| Basis of Presentation and Summary of Significant Accounting Policies | 1. Basis of Presentation and Summary of Significant Accounting Policies
Nature of Business
The Company is organized under the laws of the State of California. Effective October 18, 2013, 99¢ Only Stores converted from a California corporation to a California limited liability company, 99 Cents Only Stores LLC, that is managed by its sole member, Number Holdings, Inc., a Delaware corporation (“Parent”). The term “Company” refers to 99¢ Only Stores and its consolidated subsidiaries prior to the Conversion (as defined below) and to 99 Cents Only Stores LLC and its consolidated subsidiaries at the time of or after the Conversion. The Company is an extreme value retailer of consumable and general merchandise and seasonal products. As of January 27, 2017, the Company operated 390 retail stores with 283 in California, 48 in Texas, 38 in Arizona, and 21 in Nevada. The Company is also a wholesale distributor of various products.
Merger
On January 13, 2012, the Company was acquired through a merger (the “Merger”) with a subsidiary of Parent with the Company surviving. In connection with the Merger, the Company became a subsidiary of Parent, which is controlled by affiliates of Ares Management, L.P. (“Ares”) and Canada Pension Plan Investment Board (“CPPIB”) (together, the “Sponsors”). As a result of the Merger, the Company’s common stock was delisted from the New York Stock Exchange and the Company ceased to be a publicly held and traded equity company.
Conversion to LLC
On October 18, 2013, 99¢ Only Stores converted (the “Conversion”) from a California corporation to a California limited liability company, 99 Cents Only Stores LLC (“99 LLC”), that is managed by its sole member, Parent. In connection with the Conversion, each outstanding share of Class A common stock of 99¢ Only Stores, par value $0.01 per share, was converted into one membership unit of 99 LLC, and each outstanding share of Class B common stock of 99¢ Only Stores, par value $0.01 per share, was cancelled and forfeited. Pursuant to the laws of the State of California, all rights and property of 99¢ Only Stores were vested in 99 LLC and all debts, liabilities and obligations of 99¢ Only Stores continued as debts, liabilities and obligations of 99 LLC. 99 LLC has elected to be treated as a disregarded entity for United States federal income tax purposes. The Conversion did not have any effect on deferred tax assets or liabilities, and 99 LLC will continue to use the liability method of accounting for income taxes. 99 LLC computes its taxes on a separate return basis, but 99 LLC and Parent will continue to file consolidated or combined income tax returns with its subsidiaries in all jurisdictions. Parent is a holding company with no active business or operations and has no holdings in any business other than 99 LLC.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries required to be consolidated in accordance with accounting principles generally accepted in the United States (“GAAP”). Intercompany accounts and transactions between the consolidated companies have been eliminated in consolidation.
Fiscal Year
The Company follows a fiscal calendar consisting of four quarters with 91 days, with a 98 day quarter every five to six years each ending on the Friday closest to the last day of April, July, October or January, as applicable, and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. The Company’s fiscal year 2017 (“fiscal 2017”) began on January 30, 2016, and ended on January 27, 2017 and consisted of 52 weeks. The Company’s fiscal year 2016 (“fiscal 2016”) began on January 31, 2015, and ended on January 29, 2016 and consisted of 52 weeks. The Company’s fiscal year 2015 (“fiscal 2015”) began on February 1, 2014, and ended on January 30, 2015 and consisted of 52 weeks.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassification
Certain prior year amounts have been reclassified to conform to the current year’s presentation. Specifically, the Company adopted Accounting Standard Update (“ASU”) No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs” in the first quarter of fiscal 2017, which requires the Company to present debt issuance costs related to a recognized debt liability on the balance sheet as a direct deduction from the debt liability, similar to the presentation of original issue discounts (“OID”). The adoption of this accounting standard resulted in the reclassification of $11.5 million of debt issuance costs (net of accumulated amortization) from deferred financing costs, net to long-term debt, net of current portion on the Company’s consolidated balance sheet at January 29, 2016. The Company also early adopted ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes” in the first quarter of fiscal 2017, which requires that all deferred tax assets and liabilities be classified as long-term on the balance sheet. The adoption of this accounting standard resulted in the reclassification of $16.6 million of deferred income tax from current assets to long-term deferred income taxes liability on the Company’s consolidated balance sheet at January 29, 2016.
