senior Notes

 

11,761

 

(697

)

11,064

 

11,761

 

(228

)

11,533

 

Total deferred financing costs

 

$

24,147

 

$

(1,712

)

$

22,435

 

$

31,411

 

$

(1,011

)

$

30,400

 

 

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On January 13, 2012, in connection with the Merger, the Company 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 (a) $175 million in commitments under the ABL Facility, and (b) an aggregate principal amount under the First Lien Term Loan Facility of $525 million.

 

First Lien Term Loan Facility

 

The First Lien Term Loan Facility provides for $525 million of borrowings (which may be increased by up to $150.0 million in certain circumstances).  All obligations under the First Lien Term Loan Facility are guaranteed by Parent and the Company’s direct wholly owned subsidiary (together, the “Credit Facilities Guarantors”).  In addition, the First Lien Term Loan Facility is secured by pledges of certain of the Company’s equity interests and the equity interests of the Credit Facilities Guarantors.

 

The Company is required to make scheduled quarterly payments each equal to 0.25% of the original principal amount of the term loan (approximately $1.3 million), with the balance due on the maturity date, January 13, 2019.  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, (A) a Base Rate determined by reference to the highest of (a) the interest rate in effect determined by the administrative agent as “Prime Rate” (3.25% as of September 29, 2012), (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 multiplied by the Statutory Reserve Rate or 1.50% per annum) plus 1.00%, or (B) an Adjusted Eurocurrency Rate.  The applicable margin used is 5.50% for Eurocurrency loans and 4.50% for base rate loans.

 

On April 4, 2012, the Company amended the terms of the existing seven-year $525 million First Lien Term Loan Facility, and paid refinancing costs of $11.2 million. The amendment, among other things, decreased the applicable margin from the London Interbank Offered Rate (“LIBOR”) plus 5.50% (or base rate plus 4.50%) to LIBOR plus 4.00% (or base rate plus 3.00%) and decreased the LIBOR floor from 1.50% to 1.25%.  The maximum capital expenditures covenant in the First Lien Term Loan Facility was also amended to permit an additional $5 million in capital expenditures each year throughout the term of the First Lien Term Loan Facility.

 

The Company evaluated the proper accounting treatment for the amendment.  Specifically, the Company evaluated the position of each lender under both the original First Lien Term Loan Facility and the amended First Lien Term Loan Facility. The Company determined that a portion of the refinancing transaction should be accounted for as debt extinguishment, representing the outstanding principal amount of loans held by lenders under the original First Lien Term Loan Facility that were not lenders under the amended First Lien Term Loan Facility. In accordance with applicable guidance for debt modification and extinguishment, the Company recognized $16.3 million loss on debt extinguishment related to a portion of the unamortized debt issuance costs, unamortized original issue discount (“OID”) and refinancing costs incurred in connection with the amendment for the portion of the First Lien Term Loan Facility that was extinguished.

 

The $16.3 million loss on debt extinguishment was recorded in first quarter ended June 30, 2012 (the “first quarter of fiscal 2013”) and is summarized below (in thousands):

 

First Lien Term Loan Facility unamortized deferred financing costs 

 

$

6,950

 

First Lien Term Loan Facility unamortized OID

 

4,403

 

Fees incurred in connection with the amendment

 

4,993

 

 

 

 

 

Total loss on extinguishment

 

$

16,346

 

 

The Company recorded $0.3 million as deferred debt issuance costs and $5.9 million as OID in connection with the amendment.

 

As of September 29, 2012, the interest rate charged on the First Lien Term Loan Facility was 5.25% (1.25% Eurocurrency rate, plus the Eurocurrency loan margin of 4.00%).  As of September 29, 2012, the amount outstanding under the First Lien Term Loan Facility was $510.2 million.

 

The First Lien Term Loan Facility includes restrictions on the Company’s ability and the ability of Parent and certain of the Company’s subsidiaries to, incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, the Company’s capital stock, make certain acquisitions or investments, materially change the Company’s business, incur or permit to exist certain liens, enter into transactions with affiliates or sell our assets to, make capital expenditures or merge or consolidate with or into, another company.  As of September 29, 2012, the Company was in compliance with the terms of the First Lien Term Loan Facility.

