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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

OR

 

 

For the transition period from March 31, 2013 to January 31, 2014

 

Commission file number 1-11735

 

99 CENTS ONLY STORES LLC

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (323) 980-8145

 

Securities registered pursuant to Section 12(b) of the Act:  None

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 the Securities Act.  Yes ¨  No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨  No x

 

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 x  No ¨

 

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 ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter)  is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

The registrant is privately held.  There is no trading in the registrant’s membership units and therefore an aggregate market value based on the registrant’s membership units is not determinable.

 

As of April 14, 2014, there were 100 units outstanding of the registrant’s membership units, none of which are publicly traded.

 

 

Table of Contents

 

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 a single 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 we will continue to use the liability method of accounting for income taxes.  The Company and its Parent will continue to file consolidated or combined income tax returns with its subsidiaries in all jurisdictions.

 

Repurchase Transaction with Rollover Investors

 

On October 15, 2013, Parent and the Company entered into an agreement with the Rollover Investors, pursuant to which (a)(i) Parent purchased from each Rollover Investor all of the shares of Class A Common Stock of Parent, par value $0.001 per share (“Class A Common Stock”) and Class B Common Stock of Parent, par value $0.001 per share (“Class B Common Stock”), owned by such Rollover Investor and (ii) all of the options to purchase shares of Class A Common Stock and Class B Common Stock held by such Rollover Investor were repurchased for aggregate consideration of approximately $129.7 million (the “Gold-Schiffer Purchase”) and (b) the Company agreed to certain amendments to the Non-Competition, Non-Solicitation and Confidentiality Agreements and the Separation and Release Agreements with the Rollover Investors who were former management of the Company.  The Gold-Schiffer Purchase was completed on October 21, 2013.  Prior to completion of the transaction, Howard Gold resigned from the board of directors of each of Parent and the Company.  The Gold-Schiffer Purchase was funded through a combination of borrowings of $100 million of incremental term loans under the First Lien Term Loan Facility and cash on hand at the Company and Parent.  In connection with the Gold-Schiffer Purchase, we made a distribution to Parent of $95.5 million and an investment in shares of preferred stock of Parent of $19.2 million (see Note 7 to our Consolidated Financial Statements for information on restrictions under instruments governing the Company’s indebtedness on the Company’s ability to make dividend and similar payments.)  In addition, we made a payment of $7.8 million to the Rollover Investors to repurchase all options of Class A Common Stock and Class B Common Stock held by the Rollover Investors.

 

Our Competitive Strengths

 

Differentiated Retail Concept

 

We believe our stores offer consumers an extreme value shopping experience that is unique in our industry due to:

 

·                  Our current average store size of approximately 21,000 gross square feet,  which we believe are significantly larger than stores of other U.S. publicly reporting dollar store chains, enabling us to carry a wide assortment of consumable, general merchandise and seasonal products in a clean, attractive and comfortable shopping environment;

 

·                  Our large selection of food and grocery items, which is approximately 56% of gross sales, and includes many of the fresh produce, deli, dairy and refrigerated and frozen food items which we believe generally provide greater value than consumers can find elsewhere. We believe our extensive food and grocery offerings drive recurring traffic from customers who rely on us for their weekly household needs;

 

·                  Our wide assortment of closeout merchandise, which helps create an atmosphere of treasure-hunt excitement within our stores. We believe that our wide assortment of closeout merchandise is a competitive advantage as many of our competitors lack the vendor relationships, management expertise or logistical capabilities to handle as large a percentage of sales as we do in closeout merchandise; and

 

·                  We are able to source a significant portion of our merchandise from abroad and we believe that additional opportunities exist to increase volume of private-label and direct source foreign merchandise, which would enable us to expand our product assortment and meet consumer demands.

 

We believe, based on our industry experience, that these competitive strengths enable us to be the most productive stores among U.S. publicly reporting dollar store chains when ranked by sales per store and average sales per square foot.

 

Attractive Industry Fundamentals

 

The U.S. dollar store industry is large and growing, and we believe benefits from a number of attractive industry fundamentals which will continue to support our growth, including:

 

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·                  Historical and projected growth in dollar store revenues driven by the addition of new dollar stores and the increasing acceptance of dollar stores among consumers;

 

·                  Same store sales growth among U.S. publicly reporting dollar store chains, which are outperforming many other retail channels, particularly U.S. publicly reporting traditional grocery stores;

 

·                  Within the dollar store industry, the opportunity for larger chains, including 99 Cents, to grow faster than the overall industry, the balance of which we believe consists primarily of independent store operators; and

 

·                  Strong historical performance by dollar stores throughout economic cycles.

 

We believe that these attractive industry fundamentals, when combined with the large population size and favorable income and demographic attributes within our existing markets, represent growth opportunities for 99 Cents.

 

Attractive Store Footprint

 

We have over 30 years of experience operating our stores.  We currently operate a large network of extreme value retail stores in California and have a strong presence in three other southwestern states, Texas, Nevada and Arizona. Our stores are typically clustered in and around densely populated areas. We believe that many of our stores are more convenient than traditional “big box” retailers that typically occupy larger buildings located in less urban areas as a result of their store size requirements. We believe that the density of our store geographic coverage is a competitive advantage and would be difficult to replicate.

 

We believe that our southwestern geographic markets have attractive attributes that support our business model.  Our markets generally have large, growing and ethnically diverse populations. Many of the markets we serve have high proportions of low-income consumers, as well as nearby middle and upper middle income consumers, who we believe are increasingly shopping dollar stores.

 

Strong Vendor Relationships and Sourcing Expertise Both Domestically and Globally

 

We believe that our sourcing expertise and our long-standing, mutually beneficial vendor relationships are competitive advantages. Many of our vendors have been supplying products to us for over 20 years. We are a trusted partner and a preferred buyer to our vendors, many of whom we believe contact us first when they are selling closeout inventory. We believe we are a preferred buyer due to our ability to, among other things:

 

·                  Make immediate buying decisions;

 

·                  Acquire large volumes of inventory and take possession of goods immediately;

 

·                  Pay cash or accept abbreviated credit terms; and

 

·                  Purchase goods that have a shorter than normal shelf life or are off-season or near the end of a selling season.

 

We believe our vendor relationships are also strengthened by our ability to minimize channel conflict for the manufacturer as well as our ability to quickly sell products through well-maintained, attractively merchandised stores.

 

Strong Financial Performance and Compelling Unit Economics

 

Our store base is profitable and growing. Our stores continue to demonstrate strong revenue growth, having posted positive same-stores sales growth in nine out of the ten past years with same-store sales growth of 3.7% in transition fiscal 2014.

 

With our strong store sales productivity metrics, our new store model generates attractive cash on cash returns.  Our newly opened stores ramp up quickly and typically reach near full sales volumes within the first 12 months. Historically, our new stores have demonstrated relatively consistent profitability levels as a percentage of sales across fiscal years. Our stores have a low cost operating model with attractive margins, low maintenance capital expenditures and low ongoing working capital needs.

 

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Our Business Strategy

 

Accelerate Our Store Growth

 

We opened 27 net new stores during transition fiscal 2014 and we currently intend to open approximately 30 to 35 stores in fiscal 2015.  We plan to continue to pursue an accelerated store growth plan in our existing markets.  We believe that this will strengthen our competitive advantage in our key geographic regions and enable us to take advantage of economies of scale in distribution and store logistics.