Immaterial Error Correction
During the fourth quarter of fiscal 2017, the Company determined that deferred tax liabilities as of January 29, 2016 were overstated by $6.5 million and the deferred tax valuation allowance was understated by $6.5 million. The total net deferred tax balances as of January 29, 2016 and tax provision for fiscal 2017 were not affected by this error. The Company analyzed the impact of the $6.5 million deferred tax liability overstatement on the goodwill impairment charge recorded in fiscal 2016 and determined that the charge was understated by $7.1 million.
Management evaluated the materiality of these errors quantitatively and qualitatively, and concluded that they were not material, to the financial statements of any period presented, but has elected to correct them in the accompanying fiscal 2016 consolidated financial statements.
Certain of the as previously reported balances include the adoption of ASU 2015-03 related to debt issuance costs and ASU 2015-17 related to deferred income tax (see Note 2).The following table sets forth the effect this correction had on the Company’s prior period reported balance sheet as of January 29, 2016 (in thousands):
January 29, 2016
As Reported
Adjustments
As Adjusted
Goodwill
$
$
)
$
Total assets
)
Accumulated deficit
)
)
)
Total equity
)
Total liabilities and equity
$
$
)
$
The following table sets forth the effect this correction had on the Company’s prior statement of comprehensive loss for fiscal 2016 (in thousands):
Year Ended January 29, 2016
As Reported
Adjustments
As Adjusted
Goodwill impairment
$
$
$
Operating loss
)
)
)
Loss before provision for income taxes
)
)
)
Net loss
)
)
)
Comprehensive loss
$
)
$
)
$
)
The correction discussed above also resulted in changes to previously reported amounts in the Company’s consolidated statements of cash flows. The correction had no impact on net cash provided by operating activities. The following table sets forth the effect this correction had on the Company’s prior statement of cash flows for fiscal 2016 (in thousands):
Year Ended January 29, 2016
As Reported
Adjustments
As Adjusted
Net loss
$
)
$
)
$
)
Goodwill impairment
Net cash provided by operating activities
$
$
—
$
Certain amounts disclosed in Notes 1, 3, 5, 8 and 16 for fiscal 2016 have been revised to reflect the correction.
Cash
For purposes of reporting cash flows, cash includes cash on hand, cash at the stores and cash in financial institutions. The majority of payments due from financial institutions for the settlement of debit card and credit card transactions are processed within three business days and therefore are also classified as cash. Cash balances held at financial institutions are generally in excess of federally insured limits. These accounts are only insured by the Federal Deposit Insurance Corporation up to $250,000. The Company’s cash balances held at financial institutions and exceeding FDIC insurance totaled $4.4 million and $3.9 million as of January 27, 2017 and January 29, 2016, respectively. The Company historically has not experienced any losses in such accounts. The Company places its temporary cash investments with what it believes to be high credit, quality financial institutions. Under the Company’s cash management system, checks issued but not presented to the bank may result in book cash overdraft balances for accounting purposes. The Company reclassifies book overdrafts to accounts payable, which are reflected as an operating activity in its consolidated statements of cash flows. Book overdrafts included in accounts payable were $7.0 million and $7.9 million as of January 27, 2017 and January 29, 2016, respectively.
Allowance for Doubtful Accounts
In connection with its wholesale business, the Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer’s or tenant’s ability to meet its financial obligations subsequent to the original sale, the Company will record an allowance against amounts due and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers and tenants, the Company recognizes allowances for doubtful accounts based on the length of time the receivables are past due, industry and geographic concentrations, the current business environment and the Company’s historical experiences.
Inventories
Inventories are valued at the lower of cost or market. Inventory costs are established using a methodology that approximates first in, first out, which for store inventories is based on a retail inventory method. Valuation allowances for shrinkage as well as excess and obsolete inventory are also recorded. The Company includes spoilage, scrap and shrink in its definition of shrinkage. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. Physical inventory counts are completed at each of the Company’s retail stores at least once a year by an outside inventory service company. The Company performs inventory cycle counts at its warehouses throughout the year. The Company also performs inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory. The valuation allowances for excess and obsolete inventory are based on the age of the inventory, sales trends and future merchandising plans. The valuation allowances for excess and obsolete inventory require management judgment and estimates that may impact the ending inventory valuation and valuation allowances that may have a material effect on the reported gross margin for the period. These estimates are subject to change based on management’s evaluation of, and response to, a variety of factors and trends, including, but not limited to, consumer preferences and buying patterns, age of inventory, increased competition, inventory management, merchandising strategies and historical sell through trends. The Company’s ability to adequately evaluate the impact of inventory management and merchandising strategies executed in response to such factors and trends in future periods could have a material impact on such estimates.