 

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Table of Contents

 

During the first quarter of fiscal 2013, the Company entered into an interest rate swap agreement to limit the variability of cash flows associated with interest payments on the First Lien Term Loan Facility that result from fluctuations in the LIBOR rate.  The swap limits the Company’s interest exposure on a notional value of $261.8 million to 1.36% plus an applicable margin of 4.00%.  The term of the swap is from November 29, 2013 through May 31, 2016.  The fair value of the swap on the trade date was zero as the Company neither paid nor received any value to enter into the swap, which was entered into at market rates.  The fair value of the swap at September 29, 2012 was a liability of $2.3 million.  See Note 8 for more information on the Company’s interest rate cap and interest rate swap agreements.

 

In addition, during the first quarter of fiscal 2013, the Company entered into an interest rate cap agreement.  The interest rate cap agreement limits the Company’s interest exposure on a notional value of $261.8 million to 3.00% plus an applicable margin of 4.00%.  The term of the interest rate cap is from May 29, 2012 to November 29, 2013.   The Company paid fees of $0.05 million to enter into the interest rate cap agreement.

 

ABL Facility

 

The ABL Facility provides for up to $175.0 million of borrowings (which may be increased by up to $50.0 million in certain circumstances), subject to certain borrowing base limitations.  All obligations under the ABL Facility are guaranteed by the Company, its immediate Parent and the Company’s direct wholly owned subsidiary (together, the “ABL Guarantors”).   The ABL Facility is secured by substantially all of the Company’s assets and the assets of the ABL Guarantors.

 

Borrowings under the ABL Facility bear interest for an initial period until June 30, 2012 at an applicable margin plus, at the Company’s option, a fluctuating rate equal to (A) the highest of (a) the Federal Funds Rate plus 0.50%, (b) the interest rate in effect determined by the administrative agent as “Prime Rate” (3.25% at the date of the Merger), and (c) Adjusted Eurocurrency Rate (determined to be the LIBOR rate multiplied by the Statutory Reserve Rate) for an Interest Period of one (1) month plus 1.00% or (B) the Adjusted Eurocurrency Rate.  The interest rate charged on borrowings under the ABL Facility from the date of the Merger until June 30, 2012 was 4.25% (the base rate (prime rate at 3.25%) plus the applicable margin of 1.00%). Thereafter, borrowings under the ABL Facility will have variable pricing and will be based, at the Company’s option, on (a) LIBOR plus an applicable margin to be determined (1.75% as of September 29, 2012) or (b) the determined base rate (prime rate) plus an applicable margin to be determined (0.75% at September 29, 2012), in each case based on a pricing grid depending on average daily excess availability for the most recently ended quarter.

 

In addition to paying interest on outstanding principal under the Credit Facilities, the Company was required to pay a commitment fee to the lenders under the ABL Facility on unutilized commitments at a rate of 0.375% for the period from the date of the Merger until June 30, 2012. Thereafter, the commitment fee will be adjusted at the beginning of each quarter based upon the average historical excess availability of the prior quarter (0.50% for the quarter ended September 29, 2012). The Company must also pay customary letter of credit fees and agency fees.

 

As of September 29, 2012 and March 31, 2012, the Company had no outstanding borrowings under the ABL Facility, and availability under the ABL Facility, subject to the borrowing base was $159.7 million at September 29, 2012.

 

The ABL Facility includes restrictions on the Company’s ability, and the ability of the Parent and certain of the Company’s subsidiaries to, incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, our capital stock, make certain acquisitions or investments, materially change our business, incur or permit to exist certain liens, enter into transactions with affiliates or sell our assets to, make capital expenditures or merge or consolidate with or into, another company.  The ABL Facility was amended on April 4, 2012 to permit an additional $5 million in capital expenditures for each year during the term of the ABL Facility.  As of September 29, 2012, the Company was in compliance with the terms of the ABL Facility.

 

Senior Notes

 

On December 29, 2011, the Company issued $250 million of Senior Notes.  At March 31, 2012, the Senior Notes were guaranteed by each of the Company’s direct wholly owned subsidiaries, 99 Cents Only Stores Texas, Inc. and 99 Cents Only Stores (Nevada).  In September 2012, 99 Cents Only Stores (Nevada) corporation, an inactive wholly owned subsidiary of the Company, was dissolved.  As of September 29, 2012, the Senior Notes are guaranteed by, 99 Cents Only Stores Texas, Inc. (the “Senior Notes Guarantor”).

 

In connection with the issuance of the Senior Notes, the Company entered into a registration rights agreement that requires the Company’s to file an exchange offer registration statement, enabling holders to exchange the Senior Notes for registered notes with terms identical in all material respects to the terms of the Senior Notes, except the registered notes would be freely tradable.  The exchange offer was commenced on October 9, 2012 and closed on November 7, 2012.

