| Summary of Significant Accounting Policies | 1.
Nature of Business
Francesca’s Holdings Corporation (the “Company” or “Holdings”) is a holding company incorporated in 2007 under the laws of Delaware. The Company’s business operations are conducted through its subsidiaries. The Company operates a nationwide-chain of boutiques providing customers a unique, fun and differentiated shopping experience. The Company offers a diverse and balanced mix of apparel, jewelry, accessories and gifts at attractive values. At February 1, 2020, the Company operated 711 boutiques, which are located in 47 states throughout the United States and the District of Columbia, and its ecommerce website.
On July 1, 2019, the Company effected a 12-to-1 stock split (the “Reverse Stock Split”), reducing the number of shares of common stock outstanding on that date from 35.4 million (which excludes 1.4 million of restricted stock awards granted to members of the Company's Board of Directors prior to the Reverse Stock Split but issued after the Reverse Stock Split) to 3.1 million shares. Additionally, the number of shares of common stock subject to outstanding stock options, restricted stock awards and restricted stock units, the exercise price of outstanding stock options, and the number of shares reserved for future issuance pursuant to the Company’s equity compensation plans were adjusted proportionately in connection with the Reverse Stock Split. The number of authorized shares of common stock under the Company’s Amended and Restated Certificate of Incorporation and the par value per share of the Company’s common stock were unchanged. All historical share and per share amounts presented herein have been adjusted retrospectively to reflect these changes.
Going Concern
On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. In recent months, the outbreak has spread globally and has led governments and other authorities around the world, including federal, state and local authorities in the United States, to impose measures intended to reduce its spread, including restrictions on freedom of movement and business operations such as travel bans, border closings, business limitations and closures (subject to exceptions for essential operations and businesses), quarantines and shelter-in-place orders. These measures may remain in place for a significant amount of time and has resulted in the temporary closures of all of the Company’s boutiques from March 25, 2020 to April 30, 2020, when we began reopening a small number of our boutiques in locations where local shutdown orders have been lifted. These measures have also caused an overall disruption in the Company’s supply chain and operations; while its ecommerce and distribution center remain open, they are operating at a reduced capacity.
As a result, the Company's revenues, results of operations and cash flows have been materially adversely impacted which raises substantial doubt about the Company's ability to continue as a going concern.
In response to such events, management is taking aggressive and prudent actions to reduce expenses and defer payment of accounts payables and inventory purchases to preserve cash on hand. These actions include, but are not limited to, furloughing substantially all of the Company’s corporate and boutique employees, (for the duration of boutique closures at their location and subject to reduced staffing for a phase-in period upon reopening), base salary reduction for the Company’s senior leadership team, deferring payment of rent at the Company’s boutiques, corporate headquarters and distribution facility, beginning in April 2020 subject to discussion with its landlords and other vendors, limiting investments in its ecommerce to necessary website and supporting functions, and suspending all capital expenditures. Additionally, the Company borrowed $5.0 million under its Amended ABL Credit Facility in April 2020. The Company has also filed an income tax refund for $10.7 million with the IRS related to the provision under the Corona Aid, Relief and Economic Security Act (“CARES Act”) enacted in March 2020 that allows the carryback of net operating losses to prior years. The Company is electing to take other available relief under the CARES Act including deferral of payment of certain payroll taxes and employee retention tax credits. The Company continues to evaluate the provisions of the CARES Act and the ways in which it could assist the Company’s business or improve the Company’s liquidity.
The inclusion of a going concern qualification in the report of the Company’s independent registered public accountant on its accompanying financial statements for the fiscal year ended February 1, 2020 has resulted in a violation of certain covenants under its Amended ABL Credit Agreement and Term Loan Credit Agreement (each as defined below). On May 1, 2020, the Company entered into a letter agreement (the “JPM Letter Agreement”) in connection with its Amended ABL Credit Agreement and a letter agreement (the “Tiger Letter Agreement”) in connection with its Term Loan Credit Agreement, in each case, to obtain a waiver from its lenders of any default or event of default arising from its failure to (i) deliver annual audited consolidated financial statements for the fiscal year ended February 1, 2020 without a “going concern” or a like qualification or exception and (ii) pay rent on leased locations for the months of April, May and June, 2020. The JPM Letter Agreement and Tiger Letter Agreement contain certain conditions and covenants, including that, in the case of the JPM Letter Agreement, the Company is required to use the entire $10.7 million income tax refund requested under the CARES Act to repay certain outstanding borrowings under the Amended ABL Credit Agreement and providing that no loans will be made under the ABL Credit Agreement unless the Company’s aggregate amount of cash and cash equivalents is less than $3.0 million. See Note 15, Subsequent Events, for additional information. If the Company is unable to meet its financial covenants or if there is an event of default under either agreement, including if it is unable or elects not to pay rent on its leased locations beginning in July 2020 and does not otherwise obtain a waiver from its lenders, the Company’s lenders could instruct the administrative agent under such credit facilities to exercise available remedies including, declaring the principal of and accrued interest on all outstanding indebtedness due and payable immediately and terminating all remaining commitments and obligations under the credit facilities. Although the lenders under the Company’s credit facilities may waive the defaults or forebear the exercise of remedies, they are not obligated to do so. Failure to obtain such a waiver would have a material adverse effect on the liquidity, financial condition and results of operations and may result in filing a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in order to implement a restructuring plan.