 

Maximize Profitable Sales

 

We expect to achieve sustainable increases in sales and product margin results through enhancing the customer shopping experience, optimizing our product mix and expanding our global sourcing, as follows:

 

Enhancing the Customer Shopping Experience

 

We plan to improve our customers’ shopping experience, which we believe will maximize profitable sales in our stores, through a multi-year three-step plan for our stores:

 

1.             Raising the height of the shelving to create a dramatic canvas for visual merchandising,

 

2.             Optimizing the store layout and space allocation to drive sales and margin, and

 

3.             Remodeling our store interiors and exteriors to attract new customers.

 

During fiscal 2015, we intend to implement the first step by retrofitting our existing store base to raise our shelving to 78 inches from the current 54 inches.  We believe that this initiative will improve the customer experience by placing more products at eye level, which provides cleaner displays and creates a more appealing store appearance.

 

Optimizing Our Product Mix and Expanding Global Sourcing

 

We are increasing our focus on sourcing globally and directly, which we believe will help us to:

 

·            Supplement our private-label consumable offerings, which will enhance the category margins,

 

·            Become the “go-to destination” for general and seasonal merchandise, and

 

·            Go directly to overseas factories to expand our product assortment, increase our close-out opportunities and reduce our product costs.

 

In addition, we offer selected items priced above 99.99¢ and we believe that we have additional opportunities to expand our selection of these items.

 

Deliver Superior Key Metrics

 

We intend to become a more effective retailer with simplified business processes and organization.  We intend to upgrade our IT and supply chain infrastructure as well as build and develop our management and field operations teams.  We intend to continue to implement best practices to strengthen the operational performance of our stores. At the store level, we intend to optimize the flow of goods to and through the store. We also believe there are opportunities to further improve our operations through automated forecasting and replenishment and improved labor scheduling and to deliver superior key metrics over time. At our warehouse and distribution facilities, we intend to continue to drive operating efficiencies through consolidating and improving our warehouse and distribution facilities, labor and logistics systems as well as drive integrated supply chain initiatives to reduce operating costs. Through our operationally focused strategies, we believe we can further improve our profitability and competitive position.  Over time, we believe that this will allow us to deliver superior results in key metrics such as sales productivity, expense leverage and overall profitability.

 

Retail Operations

 

Our stores offer customers a wide assortment of regularly available consumer goods, as well as a broad variety of quality, closeout merchandise. Merchandise sold in our 99¢ Only stores is priced primarily at or below 99.99¢ per item.

 

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The following table sets forth certain relevant information with respect to our retail operations (dollar amounts in thousands, except percentages and sales per square footage):

 

		Ten Months Ended			Years Ended
		January 31, 2014			March 30, 2013			March 31, 2012 (c)			April 2, 2011			March 27, 2010
		(Successor)			(Successor)			(Pro Forma)			(Predecessor)			(Predecessor)
Net retail sales		$	1,486,699	(a)	$	1,620,683		$	1,488,094		$	1,380,357	(d)	$	1,314,214
Annual net retail sales growth rate		10.7		%(a)	8.9		%	7.8		%	5.0		%(d)	4.1		%
Store count at beginning of year		316			298			285			275			279
New stores		28			19			13			11			9
Stores closed		1			1			—			1			13		(e)
Total store count at year-end		343			316			298			285			275
Average net sales per store open the full years(f)		$	5,446	(h)	$	5,327		$	5,152		$	4,874		$	4,848
Estimated store saleable square foot		5,607,991			5,211,483			4,948,344			4,758,432			4,606,728
Average net sales per estimated saleable square foot(f)		$	330	(h)	$	321		$	309		$	291		$	289
Change in comparable net sales(g)		3.7		%(b)	4.3		%	7.3		%	0.7		%	3.9		%

 

(a)         For transition fiscal 2014, net retail sales of $1,486.7 million were based on a 44-week period and the annual net retail sales growth rate of 10.7% was calculated based on the net retail sales for the 43-week period ended January 26, 2013.  See Note 2, “Change in Fiscal Year” to the Company’s Consolidated Financial Statements for the comparative Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the ten months ended January 31, 2014 (a 44-week period) and ten months ended January 26, 2013 (a 43-week period).

 

(b)         Comparable same-store sales for transition fiscal 2014 are calculated based on the 43-week period ended January 25, 2014 as compared to the 43-week period ended January 26, 2013.

 

(c)          Amounts in pro forma fiscal year ended March 31, 2012 column represent the mathematical combination of the Predecessor financial data from April 3, 2011 to January 14, 2012 and the Successor financial data from January 15, 2012 to March 31, 2012 included in our Consolidated Financial Statements.

 

(d)         For fiscal 2011, net retail sales of $1,380.4 million were based on a 53-week period.  The other periods presented are based on a 52-week period.

 

(e)          12 underperforming stores in Texas were closed and one California store was closed in fiscal 2010 due to the expiration of its lease.

 

(f)           Stores open for 12 months.

 

(g)          Stores open at least 15 months.

 

(h)         Average net sales per store and average net sales per estimated saleable square foot are based on trailing 52-week period.

 

Merchandising.  All of our stores offer a broad variety of first-quality, name-brand and other closeout merchandise as well as a wide assortment of regularly available consumer goods. We also carry private-label consumer products made for us.  We believe that the success of our 99¢ Only stores concept arises in part from the value inherent in pricing consumable items primarily at 99.99¢ or less per item, many of which are name-brands, which generally provide greater value than consumers can find elsewhere.  We offer selected items priced above 99.99¢ and we believe that we have additional opportunities to expand our selection of these items.

 

A significant amount of our gross sales are from products available for reorder including many branded consumable items. The mix and the specific brands of merchandise frequently changes, depending primarily upon the availability of closeout merchandise at suitable prices. A significant amount of our sales are from closeout merchandise, which we believe represents a significantly larger share of closeout merchandise than those of other U.S. publicly reporting dollars stores chains, some of whom carry few or no closeouts. We currently expect to be able to obtain sufficient name-brand closeouts, as well as re-orderable merchandise, at attractive prices. We believe that the frequent changes in specific name-brands and products found in our stores encourage impulse and larger volume purchases, result in customers shopping more frequently, and help to create a sense of urgency, fun and treasure hunt excitement.

 

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We believe that we differentiate ourselves from traditional dollar stores by offering a wider assortment of food and grocery items, including frozen, dairy, deli and produce, which collectively account for approximately 56% of our revenue. Substantially all of our stores have free-standing fresh and refrigerated produce displays as well as built-in refrigerated and frozen food wall units. We believe that many of our customers shop at our stores weekly for their groceries and frequently shop 99¢ Only stores first before supplementing these purchases at other food stores.

 

Substantially all of our business is transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations have never had a significant impact on us.

 

Our retail sales by product category for the transition fiscal 2014, fiscal 2013 and pro forma fiscal 2012 are set forth below:

 

		Ten Months Ended		Years Ended
		January 31, 2014		March 30, 2013		March 31, 2012
		(Successor)		(Successor)		(Pro Forma)
Product Category:
Food and grocery		56	%	55	%	56	%
Household and housewares		14	%	14	%	14	%
Health and beauty care		9	%	9	%	9	%
Hardware		3	%	3	%	3	%
Stationery and party		5	%	5	%	6	%
Seasonal		4	%	5	%	4	%
Other		9	%	9	%	8	%
		100	%	100	%	100	%

 

We target value-conscious consumers from a wide range of socio-economic backgrounds with diverse demographic characteristics. Purchases are by cash, credit card, debit card or EBT (electronic benefit transfers). Our stores currently do not accept checks or manufacturer’s coupons. Our stores’ operating hours are designed to meet the needs of families.

 

Store Size, Layout and Locations.  We strive to provide stores that are attractively merchandised, brightly lit, clean, well-maintained, “destination” locations. Our stores are typically clustered around densely populated areas where it is convenient for our customers to do their weekly household shopping.  The interior of each store is designed to reflect a generally uniform format, featuring consistent merchandise displays, bright lighting, customized check-out counters and a distinctive color scheme on its interior and exterior signage.