In the fourth quarter of fiscal 2015, the Company recorded a charge for additional inventory shrinkage based upon the results of annual physical inventory counts completed during the quarter. This resulted in a net charge to cost of sales and a corresponding reduction in inventory of approximately $10.0 million, which was primarily related to the implementation of certain strategic initiatives, including the “Go Taller” store remodeling program. The “Go Taller” store remodeling program increased the amount of shelving space at the stores by raising the height of store shelves. During the remodeling and startup phase of the program, retail stores remained open and many products were moved from the shelves to the floor to accommodate the remodeling, which the Company believes led to an increase in misplaced and damaged products. In anticipation of the extra shelf space, more inventory was shipped to stores, which we believe also increased shrinkage. A reduction in workforce during fiscal year ended January 31, 2014 resulted in the outsourcing of the Company’s Loss Prevention department, which was not reinstated in-house until the third quarter of fiscal 2016. These initiatives collectively disrupted store operations, resulting in increased loss due to theft and misplaced and damaged inventory.
In order to obtain inventory at attractive prices, the Company takes advantage of large volume purchases, closeouts and other similar purchase opportunities. Consequently, the Company’s inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities.
Property and Equipment
Property and equipment are carried at cost and are depreciated or amortized on a straight-line basis over the following useful lives:
Owned buildings and improvements
Lesser of 30 years or the estimated useful life of the improvement
Leasehold improvements
Lesser of the estimated useful life of the improvement or remaining lease term
Fixtures and equipment
3-5 years
Transportation equipment
3-5 years
Information technology systems
For major corporate systems, estimated useful life up to 7 years; for functional standalone systems, estimated useful life up to 5 years
The Company’s policy is to capitalize expenditures that materially increase asset lives and expense ordinary repairs and maintenance as incurred.
Long-Lived Assets
The Company assesses the impairment of depreciable long-lived assets when events or changes in circumstances indicate that the carrying value may not be recoverable. The Company groups and evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual identifiable cash flows are available. Recoverability is measured by comparing the carrying amount of an asset to expected future net cash flows generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. Factors that the Company considers important that could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business; and (3) significant changes in the Company’s business strategies and/or negative industry or economic trends. On a quarterly basis, the Company assesses whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable (Level 3 measurement, see Note 8, “Fair Value of Financial Instruments”). Considerable management judgment is necessary to estimate projected future operating cash flows. Accordingly, if actual results fall short of such estimates, significant future impairments could result.
During the third quarter of fiscal 2017, the Company decided to close five retail stores in California by the end of fiscal 2017 upon the expiration of their respective lease terms. As a result of this decision, the Company recognized an impairment charge of approximately $0.1 million related to the closure of three of these stores and recorded an impairment charge of $0.1 million related to fixtures that will be disposed of and for which the Company concluded the fair value was zero. During fiscal 2017, the Company also reduced the carrying value of a held for sale property to the estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.2 million.
During fiscal 2016, due to the underperformance of two stores in Texas and one store in California, the Company concluded that the carrying value of the long-lived assets relating to such stores were not recoverable and accordingly recorded an asset impairment charge of $0.8 million. During fiscal 2016, the Company also recorded impairment charges of $0.2 million related to equipment and fixtures that will be disposed of and for which the Company concluded the fair value was zero.
During fiscal 2015, the Company wrote down the carrying value of a held for sale property to the estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.1 million.
Goodwill and Other Intangible Assets
In connection with the Merger purchase price allocation, the fair values of long-lived and intangible assets were determined based upon assumptions related to the future cash flows, discount rates and asset lives using then available information, and in some cases were obtained from independent professional valuation experts. The Company amortizes intangible assets over their estimated useful lives unless such lives are deemed indefinite.
Amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on undiscounted cash flows, and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows used in the impairment tests (Level 3 measurement, see Note 8, “Fair Value of Financial Instruments”).