The Company could experience other potential impacts as a result of the COVID-19 pandemic, including, but not limited to, charges from potential adjustments to the carrying amount of its inventory and long-lived asset impairment charges. Actual results may differ materially from the Company's current estimates as the scope of the COVID-19 pandemic evolves, depending largely, though not exclusively, on the duration of the disruption to its business.
The Company's consolidated financial statement as of February 1, 2020 were prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business.
Fiscal Year
The Company maintains its accounts on a 52‑ to 53‑ week year ending on the Saturday closest to January 31. All references herein to fiscal year “2019” represents the 52‑week period ended February 1, 2020, fiscal year “2018” represents the 52‑week period ended February 2, 2019 and fiscal year and “2017” represents the 53‑week period ended February 3, 2018.
Principles of Consolidation and Presentation
The accompanying consolidated financial statements include the accounts of the Company and all its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Management Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues, net of estimated sales return, and expenses during the reporting periods. Actual results could differ from those estimates.
Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation at the measurement date.
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Level 1 - Quoted prices in active markets for identical assets or liabilities.
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Level 2 - Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly.
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Level 3 - Unobservable inputs based on the Company’s own assumptions.
The classification of fair value measurements within the hierarchy is based upon the lowest level of input that is significant to the measurement.
Financial assets and liabilities with carrying amounts approximating fair value include cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities. The carrying amount of these financial assets and liabilities approximates fair value because of their short maturities. The carrying amount of the Company's debt approximates its fair value due to the proximity of the debt issue date and the balance sheet date and the variable component of interest on debt.
Non-financial assets and liabilities, including long-lived assets, are measured at fair value on a non-recurring basis. The fair value of those assets is determined using Level 3 inputs which generally requires the Company to make estimates of future cash flows based on historical experience, current trends, market conditions, market participant pricing assumptions considering the highest and best use of the asset and other relevant factors deemed material.
Cash and Cash Equivalents
The Company considers all interest-bearing deposits and investments purchased with an original maturity of three months or less to be cash equivalents. The Company maintains cash balances at financial institutions that may from time to time exceed the Federal Deposit Insurance Corporation’s insurance limits. The Company mitigates this concentration of credit risk by monitoring the credit worthiness of the financial institutions.
Accounts Receivable
Accounts receivable consist of amounts due from credit card companies and income tax receivable, if any. The Company’s management has reviewed accounts receivable for collectability and has determined that an allowance for doubtful accounts is not necessary at February 1, 2020 and February 2, 2019.
Inventory
The Company values merchandise inventory at the lower of cost and net realizable value on a weighted-average cost basis. Inventory costs include freight costs. The Company records merchandise receipts at the time they are delivered to the distribution center or to its boutiques directly from vendors.
The Company reviews its inventory levels to identify slow-moving merchandise. In order to clear slow-moving merchandise, the Company uses promotional markdowns or marks certain items out-of-stock and disposes of such inventory at a pace suitable for its merchandising strategy. The Company continually evaluates recent selling trends and the related promotional events or pricing strategies in place to sell through the current inventory levels.
The Company also estimates a shrinkage reserve for the period of time between the last physical count and the balance sheet date. The estimate for shrinkage reserve can be affected by changes in merchandise mix and changes in actual shrinkage trends.
Changes to the lower of cost and net realizable value and shrinkage reserves are included in costs of goods sold and occupancy costs in the consolidated statements of operations.
Property and Equipment
Property and equipment is stated at cost. Depreciation of property and equipment is provided on a straight-line basis for financial reporting purposes using the following useful lives:
Assets
Estimated Useful Lives
Equipment
3 - 5 years
Furniture and fixtures
5 years
Software, including software developed for internal use
3 - 9 years
Signage and leasehold improvements
the lesser of 5 - 10 years or lease term
Assets under construction are not depreciated until the asset is placed in service or ready for use.
When a decision is made to dispose of property and equipment prior to the end of its previously estimated useful life, the Company accelerates depreciation to reflect the use of the asset over the shortened estimated useful life. Maintenance and repairs of property and equipment are expensed as incurred, and major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts, and any gain or loss is reflected in current earnings.