 

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Table of Contents

 

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 applicable based on the date of redemption.

 

The Senior Notes are (i) equal in right of payment to all of the Company’s existing and future senior indebtedness and that of the Senior Notes Guarantor; (ii) unconditionally guaranteed on a senior unsecured unsubordinated basis by the Senior Notes Guarantor; and (iii) junior to the liabilities of its subsidiaries that are not guarantors. 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, incur restrictions on the payment of dividends or other distributions from its restricted subsidiaries, make certain investments, transfer or sell assets, engage in transactions with affiliates, or merge or consolidate with other companies or transfer all or substantially all of its assets.

 

As of September 29, 2012, the Company was in compliance with the terms of the Indenture.

 

Interest paid for the second quarter of fiscal 2013 and 2012, was $6.6 million and less than $0.1 million, respectively.  Interest paid for the first half of fiscal 2013 and 2012, was $26.1 million and less than $0.1 million, respectively.

 

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Table of Contents

 

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

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

September 29,
 2012

 

 

October 1,
 2011

 

September 29,
2012

 

 

October 1,
2011

 

 

 

(Successor)

 

 

(Predecessor)

 

(Successor)

 

 

(Predecessor)

 

First Lien Term Loan Facility

 

$

6,932

 

 

$

 

$

14,111

 

 

$

 

ABL Facility

 

221

 

 

 

383

 

 

 

Senior Notes

 

6,951

 

 

 

13,903

 

 

 

Amortization of deferred financing costs and OID

 

1,059

 

 

 

2,059

 

 

 

Other interest expense

 

374

 

 

34

 

658

 

 

335

 

Interest expense

 

$

15,537

 

 

$

34

 

$

31,114

 

 

$

335

 

 

8.                                      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 Cap

 

In May 2012, the Company entered into an interest rate cap agreement for an aggregate notional amount of $261.8 million in order to hedge the variability of cash flows related to a portion of the Company’s floating rate indebtedness. The cap agreement, effective in May 2012, hedges a portion of contractual floating rate interest commitments through the expiration of the agreement in November 2013. Pursuant to the agreement, the Company has capped LIBOR at 3.00% plus an applicable margin of 4.00% with respect to the aggregate notional amount of $261.8 million. In the event LIBOR exceeds 3.00% the Company will pay interest at the capped rate. In the event LIBOR is less than 3.00%, the Company will pay interest at the prevailing LIBOR rate. In the first half of fiscal 2013, the Company paid interest at the prevailing LIBOR rate.

 

The interest rate cap agreement has not been designated as a hedge for financial reporting purposes. Gains and losses on derivative instruments not designated as hedges are recorded directly in earnings.

 

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 agreements expires. The swap agreement, effective November 2013, will hedge a portion of contractual floating rate interest commitments through the expiration of the agreements in May 2016. As a result of the agreement, the Company’s effective fixed interest rate on the notional amount of floating rate indebtedness will be 1.36% plus an applicable margin of 4.00%.

 

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

 

Fair Value

 

The fair values of the interest rate cap and swap agreements are estimated using industry standard valuation models using market-based observable inputs, including interest rate curves (level 2). A summary of the recorded amounts included in the consolidated balance sheet is as follows (in thousands):

 

 

 

September 29,
2012

 

March 31,
2012

 

 

 

 

 

 

 

Derivatives designated as cash flow hedging instruments

 

 

 

 

 

Interest rate swap (included in other liabilities)

 

$

2,337

 

$

 

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

 

$

1,017

 

$

 

Derivatives not designated as hedging instruments

 

 

 

 

 

Interest rate cap (included in other current assets)

 

$

27

 

$

 

 

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Table of Contents

 

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

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

 

 

September 29,
 2012

 

 

October 1,
 2011

 

September 29,
2012

 

 

October 1,
2011

 

 

 

(Successor)

 

 

(Predecessor)

 

(Successor)

 

 

(Predecessor)

 

Derivatives designated as cash flow hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

Loss related to effective portion of derivative recognized in OCI

 

$

473

 

 

$

 

$

1,017

 

 

$

 

Loss related to ineffective portion of derivative recognized in interest expense

 

$

366

 

 

$

 

$

642

 

 

$

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

Loss recognized in other expense

 

$

3

 

 

$

 

$

23

 

 

$

 

 

9.                                      Fair Value of Financial Instruments

 