Goodwill and indefinite-lived intangible assets are not amortized but instead tested annually for impairment or more frequently when events or changes in circumstances indicate that the assets might be impaired. Goodwill is tested for impairment by comparing the carrying amount of the reporting unit to the fair value of the reporting unit to which the goodwill is assigned. The Company has the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step zero of the goodwill impairment test). If the Company does not perform a qualitative assessment, or determines, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of goodwill. Management has determined that the Company has two reporting units, the retail reporting unit and the wholesale reporting unit.
The Company, assisted by an independent third party valuation firm, performs the annual test for impairment in January of the fiscal year and determines fair value based on a combination of the income approach and the market approach. The income approach is based on discounted cash flows to determine fair value. The market approach uses a selection of comparable companies and transactions in determining fair value. The fair value of the trade name is also tested for impairment in the fourth quarter by comparing the carrying value to the fair value. Fair value of a trade name is determined using a relief from royalty method under the income approach, which uses projected revenue allocable to the trade name and an assumed royalty rate (Level 3 measurement, see Note 8, “Fair Value of Financial Instruments”). These approaches involve making key assumptions about future cash flows, discount rates and asset lives using then best available information. These assumptions are subject to a high degree of complexity and judgment and are subject to change.
The amount of goodwill allocated to the retail reporting unit and wholesale reporting unit was $467.2 million and $12.5 million, respectively, as of January 30, 2015.
During the third quarter of fiscal 2016, the Company determined that indicators of impairment existed to require an interim impairment analysis of goodwill and trade name, including (i) overall performance deterioration reflected in decreased comparable same-store sales and cannibalization from stores opened in fiscal 2015 under an accelerated expansion program, (ii) increases in inventory shrinkage and buildup of excess inventory, (iii) decreased margin due to disappointing results from sales promotions and (iv) a decision to delay the pace of future store openings. The first step evaluation concluded that the fair value of the retail reporting unit was below its carrying value. The Company performed step two of the goodwill impairment test that requires the retail reporting unit’s fair value to be allocated to all of the assets and liabilities of the reporting unit, including any intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination, including consideration of the fair value of tangible property and intangible assets. As a result of this preliminary analysis and based on best estimate, the Company recorded a $120.0 million non-cash goodwill impairment charge in the third quarter of fiscal 2016, which was reflected as goodwill impairment in the consolidated statements of comprehensive income (loss). The finalization of the preliminary goodwill impairment test was completed in the fourth quarter of fiscal 2016 and resulted in a $20.9 million adjustment in goodwill, lowering the estimated third quarter of fiscal 2016 goodwill impairment charge from $120.0 million to $99.1 million.
During the fourth quarter of fiscal 2016, the Company completed step one of its annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of the Company’s reporting units exceeded their carrying amounts.
The remaining amount of goodwill allocated to the retail reporting unit and wholesale reporting unit was $368.1 million and $12.5 million, respectively, as of January 29, 2016.
During the fourth quarter of fiscal 2017, the Company completed step one of its annual goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of the Company’s reporting units exceeded their carrying amounts. The results of this test showed that the fair value of our retail reporting unit exceeded its carrying value by a substantial amount. The results of this test showed that the fair value of wholesale reporting unit exceeded carrying value by approximately 18%. As discussed above, considerable management judgment is necessary in estimating future cash flows, market interest rates, discount rates and other factors affecting the valuation of goodwill. The Company’s forecasts used in its fiscal 2017 annual impairment test include growth in net sales, new store openings and same-store sales, positive trends in cost of sales and selling, general and administrative expense. In each case, these estimates and assumptions could be materially affected by factors such as unforeseen events or changes in general economic conditions, a decline in comparable company market multiples, changes to discount rates, increased competitive forces, inability to maintain pricing structure, deterioration of vendor relationships, failure to adequately manage and improve inventory processes and procedures and changes in customer behavior which could result in changes to management’s strategies. If operating results continue to change versus the Company’s expectations, additional impairment charges may be recorded in the future.