Leases
Adoption of Accounting Standards Codification 842
On February 3, 2019, the Company adopted the provisions of Accounting Standards Codification ("ASC”) 842, “Leases,” and its amendments. In adopting the standard, the Company used the additional, optional transition method which allows entities to initially apply the new standard by recognizing a cumulative-effect adjustment to the opening balance of retained earnings at the date of adoption. ASC 842 establishes comprehensive accounting and financial reporting requirements for leasing arrangements, supersedes the existing requirements in ("ASC”) 840, “Leases”, and requires lessees to recognize substantially all lease assets and lease liabilities on the balance sheet. Prior period amounts and disclosures were not adjusted and continue to be reported under ASC 840.
In applying the new standard, the Company elected the package of practical expedients which allows the Company to carry forward its prior conclusions under ASC 840 about lease identification, lease classification, and initial direct costs. The Company also elected the practical expedient of combining lease and non-lease components as a single lease component as well as the short-term lease recognition exemption for all leases at transition.
As a result of the adoption, the Company recorded an operating lease liability of $ 278.9 million and operating lease right-of-use (“ROU”) asset of $242.9 million at February 3, 2019. Additionally, the Company recognized a $1.8 million cumulative-effect adjustment to the beginning balance of retained earnings related to the impairment of certain operating lease ROU assets subjected to impairment testing under existing accounting guidance for which indicators of impairment existed at the time of the adoption of ASC 842. The adoption of ASC 842 did not have a material impact to the consolidated statements of operations or cash flows.
Accounting Policy Under ASC 842
The Company leases boutiques, its distribution center and office space and certain boutique and corporate office equipment under operating leases. The Company determines if an arrangement contains a lease at inception and recognizes operating lease ROU assets and operating lease liabilities at the commencement date based on the present value of the fixed lease payments over the lease term and, for operating lease ROU assets, include initial direct costs and exclude lease incentives. Variable lease payments are expensed as incurred. Lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will elect that option. Subsequent to the recognition of its operating lease ROU assets and operating lease liabilities, the Company recognizes lease expense related to its operating lease payments on a straight-line basis over the lease term.
Operating lease liabilities are calculated using the effective interest method and recognized at the commencement date based on the present value of lease payments over the reasonably certain lease term. As the interest rate implicit in the Company’s leases is not readily determinable, the Company utilized a collateralized incremental borrowing rate determined through the development of a synthetic credit rating to calculate the present value of its lease payments.
The Company accounts for lease and non-lease components as a single component. Accordingly, the Company’s fixed lease payments mainly consists of base rent, common area maintenance and landlord advertising. Additionally, the Company also elected the short-term lease recognition exemption for all leases.
Accounting Policy Under ASC 840
The Company leases boutiques and its distribution center and office space under operating leases. The majority of the Company’s lease agreements provide for tenant improvement allowances, rent escalation clauses and/or contingent rent provisions.
The Company records rent expense on a straight-line basis over the lease term, which generally begins on the possession date. Certain leases provide for contingent rents, in addition to a basic fixed rent, which are determined as a percentage of gross sales in excess of specified levels. The Company records a contingent rent liability and the corresponding rent expense when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable.
Landlord incentives, such as tenant improvement allowances, are deferred and amortized on a straight-line basis over the lease term as a reduction of rent expense.
Debt Issuance Costs
Debt issuance costs represent capitalized costs incurred related to the issuance or amendment of the Company’s credit facilities. These costs are amortized to interest expense using the effective interest method over the term of the loan. Debt issuance costs associated with the Company’s Term Loan Credit Agreement are presented on the Company's consolidated balance sheet as a direct reduction in the carrying value of the associated debt liability. Fees incurred by the Company to obtain its revolving credit facility are included within other assets on the Company's consolidated balance sheet.
Revenue Recognition
The Company recognizes revenue when control of the merchandise is transferred to customers in an amount that reflects the consideration received in exchange for such merchandise. For boutique sales, control is transferred at the point at which the customer receives and pays for the merchandise at the register. For ecommerce sales, control is transferred when merchandise is tendered to a third party carrier for delivery to the customer. The consideration received is the stated price of the merchandise, net of any discount, sales tax collected and estimated sales returns, and, in the case of ecommerce sales, includes shipping revenue. Cash is typically received on the day of or, in the case of credit or debit card transactions, within several days of the related sales. Management estimates future returns on previously sold merchandise based on return history and current sales levels. Estimated returns are periodically compared to actual sales returns and adjusted, if appropriate. The provision for estimated returns is included in accrued liabilities while the associated cost of merchandise is included as part of prepaid and other current assets in the consolidated balance sheets.
The Company adopted ASC 606, “Revenue from Contracts with Customers” on February 4, 2018 using the modified retrospective approach. Prior period amounts were not adjusted and continue to be reported in accordance with ASC 605, “Revenue Recognition.” As a result of adoption of ASC 606, the Company recorded an adjustment of $2.1 million, net of $0.7 million tax effect, to the beginning balance of retained earnings related to the change in timing of recognizing gift card breakage income.