 

Marketing and Advertising.  Our marketing efforts are based on our network of locations with good visibility, effective and efficient signage, word-of-mouth publicity, a grand new store opening program and occasionally supplemental advertising.

 

Purchasing

 

We believe a primary factor contributing to our success is our ability to identify and take advantage of opportunities to purchase merchandise with high customer appeal at prices lower than regular wholesale. We purchase most merchandise directly from the manufacturer. Other sources of merchandise include wholesalers, manufacturers’ representatives, importers, barter companies, auctions, professional finders and other retailers, varying on the season and closeout activity.

 

We continuously seek out buying opportunities from both our existing vendors and new sources. No single vendor accounted for more than 5% of our total purchases in transition fiscal 2014. During transition fiscal 2014, we purchased merchandise from more than 999 vendors, many of which have been supplying us product for over 20 years.

 

A significant portion of the merchandise purchased by us in transition fiscal 2014 was closeout merchandise. We have developed strong relationships with many vendors and distributors who recognize that our merchandise can be moved quickly through our retail and wholesale distribution channels. Our buyers continuously search for closeout opportunities.

 

Our experience and expertise in buying merchandise has enabled us to develop relationships with many manufacturers that often offer some or all of their closeout merchandise to us prior to attempting to sell it through other channels. The key elements to these vendor relationships include our (i) ability to make immediate buying decisions; (ii) experienced buying staff; (iii) willingness to take on large volume purchases and take possession of merchandise immediately; (iv) ability to pay cash or accept abbreviated credit terms; (v) commitment to honor all issued purchase orders; and (vi) willingness to purchase goods close to a target season or out of season. We believe our relationships with our vendors are further enhanced by our ability to minimize channel conflict for a manufacturer.

 

Our strong relationships with many manufacturers and distributors, along with our ability to purchase in large volumes, also enable us to purchase re-orderable name-brand goods at prices that we believe are below general wholesale prices.

 

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Employees

 

As of January 31, 2014, we had approximately 15,000 employees. None of our employees are party to a collective bargaining agreement and none are represented by a labor union.

 

Trademarks

 

“99¢ Only Stores,” “Bargain Wholesale” and multiple other product trademarks are listed on the United States Patent and Trademark Office Principal Register. We believe that our trademarks are an important but not critical element of our merchandising strategy. We routinely undertake enforcement efforts against certain parties whom we believe are infringing upon our “99¢” family of marks and our other intellectual property rights, although we believe that simultaneous litigation against all persons everywhere whom we believe to be infringing upon these marks is not feasible.

 

Seasonality

 

For information regarding the seasonality of our business, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Seasonality and Quarterly Fluctuations,” which is incorporated by reference in this Item 1.

 

Environmental Matters

 

In the ordinary course of business, we handle or dispose of commonplace household products that are classified as hazardous materials under various environmental laws and regulations. Under various federal, state, and local environmental laws and regulations, current or previous owners or occupants of property may face liability associated with hazardous substances. These laws and regulations often impose liability without regard to fault. In the future we may be required to incur substantial costs for preventive or remedial measures associated with hazardous materials. We have several storage tanks at our distribution and warehouse facilities, including: an aboveground and an underground diesel storage tank and compressed natural gas tank at the City of Commerce, California warehouse; ammonia storage at the Southern California cold storage facility and the Texas warehouse; aboveground diesel and propane storage tanks at the Texas warehouse; an aboveground propane storage tank at our two main Southern California warehouses; and an aboveground propane storage tank at our leased Slauson distribution center in City of Commerce, California.  Except as disclosed in Item 3. Legal Matters, we have not been notified of, and are not aware of, any potentially material current environmental liability, claim or non-compliance, concerning our owned or leased real estate.

 

Available Information

 

We make available free of charge our annual and transition reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports through a hyperlink from the “Investor Relations” portion of our website, www.99only.com, to the Securities and Exchange Commission’s website, www.sec.gov.  Such reports are available on the same day that we electronically filed them with or furnished to the Securities and Exchange Commission.  The reference to our website address does not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.

 

Copies of the reports and other information we file with the Securities and Exchange Commission may also be examined by the public without charge at 100 F Street, N.E., Room 1580, Washington D.C., 20549, or on the Internet at http://sec.gov.  Copies of all or a portion of such materials can be obtained from the Securities and Exchange Commission upon payment of prescribed fees.  Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information.

 

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We rely on certain software vendors to maintain and periodically upgrade many of these systems. The software programs supporting many of our systems are maintained and supported by independent software companies. The inability of these companies to continue to maintain and upgrade these information systems and software programs might disrupt or reduce the efficiency of our operations if we were unable to convert to alternate systems in an efficient and timely manner. In addition, costs and potential interruptions associated with the implementation of new or upgraded systems and technology could also disrupt or reduce the efficiency of our operations.

 

We rely on proprietary systems and these systems may not support our growth plans.  Our decision to implement a new Enterprise Resource Planning (“ERP”) software platform may cost more than expected and could interrupt operational transactions during the implementation

 

We depend on a variety of information systems for our operations, many of which are proprietary, which have historically supported many of our business operations such as inventory and order management, shipping, receiving, and accounting. Because most of our information systems consist of a number of internally developed applications, it can be more difficult to upgrade or adapt them compared to commercially available software solutions. We are currently in the process of migrating our operations from our legacy proprietary system to SAP’s enterprise resource planning software, which includes integrated financial and inventory management systems. There are inherent risks associated with replacing and changing these core systems, including accurately capturing data and possible supply chain and vendor payment disruptions.  In addition, this process is complex, time-consuming and expensive. Although we believe we are taking appropriate action to mitigate the risks through testing, training and staging implementation, we can make no assurances that we will not have disruptions, delays and/or negative business impacts from this forthcoming deployment. Any operational disruptions during the course of this process, delays or deficiencies in the design and implementation of the new ERP system, or in the performance of our legacy systems could materially and adversely affect our ability to effectively run and manage our business.  Our success depends, in large part, on our ability to manage our inventory, pay our vendors and record and report financial and management information on a timely and accurate basis, which could be impaired while we are making these enhancements.  Even if the implementation proceeds as planned, the cost of the system could have a material adverse effect on our results of operation. Portions of our IT infrastructure also may experience interruptions, delays or cessations of service or produce errors in connection with systems integration or migration work that takes place from time to time. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive. Such disruptions could materially and adversely impact our ability to fulfill orders and interrupt other processes. If our information systems do not allow us to transmit accurate information, even for a short period of time, to key decision makers, the ability to manage our business could be disrupted and the results of operations and financial condition could be materially and adversely affected.  Additionally, while we have spent considerable efforts to plan and budget for the implementation of the system, changes in scope, timeline or cost could have a material adverse effect on our results of operations.  Failure to properly or adequately address these issues could impact our ability to perform necessary business operations, which could materially and adversely affect our reputation, competitive position, business, results of operations and financial condition.

 

Natural disasters, unusually adverse weather conditions, pandemic outbreaks, terrorist acts, and global political events could cause temporary or permanent distribution center or store closures, impair our ability to purchase, receive or replenish inventory, or decrease customer traffic, all of which could result in lost sales and otherwise adversely affect our financial performance

 

The occurrence of natural disasters, such as earthquakes, hurricanes, fires, floods and tsunamis, unusually adverse weather conditions, pandemic outbreaks, terrorist acts or disruptive global political events, such as civil unrest in countries in which our vendors are located, or similar disruptions could adversely affect our operations and financial performance. These events could result in the closure of one or more of our distribution centers or a significant number of stores, the temporary or long-term disruption in the supply of products from some local and overseas vendors, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to our distribution centers or stores, the temporary reduction in the availability of products in our stores, and disruption to our information systems.