The Company complies with ASC 820-10-35, “Fair Value Measurement and Disclosures,” which establishes 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 under ASC 820-10-35 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 utilizes 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 as of September 29, 2012 (in thousands):

 

 

 

September 29, 2012

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Money market funds

 

$

1

 

$

1

 

$

 

$

 

Auction rate securities

 

1,603

 

 

 

1,603

 

 

 

 

 

 

 

 

 

 

 

Total available-for-sale securities

 

$

1,604

 

$

1

 

$

 

$

1,603

 

Other current assets — interest rate cap

 

$

27

 

$

 

$

27

 

$

 

Other assets — assets that fund deferred compensation

 

$

5,195

 

$

5,195

 

$

 

$

 

LIABILITES

 

 

 

 

 

 

 

 

 

Other long-term liabilities — interest rate swap

 

$

2,337

 

$

 

$

2,337

 

$

 

Other long-term liabilities — deferred compensation

 

$

5,195

 

$

5,195

 

$

 

$

 

 

Level 1 investments include money market funds.  The fair value of money market funds is based on quoted market prices in an active market and there are no restrictions on the redemption of money market funds.  Level 1 also includes $5.2 million of deferred compensation assets that fund the liabilities related to the Company’s deferred compensation, including investments in trust funds.  The fair values of these funds are based on quoted market prices in an active market.

 

Level 2 measurements include interest rate cap and swap agreements that are estimated using industry standard valuation models using market-based observable inputs, including interest rate curves.

 

Level 3 investments include auction rate securities of $1.6 million.  The valuation of the auction rate securities is based on Level 3 unobservable inputs which consist of recommended fair values provided by Houlihan Capital Advisors, LLC, an independent securities valuation firm.

 

The Company did not have any transfers of investments in and out of Levels 1 and 2 during the second quarter and the first half of fiscal 2013.

 

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Table of Contents

 

The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis as of March 31, 2012 (in thousands):

 

 

 

March 31, 2012

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

ASSETS

 

 

 

 

 

 

 

 

 

Money market funds

 

$

1,627

 

$

1,627

 

$

 

$

 

Auction rate securities

 

2,004

 

 

 

2,004

 

 

 

 

 

 

 

 

 

 

 

Total available-for-sale securities

 

$

3,631

 

$

1,627

 

$

 

$

2,004

 

Other assets — assets that fund deferred compensation

 

$

5,136

 

$

5,136

 

$

 

$

 

LIABILITES

 

 

 

 

 

 

 

 

 

Other long-term liabilities — deferred compensation

 

$

5,136

 

$

5,136

 

$

 

$

 

 

Level 1 investments include money market funds of $1.6 million.  The fair value of money market funds is based on quoted market prices in an active market and there are no restrictions on the redemption of money market funds.  Level 1 also includes $5.1 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 investments as of March 31, 2012.

 

Level 3 investments include auction rate securities of $2.0 million.  The valuation of the auction rate securities is based on Level 3 unobservable inputs which consist of recommended fair values provided by Houlihan Capital Advisors, LLC, an independent securities valuation firm.

 

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

 

Auction Rate Securities

 

 

 

Fair Value Measurements Using Significant Unobservable Inputs
 (Level 3)

 

 

 

For the Second Quarter Ended

 

For the First Half Ended

 

Description

 

September 29, 2012

 

 

October 1, 2011

 

September 29, 2012

 

 

October 1, 2011

 

 

 

(Successor)

 

 

(Predecessor)

 

(Successor)

 

 

(Predecessor)

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

1,622

 

 

$

8,057

 

$

2,004

 

 

$

8,409

 

Transfers into Level 3

 

 

 

 

 

 

 

Total realized/unrealized gains (loss):

 

 

 

 

 

 

 

 

 

 

 

Included in earnings

 

 

 

(12

)

(44

)

 

3

 

Included in other comprehensive loss

 

7

 

 

39

 

(1

)

 

24

 

Purchases, redemptions and settlements:

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 

 

 

 

 

Redemptions

 

(26

)

 

(399

)

(356

)

 

(751

)

Ending balance

 

$

1,603

 

 

$

7,685

 

$

1,603

 

 

$

7,685

 

 

 

 

 

 

 

 

 

 

 

 

 

Total amount of unrealized gains (losses) for the period included in other comprehensive loss attributable to the change in fair market value relating to assets still held at the reporting date

 

$

7

 

 

$

39

 

$

7

 

 

$

24

 

 

In connection with the Merger, the Company entered into the Credit Facilities, including the ABL Facility of $175 million and the First Lien Term Loan Facility of $525 million, and also issued $250 million of the Senior Notes with a coupon rate of 11% in a private placement. The outstanding debt under the Credit Facilities and the Senior Notes is recorded in the financial statements at historical cost, net of applicable unamortized discounts.