Cost of Goods Sold and Occupancy Costs
Cost of goods sold and occupancy costs include the cost of purchased merchandise, freight costs from the Company’s suppliers to its distribution centers and freight costs for merchandise shipped directly from its vendors to its boutiques, allowances for inventory shrinkage and obsolescence, boutique occupancy costs including lease expenses, utilities, property taxes, boutique assets depreciation, boutique repair and maintenance costs, and shipping costs related to ecommerce sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include boutique and headquarters payroll (including buying department), employee benefits, freight from distribution centers to boutiques, boutique pre-opening expense, credit card merchant fees, costs of maintaining the Company’s ecommerce operations, travel and administration costs, corporate asset depreciation, stock-based compensation and other expenses related to operations at the corporate headquarters.
Freight costs included in selling, general and administrative expenses amounted to $4.4 million, $4.4 million and $4.8 million in fiscal years 2019, 2018, and 2017, respectively.
Advertising
Advertising costs are charged to expense as incurred or, in the case of media production costs (such as television or print), when advertising first takes place. Advertising costs were $3.9 million, $5.3 million and $4.2 million in fiscal years 2019, 2018 and 2017, respectively, and were included in selling, general and administrative expenses.
Stock-Based Compensation
Stock-based compensation is measured at the grant date fair value and recognized as expense over the requisite service period (generally the vesting period of the award). Beginning in fiscal year 2017, forfeitures were recognized as they occur rather than estimating expected forfeitures.
The fair value of restricted stock awards and restricted stock units are determined based on the closing price of the Company’s common stock on the award date. For awards subject to performance conditions, compensation expense is recognized over the requisite service period when it is probable that the specified performance goals will be achieved.
The fair value of time-based stock options is estimated using the Black Scholes option pricing model which requires extensive use of judgment and estimates, including expected stock volatility, expected term, risk-free interest rate and expected dividend yield.
Impairment of Long-Lived Assets, Including Operating Lease ROU Assets
The Company evaluates long-lived assets held for use, including operating lease ROU assets, and held for sale whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows, which is generally at a boutique level. In determining whether an impairment has occurred, the Company considers both qualitative and quantitative factors.
The quantitative analysis involves estimating the undiscounted future cash flows directly related to that asset and comparing it against its carrying value. If the carrying value of the asset is greater than the sum of the undiscounted future cash flows, an impairment loss is recognized for the difference between the carrying value of the asset and its fair value. The fair value of the asset group is generally determined using discounted future cash flows or a market participant’s ability to generate economic benefits using the asset in its highest and best use, whichever is appropriate. The determination of fair value takes into account the asset’s historical performance, current sales trends, market conditions, market participant pricing assumptions considering the highest and best use of the asset and other relevant factors deemed material, and discounted using a rate commensurate with the risk. The inputs used in the determination of the fair value are considered as Level 3 inputs in the fair value hierarchy, which require a significant degree of judgment and are based on the Company’s own assumptions.
Income Taxes
The Company accounts for income taxes using the liability method. Under this method, the amount of taxes currently payable or refundable is accrued, and deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences that currently exist between the tax basis and the financial reporting basis of the Company’s assets and liabilities. Valuation allowances are established against deferred tax assets when it is more-likely-than-not that the realization of those deferred tax assets will not occur.
Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years when those temporary differences are expected to be realized or be realized or settled. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that includes the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future.
A tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. The Company recognizes tax liabilities for uncertain tax positions and adjusts these liabilities when the Company’s judgment changes as a result of the evaluation of new information not previously available. Interest and penalties related to unrecognized tax benefits are recognized in income tax expense. The Company has no uncertain tax positions requiring accrual at February 1, 2020 and February 2, 2019.
Recent Accounting Pronouncements Not Yet Adopted
In December 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2019-12, "Simplifying the Accounting for Income Taxes." The ASU intends to enhance and simplify aspects of the income tax accounting guidance in ASC 740, "Income Taxes" as part of the FASB's simplification initiative. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2020 with early adoption permitted. The Company is currently evaluating the impact this guidance may have on our Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-15, “Intangibles-Goodwill and Other-Internal-Use-Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract.” ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new guidance will be effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The Company adopted the provisions of this guidance on February 2, 2020 and does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 changes the methodology for measuring credit losses on financial instruments and timing of when such losses are recorded. Since the original issuance of ASU 2016-13, the FASB has issued several amendments and updates to this guidance. This new guidance is effective for public companies, except for smaller reporting companies, for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For smaller reporting companies, such as the Company, this new guidance will be effective for fiscal year beginning after December 15, 2022, and interim periods within those fiscal year. Early adoption is permitted. The guidance is to be adopted using the modified retrospective approach. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. |