 

Our current insurance program may expose us to unexpected costs and negatively affect our financial performance

 

Our insurance coverage reflects deductibles, self-insured retentions, limits of liability and similar provisions that we believe are prudent. However, there are types of losses we may incur but against which we cannot be insured or which we believe are not economically reasonable to insure, such as losses due to employment practices, acts of war, employee, blackouts and certain other crime and some natural disasters, including earthquakes and tsunamis. If we incur these losses and they are material, our business could suffer. In addition, we self-insure a significant portion of expected losses under our workers’ compensation and general liability programs. Unanticipated changes in any applicable actuarial assumptions and management estimates underlying our recorded liabilities for these losses could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on our financial condition and results of operations.  In the third quarter of transition fiscal 2014, we recorded an increase to our workers’ compensation accrual of $38.1 million, primarily as a result of an increase in severity of workers’ compensation claims. We have begun implementing action plans to reduce the frequency and severity of workers’ compensation claims against us, however there can be no assurance that such frequency or severity will decrease over time.  Although we continue to maintain property insurance for catastrophic events, we are effectively self-insured for property losses up to the amount of our deductibles. If we experience a greater number of these losses than we anticipate, our financial performance could be adversely affected.

 

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We face risks associated with international sales and purchases

 

International sales historically have not been important to our overall net sales. However, some of our inventory we purchase from domestic vendors is manufactured outside the United States, primarily China and we expect to directly source an increasing portion of our products from outside of the United States.  Because we expect a larger percentage of our merchandise to be manufactured or sourced abroad, we will be required to order these products further in advance than would be the case if these products were manufactured domestically.  International transactions may be subject to risks such as:

 

·                  political or financial instability or disputes;

 

·                  lack of knowledge by foreign manufacturers of or compliance with applicable federal and state product, content, packaging and other laws, rules and regulations;

 

·                  foreign currency exchange rate fluctuations and local economic conditions, including inflation;

 

·                  uncertainty in dealing with foreign vendors and countries where the rule of law is less established;

 

·                  raw material shortages, factory consolidations, work stoppages, strikes and political unrest;

 

·                  risk of loss due to overseas transportation;

 

·                  import and customs review can delay delivery of products as could labor disruptions at ports;

 

·                  changes in import and export regulations, including “trade wars” and retaliatory responses;

 

·                  changes in tariff, import duties and freight rates; and

 

·                  testing and compliance.

 

The United States and other countries have at times proposed various forms of protectionist trade legislation.  We are subject to trade restrictions in the form of tariffs or quotas, or both, applicable to the products we sell as well as to raw material imported to manufacture those products. We may also be subjected to additional duties, significant monetary penalties, the seizure and forfeiture of the products we are attempting to import, or the loss of import privileges if we or our vendors are found to be in violation of U.S. laws and regulations applicable to the importation of our products. Our and our vendors’ compliance with the regulations is subject to interpretation and review by applicable authorities.  Any changes in current tariff structures or other trade policies or interpretations could result in increases in the cost of and/or store level reduction in the availability of certain merchandise and could adversely affect our ability to purchase such merchandise and our operations.  In addition, decreases in the value of the U.S. dollar against foreign currencies, particularly the Chinese renminbi, could increase the cost of products we purchase from overseas vendors. The pricing of our products in our stores may also be affected by changes in foreign currency rates and require us to make adjustments which would impact our revenue and profit.

 

Disruptions due to labor stoppages, strikes or slowdowns, or other disruptions involving our vendors or the transportation and handling industries also may negatively affect our ability to receive merchandise and thus may negatively affect sales.  Prolonged disruptions could also materially increase our labor costs both during and following the disruption.  Significant increases in wages or wage taxes paid by contract facilities may increase the cost of goods manufactured, which could have a material adverse effect on our profit margins and profitability.  For example, the costs of labor and wage taxes have increased in China, which means we are at risk of higher costs associated with goods manufactured in China.

 

These and other factors affecting our vendors and our access to products, including the supply of our imported merchandise or the imposition of additional costs of purchasing or shipping imported merchandise, could have a material adverse effect on our business, financial condition and results of operations unless and until alternative supply arrangements are secured. Products from alternative sources may be of lesser quality or more expensive than those we currently purchase, resulting in a loss of sales or profit.  As we increase our imports of merchandise from foreign vendors, the risks associated with foreign imports will increase.

 

We have potential risks regarding our store physical inventories

 

Although we have a perpetual inventory system in our warehouses, we currently do not have a perpetual inventory system in our stores. Furthermore, physical inventories in all existing stores are not performed at the end of each fiscal period, and there are additional processes and procedures surrounding store physical inventories that we believe need to be improved. In particular, we have identified that certain personnel managing or performing store physical inventories need additional training in order to consistently follow our physical inventory processes and procedures, and properly document the physical inventory results. We have increased our excess and obsolete inventory reserves and we are in the process of implementing an SAP system throughout the Company, including all retail stores.  In anticipation of this implementation, we have initiated additional training for store employees and new physical inventory procedures. Our failure to adequately reserve for excess and obsolete inventory or our inability or failure to effectively implement these measures on our expected timeframe, or at all, or otherwise to not continue to improve our physical inventory processes and procedures could have a materially adverse effect on our store physical inventory results, shrinkage and margins.  This in turn could materially affect our ability to timely complete our financial reporting obligations and our financial condition and results or operations.

 

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We could encounter risks related to transactions with affiliates

 

Prior to the Merger, we leased 13 store locations and a parking lot associated with one of these stores from the Rollover Investors and their affiliates, of which 12 stores were leased on a month to month basis. In connection with the Merger, we entered into new lease agreements for these 13 stores and one parking lot. Although the terms negotiated were acceptable to us, we cannot be certain that terms negotiated are no less favorable than a negotiated arm’s length transaction with a third party.

 

We rely heavily on our executive management team and changes in our management team could adversely affect our business strategy, performance and results of operations

 

We have historically relied heavily on the continued service of our executive management team.  Effective January 23, 2013, Eric Schiffer, Jeff Gold and Howard Gold separated from their positions as Chief Executive Officer, Chief Administrative Officer and Executive Vice President of Special Projects, respectively.  Richard Anicetti and Michael Fung were appointed Interim President and Chief Executive Officer and Interim Executive Vice President and Chief Administrative Officer, respectively, and served from January 23, 2013 until September 3, 2013 and September 23, 2013, respectively.  Stéphane Gonthier was appointed President and Chief Executive Officer of the Company and Parent on September 3, 2013.  Competition for skilled and experienced management personnel is intense, and we may be unable to identify, hire and effectively integrate new members of management into senior positions on our anticipated timeframe or at all, which could disrupt our business.  Moreover, these and any other changes in management could result in changes to, or affect the execution of, our business strategy, which could adversely affect our performance and results of operations.

 

Our operating results may fluctuate and may be affected by seasonal buying patterns

 

Historically, we have experienced higher net sales and higher operating income during the quarters that have included the Halloween, Christmas and Easter selling seasons.  If for any reason our net sales were to fall below norms during the Halloween, Christmas and/or Easter selling seasons, it could have an adverse impact on profitability and impair the results of operations for the entire fiscal year. Transportation scheduling, warehouse capacity constraints, supply chain disruptions, adverse weather conditions, labor disruptions or other disruptions during peak holiday seasons could also affect net sales and profitability for the fiscal year.