 

The Credit Facilities are tied directly to market rates and fluctuate as market rates change; as a result, the carrying value of the Credit Facilities approximates fair value as of September 29, 2012.

 

The Senior Notes are not tied to market rates and were sold in a private placement. Since there are no quoted prices in active markets, the fair value of the Senior Notes was estimated using a discounted cash flow analysis with Level 3 inputs. The fair value of the Senior Notes was estimated at $256.6 million, or $6.6 million greater than the carrying value, as of September 29, 2012.  The fair value of the Senior Notes was estimated at $259.3 million, or $9.3 million greater than the carrying value, as of March 31, 2012.

 

See Note 7 for more information on the Company’s debt.

 

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Table of Contents

 

10.                               Stock-Based Compensation

 

Successor stock-based compensation

 

Number Holdings, Inc. 2012 Equity Incentive Plan

 

On February 27, 2012, the board of directors of Parent adopted the Number Holdings, Inc. 2012 Stock Incentive Plan (the “2012 Plan”), which authorizes equity awards to be granted for up to 74,603 shares of Class A common stock, par value $0.001 per share, of  Parent (the “Class A Common Stock”) and 74,603 shares of Class B common stock, par value $0.001 per share, of  Parent (the “Class B Common Stock”), of which, as of September 29, 2012, options for 52,680 shares of each Class were issued to certain members of management with an aggregate exercise price of $1,000 for one share of Class A Common Stock and for one share of Class B Common Stock, together.  Options become exercisable over the five year service period and have terms of ten years from date of the grant.  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.

 

Accounting for stock-based compensation

 

The fair value of the option awards is recognized as compensation expense on a straight line basis over the requisite service period of the award, and is included in operating expense.  Determining the fair value of options at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise and the associated volatility.  At the grant date, the Company estimates an amount of forfeitures that will occur prior to vesting.  During the second quarter and the first half of fiscal 2013, the Company incurred stock-based compensation expense of $0.8 million and $1.6 million, respectively.

 

The fair value of stock options was estimated at the date of grant using the Black-Scholes pricing model with the following assumptions:

 

 

 

For the First Half Ended 
September 29, 2012

 

 

 

 

 

Weighted-average fair value of options granted

 

$

374.29

 

Risk free interest rate

 

0.72

%

Expected life (in years)

 

6.32

 

Expected stock price volatility

 

37.9

%

Expected dividend yield

 

None

 

 

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 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.

 

As of September 29, 2012, there was $14.7 million of total unrecognized compensation cost related to non-vested options that is expected to be recognized over the remaining weighted-average vesting period of 4.3 years.  No options were vested or exercised during the Successor period.

 

The following summarizes stock option activity in the first half of fiscal 2013:

 

 

 

Number of 
Shares

 

Weighted Average
 Exercise Price

 

Weighted Average
Remaining
Contractual Life 
(Years)

 

Options outstanding at the beginning of the period

 

50,905

 

$

1,000

 

 

 

Granted

 

2,295

 

$

1,000

 

 

 

Exercised

 

 

$

 

 

 

Cancelled

 

(520

)

$

1,000

 

 

 

 

 

 

 

 

 

 

 

Outstanding at the end of the period

 

52,680

 

$

1,000

 

9.50

 

 

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The following table summarizes the stock awards available for grant under the 2012 Plan:

 

 

 

Number of Shares

 

Available for grant as of March 31, 2012

 

23,698

 

Authorized

 

 

Granted

 

(2,295

)

Cancelled

 

520

 

Available for grant at September 29, 2012

 

21,923

 

 

Predecessor Stock-Based Compensation

 

Prior to the Merger, the Company maintained the 99¢ Only Stores 2010 Equity Incentive Plan and the 1996 Equity Incentive Plan, as amended, which provided for the grant of options, performance stock units (“PSUs”) and other stock-based awards.  All outstanding stock-based awards outstanding prior to the Merger became fully vested in connection with the Merger. For the second quarter and the first half of fiscal 2012, the Company incurred non-cash stock-based compensation expense related to Predecessor stock options, PSUs and restricted stock units of $0.6 million and $1.3 million, respectively.