Additionally, during the fourth quarter of fiscal 2017, the Company completed its annual indefinite-lived intangible asset impairment test and determined there was no impairment to the trade name since the fair value of the trade name exceeded its carrying amount. The results of this test showed that the fair value of trade name exceeded carrying value by approximately 18%. The relief from royalty method estimates our theoretical royalty savings from ownership of the intangible asset. Key assumptions used in this model included sales projections, discount rates and royalty rates, and considerable management judgment is necessary in developing and evaluating such assumptions. If future results are not consistent with current estimates and assumptions, impairment charges maybe recorded in future.
Derivatives
The Company accounts for derivative financial instruments in accordance with authoritative guidance for derivative instrument and hedging activities. Financial instrument positions taken by the Company are primarily intended to be used to manage risks associated with interest rate exposures.
The Company’s derivative financial instruments are recorded on the balance sheet at fair value, and are recorded in either current or noncurrent assets or liabilities based on their maturity. Changes in the fair values of derivatives are recorded in net earnings or other comprehensive income (“OCI”), based on whether the instrument is designated and effective as a hedge transaction and, if so, the type of hedge transaction. Gains or losses on derivative instruments reported in accumulated other comprehensive income (“AOCI”) are reclassified to earnings in the period the hedged item affects earnings. Any ineffectiveness is recognized in earnings in the period incurred.
Income Taxes
The Company uses the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The Company’s ability to realize deferred tax assets is assessed throughout the year and a valuation allowance is established accordingly. The Company recognizes the impact of a tax position only if it is more likely than not to be sustained upon examination based on the technical merits of the position. The Company recognizes potential interest and penalties related to uncertain tax positions in income tax expense. Refer to Note 5, “Income Tax Provision” for further discussion of income taxes.
Stock-Based Compensation
The Company accounts for stock-based payment awards based on their fair value. The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods. For awards classified as equity, the Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model or other appropriate valuation models. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the stock price. Stock options are generally granted to employees at exercise prices equal to or greater than the fair market value of the stock at the dates of grant. The fair value of options granted to the current Chief Executive Officer were valued using a binomial model and the Monte Carlo simulation method. Refer to Note 11, “Stock-Based Compensation Plans” for further discussion of the Company’s stock-based compensation.
Revenue Recognition
The Company recognizes retail sales in its retail stores at the time the customer takes possession of merchandise. All sales are net of discounts and returns and exclude sales tax. Wholesale sales are recognized in accordance with the shipping terms agreed upon on the purchase order. Wholesale sales are typically recognized free on board origin, where title and risk of loss pass to the buyer when the merchandise leaves the Company’s distribution facility.
The Company has a gift card program. The Company does not charge administrative fees on gift cards and the Company’s gift cards do not have expiration dates. The Company records the sale of gift cards as a current liability and recognizes a sale when a customer redeems a gift card. The liability for outstanding gift cards is recorded in accrued expenses.
Cost of Sales
Cost of sales includes the cost of inventory, freight in, obsolescence, spoilage, scrap and inventory shrink, and is net of discounts and allowances. Cost of sales also includes receiving, warehouse costs and distribution costs (which include payroll and associated costs, occupancy, transportation to and from stores and depreciation expense). Cash discounts for satisfying early payment terms are recognized when payment is made, and allowances and rebates based upon milestone achievements such as reaching a certain volume of purchases of a vendor’s products are included as a reduction of cost of sales when such contractual milestones are reached or based on other systematic and rational approaches where possible.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include the costs of selling merchandise in stores (which include payroll and associated costs, occupancy and other store-level costs) and corporate costs (which include payroll and associated costs, occupancy, advertising, professional fees and other corporate administrative costs). Selling, general and administrative expenses also include depreciation and amortization expense relating to these costs.
Leases
The Company follows the policy of capitalizing allowable expenditures that relate to the acquisition and signing of its retail store leases. These costs are amortized on a straight-line basis over the applicable lease term.
The Company recognizes rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred rent. Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.
In certain lease arrangements, the Company can be involved with the construction of the building. If it is determined that the Company has substantially all of the risks of ownership during construction of the leased property and therefore is deemed to be the owner of the construction project, the Company records an asset for the amount of the total project costs and an amount related to the value attributed to the pre-existing leased building in property and equipment, net and the related financing obligation as part of current and non-current liabilities. Once construction is complete, if it is determined that the asset does not qualify for sale-leaseback accounting treatment, the Company amortizes the obligation over the lease term and depreciates the asset over the life of the lease. The Company does not report rent expense for the portion of the rent payment determined to be relat |