 

In addition to seasonality, many other factors may cause the results of operations to vary significantly from quarter to quarter. These factors, some beyond our control, include the following:

 

·                  the number, size and location of new stores and timing of new store openings;

 

·                  the distance of new stores from existing stores and distribution sources;

 

·                  the level of advertising and pre-opening expenses associated with new stores;

 

·                  the integration of new stores into operations;

 

·                  the general economic health of the extreme value retail industry;

 

·                  changes in the mix of products sold;

 

·                  increases in fuel, shipping merchandise and energy costs;

 

·                  the ability to successfully manage inventory levels and product mix across our multiple distribution centers and our stores;

 

·                  changes in personnel;

 

·                  the expansion by competitors into geographic markets in which they have not historically had a strong presence;

 

·                  fluctuations in the amount of consumer spending; and

 

·                  the amount and timing of operating costs and capital expenditures relating to the growth of the business and our ability to uniformly capture such costs.

 

·                  the timing of certain holidays, such as Easter and Halloween.

 

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Impairment of our goodwill or our intangible assets could negatively impact our net income and stockholders’ equity

 

A substantial portion of our total assets consists of goodwill and intangible assets. Goodwill and certain intangible assets are not amortized, but are tested for impairment at least annually and between annual tests if events or circumstances indicate that it is more likely than not that the fair value of our net assets is less than its carrying amount. Testing for impairment involves an estimation of the fair value of our net assets and other factors and involves a high degree of judgment and subjectivity. There are numerous risks that may cause the fair value of our net assets to fall below its carrying amount, including those described elsewhere in this Report. If we have an impairment of our goodwill or intangible assets, the amount of any impairment could be significant and could negatively impact our net income and stockholders’ equity for the period in which the impairment charge is recorded.

 

Risks Related to Our Substantial Indebtedness

 

We have substantial indebtedness and lease obligations, which could affect our ability to meet our obligations under our indebtedness and may otherwise restrict our activities

 

Our total indebtedness, as of January 31, 2014, was $855.4 million, consisting of borrowings under our First Lien Term Facility of $605.4 million and $250 million of Senior Notes. We have an additional $175 million of available borrowings under our ABL Facility and, subject to certain limitations and the satisfaction of certain conditions, we are also permitted to incur up to an aggregate of $100 million of additional borrowings under incremental facilities in our ABL Facility and First Lien Term Facility.

 

We also have, and will continue to have, significant lease obligations. As of January 31, 2014, our minimum annual rental obligations under long-term operating leases for fiscal 2015 are $59.7 million.

 

Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under the Senior Notes and our Credit Facilities. Our substantial indebtedness could have important consequences, including:

 

·                  increasing our vulnerability to adverse economic, industry or competitive developments;

 

·                  requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

 

·                  exposing us to the risk of increased interest rates because certain of our borrowings, including borrowings under our Credit Facilities, are at variable rates of interest;

 

·                  making it more difficult for us to satisfy our obligations with respect to our indebtedness, including the Senior Notes, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants and borrowing conditions, could result in an event of default under the Indenture and the agreements governing such other indebtedness;

 

·                  restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;

 

·                  imposing restrictions on the operation of our business that may hinder our ability to take advantage of strategic opportunities or to grow our business;

 

·                  limiting our ability to obtain additional financing for working capital, capital expenditures (including real estate acquisitions and store expansion), debt service requirements and general corporate or other purposes, which could be exacerbated by further volatility in the credit markets; and

 

·                  limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to any of our competitors who are less leveraged and who therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting.

 

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We and our subsidiaries are still able to incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial indebtedness

 

We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The indenture governing the Senior Notes and our Credit Facilities each contain restrictions on the incurrence of additional indebtedness. However, these restrictions are subject to a number of significant qualifications and exceptions, and under certain circumstances, the amount of indebtedness that could be incurred in compliance with these restrictions could be substantial. Accordingly, we and our subsidiaries may be able to incur substantial additional indebtedness in the future. We have an additional $175 million of available borrowings under our ABL Facility. Subject to certain limitations and the satisfaction of certain conditions, we are also permitted to incur up to an aggregate of $100 million of additional borrowings under incremental facilities in our ABL Facility and First Lien Term Facility. If new debt is added to our and our subsidiaries’ current debt levels, the risks that we now face as a result of our leverage would intensify and could have a negative impact on our credit rating.

 

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful

 

Our ability to make scheduled payments on or to refinance our debt obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal of, and premium, if any, and additional interest, if any, on, our indebtedness, including the Senior Notes.

 

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness, including the Senior Notes. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of the indentures governing the Senior Notes and our Credit Facilities or any future debt instruments that we may enter into may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

 

Our debt agreements contain restrictions that limit our flexibility in operating our business

 

Our Credit Facilities and the Indenture contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our Parent’s (solely with respect to our Credit Facilities) and our restricted subsidiaries’ ability to, among other things:

 

·                  incur additional indebtedness or issue certain preferred shares;

 

·                  pay dividends on, repurchase or make distributions in respect of our capital stock or make other restricted payments;

 

·                  make certain investments;

 

·                  transfer or sell certain assets;

 

·                  create or incur liens;

 

·                  consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

·                  enter into certain transactions with our affiliates.

 

A breach of any of these covenants could result in a default under one or more of these agreements, including as a result of cross default provisions, and, in the case of our Credit Facilities, permit the lenders to cease making loans to us. Upon the occurrence of an event of default under our Credit Facilities, the lenders could elect to declare all amounts outstanding under our Credit Facilities to be immediately due and payable and terminate all commitments to extend further credit under the ABL Facility. Such actions by those lenders could cause cross defaults under our other indebtedness. If we were unable to repay those amounts, the lenders under our Credit Facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of our assets as collateral under our Credit Facilities. If the lenders under our Credit Facilities accelerate the repayment of borrowings, we may not have sufficient assets to repay our Credit Facilities as well as our other indebtedness, including the Senior Notes.

 

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Item 6. Selected Financial Data

 

The selected consolidated financial data presented below as of January 31, 2014 (Successor) and March 30, 2013 (Successor) and for the ten months ended January 31, 2014 (Successor), for the year ended March 30, 2013 (Successor), the periods January 15, 2012 to March 31, 2012 (Successor), and April 3, 2011 to January 14, 2012 (Predecessor), have been derived from our Consolidated Financial Statements and notes thereto included in this Report. The selected consolidated financial data as of March 31, 2012, April 2, 2011 and March 27, 2010 (Predecessor), and for the years ended April 2, 2011 (Predecessor) and March 27, 2010 (Predecessor) have been derived from our audited consolidated financial statements which are not included in this Report.

 

The Successor period for the ten months ended January 31, 2014 is comprised of 44 weeks.  The Successor fiscal year ended March 30, 2013 is comprised of 52 weeks. The Successor period January 15, 2012 to March 31, 2012 contains 11 weeks.  The Predecessor period April 3, 2012 to January 14, 2012 contains 41 weeks. The Predecessor fiscal year ended on April 2, 2011 is comprised of 53 weeks while the Predecessor fiscal year ended March 27, 2010 is comprised of 52 weeks.

 

The Merger was accounted for as a business combination whereby the purchase price paid to effect the Merger was allocated to recognize the acquired assets and liabilities at fair value.  In connection with the Merger, we incurred significant indebtedness.  Subsequent to the Merger, interest expense and non-cash depreciation and amortization charges have significantly increased. The historical results presented below are not necessarily indicative of the results to be expected for any future period.  The information should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and notes thereto included in this Report.