 

11.                               Related-Party Transactions

 

See Note 8 to the Company’s audited financial statements included in the Registration Statement for a description of the Company’s related-party transactions.

 

12.                               Income Taxes

 

The effective income tax rate for the first half of 2013 was (35.5)% compared to a rate of 38.0% for the first half of fiscal 2012.  The decrease in the effective tax rate is primarily due to lower pretax income.

 

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 2007 through 2010.  The tax return for the period ended March 27, 2010 was chosen for examination by Internal Revenue Service.  The Internal Revenue Service has completed its examination and has made no changes to the reported tax.

 

13.                               Commitments and Contingencies

 

Credit Facilities

 

The Company’s credit facilities and commitments are discussed in detail in Note 7.

 

As of September 29, 2012, the Company also had a standby letter of credit for $0.4 million related to one of its leased properties, where the lessor is a named beneficiary in the event of a default by the Company, and potentially is entitled to draw on the letter of credit in the event of a specified default.  The letter of credit expired in October 2012.  The Company is in compliance with its lease terms and scheduled payments.

 

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.

 

At September 29, 2012 and March 31, 2012, the Company had recorded a liability $37.8 million and $39.0 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 September 29, 2012 and March 31, 2012 for workers’ compensation claims in Texas.  The Company purchases workers’ compensation insurance coverage in Arizona and Nevada.

 

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Self-Insured Health Insurance Liability

 

During the second quarter of fiscal 2012, the Company began self-insuring for a portion of its employee medical benefit claims.  At September 29, 2012 and March 31, 2012, the Company had recorded a liability of $0.7 million and $0.9 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.

 

Legal Matters

 

Pricing Policy Matters

 

In July 2010, two actions captioned Phillip Kavis v. 99¢ Only Stores, et al. and Leonard Morales v. 99¢ Only Stores were filed in the Superior Court of California, Los Angeles County.  In these now consolidated actions, Plaintiffs filed putative class action complaints against the Company claiming violations of California’s Unfair Competition Law (California Business & Professions Code Section 17200), False Advertising Law (California Business & Professions Code Section 17500), and Consumer Legal Remedies Act (California Civil Code Section 1770), as well as alleged intentional misrepresentation, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, and unjust enrichment, arising out of the Company’s September 2008 change in pricing policy.  Plaintiffs sought actual damages, restitution, including disgorgement of all profits and unjust enrichment allegedly obtained by the Company, statutory damages and civil penalties, equitable and injunctive relief, exemplary damages, prejudgment and post-judgment interest, and their attorney’s fees and costs.

 

On May 11, 2012, the Court granted final approval of a settlement between the plaintiffs in these actions and the Company and entered judgment in accordance with the terms of the settlement.  The settlement requires the Company to make certain postings in its stores and pay a total of $100,000 in attorneys’ fees, costs and plaintiff enhancements in exchange for a judgment extinguishing the claims relating to the revised pricing structure by all its customers in all states of operation from September 8, 2008 through the date of judgment.  The settlement has become effective with no appeal, and the Company has made the required payments and implemented the required measures.

 

Wage and Hour Matters

 

Luis Palencia v. 99¢ Only Stores, Superior Court of the State of California, County of Sacramento.   Plaintiff, a former assistant manager, who the Company employed from June 12, 2009 through September 9, 2009, filed this action in June 2010, asserting claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged unpaid overtime due to “off the clock” work, failure to pay minimum wage, failure to provide meal and rest periods, failure to provide proper wage statements, failure to pay wages timely during employment and upon termination and failure to reimburse business expenses.  Mr. Palencia also asserted a derivative claim for unfair competition under the California Business and Professions Code.  Mr. Palencia sought to represent three sub-classes: (i) an “unpaid wages subclass” of all non-exempt or hourly paid employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification, (ii) a “non-compliant wage statement subclass” of all non-exempt or hourly paid employees of the Company who worked in California and received a wage statement within one year prior to the filing of the complaint until the date of certification, and (iii) an “unreimbursed business expenses subclass” of all employees of the Company who paid for business-related expenses, including expenses for travel, mileage or cell phones in California within four years prior to the filing of the complaint until the date of certification.  Plaintiff sought to recover alleged unpaid wages, interest, attorney’s fees and costs, declaratory relief, restitution, statutory penalties and liquidated damages.  He also sought to recover civil penalties as an “aggrieved employee” under the Private Attorneys General Act of 2004.  Following a mediation of this matter, the parties entered into a settlement agreement on November 2, 2011.  The Court granted preliminary approval of the settlement on April 20, 2012, and a final fairness hearing was set for September 14, 2012.  The Company accrued $2.2 million in the period from April 3, 2011 to January 14, 2012 for expected payments in connection with the settlement.  The settlement agreement was granted final approval by the court on September 14, 2012, and judgment was entered on October 11, 2012.