 

		Ten Months Ended			Year Ended			For the Periods							Years Ended
		January 31,  2014			March 30, 2013			January 15, 2012 to March 31, 2012				April 3, 2011 to January 14, 2012			April 2,  2011			March 27, 2010
		(Successor)			(Successor)			(Successor)				(Predecessor)			(Predecessor)			(Predecessor)
		(Amounts in thousands, except operating data)
Statements of Income Data:
Net Sales:
99¢ Only Stores		$	1,486,699		$	1,620,683		$	329,361			$	1,158,733		$	1,380,357		$	1,314,214
Bargain Wholesale		42,044			47,968			9,555				34,047			43,521			40,956
Total sales		1,528,743			1,668,651			338,916				1,192,780			1,423,878			1,355,170
Cost of sales (excluding depreciation and amortization expense as shown separately below)		946,048			1,028,295			203,775				711,002			842,756			797,748
Gross profit		582,695			640,356			135,141				481,778			581,122			557,422
Selling, general and administrative expenses:
Operating expenses		514,511			523,495			110,477				376,122			436,034			436,608
Depreciation		52,467			56,810			11,361				21,855			27,587			27,381
Amortization of intangible assets		1,500			1,767			374				14			18			17
Total operating expenses		568,478			582,072			122,212				397,991			463,639			464,006
Operating income		14,217			58,284			12,929				83,787			117,483			93,416
Other expense (income), net		55,195			77,282			16,119				340			(741		)	(135		)
(Loss) income before provision for income taxes		(40,978		)	(18,998		)	(3,190		)		83,447			118,224			93,551
(Benefit) provision for income taxes		(28,493		)	(10,089		)	2,103				33,699			43,916			33,104
Net (loss) income		$	(12,485	)	$	(8,909	)	$	(5,293	)		$	49,748		$	74,308		$	60,447
Company Operating Data:
Sales Growth:
99¢ Only Stores		N/A			8.9		%	N/A				N/A			5.0		%	4.1		%
Bargain Wholesale		N/A			10.0		%	N/A				N/A			6.3		%	0.3		%
Total sales		N/A			8.9		%	N/A				N/A			5.1		%	4.0		%
Gross margin		38.1		%	38.4		%	39.9		%		40.4		%	40.8		%	41.1		%
Operating margin		0.9		%	3.5		%	3.8		%		7.0		%	8.3		%	6.9		%
Net (loss) income		(0.8		)%	(0.5		)%	(1.6		)%		4.2		%	5.2		%	4.5		%

 

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		January 31, 2014			March 30,  2013			March 31, 2012				April 2, 2011			March 27, 2010
		(Successor)			(Successor)			(Successor)				(Predecessor)			(Predecessor)
		(Amounts in thousands, except operating data)
Retail Operating Data (a) :
99¢ Only Stores at end of period		343			316			298				285			275
Change in comparable stores net sales (b)		3.7		%	4.3		%	N/A				0.7		%	3.9		%
Average net sales per store open the full year		$	5,446		$	5,327		N/A				$	4,874		$	4,848
Average net sales per estimated saleable square foot (c)		$	330		$	321		N/A				$	291		$	289
Estimated saleable square footage at year end		5,607,991			5,211,483			4,948,344				4,758,432			4,606,728
Balance Sheet Data:
Working capital		$	96,326		$	152,362		$	153,541			$	323,314		$	263,905
Total assets		$	1,770,234		$	1,757,237		$	1,768,041			$	824,215		$	745,986
Capital lease obligation, including current portion		$	285		$	354		$	431			$	448		$	519
Long-term debt, including current portion		$	855,390		$	758,325		$	763,601			$	—		$	—
Total member’s/shareholders’ equity		$	499,087		$	638,970		$	630,767			$	681,549		$	600,422

 

(a)         Includes retail operating data solely for our 99¢ Only Stores. For comparability purposes, average net sales per store and average net sales per estimated saleable square foot are based on a trailing 52-week period for all periods presented. Comparable stores net sales is based on a comparable 52-week period for all periods presented, except for the ten months ended January 31, 2014, which is based on a comparable 43-week period of the prior year.

(b)         Change in comparable stores net sales compares net sales for all stores open at least 15 months.

(c)          Computed based upon estimated total saleable square footage of stores open for at least 12 months.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in connection with “Item 6. Selected Financial Data” and “Item 8. Financial Statements and Supplementary Data” of this Report.

 

Overview

 

On December 16, 2013, the board of directors of our sole member, Parent, approved a resolution changing the end of our fiscal year. Prior to the change, our fiscal year ended on the Saturday closest to the last day of March.  Our new fiscal year end is the Friday closest to the last day of January, with each successive quarterly period ending the Friday closest to the last day of April, July, October or January, as applicable.  As a result of this change, our fiscal year 2014 consisted of 44 weeks and transition fiscal 2014 and the fourth interim period of transition fiscal 2014 ended on January 31, 2014.

 

On January 13, 2012, we merged with Number Merger Sub, Inc. and became a subsidiary of Parent. See Item 1, “Business—Merger” for more information about the Merger.  As a result of the Merger, we have prepared separate discussion and analysis of our consolidated operating results, financial condition and liquidity for the “Predecessor” and “Successor” periods relating to the periods preceding and succeeding the Merger, respectively.  Fiscal 2013 began on April 1, 2012 and ended on March 30, 2013 and consisted of 52 weeks.  Fiscal 2012 is presented as a Successor period from January 15, 2012 to March 31, 2012 consisting of 11 weeks and a Predecessor period from April 3, 2011 to January 14, 2012 consisting of 41 weeks, for a total of 52 weeks.  Fiscal 2015 will consist of 52 weeks beginning February 1, 2014 and ending January 30, 2015.  For comparability purposes, same-store sales for transition fiscal 2014 are based on the 43-week period ended January 25, 2014 as compared to the 43-week period ended January 26, 2013.  Annual same-store sales for all other periods presented are based on the comparable 52-week period.  For comparability purposes, average annual sales per store and annual sales per estimated saleable square foot calculations included in this Report are based on trailing 52-week period, ended January 25, 2014 for transition fiscal 2014, ended on  March 30, 2013 for fiscal 2013 and ended on March 31, 2012 for fiscal 2012.

 

In accordance with GAAP, we are required to separately present our results for the Predecessor and Successor periods.  We have also prepared supplemental unaudited discussion and analysis of the combined Predecessor and Successor periods, on a pro forma basis (“pro forma fiscal year 2012”).  Management believes that reviewing our results on a pro forma basis is important in identifying trends or reaching conclusions regarding our overall performance.  The unaudited pro forma fiscal year 2012 financial data is for informational purposes only and should be read in conjunction with our historical financial data appearing throughout this Report.

 

During transition fiscal 2014, we had net sales of $1,528.7 million, operating income of $14.2 million and net loss of $12.5 million.  Same-store sales in transition fiscal 2014 increased by 3.7%.  Average sales per store open at least 12 months, on a trailing 52-week period, increased to $5.4 million in transition fiscal 2014 from $5.3 million in fiscal 2013.  Average net sales per estimated saleable square foot (computed for stores open at least 12 months) on a trailing 52-week period increased to $330 per square foot for transition fiscal 2014 from $321 per square foot for fiscal 2013. Existing stores at January 31, 2014 averaged approximately 21,000 gross square feet.

 

In transition fiscal 2014, we continued to expand our store base by opening 27 net new stores. Of these newly opened stores, 13 stores are located in California, two in Nevada, five in Arizona, and seven in Texas.  In fiscal 2015, we currently intend to increase our store count by approximately 30 to 35 stores, all of which are expected to be opened in our existing markets. We believe that our near term growth in fiscal 2015 will primarily result from new store openings in our existing territories and increases in same-store sales.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements requires management to make estimates and assumptions that affect reported earnings. These estimates and assumptions are evaluated on an on-going basis and are based on historical experience and other factors that management believes are reasonable. Estimates and assumptions include, but are not limited to, the areas of inventories, long-lived asset impairment, goodwill and other intangibles, legal reserves, self-insurance reserves, leases, taxes and share-based compensation.