 

Sheridan Reed v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles.   Plaintiff, a former store manager for the Company, filed this action in April 2010.  He originally asserted claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged failure to pay overtime at the proper rate, failure to pay vested vacation wages, failure to pay wages timely upon termination of employment and failure to provide accurate wage statements.  Mr. Reed also asserted a derivative claim for unfair competition under the California Business and Professions Code.  In September 2010, Mr. Reed amended his complaint to seek civil penalties under the Private Attorneys General Act of 2004.  Mr. Reed sought to represent four sub-classes: (i) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were paid bonuses, commissions or incentive wages, who worked overtime, and for whom the bonuses, commissions or incentive wages were not included as part of the regular rate of pay for overtime purposes, (ii) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who earned vacation wages and were not paid their vested vacation

 

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wages at the time of termination; (iii) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were not furnished a proper itemized wage statement; and (iv) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were not paid all wages due upon termination.  Plaintiff sought to recover alleged unpaid wages, statutory penalties, interest, attorney’s fees and costs, declaratory relief, injunctive relief and restitution.  He also sought to recover civil penalties as an “aggrieved employee” under the Private Attorneys General Act of 2004.  The parties executed a formal settlement agreement on April 5, 2012, which, if approved by the Court, will resolve the remainder of the lawsuit by settling the class-wide claims for failure to pay overtime at the proper rate, failure to pay wages timely upon termination of employment and failure to provide accurate wage statements.  In addition, the settlement will resolve Plaintiff’s individual claim for failure to pay vested vacation wages and includes a general release by Plaintiff in the Company’s favor.  The Company has accrued approximately $0.6 million for expected payments in connection with this settlement.  The Court granted preliminary approval of the settlement on July 16, 2012, and a final fairness hearing was held on October 25, 2012.  If the settlement agreement is not finally approved by the court, the Company cannot predict the outcome of this lawsuit.

 

Thomas Allen v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles.  Plaintiff, a former store manager for the Company, filed this action on March 18, 2011. He asserted claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged failure to pay overtime, failure to provide meal and rest periods, failure to pay wages timely upon termination, and failure to provide accurate wage statements.  Mr. Allen also asserted a derivative claim for unfair competition under the California Business and Professions Code.  Mr. Allen seeks to represent a class of all employees who were employed by the Company as salaried managers in 99¢ Only retail stores from March 18, 2007 through the date of trial or settlement.  Plaintiff seeks to recover alleged unpaid wages, statutory penalties, interest, attorney’s fees and costs, declaratory relief, injunctive relief and restitution.  On October 17, 2011, the Court heard the Company’s motion to compel Plaintiff Allen to arbitrate his claims on an individual basis, and following the hearing, the Court ordered the parties to submit further briefing and argument.  Following this supplemental briefing and while the motion was under advisement, Mr. Allen sought leave to amend his complaint to add a cause of action pursuant to the Private Attorneys General Act of 2004 (“PAGA”).  The Company did not oppose this motion and on January 5, 2012, the Court granted Mr. Allen’s motion and his First Amended Complaint was filed.  On February 27, 2012, the Court denied the Company’s motion to compel arbitration.  The Company filed a notice of its intention to appeal that ruling on April 12, 2012.  Following a mediation of this matter on August 30, 2012, the parties entered into a “term sheet” settlement agreement for a minimal amount, which is subject to court approval. If the settlement agreement is not approved by the court, the Company cannot predict the outcome of this lawsuit.

 