 

We believe that the following items represent the areas where more critical estimates and assumptions are used in the preparation of our financial statements:

 

Inventory valuation.  Inventories are valued at the lower of cost or market. Inventory costs are established using a methodology that approximates first in, first out, which for store inventories is based on a retail inventory method.  Valuation allowances for shrinkage, as well as excess and obsolete inventory are also recorded. 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 our retail stores at least once a year by an outside inventory service company.  We perform inventory cycle counts at our warehouses throughout the year.  We also perform inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory.  The valuation allowances for excess and obsolete inventory are based on the age of the inventory, sales trends and future merchandising plans.  The valuation allowances for excess and obsolete inventory in many locations (including various warehouses, store backrooms, and sales floors of our 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.

 

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In the fourth quarter of fiscal 2013, we revised our inventory merchandising and liquidation philosophies to significantly reduce and liquidate slow moving inventories prospectively as directed by the current management team.  As a result of this change, we recorded a charge to cost of sales and a corresponding reduction in inventory of approximately $9.1 million in the fourth quarter of fiscal 2013. This is a prospective change and did not have an effect on prior periods.

 

At the end of the third quarter of transition fiscal 2014, based on new merchandising plans, we increased our valuation allowances for excess and obsolete inventory.  The Company recorded a charge to cost of sales and a corresponding reduction in inventory of approximately $9.6 million.  This is a prospective change and did not have an effect on prior periods.

 

Considerable management judgment is necessary to estimate these inventory valuation reserves. As an indicator of the sensitivity of this estimate, a 10% increase in our estimates of expected losses from shrinkage and the excess and obsolete inventory provision at January 31, 2014, would have increased these reserves by approximately $1.8 million and $2.0 million, respectively, and increased pre-tax loss in transition fiscal 2014 by the same amounts.

 

In order to obtain inventory at attractive prices, we take advantage of large volume purchases, closeouts and other similar purchase opportunities. Consequently, our inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities.  Our inventory was $206.2 million as of January 31, 2014 and $201.6 million as of March 30, 2013.

 

Long-lived asset impairment.  We assess 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 we consider important which could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner we use of the acquired assets or the strategy for our overall business; and (3) significant changes in our business strategies and/or negative industry or economic trends. On a quarterly basis, we assess whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable. Considerable management judgment is necessary to estimate projected future operating cash flows.  Accordingly, if actual results fall short of such estimates, significant future impairments could result.  During transition fiscal 2014, we did not record any long-lived asset impairment charges.  During fiscal 2013, we wrote down the carrying value of a held for sale property to estimated net realizable value, net of expected disposal costs, and accordingly recorded an asset impairment charge of $0.5 million.  During the Successor and Predecessor periods of fiscal 2012, we did not record any long-lived asset impairment charges.  We have not made any material changes to our long-lived asset impairment methodology during transition fiscal 2014.

 

Goodwill and other intangible assets.  The Merger was accounted for as a purchase business combination, whereby the purchase price paid was allocated to recognize the acquired assets and liabilities at their fair value. In connection with the purchase price allocation, certain intangible assets were established or revalued. The purchase price in excess of the fair value of assets and liabilities was recorded as goodwill.

 

Indefinite-lived intangible assets, such as the 99¢ trademark and goodwill, are not subject to amortization. We assess the recoverability of indefinite-lived intangibles whenever there are indicators of impairment, or at least annually in the fourth quarter. If the recorded carrying value of an intangible asset exceeds our estimated fair value, we record a charge to write the intangible asset down to its fair value.

 

Intangible assets with a definite life are amortized on a straight line basis over their useful lives. Amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on undiscounted cash flows, and, if impaired, written down to fair value based on either discounted cash flows or appraised values.  Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows used in the impairment tests.

 

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During the fourth interim period of transition fiscal 2014, we completed step one of our goodwill impairment test for the two reporting units and determined that there was no impairment of goodwill since the fair value of the reporting units exceeded the carrying amount.  Additionally, during the fourth interim period of transition fiscal 2014, we completed our annual indefinite-lived intangible asset impairment test and determined there was no impairment since the fair value of the 99¢ trademark exceeded the carrying amount of the trademark. Considerable management judgment is necessary in estimating future cash flows, market interest rates, discount rates and other factors affecting the valuation of goodwill and intangibles.  We use historical financial information, internal plans and projections, and industry information in making such estimates.  However, because the new basis of accounting established at the Merger date set the book values of goodwill and intangibles equal to fair value and impairment tests are highly sensitive to changes in assumptions, minor changes to assumptions, including assumptions regarding future performance (including sales growth, pricing and commodity costs) and discount rates, could result in impairment losses. In our transition fiscal 2014 impairment test, both our retail reporting unit and our wholesale reporting unit had excess fair value over the book value of net assets that was substantial. Our 99¢ trademark fair value also exceeded the book value in transition fiscal 2014.

 

Legal reserves.  We are subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of business.  A number of these lawsuits, proceedings and claims may exist at any given time.  While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business are expected to have a material adverse effect on our financial position, results of operations, or overall liquidity. Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our reports pursuant to the Securities Exchange Act of 1934, as amended.  We record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.

 

There were no material changes in the estimates or assumptions used to determine legal reserves during transition fiscal 2014 and a 10% change in legal reserves would not be material to our consolidated financial position or results of operations.

 

Self-insured workers’ compensation liability.  We self-insure for workers’ compensation claims in California and Texas. We have established a liability for losses from both estimated known and incurred but not reported insurance claims based on reported claims and actuarial valuations of estimated future costs of known and incurred but not yet reported claims. Should an amount of claims greater than anticipated occur, the liability recorded may not be sufficient and additional workers’ compensation costs, which may be significant, could be incurred. We do not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing our workers’ compensation liability.  As a result of the increase in severity of open claims, we significantly increased our workers’ compensation liability reserves in transition fiscal 2014. As an indicator of the sensitivity of this estimate, at January 31, 2014, a 10% increase in our estimate of expected losses from workers compensation claims would have increased this reserve by approximately $7.4 million and increased transition fiscal 2014 pre-tax loss by the same amount.

 

Self-insured health insurance liability.  During the second quarter of fiscal 2012 ended October 1, 2011, we began self-insuring for a portion of our employee medical benefit claims.  The liability for the self-funded portion of our health insurance program is determined actuarially, based on claims filed and an estimate of claims incurred but not yet reported. We maintain stop loss insurance coverage to limit our exposure for the self-funded portion of our health insurance program.  At January 31, 2014, a 10% change in self-insurance liability would not have been material to our consolidated financial position or results of operations.

 

Operating leases.  We recognize rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred tenant improvements. Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.

 

For store closures where a lease obligation still exists, we record the estimated future liability associated with the rental obligation on the cease use date (when the store is closed).  Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs. Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimation of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from our estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.

 

As of March 31, 2013, we had an accrual of $0.7 million for lease termination costs associated with Texas store closures. During the first quarter of transition fiscal 2014, we reversed the lease termination costs accrual, and as of January 31, 2014, we did not have any remaining lease obligations in connection with prior Texas store closures.