Shelley Pickett v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles.  Plaintiff Shelley Pickett filed a representative action complaint against the Company on November 4, 2011, alleging a PAGA claim virtually identical that of another matter which was dismissed with prejudice in December 2011, Bright v. 99¢ Only Stores. Like the plaintiff in the Bright case, Plaintiff Pickett asserts that the Company violated section 14 of Wage Order 7-2001 by failing to provide seats for its cashiers behind checkout counters. She seeks civil penalties of $100 to $200 per violation, per each pay period for each affected employee, and attorney’s fees.  On November 8, 2011, Plaintiff Pickett filed a Notice of Related Case, stating that her case and the Bright case assert “identical claims.” After hearing arguments from the parties on December 1, 2011, the Court determined that the cases were related and assigned Pickett’s case to Judge William Fahey, the judge who presided over the Bright case.  Plaintiff Pickett then attempted to exercise a 170.6 challenge to Judge Fahey, which the Company opposed. The Court struck Plaintiff Pickett’s 170.6 challenge on December 16, 2011. Plaintiff Pickett appealed this ruling, filing a petition for writ of mandate on December 30, 2011. The Company filed an opposition to Plaintiff Pickett’s petition and oral argument took place on February 1, 2012.  On February 22, 2012, the Court of Appeal ruled in Plaintiff Pickett’s favor and issued the writ of mandate.  On April 2, 2012, the Company filed a petition for review of that ruling with the California Supreme Court, which Pickett answered on April 23, 2012.  The California Supreme Court denied the Company’s petition for review on May 9, 2012 and the Court of Appeals has remanded the case to Los Angeles Superior Court.  On October 2, 2012, the Company filed a motion to compel arbitration of Pickett’s individual claims or, in the alternative, to strike the representative action allegations in the Complaint.  The motion is expected to be heard on November 15, 2012, and a case management conference has been set for that date. The Company cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.

 

Regulatory Matters

 

The Company recently received Notices to Comply with hazardous waste and/or hazardous materials storage requirements for certain of its stores and its distribution centers in Southern California.  The agencies that have delivered such notices to the Company include the Los Angeles County Fire Department, Health Hazardous Materials Division, the Ventura County Environmental Health Division, the Santa Barbara County Fire Department and the City of Oxnard.  The Notices concern alleged non-compliance with a variety of hazardous waste and hazardous material regulatory requirements imposed under California law identified during recent compliance inspections and require corrective actions to be taken by certain dates set forth in the Notices.  The Company is working to implement the required corrective actions.  Although the agencies can also seek civil penalties for the alleged instances of past non-compliance, even after corrective action is taken, no penalties have been demanded for any of the alleged non-compliance.  If penalties are demanded by these agencies in the future, the Company cannot predict the amount of penalties that may be sought.

 

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

 

14.                               Texas Market

 

As a result of the Company’s decision in September 2008 to close its Texas operations, which was later suspended and, in August 2009, reversed, the Company closed 16 of its Texas stores starting from the fourth quarter of fiscal 2009 through the second quarter of fiscal 2010.  As described in prior Company filings, the Company had recorded impairment charges as well as lease termination costs related to closing some of these stores.  As of March 31, 2012, the Company had an estimated lease termination costs accrual of approximately $1.1 million.  During the first half of fiscal 2013, the Company increased the estimated lease termination costs accrual by approximately $0.2 million and paid approximately $0.3 million related to these costs.  As of September 30, 2012, the remaining balance of the Company’s estimated lease termination costs accrual was $1.0 million and is expected to be paid by the end of fiscal 2013.  As of September 29, 2012, the Company operates 37 stores in Texas.

 

The following table summarizes the Texas store closures remaining obligations as of September 29, 2012 (in thousands):

 

 

 

Lease Termination
Cost

 

Remaining obligations as of March 31, 2012

 

$

1,079

 

Accretion expenses

 

209

 

Cash payments

 

(283

)

Remaining obligations as of September 29, 2012

 

$

1,005

 

 

15.                               Assets Held for Sale

 

Assets held for sale during the quarter ended September 29, 2012 consisted of the vacant land in La Quinta, California and the vacant land in Rancho Mirage, California. The carrying value as of September 29, 2012 for the La Quinta land was $0.4 million and the Rancho Mirage land was $2.2 million.

 

In June 2012, the Company completed the sale of its Eagan, Minnesota warehouse that had been classified as held for sale. The warehouse had a carrying value of $6.4 million and the Company recorded a loss on sale of $0.2 million in the first quarter of fiscal 2013.

 

16.                               Other Current Liabilities

 

Other current liabilities as of September 29, 2012 and March 31, 2012 are as follows (in thousands):

 

 

 

September 29,
2012

 

March 31,
2012

 

Accrued interest

 

$

9,903

 

$

7,898

 

Accrued legal reserves and fees

 

5,400

 

4,866

 

Accrued utilities

 

3,799

 

2,709

 

Accrued property taxes

 

3,503

 

2,974

 

Accrued rent and related expenses

 

3,186

 

2,830

 

Accrued outside services

 

1,470

 

945

 

Accrued professional fees

 

989

 

1,220

 

Accrued advertising

 

470

 

577