 

Tax Valuation Allowances and Contingencies.  We recognize deferred tax assets and liabilities using the enacted tax rates for the effect of temporary differences between the financial reporting basis and tax basis of recorded assets and liabilities.  Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. We had approximately $124.6 million of net deferred tax liabilities as of January 31, 2014, which was comprised of approximately $102.4 million of net deferred tax assets and $227.0 million of deferred tax liabilities.  We had approximately $153.7 million of net deferred tax liabilities as of March 30, 2013, which was comprised of approximately $83.7 million of net deferred tax assets and $237.4 million of deferred tax liabilities, net of tax valuation allowance of $11.6 million.  Management evaluated the available evidence in assessing our ability to realize the benefits of our deferred tax assets at January 31, 2014 and concluded it is more likely than not that we will realize all of our deferred tax assets.  Significant management judgment is required in accounting for income tax contingencies as the outcomes are often difficult to predict.  There are no uncertain tax positions at January 31, 2014.

 

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Share-Based Compensation.  Subsequent to the Merger, Parent issued options to acquire shares of common stock of our Parent to certain of our executive officers and employees. We account for stock-based payment awards based on their fair values.  Stock options have a term of ten years.  For awards classified as equity, we estimate the fair value for each option award as of the date of grant using the Black-Scholes option pricing model or other appropriate valuation models.  Assumptions utilized to value options in transition fiscal 2014, fiscal 2013 and Successor fiscal 2012 periods include estimating the fair value of Parent’s common stock (which is not publicly traded), the term that the options are expected to be outstanding, an estimate of the volatility of Parent’s stock price (which is based on a peer group of publicly traded companies), applicable interest rates and the expected dividend yield of Parent’s common stock. Other factors involving judgments that affect the expensing of share-based payments include estimated forfeiture rates of stock-based awards.  All of the options that we have granted to our executive officers and employees (with the exception of options granted to Rollover Investors that contained no repurchase rights and options granted to our current chief executive officer and certain directors that contain less restrictive repurchase rights) give the Parent repurchase rights as described in more detail in Note 12 to the Consolidated Financial Statements. In accordance with accounting guidance, we have not recorded any stock-based compensation expense for these grants.  For all other time-based options, the value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods, which is generally a vesting term of five years.  As described in more detail in Note 12 to the Consolidated Financial Statements, certain former executive put rights that were previously outstanding were classified as equity awards and revalued using a binomial model at each reporting period with changes in fair value recognized as stock-based compensation expense.  As further described in Note 12 to the Consolidated Financial Statements, we have also granted options to our current chief executive officer that will vest only upon achievement of certain performance hurdles.  These options were valued using a Monte Carlo simulation method.  Compensation expense associated with these options will not be recognized until it is probable that the performance hurdles will be achieved.

 

Predecessor Periods

 

We recognized stock-based compensation expense ratably over the requisite service periods, which was generally a vesting term of three years.  Such stock options typically had a term of ten years and were valued using the Black-Scholes option pricing model.  The fair value of the performance stock units (“PSUs”) and restricted stock units (“RSUs”) was based on the stock price on the grant date.  The compensation expense related to PSUs was recognized only when it was probable that the performance criteria would be met.  The compensation expense related to RSUs was recognized based on the number of shares expected to vest.  Stock-based awards outstanding prior to the Merger vested in full in connection with the Merger and were converted into a right to receive Merger Consideration.

 

Results of Operations

 

The following discussion defines the components of the statement of income and should be read in conjunction with “Item 6. Selected Financial Data.”

 

Net Sales:  Revenue is recognized at the point of sale in our stores (“retail sales”). Bargain Wholesale sales revenue is recognized in accordance with the shipping terms agreed upon on the purchase order.  Bargain Wholesale sales are typically recognized free on board origin, where title and risk of loss pass to the buyer when the merchandise leaves our distribution facility.

 

Cost of Sales:  Cost of sales includes the cost of inventory, freight in, inter-state warehouse transportation costs and inventory shrinkage (obsolescence, spoilage, and shrink), 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 addition, we analyze our inventory levels and related cash discounts received to arrive at a value for cash discounts to be included in the inventory balance.  We do not include purchasing, receiving, distribution, warehouse costs and transportation to and from stores in our cost of sales, which totaled $77.4 million, $77.5 million, $15.6 million and $56.0 million for transition fiscal 2014, fiscal 2013, 2012 Successor period and 2012 Predecessor period, respectively.  Due to this classification, our gross profit rates may not be comparable to those of other retailers that include costs related to their distribution network in cost of sales.

 

Selling, General, and Administrative 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, stock-based compensation expense and other corporate administrative costs).  Selling, general, and administrative expenses also include depreciation and amortization expense.

 

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Other Expense (Income):  Other expense (income) relates primarily to loss on extinguishment of debt, interest expense on our debt, capitalized leases and the impairment charges related to our marketable securities, net of interest income on our marketable securities.

 

The following table sets forth for the periods indicated, certain selected income statement data, including such data as a percentage of net sales.  The ten months ended January 31, 2014 consists of 44 weeks.  The year ended March 30, 2013 consists of 52 weeks.  The Successor period from January 15, 2012 to March 31, 2012 consists of 11 weeks while the Predecessor period from April 3, 2011 to January 14, 2012 consists of 41 weeks.(the percentages may not add up due to rounding):

 

		Ten Months Ended					Year Ended					For the Periods
		January 31, 2014			% of Net Sales		March 30, 2013			% of Net Sales		January 15, 2012 to  March 31, 2012			% of Net Sales			April 3, 2011 to January 14, 2012			% of Net Sales
		(Successor)					(Successor)					(Predecessor)						(Predecessor)
		(Amounts in thousands, except percentages)
Net Sales:
99¢ Only Stores		$	1,486,699		97.2	%	$	1,620,683		97.1	%	$	329,361		97.2	%		$	1,158,733		97.1	%
Bargain Wholesale		42,044			2.8		47,968			2.9		9,555			2.8			34,047			2.9
Total sales		1,528,743			100.0		1,668,651			100.0		338,916			100.0			1,192,780			100.0
Cost of sales (excluding depreciation and amortization expense shown separately below)		946,048			61.9		1,028,295			61.6		203,775			60.1			711,002			59.6
Gross profit		582,695			38.1		640,356			38.4		135,141			39.9			481,778			40.4
Selling, general and administrative expenses:
Operating expenses		514,511			33.7		523,495			31.4		110,477			32.6			376,122			31.5
Depreciation		52,467			3.4		56,810			3.4		11,361			3.4			21,855			1.8
Amortization of intangible assets		1,500			0.1		1,767			0.1		374			0.1			14			0.0
Total selling, general and administrative expenses		568,478			37.2		582,072			34.9		122,212			36.1			397,991			33.4
Operating income		14,217			0.9		58,284			3.5		12,929			3.8			83,787			7.0
Other (income) expense:
Interest income		(16		)	0.0		(342		)	0.0		(29		)	0.0			(291		)	0.0
Interest expense		50,820			3.3		60,898			3.6		16,223			4.8			381			0.0
Other-than-temporary investment impairment due to credit loss		—			0.0		—			0.0		—			0.0			357			0.0
Loss on extinguishment of debt		4,391			0.3		16,346			1.0		—			0.0			—			0.0
Other		—			0.0		380			0.0		(75		)	0.0			(107		)	0.0
Other expenses, net		55,195			3.6		77,282			4.6		16,119			4.8			340			0.0
(Loss) income before provision for income taxes		(40,978		)	(2.7	)	(18,998		)	(1.1	)	(3,190		)	(0.9	)		83,447			7.0
(Benefit) provision for income taxes		(28,493		)	(1.9	)	(10,089		)	(0.6	)	2,103			0.6			33,699			2.8
Net (loss) income		$	(12,485	)	(0.8	)	$	(8,909	)	(0.5	)%	$	(5,293	)	(1.6	)%		$	49,748		4.2	%

 

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